MSD INC. v. United States, Civ. A. No. C74-498 to C74-500.
| Decision Date | 25 March 1977 |
| Docket Number | Civ. A. No. C74-498 to C74-500. |
| Citation | 434 F. Supp. 85 |
| Parties | M. S. D., INCORPORATED, Plaintiff, v. UNITED STATES of America, Defendant. The SIGNAL DEVICES AND ALARM COMPANY, Plaintiff, v. UNITED STATES of America, Defendant. MORSE SIGNAL DEVICES, INC., Plaintiff, v. UNITED STATES of America, Defendant. |
| Court | U.S. District Court — Northern District of Ohio |
COPYRIGHT MATERIAL OMITTED
Bennet Kleinman, Kahn, Kleinman, Yanowitz & Arnson, Cleveland, Ohio, for plaintiff.
Robert M. Greco, David J. Curtin, Trial Atty., Tax Div., Dept. of Justice, Washington, D. C., James C. Lynch, Cleveland, Ohio, for defendant.
The three plaintiff corporations, M.S.D., Inc., The Signal Devices and Alarm Company, and Morse Signal Devices, Inc., initiated these three actions against the United States of America pursuant to 28 U.S.C. § 1346(a)(1)1 in order to obtain income tax refunds and interest for the taxable year ending March 31, 1970. The amount of federal income tax to which each plaintiff corporation claims entitlement to a refund is:
Plaintiff Amount
M.S.D., Inc. $ 637.00
Morse Signal Devices, Inc. 6,152.00
The Signal Devices and Alarm Company 1,670.00
The three cases were consolidated for trial because they all present a common issue: whether payments made by each of the plaintiffs to the widow of Morris Weinstock, a deceased employee who controlled 50% of each corporate plaintiff's stock at the time of his death, constitutes an ordinary and necessary business expense under 26 U.S.C. § 162(a)2, and is deductible from each corporation's gross income under 26 U.S.C. § 404(a)(5)3. The Court holds that the funds which each plaintiff paid Morris' widow were not "necessary" business expenses because none of these payments were intended by any of the corporations to be made in exchange for a business benefit, and therefore none were deductible under Sections 162(a) and 404(a)(5). The Court enters judgment for the defendant in each of these three cases.
Plaintiff M.S.D., Incorporated is an enterprise organized under the laws of the State of Ohio and engaged in business activities which include the purchase and leasing of protection alarm systems, the ownership and operation of alarm system repair vehicles, and central office equipment. M.S.D.'s principal business location is in Cleveland, Ohio and its business services are performed throughout northeast Ohio. During Morris' life and presently, the shares of stock of this plaintiff were owned equally by the families of the two founding brothers, Morris and Jack Weinstock. Morris Weinstock was President of M.S.D. from the time of its incorporation until October 18, 1969, the date of his death. Additionally, Morris was a member of the Board of Directors during the same period.4
Plaintiff Morse Signal Devices, Incorporated is an enterprise organized under the laws of the State of Ohio. Its business activities include purchase, sale, installation and service of protective alarm systems. Prior to Morris' death, 50% of the stock of Morse Signal Devices was owned by Morris' family and 50% was owned by Jack's family. Presently Morse Signal Devices stock is equally divided between the families of the two brothers. Morris Weinstock was President and a member of the Board of Directors of Morse Signal Devices from the time of its incorporation until the date he died.5
Plaintiff The Signal Devices and Alarm Company is a corporation organized under the laws of Ohio. Its business activities correspond to that of plaintiff Morse Signal Devices, Inc. During Morris Weinstock's life both he and Jack each owned 50% of the shares of The Signal Devices and Alarm Company, and those shares are presently owned equally between the families of the two brothers. Morris Weinstock was President and a member of the Board of Directors of The Signal Devices and Alarm Company from 1958 until the date of his death in 1969.6
In 1948, Morris and Jack Weinstock purchased an enterprise in Los Angeles, California, now known as Morse Signal Devices of California, which was in the business of installing, servicing and monitoring alarm systems in the greater Los Angeles area. In 1949, Morris and Jack Weinstock decided to move from Cleveland, Ohio to Los Angeles, California, and in that year Jack Weinstock and his family moved to the Los Angeles area. Morris Weinstock's family left Cleveland and took up permanent residence in Los Angeles in 1950. After moving to Los Angeles, Morris and Jack operated Morse of California, and received salaries for their services to that corporation.7
Arthur Orner, Morris Weinstock's brother-in-law, was employed by all three of the Cleveland corporations for several years before Morris and Jack moved to California. Orner remained in Cleveland, after the Weinstocks moved, and he held the position of general manager in each of the Cleveland corporations. Orner's job entailed supervising the routine day to day production and service operations of each of the corporations.8
The testimony of Harry Baumgarten, Julius Bovill, and Lessing Gold demonstrates that throughout the 1950s and 1960s Morris Weinstock was an unusually vibrant, talented businessman who set the policies of each of the three plaintiff corporations located in Cleveland. Once every two months Morris visited Cleveland from California, and stayed for 10 to 14 days. During these visits Morris was in close personal contact with Baumgarten, the outside accountant for each of the three Cleveland corporations, and throughout the year Morris conveyed instructions and policy decisions at least once a week via letters, telephone, or dictabelt voice recordings to both Orner and Baumgarten. Baumgarten testified that he discussed the financial status of the three Cleveland corporations only with Morris, and that Morris guided the financial policy for each corporation. A leader in his field, Morris promoted the welfare of the whole security alarm industry by organizing the National Burglar and Fire Alarm Association9, from which he no doubt developed many unique business contacts which made him an unusually valuable employee to the three Cleveland corporations that were 50% controlled by his family.
Gold testified that in the mid-1960s few security alarm business generated gross sales in excess of $1,000,000, however, during that time frame, the three plaintiff corporations together, under Morris' stewardship, consistently topped the $1,000,000 sales figure. The testimony of Baumgarten, Bovill, and Gold, based on their respective expertise10, indicates that an executive employee with Morris' talent could easily expect to receive annual compensation of at least $70,000 per year in the executive employment market. However, during the 1960s Morris received only $20,000 to $30,000 per year in salary and dividends from the three plaintiff corporations combined, and his corporate compensation did not increase significantly, either to compensate for inflation, or in response to the consistent rise in sales which occurred under his leadership. During the early and mid-1960s Morris was repeatedly advised that his salary was low11, but nevertheless he did not increase it. In the middle and late 1960s the three plaintiff corporations, pursuant to Morris' plans, prepared to issue stock to the public for the first time, and in anticipation of this event, structured their accounting techniques to minimize cash outflows and maximize financial surpluses and internal cash flow.
On March 25, 1965, Morris and Jack Weinstock, as employees, both entered into similar agreements with each of the plaintiff corporations. The agreements provided that upon the death of the employee, the employer-corporation would make monthly payments to his widow equal to 1/84th of the aggregate compensation paid the deceased employee during the seven year period immediately preceding his death. Though the widow of the deceased employee was entitled to receive the aforesaid payments for a period of seven years, none of the corporations sustained a duty to make any payments if the widow died before the expiration of the period in which she was to be paid. The agreements recite that the payments were to be made in consideration of (i) the employee's past and continued services to the plaintiff; and (ii) the employee's covenant not to compete with the business of the employer for a five year period in the event of termination of his services.12
On the date the three agreements were executed, Morris was 55 years old and Jack was 53 years old.13 Morris Weinstock never intended to leave the employ of the Cleveland corporations. He and his brother Jack had a close personal and working relationship, hence the Court finds that in 1965 there was no threat, or indication of any sort, that Morris considered employment elsewhere.
Morris and Jack Weinstock were the only persons who had agreements with the Cleveland corporations under which payments were to be made to the surviving spouses of corporate employees. Before these agreements were executed in March, 1965, these corporations had no agreements with any of their employees, officers or directors, including Morris and Jack, under which similar widow payments would be made.14
On October 18, 1969 Morris Weinstock died and pursuant to the March 25, 1965 agreements the three Cleveland corporations subsequently made the following payments to Morris' widow, Ann Weinstock, within the fiscal year ending March 31, 1970:
M.S.D. Incorporated $ 2,667
Signal Devices and Alarm
Incorporated 3,200
Morse Signal Devices and
Alarm Incorporated 12,267
Each of the corporations claimed these payments as deductions on their corporate income tax returns filed for the fiscal year ended March 31, 1970 as "deferred compensation" payments.15...
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