Henk v. Columbus Auto Supply, Inc., s. 37742

Decision Date05 February 1960
Docket Number37743,Nos. 37742,s. 37742
Citation101 N.W.2d 415,257 Minn. 255
CourtMinnesota Supreme Court
Parties, 60-1 USTC P 9325 Helen Selvig HENK, as Adm'x of Estate of Florian A. Henk, deceased, Respondent, v. COLUMBUS AUTO SUPPLY, INC., et al., Defendants, Columbus Auto Supply, Inc., Mark J. McCabe, as Receiver of Columbus Auto Supply, Inc., and Joseph Henk, Respondents-Appellants, United States of America, claimant, Appellant-Respondent.

Syllabus by the Court.

1. 26 U.S.C.A. § 23(a)(1)(A), provides:

'In computing net income there shall be allowed as deductions:

'All the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business, including a reasonable allowance for salaries or other compensation for personal services actually rendered; * * *. ' Held that the court erred in failing to include a reasonable allowance for salaries or other compensation for personal services actually rendered by the officers of the corporation taxpayer as a deduction in computing net income in an income tax return.

2. Taxpayer corporation was liable for ordinary income tax and also excess profits tax and filed a return only for ordinary income tax. Held, where a taxpayer is liable for two taxes and has an obligation to file two returns, it cannot be said that one return addressed to but one of the liabilities answers the purpose of both.

Mark J. McCabe, Minneapolis, for appellant and Pro Se.

Culhane & Culhane (James E. Culhane) and R. Scott Bryngelson, Minneapolis, for respondent Henk.

Fallon Kelly, U.S. Dist. Atty., Clifford Janes, William S. Fallon and Frank W. Rogers, Asst. Dist. Attys., St. Paul, Charles K. Rice, Asst. Atty. Gen., Lee A. Jackson, I. Henry Kutz and George F. Lynch, Dept of Justice, Washington, D.C., for respondents.

MAGNEY, Commissioner.

On August 25, 1951, Mark J. McCabe was appointed operating receiver of Columbus Auto Supply, Inc. On October 31, 1952, the United States of America filed a claim in the receivership in the sum of $7,615.08 for income taxes against the corporation. A supplemental claim of $115,891.59 was filed later. After a trial in which certain interrogatories were submitted to a jury, judgment was entered against the corporation taxpayer, and it appeals therefrom. The court, in its findings, denied the government's claims for excess profits taxes for the years 1944, 1945, and 1946 on the ground that the statute of limitations had run against them. Because of these adverse findings, the government also appeals from the judgment.

In 1937, Joseph Henk, as sole proprietor, opened a store in Minneapolis for the sale of automotive supplies. His brother Florian came to work for him. Since 1918 Joseph had been engaged in the same kind of business either as sole proprietor or as a partner. In 1940, Joseph, Florian, and one F. N. Fry formed a corporation under the name of Continental Auto Supply, Inc. Later the name was changed to Columbus Auto Supply, Inc. Two thousand shares of stock were issued, 1,000 to Fry, 999 to Joseph, and one to Florian. In 1941, Fry withdrew, and the corporation purchased his shares. Florian's one share of stock was turned over to Joseph in 1948. In 1937, when Florian came to work for Joseph, the brothers agreed to share the profits of the business equally. This arrangement continued after the corporation took over. What each brother received under this agreement was called a bonus. It was the regular practice to declare a bonus at the close of each fiscal year, which ended on April 30. All but about $500 of the earnings of the corporation was divided each year in that manner until Jerome, a son of Joseph, returned from the service and went to work for the corporation. Commencing April 30, 1946, the profits were split three ways, all sharing equally. The share each received was called a bonus. Joseph drew $25 a week; Florian, $40.20; and Jerome started out at about $40 per week. Florian died December 27, 1949. After his death the drawings of Joseph and Jerome increased.

For the fiscal year ending April 30, 1944, Joseph and Florian each received $9,000 as bonus. That was the first year that the corporation paid or was able to pay a bonus. In 1945, each received $15,000; in 1946, each received $18,000; in 1947, Joseph, Florian, and Jerome each received $11,000; in 1948, Joseph received $7,606.36; Florian, $6,815.98; and Jerome, $5,977.63. In 1949, Joseph received $6,285.86 and Jerome received $5,714.14. In 1950, Joseph and Jerome each received $4,300 as bonus and drew $4,145.76; in 1951, Joseph and Jerome each received a bonus of $1,462.68 and drew $10,100 and $6,463.11, respectively. Every year the corporation listed the bonuses on its Federal income tax return and claimed them as deductions for personal services actually rendered.

After the officers had declared the bonuses for themselves, checks were issued by the corporation in payment. The checks covered the amount of the bonus in each case, less the withholding and social security taxes. They were accepted as salary or compensation. It was intended that the checks eventually would be cashed. Very few of them actually were cashed. Some were exchanged for notes of the corporation. The checks were not cashed because the cash was needed in the operation of the business. The bonus was the only compensation given to the officers in payment of their services aside from the small amounts they received as drawings. It is clear from the evidence that, when the drawing account was fixed at so much per week, it was anticipated that additional compensation would be received. Joseph, Florian, and Jerome paid their own individual income taxes on the drawings and the bonuses. They disclosed in their individual returns that the bonuses were compensation for their services to the corporation. No fault has been found with their individual income tax returns.

During the years that Joseph, Florian, and Jerome received bonus payments they devoted long hours and much effort--except Florian during his last illness--to the affairs of the corporation. The growth and success of the business attest to the quality of the services rendered.

The trial court, in commenting in its findings on the services of Joseph, stated:

'That during all the fiscal years of the corporation * * * Joseph L. Henk actually rendered personal services to said corporation by devoting all his time and attention to the business and affairs of said corporation in an executive capacity, and that his work and efforts were largely responsible for the success and growth of said business.'

In answer to an interrogatory, the jury found that there was no fraud with intent to wilfully evade taxes. On the evidence, no other finding could be sustained. The figures set out in the income tax returns for the several years involved are correct. The government does not dispute them. Its only complaint is that the amounts listed as bonuses were in fact a distribution of profits. In every income tax return that was filed, the amounts received as bonuses were clearly designated as bonuses. The income tax return for the year ending April 30, 1944, was filled out at the local office of the Bureau of Internal Revenue. Joseph took the profit-and-loss sheet and the balance sheet to the government office. These papers reflected correctly the business operations of the corporation during the year. Joseph told his contacts in the office that the year just ended was the first in which the corporation had made a substantial profit and was the first year in which a bonus had been taken. He asked for advice and assistance in connection with the preparation of the income tax return. The financial statements submitted clearly specified that $18,000 had been paid in bonuses to Joseph and Florian, $9,000 each. The papers were checked; Joseph was asked some questions, among them concerning the bonuses, the officers of the corporation, the method of doing business, and the name of the bookkeeper. He was notified when the return was ready and went down to the office. He there signed the return and delivered a check for the amount due. The returns for the years 1946 and 1947 were prepared in the revenue office in substantially the same manner. The records of the company submitted to the office plainly set out the amounts paid as bonuses and designated as bonuses and the drawings, and the bonus and drawings figures inserted in the returns in the internal revenue office came from those records. The figures have not been challenged.

When the corporation first started out it had 8 employees, including officers. At the time of the trial it had 15 employees, the greatest number it ever had. As to the monetary value of the services of Joseph, Florian, and Jerome, there was testimony to the effect that it was worth more than the amount of their combined drawings and bonuses. No testimony was offered by the government as to the value of these services.

The court found that, as compensation to the Henks for their services to the corporation, there was paid to them the amounts of the drawings--properly designated as 'drawings' in the findings--and that these drawings constituted the full compensation that the corporation agreed to pay them. Joseph testified that the drawings were not intended as full compensation for the services of the officers and that their real compensation was to come from the splitting of the earnings in the form of a bonus. It must be plain, in view of the services performed by the officers and the volume of business, that the small weekly drawings were not and could not have been intended as full compensation but simply drawings on account, as the designation itself clearly indicates. The record is conclusive that the drawings actually did not represent the reasonable value of the services rendered by the Henks to the corporation and were therefore not full compensation.

Two of the special interrogatories submitted to the...

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