ISC, INCORPORATED v. Commissioner

• Citation: 1978 TC Memo 288,37 TCM (CCH) 1206
• Decision Date: 27 July 1978
• Docket Number: Docket No. 3653-74.
• Parties: I.S.C., Incorporated v. Commissioner.
• Court: U.S. Tax Court

37 TCM (CCH) 1206

1978 TC Memo 288

T.C. Memo. 1978-288.

I.S.C., Incorporated v. Commissioner.

Docket No. 3653-74.

United States Tax Court.

Filed July 27, 1978.

Vincent C. Murovich, Robert G. MacAlister, and William C. McClure 103 Smithfield St., Pittsburgh, Pa., for the petitioner. Russell F. Kurdys, for the respondent.

Memorandum Findings of Fact and Opinion

SIMPSON, Judge:

The Commissioner determined the following deficiencies in the petitioner's Federal income taxes:

                  Taxable Year Ending           Deficiency
                    Sept. 30,  1966 ........    $ 58,737.95
                    Sept. 30,  1970 ........     223,883.13
                

The deficiency for the year ending September 30, 1966, resulted from adjustments to income for the year ending September 30, 1969, which led to a decrease in the net operating loss to be carried back to the year ending September 30, 1966. The issues remaining for decision are: (1) Whether the petitioner established a stock bonus trust qualified under section 401(a) of the Internal Revenue Code of 1954¹ by September 30, 1970, the final day of its taxable year; (2) whether the petitioner has proved that the Commissioner erred in lengthening the useful lives it assigned to certain equipment, machinery, and leasehold improvements for purposes of computing its depreciation deductions; and (3) whether the petitioner has substantiated deductions it claimed for legal expenses and for travel and entertainment expenses. If we find that the petitioner established a qualified stock bonus trust as of September 30, 1970, we must also determine the fair market value of 25.3 shares of stock contributed by it to such trust on June 14, 1971, for purposes of establishing the amount of the deduction to which it is entitled under section 404(a)(3) and (6).

Findings of Fact

Some of the facts have been stipulated, and those facts are so found.

The petitioner, I.S.C., Incorporated (I.S.C.), is a Pennsylvania corporation which had its principal office in Pittsburgh, Pa., at the time it filed its petition in this case. I.S.C. was incorporated on September 23, 1957, as W & T Salvage Co. W & T Salvage Co. and its subsidiary corporations filed a consolidated Federal income tax return for the taxable year ending September 30, 1966, with the District Director of Internal Revenue, Pittsburgh, Pa. The name W & T Salvage Co. was changed to I.S.C., Incorporated, as of January 1, 1967. I.S.C. and its subsidiaries filed consolidated Federal income tax returns for the taxable years ending September 30, 1969, and September 30, 1970, with the Internal Revenue Service Center, Philadelphia, Pa. The returns for the years ending September 30, 1964 through September 30, 1969, were prepared and filed using the cash method of accounting. For the year ending September 30, 1970, and thereafter, I.S.C. prepared and filed its returns using the accrual method of accounting.

On September 21, 1970, the board of directors of I.S.C. held a meeting for the purpose of considering the establishment of an employee stock ownership plan (the plan). The minutes of such meeting recite that:

Copies of the proposed Stock Bonus Plan and Trust Agreement were submitted to the meeting and all of the relevant provisions were discussed by the Directors. Thereupon, on motion duly made, seconded and unanimously carried, it was:

RESOLVED, that the proposed Employee Stock Ownership Plan be and the same is hereby approved and adopted, and that the appropriate officers of the Company be and are hereby authorized and directed to cause said Plan to be duly executed and disclosed to the Employees.

* * *

The Chairman pointed out that contributions under the Employee Stock Ownership Plan are not required to be actually made until the time of filing of the Federal Income Tax Return of the Company for the fiscal year. However, the Chairman suggested that since the Plan as approved contemplated the use of an Employee Stock Ownership Trust, the proposed Trust Agreement creating such a Trust should be considered and approved at this meeting. Accordingly, the Chairman submitted to the meeting a copy of the proposed Employee Stock Ownership Trust Agreement naming The Union National Bank of Pittsburgh as the proposed Trustee.

After discussing the various provisions of the proposed Trust Agreement, upon motion duly made, seconded and unanimously carried, it was:

RESOLVED, that the foregoing Employee Stock Ownership Trust Agreement submitted to the meeting be and the same is hereby adopted and approved, and that the appropriate officers of the Corporation be and the same are hereby authorized to execute and deliver the same to The Union National Bank of Pittsburgh for its execution prior to the date of the initial required contribution under the new Plan.

RESOLVED FURTHER that The Union National Bank of Pittsburgh be and the same is hereby appointed as Trustee under the foregoing Trust Agreement subject to the acceptance and execution of the same by said bank.

RESOLVED FURTHER that the Secretary is hereby instructed to attach copies of the foregoing Planand Trust Agreement * * * to the minutes of this meeting. Emphasis supplied.

At the September 21, 1970 meeting, the board of directors also appointed a committee to administer the plan. It was further "irrevocably determined" that I.S. C's contribution to the plan for its year ending September 30, 1970, should be equal to 15 percent of the total compensation of all participating employees.

As authorized by the board of directors, the plan was executed on September 21, 1970. The plan provided for contributions to a trust to be administered for the exclusive benefit of participants and their beneficiaries. The plan also provided that "Neither amendment nor termination shall retroactively reduce the rights of participants nor permit the use of any part of the Trust Fund for any purpose other than sic for the exclusive benefit of the participants and their Beneficiaries." With respect to the trust, the plan contained the following definitions:

Trust: The Trust created by the Trust Agreement entered into between the Company and the Trustee. * * * Trust Agreement: The Agreement between the Company and the Trustee or any successor trustee, establishing the Trust and specifying the duties of the Trustee.

The plan also stated: "A copy of the Trust Agreement is available for your review in the Company's office." However, the trust agreement was not executed by I.S.C. and The Union National Bank of Pittsburgh until June 14, 1971, and no copy of a proposed trust agreement was attached to the minutes of the September 21, 1970 meeting. The trust agreement, as executed, provided that it was to be effective as of October 1, 1969.

On June 14, 1971, the board of directors of I.S.C. held another special meeting to determine the fair market value, as of September 30, 1970, of the common stock of I.S.C. At such meeting, the board of directors approved a fair market value of $15,514.56 per share. The directors resolved that a contribution be made to the trust in the aggregate sum of $392,518.50, which sum was stated to be equal to 15 percent of the compensation of all participating employees, for the year ending September 30, 1970. They further resolved that such contribution be made in shares of the company's common stock, based on a per-share valuation of $15,514.56, and authorized the issuance and delivery to the trustee of 25.3 shares from I.S.C.'s authorized but unissued stock. The shares were delivered to the trustee on June 14, 1971, one day prior to the last day for the filing of I.S.C.'s return for the year ending September 30, 1970.

On June 16, 1971, I.S.C. filed an Application for Determination under sections 401(a), 405(a), and 501(a) (Form 4573), with the District Director, Internal Revenue Service, Pittsburgh, Pa. In such application, I.S.C. stated that the plan was adopted on September 21, 1970, and that the trust was executed on June 14, 1971. In a determination letter dated September 21, 1971, the district director advised I.S.C. that its plan, as amended,² was qualified under section 401(a).

On its Federal income tax return for the year ending September 30, 1970, I.S.C. deducted $392,518.50 for its contribution to the plan. In its statement in support of such deduction, it stated: "The trust or contract and any amendments thereto were put into effect so that contributions thereunder were irrevocable on September 21, 1970." The Commissioner disallowed such deduction, claiming that the trust, which was part of the plan, was not in existence during the year ending September 30, 1970. The Commissioner further claimed the 25.3 shares did not have an aggregate value of $392,518.50 as claimed in I.S.C.'s return for such year.

During the years at issue, the principal business of I.S.C. was the processing of slag from steel mills and the reclamation of iron material remaining in the slag. In addition, wholly owned subsidiary corporations were engaged in the construction business and in the restaurant business.

From 1957 through 1972, I.S.C. conducted a slag-processing operation under a contract with Jones & Laughlin Steel Corporation (J & L). The slag-processing operation involved loading molten slag onto trucks. The slag was then taken to a reclamation area, where slag with a high metal content was magnetically separated from that with a lower metal content. The slag with a high metal content was sold back to J & L to be used as raw stock. The remainder was either used as land fill or discarded. The trucks, crawlers, and other machinery and equipment used to transport and process the slag were subject to severe use.

During the year ending September 30, 1970, I.S.C. had 34 Euclid trucks and 2 Euclid crawlers which were used in its slag-processing operation. All of such trucks and crawlers had been acquired used. Of the trucks and crawlers listed on I.S.C.'s depreciation schedule for 1970, 4 had been acquired in 1958, 6 had been...