Northlich, Stolley, Inc. v. United States
| Decision Date | 10 November 1966 |
| Docket Number | No. 294-62.,294-62. |
| Citation | 368 F.2d 272 |
| Parties | NORTHLICH, STOLLEY, INC. v. The UNITED STATES. |
| Court | U.S. Claims Court |
Charles F. Wood, Louisville, Ky., for plaintiff. Laramie L. Leatherman, Louisville, Ky., attorney of record. Greenebaum, Barnett, Wood & Doll, Louisville, Ky., of counsel.
Gilbert W. Rubloff, Washington, D. C., with whom was Asst. Atty. Gen., Mitchell Rogovin, for defendant. Lyle M. Turner and Philip R. Miller, Washington, D. C., of counsel.
Before COWEN, Chief Judge, WHITAKER, Senior Judge, LARAMORE, DURFEE and DAVIS, Judges.
This case was referred to trial commissioner Richard Arens with directions to make findings of fact and recommendation for conclusions of law. The commissioner has done so in an opinion and report filed on August 30, 1965. Exceptions to the commissioner's findings of fact and recommendation for conclusions of law were filed by plaintiff and defendant requested that the court adopt both the findings of fact and recommended conclusions of law in their entirety. The case was submitted to the court on the briefs of the parties and oral argument of counsel. Since the court agrees with the trial commissioner's findings, opinion and recommended conclusions of law, as hereinafter set forth, it hereby adopts the same as the basis for its judgment in this case. Plaintiff is, therefore, not entitled to recover and the petition is dismissed.
ARENS, Commissioner:
Plaintiff, a Kentucky corporation, is an advertising agency with offices in Louisville, Kentucky, and Cincinnati, Ohio. It files its Federal income tax returns on the basis of a fiscal year ending September 30, and computes its taxable income on the accrual method of accounting.
Plaintiff brings this action to recover alleged overpayment of Federal income tax and assessed interest paid as a result of disallowances made by the Commissioner of Internal Revenue in amounts claimed by plaintiff as deductible business expense in the form of officers' salaries.
The pertinent facts of the case, as supplemented by detailed material in the accompanying findings, are as follows:
Plaintiff's Federal income tax return for the fiscal year ending September 30, 1957, included as a deductible business expense, under the heading "OFFICERS' SALARIES," the following:
____________________________________________________________________________
| Salary | Bonus | Total
_________________________________________|____________|_________|___________
W. R. Northlich, President ..............| $28,000.08 | $10,240 | $38,240.08
J. S. Huff, Senior Vice President .......| 7,999.92 | 6,840 | 14,839.92
A. Stolley, Executive Vice President ....| 18,000.00 | 5,600 | 23,600.00
D. K. Smith, Secretary-Treasurer ........| 7,999.92 | 3,400 | 11,399.92
____________________________________________________________________________
Upon examination of the aforementioned return, the Commissioner of Internal Revenue disallowed an amount equal to the amount listed in the returns as bonus for W. R. Northlich, for J. S. Huff, and for D. K. Smith; and disallowed $2,856.37 of the total amount paid to A. Stolley. The ground for the disallowances was that the payments did not, to the extent of the amounts disallowed, constitute a reasonable allowance for salaries or other compensation for personal services actually rendered within the meaning of Section 162(a) (1) of the Internal Revenue Code of 1954.
Plaintiff's Federal income tax return for the fiscal year ending September 30, 1958, included as a deductible business expense, under the heading "OFFICERS' SALARIES," the following:
______________________________________________________________________________
| Salary | Bonus | Total
_________________________________________|____________|___________|___________
W. R. Northlich, President ..............| $26,600.10 | $5,911.12 | $32,511.22
J. S. Huff, Senior Vice President .......| 7,599.96 | 3,522.22 | 11,122.18
A. Stolley, Executive Vice President ....| 17,100.00 | 2,955.55 | 20,055.55
D. K. Smith, Secretary-Treasurer ........| 7,599.96 | 1,761.11 | 9,361.07
_______________________________________________________________________________
Upon examination of the aforementioned return, the Commissioner of Internal Revenue disallowed an amount equal to the amount listed in the return as bonus for W. R. Northlich, for J. S. Huff, and for D. K. Smith; and disallowed $1,561.30 of the total amount paid to A. Stolley. The ground for the disallowances was the same as the ground for the disallowances in plaintiff's income tax return for the fiscal year ending September 30, 1957.
Prior to 1949, there had been for some 15 years a partnership advertising agency known as Farson and Huff in Louisville, Kentucky, in which Mr. J. S. Huff and his wife, Margaret Huff, each held a one-third interest, and in which Miss Dorothy K. Smith held a one-third interest. This agency is hereinafter usually referred to as the Louisville Partnership.1
By 1949, the Louisville Partnership had accumulated a substantial amount of capital in excess of its business needs in the Louisville area. As a result, the partners were interested in investing some of the excess funds in an advertising agency located in another city.
Prior to 1949, Mr. W. R. Northlich had been engaged for over 20 years in the advertising and related businesses. In 1948, he was employed as an executive in a Cincinnati, Ohio, advertising agency which, because of the loss of its major client, caused Mr. Northlich to look for a new connection. At the time, several firms, whose accounts he had been servicing in the Cincinnati area, indicated to him that they would transfer their billings,2 aggregating more than $300,000 annually, to him if he should make satisfactory arrangements with another advertising concern. Because Mr. Northlich did not have the relatively large amount of capital needed to finance an advertising agency, he discussed various arrangements with prospective business associates, including the Louisville Partnership, with capital to invest in an advertising agency. At that time, the Louisville Partnership had no clients in Cincinnati.
On February 7, 1949, a partnership advertising agency known as Farson, Huff and Northlich, with the principal office and place of business in Cincinnati, Ohio, was formed by the Louisville Partnership and W. R. Northlich. This partnership is hereinafter usually referred to as the Cincinnati Partnership.
The partnership agreement, though not formally executed, was reduced to writing and adhered to at all times. The agreement provided that:
(1) The Louisville Partnership was to advance and loan to the Cincinnati Partnership "the necessary funds to pay for all operating costs and expenses, including equipment, alterations and the salaries of all personnel employed" in the Cincinnati office.
(2) W. R. Northlich was to contribute the interest which he had in certain advertising accounts and to devote his entire time to the Cincinnati Partnership. He was to receive a salary of $16,000 per year which was to be guaranteed for the first year by the Louisville Partnership; thereafter, his salary was to remain constant until the partners entered into some other agreement.
(3) The Louisville Partnership was to "devote as much time as may be agreed upon between the partners to advancing and rendering profitable the business of" the Cincinnati Partnership.
(4) The Louisville Partnership was to have two-thirds interest and W. R. Northlich was to have one-third interest in the Cincinnati Partnership, and the profits and losses were to be allocated accordingly.
After its formation, the Cincinnati Partnership was operated in accordance with the partnership agreement. Mr. Northlich directed the day-to-day operations of the business but Miss Dorothy K. Smith handled the fiscal and accounting affairs of the Cincinnati Partnership from Louisville (110 miles from Cincinnati), where she was assisted by clerical and accounting employees who were paid by both the Louisville Partnership and the Cincinnati Partnership in accordance with the amount of time devoted to the respective affairs of the two partnerships. These affairs included the billings, accounts receivable, and finances between the Louisville Partnership and the Cincinnati Partnership. Mr. Huff participated on occasions with Mr. Northlich in discussions with prospective clients. Both Mr. Huff and Miss Smith conferred either by person or by telephone frequently with Mr. Northlich concerning the operations of the Cincinnati Partnership and generally assisted in its development. The record does not reveal any time allocation by Mr. Huff and Miss Smith as between the Louisville Partnership and the Cincinnati Partnership.
The progressive increase in the prosperity of the Cincinnati Partnership was evidenced by the rise in gross receipts from approximately $327,000 in 1949 to over $1,500,000 in 1954; and by the increase in net profit from a loss of approximately $2,500 in 1949 to a net profit of about $46,000 in 1954. Subsequent to the first year, 25 percent of the profits were credited to the two capital accounts of the partners. Mr. Northlich received one-third of the amount so credited and the Louisville Partnership received the remaining two-thirds.
Mr. Northlich was the only member of the Cincinnati Partnership who received a salary. His salary, while the partnership was in operation, was as follows:
Year: Salary
1949 (February through
December) ............ $14,205.02
1950 ........................ 15,999.84
1951 ........................ 17,666.64
1952 ........................ 18,000.00
1953 ........................ 23,000.00
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