Ohio Battery & Ignition Co. v. Comm'r of Internal Revenue

• Decision Date: 19 June 1945
• Docket Number: Docket No. 3074.
• Citation: 5 T.C. 283
• Parties: OHIO BATTERY & IGNITION COMPANY, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
• Court: U.S. Tax Court

5 T.C. 283

OHIO BATTERY & IGNITION COMPANY, PETITIONER,

v.COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

Docket No. 3074.

Tax Court of the United States.

Promulgated June 19, 1945.

Petitioner, an Ohio corporation on an accrual basis, was owned by two brothers and their wives, who were on a cash basis of accounting. The two men were petitioner's president and treasurer, respectively. In 1940 their total authorized salaries amounted to $11,000, and in 1941 their authorized salaries totaled $20,000. On December 31 of each year a substantial part of these salaries remained unpaid. On December 31 of each year the balance of the salaries was accrued and credited, without restriction as to time or manner of payment, to the respective accounts of the officers on petitioner's books as accounts payable. At the close of each year petitioner did not have sufficient cash on hand to pay the accrued accounts, but its credit at the bank was such that it could have borrowed the amounts necessary for such payments within the years of accrual. There was no understanding or agreement that the amounts so credited could not be drawn at any time the brothers desired. The two brothers did not need the money for their income and did not wish to strip the corporation of it. The amounts were reported by them as income in their individual income tax returns in the respective years of accrual. Held, that the provisions of subdivisions (1) and (2) of section 24(c), Internal Revenue Code, do not apply and, accordingly, that the unpaid salaries credited to the officers' accounts were constructively received by them and were properly includible in the income tax returns of the officers for the years in question, and the Commissioner erred in denying the deductions claimed. Albert A. Arbaugh, Esq., for the petitioner.

Melvin S. Huffaker, Esq., for the respondent.

This proceeding involves deficiencies as follows:

+-----------------------------------------------+
                ¦1940 income tax                       ¦$485.23 ¦
                +--------------------------------------+--------¦
                ¦1941 income tax                       ¦1,745.30¦
                +--------------------------------------+--------¦
                ¦1941 declared value excess profits tax¦257.60  ¦
                +--------------------------------------+--------¦
                ¦1941 excess profits tax               ¦1,322.46¦
                +-----------------------------------------------+
                

In its income tax return for 1940 petitioner accrued and deducted as an expense $11,000 representing officers' salaries, of which only $8,400 was actually paid in that year. In its income tax return for 1941 petitioner accrued and deducted as an expense $20,000 representing officers' salaries, of which only $9,512 was actually paid in that year. In addition to uncontested adjustments, respondent disallowed that part of the deduction for such salaries which had been accrued but, as respondent claims, was not paid before March 15 of the succeeding year. The question presented is whether the disallowance of the deductions for salaries was authorized by section 24(c) of the Internal Revenue Code.

Certain of the facts herein are stipulated and are found accordingly. Facts found other than those stipulated are based upon evidence adduced at the hearing.

FINDINGS OF FACT.

Petitioner is an Ohio corporation, having its office and principal place of business at Canton, Ohio. Its income tax returns for the years in question were filed with the collector of internal revenue for the eighteenth district of Ohio at Cleveland. At all times material herein, its books and Federal tax returns were kept and filed on an accrual basis.

During 1940 and 1941 Sanford S. Lazarus and his brother, Leon E. Lazarus, were president and treasurer and vice president and secretary, respectively, of petitioner, and devoted their full time and attention to its business. The two men and their wives owned all the outstanding stock of petitioner. Each of the men owned 1,097 shares and their wives owned one share each.

The authorized salary for each of the men for 1940 was $5,500. During that year each received $4,200 in cash and on December 31, 1940 petitioner credited $1,300 to the personal account of each, which was the balance then remaining due as salary for 1940. No other action or transaction occurred with respect to these accrued salaries until after March 15, 1941.

The authorized salary for each of the Lazarus in 1941 was $10,000, and during that year each received $4,756. On December 31, 1941, petitioner credited the sum of $5,244 to each of them in a bonus payable account, which amount was the unpaid balance of his 1941 salary. The crediting entries disclosed no restriction as to the time or manner of payment of the above accounts for either year, and there was no such restriction. There was no understanding or agreement that the amounts could not be drawn at any time the brothers desired to do so. It was understood that the salaries were available to the two brothers at any time. They, however, did not require the money, did not need it for their own income, but were able to ‘navigate‘ on what they were drawing. They did not want to strip the corporation of it.

On advice of its auditor, the petitioner, on March 10, 1942, issued a demand promissory note to each of these men for the balance of his 1941 salary. The notes bore interest at the rate of 6 percent per annum until paid. The note to Sanford S. Lazarus was in the face amount of $3,971.45. The note to Leon E. Lazarus was in the face amount of $4,021.04. The difference between the amounts of the notes and of the accrued but unpaid salaries for 1941 resulted from charges of various small items against their respective accounts. These notes remained in the possession of the payees until fully paid some time during 1943. No part thereof was paid prior to that year. It was the intention of petitioner in issuing the notes and of the payees in receiving them that they should constitute payment of the salaries for 1941 to the extent of the respective amounts thereof.

The notes were worth par. The cash position of petitioner at the close of the years 1940 and 1941, respectively, was weak, but its credit was good.

The bank with which the petitioner was doing its banking would, on December 31, 1940, and on December 31, 1941, have loaned the petitioner $15,000 to $20,000 on unsecured note; and that line of credit continued up to the date of trial. Such a loan could have been completed and the money credited to the petitioner's account in one banking day. On January 15, 1940, the bank loaned petitioner $6,500 on its unsecured note. On December 31, 1940, petitioner had total assets of $88,871.22, including cash of $125, accounts receivable (less reserve for bad debts) $24,839.15, merchandise inventory $45,435.86, and other fixed assets $16,877.91. Its current liabilities were $30,542.70, other liabilities (other than stock) $4,554.20, and surplus $14,622.60. On December 31, 1941, its total assets were $128,331.42, including cash $2,600.82, accounts receivable (less reserve for bad debts) $26,192.01, inventory $46,770.60, and fixed assets $51,033.68. Its current liabilities were $27,001.51, other liabilities, other than stock, $18,696.22, and on a first mortgage $26,205.89. Surplus was $17,303.35.

From and after the time of crediting the accrued salaries to the accounts of the two officers in each of the years 1940 and 1941, petitioner, without borrowing, was not in a financial position to pay the accounts within the year of accrual, but it could have borrowed sufficient money to make such payments, and within possibly 30 days after the end of each year of accrual it could have paid in full the salaries of the preceding year's accrual without borrowing.

In its tax return for 1940 petitioner deducted as an expense $11,000 representing officers' salaries. For the year 1941 petitioner deducted $20,000 as officers' salaries. Respondent as to 1940 determined the deficiencies herein by disallowing deductions for the parts of the salaries which had been accrued but not paid in cash or by charges against the credit for salaries, and as to 1941 he disallowed $8,666.50 on the ground that notes given in that amount, for compensation accrued but unpaid, did not constitute payment.

The income tax returns of Sanford S. Lazarus and Leon E. Lazarus were filed on a cash basis, and for the years involved each reported as income the entire amount of the authorized and accrued salaries.

OPINION.

DISNEY, Judge:

The question presented is, are the provisions of section 24(c) of the Internal Revenue Code¹ applicable to the facts here, thus prohibiting the deductions for income tax purposes of the unpaid salary balances credited to petitioner's officers for the years 1940 and 1941?

It is uncontroverted that the contentions set forth in subdivisions (1), (2), and (3) of section 24(c) must coexist in order to prevent such deductions. Petitioner concedes the applicability of subdivision (3), but contends (a) that the crediting of the unpaid part of the salaries to its officers' accounts constitutes, under the facts here, constructive payment thereof within the years of accrual and thus renders inapplicable subdivision (1) both as to 1940 and 1941; and (b) that the issuance of its notes on March 10, 1942, for...