Garrison v. Comm'r of Internal Revenue

• Decision Date: 15 May 1969
• Docket Number: Docket No. 5405-67.
• Citation: 52 T.C. 281
• Parties: JOSEPH GARRISON AND IDA GARRISON, PETITIONERS v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT
• Court: U.S. Tax Court

52 T.C. 281

JOSEPH GARRISON AND IDA GARRISON, PETITIONERS

v.COMMISSIONER OF INTERNAL REVENUE, RESPONDENT

Docket No. 5405-67.

Tax Court of the United States.

Filed May 15, 1969.

Nathan D. Rollins, for the petitioners.

Harvey N. Shapiro, for the respondent.

Petitioner Joseph Garrison was the principal stockholder-officer-employee of a corporation and received a purported $40,000 bonus for his services. The bonus was authorized and paid after the corporation had determined to liquidate, ceased doing business, and sold its operating assets. On audit of the corporation's return, respondent disallowed (15,000 of the bonus as excessive compensation and the corporation conceded the disallowance. Held, on the particular facts, the $15,000 constituted a distribution in complete liquidation in respect of petitioner's stock within the meaning of sec. 331(a), I.R.C. 1954. TANNENWALD, Judge:

Respondent determined a deficiency in petitioners' income tax for the year 1964 in the amount of $,474.82. The sole issue for our determination is whether $15,000 of a bonus paid by Garrison Produce Co. to petitioner Joseph M. Garrison, which was admittedly excessive compensation, is taxable as compensation or as a liquidating distribution. Certain other adjustments on which the parties have reached agreement will be reflected in the Rule 50 computation.

FINDINGS OF FACT

All of the facts are stipulated and are found accordingly.

Petitioners (hereinafter referred to individually as Joseph or Ida) are husband and wife, who had their legal residence in University Heights, Ohio, at the time of filing the petition herein. They filed an initial and an amended joint Federal income tax return for the taxable year 1964 with the district director of internal revenue, Cleveland, Ohio.

Joseph and one Joseph Fisher formed a partnership known as Garrison Produce Co. (hereinafter referred to as Produce, paper bag, and packaging business. They formed a corporation of the same name in 1951, which issued 75 shares of stock to each of the former partners in exchange for the net assets of the partnership.

In 1953, Joseph Fisher retired from the business, and thereafter the 150 outstanding Produce shares were held as follows: Joseph, 115 shares; Ida, 30 shares; and Murray B. Garrison (hereinafter Murray), petitioners' son, 5 shares. Joseph continued as president and general manager; Ida became a director and was elected secretary and treasurer but took no active part in the business and received no salary; Murray became a director and vice president and participated in the daily operation of the business.

Throughout its existence, Produce engaged in the candling and processing of eggs and, at the height of its operations, employed 30 to 35 persons. Joseph's compensation, which consisted of a fixed salary plus a bonus of 2 percent of annual sales, increased periodically, although prior to 1963 he never received the full bonus. Produce's sales for the year 1963 were $1,864,521.23.

On October 26, 1963, Produce adopted a plan to liquidate within 12 months. It ceased business on November 1, 1963, and all of its operating assets were sold in that month. Notice of the plan of liquidation was filed with the Internal Revenue Service on November 20, 1963.

For the year 1963, Joseph received a salary of $15,000 and Murray received a salary of $11,600. Bonuses were voted for Joseph and Murray in the amounts of $40,000 and $22,000, respectively, for the year 1963 at the annual shareholders meeting on January 27, 1964. These were not paid until March 9, 1964, when Joseph received $40,000 and Murray only $20,000. The liquidation of Produce was completed on July 31, 1964, when Joseph received $36,685 in cash and property, Ida, $9,570, and Murray, $1,595, for a total of $47,850, or $319 per share. Petitioners' basis in their 145 shares of Produce stock was $28,000.

For Federal income tax purposes, petitioners reported the $40,000 payment as compensation received in 1964 and Produce deducted the bonus as accrued compensation for the year 1963.

Upon audit of Produce's 1963 tax return, Produce and respondent agreed that $15,000 of the amount received by Joseph and $11,600 of the amount received by Murray as bonuses constituted excessive compensation and were accordingly not deductible.

Petitioners thereafter amended their 1964 income tax return and filed a claim for refund, characterizing the $15,000 of concededly excessive compensation as a ‘liquidating dividend,‘ and therefore taxable as capital gain.¹

ULTIMATE FINDING OF FACT

The $15,000 disallowed as a deduction to Produce was a distribution in liquidation to Joseph.

OPINION

This case presents the question whether a purported compensatory bonus payment to the principal stockholder-officer-employee of a closely held corporation in liquidation, which the respondent and the corporation subsequently agreed was excessive in part, may be treated as a distribution in liquidation and therefore entitled to capital gains treatment under section 331(a)(1). ² The precise issue herein has not been previously litigated.

Petitioner Joseph Garrison was the principal stockholder, officer, and employee of Produce. By the taxable year involved, Produce had ceased doing business and was being completely liquidated. In the course of that liquidation, Joseph was voted and was paid the sum of $40,000 as ‘a bonus for services * * * which shall include the 2% of sales due him.’ Produce deducted that amount as compensation paid. Upon the subsequent audit of the corporation's Federal income tax return, it was agreed that $15,000 of that amount was excessive and a corresponding deduction was disallowed. Petitioners now contend that, as a result of such disallowance, the $15,000 should be considered as having been received by Joseph as a distribution in liquidation of his stock interest in Produce. Respondent contends that the disallowance did no more than indicate that the $15,000 was not ‘a reasonable allowance for * * * compensation for personal services' under section 162(a)(1) and that, against the factual background of this case, the amount should be treated as the parties originally characterized it and not as a distribution in liquidation.

Initially, petitioners assert that, by reason of the prior disallowance, respondent is estopped from claiming that the excessive payment did not constitute a liquidating distribution. We find this contention to be without merit. In the instant case, different parties are involved and respondent's determination has not been the subject either of prior litigation or of a binding agreement to which the corporation or petitioners were parties. Under these circumstances, the doctrine of equitable estoppel— which, in any event, has found scant acceptance in the field of taxation— is inapplicable. Guenzel's Estate v. Commissioner 258 F.2d 248 (C.A. 8, 1958), affirming 28 T.C. 59 (1957); Powers Photo Engraving Co. v. Commissioner, 197 F.2d 704 (C.A. 2, 1952), affirming per curiam as to this issue 17 T.C. 393 (1951); Smale & Robinson, Inc. v. United States, 123 F.Supp. 457 (S.D. Cal. 1954); William Fleming, 3 T.C. 974, 984 (1944), affd. 155 F.2d 204 (C.A. 5, 1946). Compare Automobile Club v. Commissioner, 353 U.S. 180 (1957). Accordingly, we turn to a determination of the substantive issue confronting us.

Various unsuccessful attempts have been made to characterize amounts disallowed as excessive compensation as nontaxable receipts in the hands of the recipients. Thus, such amounts have been refused the status of gifts. Lengsfield v. Commissioner, 241 F.2d 508 (C.A. 5, 1957); Smith v. Manning, 189 F.2d 345 (C.A. 3, 1951); Stanley B. Wood, 6 T.C. 930 (1946). Similarly, such payments have not been considered repayments of loans. D. J. Jorden, 11 T.C. 914 (1948). Likewise, an attempt to classify such a payment by one subsidiary corporation to a second subsidiary corporation as a constructive dividend to the parent and a contribution to capital of the second subsidiary has also failed. Sterno Sales Corporation v. United States, 345 F.2d 552 (Ct. Cl. 1965); cf. Zeunen Corporation v. United States, 227 F.Supp. 952 (E.D. Mich. 1964).³

A careful reading of these cases reveals that excessive compensation does not, as a matter of law, retain that characterization for tax purposes in the hands of the recipient. Nor must it necessarily be considered something other than compensation. Neither the label initially affixed by the taxpayer nor the failure of the respondent to provide an alternative label for the disallowed payment is conclusive.⁴ The touchstone for decision is a factual determination as to the actual nature of the payment in question under all the circumstances, free from any compulsory inhibitions stemming from the designations of the parties. As the Court of Appeals stated in Lengsfield v. Commissioner, supra:

Whether or not a corporate distribution is a dividend or something else, such as a gift, compensation for services, repayment of a loan, interest on a loan, or payment for property purchased, presents a question of fact to be determined in each case. * * * (See 241 F.2d at 510.)

Respondent's regulations recognize the factual foundation for such a determination in the case of distributions by an ongoing corporation. Secs. 1.162-7(b)(1) and 1.162-8, Income Tax Regs.⁵ We perceive no valid reason for not applying the rationale of those regulations in a situation involving the liquidation of a corporation. Cf. Robert Gage Coal Co., 2 T.C. 488, 500-502 (1943); Jas J. Gravely, 44 B.T.A. 722, 728 (1941). The standard to be applied is not unlike the ‘net effect’ test employed in determining whether distributions are essentially equivalent to a dividend. Cf. e.g., Woodworth v. Commissioner, 218 F.2d 719 (C.A. 6, 1955), affirming a Memorandum Opinion of this Court; Flanagan v. Helvering, 116 F.2d 937 (C.A.D.C. 1940), affirming a Memorandum Opinion of this Court; see Levin v. Commissioner, 385...