Menard, Inc. v. Commissioner

• Decision Date: 16 September 2004
• Docket Number: Docket No. 673-02.,Docket No. 674-02.
• Citation: 88 T.C.M. 229
• Parties: Menard, Inc. v. Commissioner. John R. Menard, v. Commissioner.
• Court: U.S. Tax Court

88 T.C.M. 229

T.C. Memo. 2004-207

Menard, Inc. v. Commissioner.

John R. Menard, v. Commissioner.

Docket No. 673-02.

Docket No. 674-02.

United States Tax Court.

September 16, 2004.

Robert E. Dallman, Vincent J. Beres, and Robert J. Misey, Jr., for petitioners;

Christa A. Gruber, J. Paul Knap, and Michael Calabrese, for respondent.

MEMORANDUM FINDINGS OF FACT AND OPINION

MARVEL, Judge:

These cases were consolidated upon motion of the parties for purposes of trial, briefing, and opinion. Respondent determined deficiencies and section 6662(a)¹ accuracy-related penalties with respect to petitioners' income tax and, by amendment to answer, increased those deficiencies as follows:

                Menard, Inc., docket No. 673-02
                      TYE Jan. 31       Deficiency       Accuracy-related penalty
                                                              sec. 6662(a)
                        1998           $8,966,233                $430,414
                John R. Menard, docket No. 674-02
                        Year           Deficiency       Accuracy-related penalty
                                                              sec. 6662(a)
                        1998           $4,909,407               $981,882
                

At the close of trial, pursuant to Rule 41(b)(1), respondent moved to amend the pleadings to conform to the evidence in light of testimony revealing that petitioner Menard, Inc., paid, and claimed as a deduction, Team Menard, Inc., salaries. We granted respondent's motion. On the basis of the Rule 41(b)(1) motion and concessions of the parties,² respondent determined petitioners' deficiencies and section 6662(a) accuracy-related penalties as follows:

                Docket No.       Deficiency       Accuracy-related penalty
                                                              sec. 6662(a)
                        673-02         $9,069,126               $460,031
                        674-02          2,587,000                517,400
                

After further concessions,³ the issues for decision are:

(1) Whether petitioner Menard, Inc. (Menards), is entitled to deduct $20,642,485, the total compensation paid to petitioner John R. Menard (Mr. Menard), or some lesser amount, as officer's compensation for the taxable year ending January 31, 1998 (TYE 1998);

(2) whether Menards is entitled to claim deductions under section 162 of $6,563,548 for the payment of Team Menard, Inc. (TMI), salaries and expenses during TYE 1998;

(3) whether Menards's payment of TMI's salaries and expenses during the calendar year 1998 of $5,703,251 constituted a constructive dividend to Mr. Menard for 1998;

(4) whether interest of $639,302 that accrued during 1998 on loans from Mr. Menard to Menards, but that was paid to and reported by Mr. Menard in 1999, constituted interest income constructively received in 1998; and

(5) whether Menards and Mr. Menard are liable for accuracy-related penalties under section 6662(a) for negligence or disregard of rules or regulations.

FINDINGS OF FACT

Some of the facts have been stipulated. We incorporate the stipulated facts into our findings by this reference.⁴ Both Menards's principal place of business and Mr. Menard's residence were located in Eau Claire, Wisconsin, when the petitions in these consolidated cases (hereinafter this case) were filed.

I. Menards

Menards is an accrual basis taxpayer and has a fiscal year ending January 31 for tax and financial reporting purposes. On October 15, 1998, Menards timely filed Form 1120, U.S. Corporation Income Tax Return, for TYE 1998 and reported $315,326,485 of taxable income.

A. Menards's Business In General

Menards was incorporated on February 2, 1962, in Wisconsin. Since its incorporation, Menards has been primarily engaged in the retail sale of hardware, building supplies, paint, garden equipment, and similar items. Menards has approximately 160 stores in nine Midwestern States and is one of the nation's top retail home improvement chains, third only to Home Depot and Lowe's. In TYE 1998, Menards's revenue totaled $3.42 billion.

B. Menards's Corporate Structure⁵

Menards has three major divisions: Operations, manufacturing, and corporate. All department managers, plant managers, and supervisors report to Mr. Menard and his division managers.

1. Operations

The operations division controls Menards's retail stores. Mr. Menard's brother, Lawrence Menard (L. Menard), serves as operations manager and oversees all aspects of the stores' operations with respect to personnel. The merchandising department, an offshoot of the operations division, handles the stores' merchandising needs. Edward S. Archibald, senior merchandising manager, oversees the purchasing, merchandising, and marketing of all items for resale at Menards. Mr. Archibald's involvement in marketing includes the use of print and broadcast media for store promotions.

2. Manufacturing

Midwest Manufacturing (Midwest), the manufacturing division, operated eight manufacturing plants during TYE 1998. Dennis W. Volbrecht, Midwest's general manager, oversees all departments and facilities, supervises the plant managers, and assists in the design and proposal of products.

3. Corporate

The corporate division comprises, among other things, the accounting, legal, properties, construction, and store-planning departments. In the accounting department, Robert J. Norquist, corporate controller, manages all functions of the general ledger system, including the preparation of monthly financial statements. Mr. Norquist is also responsible for the fixed asset system; accounts payable; the payroll systems; tax returns for sales tax, payroll tax, and excise tax; and the day-to-day cashflow.

As head of the properties department, Marvin Prochaska is responsible for the acquisition, development, management, and disposition of real estate for Menards. Mr. Prochaska is also responsible for Menards's construction and store-planning departments. The construction department provides onsite and offsite construction management for Menards's construction projects, and store planning works with civil engineers to develop site, structural, architectural, and floor plans.

C. Menards's Officers and Shareholders

1. Officers

During TYE 1998, Menards's corporate officers were Mr. Menard, president and chief executive officer (CEO); Mr. Prochaska, vice president of real estate; Earl Rasmussen, chief financial officer and treasurer; and Chris Menard (C. Menard), secretary.⁶ The officers received compensation for TYE 1998 in the following amounts:

                Officer               Compensation
                         Mr. Menard             $20,642,485
                         Mr. Prochaska            121,307
                         Mr. Rasmussen             55,702
                         Mr. C. Menard            172,815
                

2. Shareholders

Since the incorporation of Menards, Mr. Menard has been the controlling shareholder. During the years at issue, Mr. Menard owned all of the class A voting stock and approximately 56 percent of the class B nonvoting stock. Mr. Menard's family members and trusts named after him and his family members held the remaining class B shares.⁷ In all, Mr. Menard owned approximately 89 percent of Menards's voting and nonvoting stock. Menards has never paid dividends to its shareholders.

D. Menards's Employee Compensation Plan

1. In General

During TYE 1998, Menards provided all employees with health, 401(k), and instant profit-sharing (IPS)⁸ plans. Other than IPS and Mr. Menard's bonus plan discussed, infra, Menards had no written bonus plan for its officers. However, Menards's executives met with Mr. Menard to discuss performance goals and compensation. Menards regularly paid low base salaries to executives, supplemented with large bonuses.⁹

2. Mr. Menard's Compensation Plan

In addition to the forms of compensation available to all employees, Menards pays Mr. Menard an annual bonus. Since 1973,¹⁰ Mr. Menard has received an annual bonus equal to 5 percent of Menards's net income before taxes (the 5-percent bonus). The 5-percent bonus is subject to the following reimbursement agreement: In the event that the Commissioner disallows as a deduction any portion of Mr. Menard's compensation, Mr. Menard must repay to Menards the entire amount disallowed.

In a resolution effective December 20, 1996, Menards's board of directors¹¹ decided that, for TYE 1998, Menards would pay Mr. Menard a salary of $157,500 and the 5-percent bonus. Mr. Menard's total compensation in TYE 1998 consisted of the following items:

                Item                 Amount
                         Base Salary
                            (regular weekly payroll         $62,400
                         Base salary
                            (paid in December)               95,100
                         5-percent bonus                 17,467,800
                         IPS                              3,017,100
                         Christmas gift bond                    185
                                                        ___________
                                                        120,642,585
                1 This figure contains an unreconciled difference of $100 on Mr. Menard's 1997 Form W-2, Wage and Tax Statement
                

Mr. Menard's total compensation constituted 0.6 percent of Menards's TYE 1998 gross receipts and 5.16 percent of all other employees' wages.

II. Comparable Companies and Rate of Return on Investment

A. Compensation Paid by Comparable Publicly Traded Companies

For purposes of comparing Mr. Menard's compensation to CEO compensation of publicly traded companies, the comparison group consists of the following five publicly traded companies: Home Depot, Kohl's, Lowe's, Staples, and Target. For services performed in TYE 1998, the comparison group companies paid compensation to their CEOs as follows:

                Company            Compensation
                          Home Depot          $2,841,307
                          Kohl's               5,110,578
                          Lowe's               6,054,977
                          Staples              6,868,747
                          Target              10,479,528
                

B. Rate of Return on Investment

For TYE 1998, the comparison group companies' and Menards's rates of return on equity¹² were as follows:

                Company            Return on Equity
                          Menards                 18.8%
                          Home Depot              16.1

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