GILMAN PAPER COMPANY v. CIR
| Decision Date | 13 December 1960 |
| Docket Number | No. 91,Docket 26303.,91 |
| Parties | GILMAN PAPER COMPANY, Petitioner, v. COMMISSIONER OF INTERNAL REVENUE, Respondent. |
| Court | U.S. Court of Appeals — Second Circuit |
Frederick Bernays Wiener, Washington, D. C. (Joseph F. Klein, Myron A. Finke and Saul Gordon, New York City, on the brief), for petitioner.
Kenneth E. Levin, Dept. of Justice, Washington, D. C. (Charles K. Rice, Asst. Atty. Gen., Lee A. Jackson and Melva M. Graney, Dept. of Justice, Washington, D. C., on the brief), for respondent.
Before LUMBARD, Chief Judge, and WATERMAN and MOORE, Circuit Judges.
The Gilman Paper Company appeals from a decision of the Tax Court upholding an asserted income tax deficiency for the calendar year 1951. In determining its income tax for that year petitioner deducted $250,000 as salary paid to its president, Charles Gilman. The Commissioner disallowed any deduction in excess of $110,000 on the ground that it was not a reasonable allowance for personal services actually rendered.
In 1940 the common stock of Gilman Paper Company was wholly owned by members of the Gilman family. Isaac Gilman (the father) held 64%; Charles Gilman (the son) held 20%; four daughters each held 4%. In that year an agreement was entered into between the corporation, Isaac Gilman and Charles Gilman. It provided that all outstanding common stock be converted to non-voting preferred, that Isaac Gilman would receive six shares of common stock and Charles Gilman four shares, with the understanding that no other voting stock was to be issued, and that upon the death of Isaac Gilman, Charles Gilman would have the option of purchasing two shares of common stock from Isaac Gilman's estate. It was further provided that upon exercising the option Charles Gilman should enter into an agreement, in part, as follows:
"That so long as he shall be employed by Gilman Paper Co. * * * that any compensation, that the said Charles Gilman shall receive for services rendered or to be rendered in excess of $30,000 per year, plus 10% of the net profits of the Gilman Paper Company in excess of $200,000 in any one year as computed for federal income taxes, shall be received by the said Charles Gilman as trustee for the benefit of all stockholders of the said Gilman Paper Co."
In October 1944, following the death of Isaac Gilman, Charles Gilman exercised his option and agreed to the terms referred to in the 1940 contract. In October 1945 the directors of the company, with Charles Gilman not voting, adopted a resolution reading:
"Resolved, that the annual salary of the President, Charles Gilman, from this Company commencing January 1st, 1945 shall be a sum equal to 10% of the net profits of this Company in excess of Two Hundred Thousand Dollars ($200,000.00) in any one year as reported by the auditors for the Company in their annual report before deduction of the amount of compensation to be paid and before provision for Federal Income Taxes."
The resolution fixing Charles Gilman's salary was followed in 1945, 1946, and 1949, but has not been adhered to in other years. In 1947, 1948, and 1950 the corporation's net income before taxes and before payment of Charles Gilman's compensation was respectively $4,384,529, $1,963,562, and $1,915,424. Yet Charles Gilman received only $100,000 in 1947 and in 1948, and $110,000 in 1950. In 1951, the year in question, when net earnings, as computed above, were $3,900,494, Charles Gilman drew only $250,000, although compensation computed according to the resolution would have amounted to some $370,049. In that same year Charles Gilman waived a $115,302 dividend on his preferred stock.
On these facts the Commissioner disallowed so much of the salary deduction as exceeded $110,000. Statutory authority for this action comes from § 23 of the Internal Revenue Code of 1939, 26 U.S.C.A. § 23 which allows as a deduction "ordinary and necessary expenses * * * including a reasonable allowance for salaries or other compensation for personal services actually rendered." The Regulations provide that "the test" is whether the payments "are reasonable and are in fact payments purely for services." Treas.Regs. 111, 29.23(a)-6. It is noted that an ostensible salary may, in the case of a closed corporation, actually be a dividend. Further,
Judge Train of the Tax Court found that the compensation agreement was entered into in 1945,...
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