PLASTIC BINDING CORPORATION v. Commissioner, Docket No. 117-65

• Decision Date: 13 July 1967
• Docket Number: 7124-65.,Docket No. 117-65
• Citation: PLASTIC BINDING CORPORATION v. Commissioner, 26 T.C.M. (CCH) 687, 1967 TC Memo 149 (T.C. 1967)
• Parties: Plastic Binding Corporation v. Commissioner. Bertha I. Spinner v. Commissioner.
• Court: U.S. Tax Court

26 T.C.M. (CCH) 687 (1967)

T.C. Memo. 1967-149.

Plastic Binding Corporation v.Commissioner.

Bertha I. Spinner v.Commissioner.

Docket Nos. 117-65, 7124-65.

United States Tax Court.

Filed July 13, 1967.

Maurice P. Wolk, for the petitioner in docket No. 117-65.Bernard H. Sokol, for the petitioner in docket No. 7124-65.James F. Hanley, for the respondent.

Memorandum Findings of Fact and Opinion

SIMPSON, Judge:

The respondent determined a deficiency in petitionerBertha I. Spinner's Federal income tax of $12,461.74 for 1961 and $9,764.02 for 1962.In the case of Plastic Binding Corporation, he determined a deficiency in Federal income tax of $14,820 for its taxable year ending September 30, 1961, and $7,410 for its taxable year ending September 30, 1962.

In these consolidated proceedings, the issues are whether the amounts which a widow receives from the employer of her deceased husband by reason of his death are gifts or are includable in her gross income as compensation or as dividends, and whether such amounts are deductible by the employer.

Findings of Fact

Some of the facts were stipulated and those facts are so found.

The petitioner in docket No. 7124-65, Bertha I. Spinner(Bertha), resided in Chicago, Illinois, when her petition in this case was filed with this Court.She filed her Federal income tax returns on a calendar year basis for 1961 and 1962 with the district director of internal revenue at Chicago.

The petitioner in docket No. 117-65, Plastic Binding Corporation(Plastic), is a Delaware corporation which had its principal office in Chicago, Illinois, when the petition in this proceeding was filed.It used an accrual method of accounting for determining taxable income and filed Federal income tax returns with the district director of internal revenue at Chicago for its taxable years ending on September 30, 1961, and September 30, 1962.

Plastic was organized in 1935 and has been engaged in the manufacture of plastic bindings and equipment used in the book binding process.During recent years, the business has been profitable.From 1953 through 1961, Plastic paid a dividend of $16 per share, and in 1962, it was increased to $20 per share.In 1961, the total cash dividends paid amounted to $51,200, approximately two-thirds of its after-tax profits.In 1962, dividends amounted to $64,000 and exceeded after-tax income.

The ownership of Plastic was equally divided between two families.Immediately prior to September 1960, the outstanding stock of Plastic was held as follows:

                                             Number of
                      Shareholder                              Shares
                  Isidore Spinner .........................    800
                  *Isidore Spinner, Trustee ...........    400
                  Ruth Spinner Rapp .......................    400
                  John Smart ..............................    300
                  Gwen Smart ..............................    233
                  Edgar G. Richards .......................    200
                  Florence Richards .......................    333
                  A. D. Elden .............................    300
                  Vera Elden ..............................    234
                                                             _____
                                                             3,200
                * Beneficial ownership of these shares was in
                Mrs. Lloyd Spinner
                

Gwen Smart is the wife of John Smart(Smart); Edgar G. Richards is Smart's brother-in-law; Florence Richards is Smart's sister; A. D. Elden(Elden) is Smart's brother-in-law; the late Vera Elden was Smart's sister.Ruth Spinner Rapp is Isidore Spinner's (Spinner) daughter and is married to Joseph Rapp.

Following the death of Spinner, his 800 shares passed to Continental Illinois National Bank and Trust Company(Continental) as executor of his estate.Such stock was included in a residuary bequest to Bertha, Spinner's widow, and the bank would vote such stock in accordance with her wishes unless such action would be inconsistent with its fiduciary duty to preserve the value of the stock.Bertha succeeded Spinner as trustee of the 400 shares held for Mrs. Lloyd Spinner and had the right to vote such shares.

Plastic had four directors, and, historically, two were designated by the Spinner family and two by the Smart family.Immediately before Spinner's death, the board of directors was composed of Spinner and Bertha, Smart, and Elden.Relations between the two families were strictly on a business basis.

On September 18, 1960, Spinner died leaving Bertha a widow.Spinner was one of the founders of Plastic and was, until his death, its president and chief executive officer, as well as one of its directors.He began work with the corporation in 1935 at a salary of $6,500 per year, which was increased 3 to 5 years later to $10,000.Subsequent salary increases brought his annual compensation to $30,000 by the time of his death.Most of Plastic's employees had been hired by Spinner, and he was in contact with the corporation's customers.

Spinner left a will in which he directed his executor"to make every effort" to have Bertha substituted in Spinner's place in all of his business enterprises and to receive all of his salaries and other compensation.It was Continental's policy to treat such language in a will as precatory, requiring the bank's best efforts to accomplish the testator's wishes, but not requiring it to bring a law suit for that purpose.Myron Davis(Davis), a New York lawyer who had some familiarity with the business and other affairs of Plastic since 1939, and who had represented the Smart family, accompanied Smart to the funeral and learned of this will and Bertha's desire to succeed Spinner as president of Plastic.

Shortly after he returned to New York, Davis received a call from Harry Schulman(Schulman), a Chicago attorney.Schulman advised Davis that he represented Bertha and the Spinner family.Schulman stated that there were several unresolved questions in connection with Plastic's business and that Bertha desired a meeting of the company's board of directors in Chicago as soon as possible.

Early in October 1960, Smart and Davis went to Chicago and met with Elden and Schulman.Schulman demanded that Plastic pay to Bertha the sum of $60,000, which was the equivalent of 2 years of her late husband's salary.Schulman also indicated that Bertha wanted to succeed Spinner as president of Plastic.Smart and Elden, who comprised a majority of the board of directors at that time, did not agree to either request by Schulman.

Both before and after Spinner's death, Plastic made salary continuation payments to families of deceased key personnel.In the judgment of Smart and Elden, this policy serves the business and economic interests of Plastic because it improves the morale of key employees and encourages their loyalty to the company.Prior to Spinner's death, salary continuation payments were made to the families of two key employees; since Spinner's death, similar payments were made to the families of two other key workers.Of these deceased employees, only one was a stockholder.

Smart and Elden always believed that some payment should be made to Bertha, but they thought that $60,000 was excessive.In determining the amount of salary continuation payments to be made to the family of a deceased employee, Plastic's directors generally took into consideration a number of factors such as the nature and length of the decedent's employment, his contribution to the success of the business, and the salary which he had received from Plastic while alive.Based upon these considerations, Smart believed that Plastic should pay $30,000 to Spinner's widow; Elden felt that she should get not more than $30,000, but possibly less.

Since the parties were unable to reach an agreement during the early October meeting, the attorneys, Davis and Schulman, were directed to continue negotiations.In the course of their discussions, Schulman continued to demand $60,000 for Bertha, to ask that she be appointed president of Plastic, and to urge that a new director from the Spinner family be elected to replace Spinner.

During the course of the negotiations between the attorneys, Schulman pointed out that because the Spinner and Smart families each owned 50 percent of Plastic's capital stock, either family could prevent a quorum from being present at annual stockholders' meetings and could thereby lead to appointment of a receiver for the company and possibly its ultimate liquidation.Davis notified Smart and Elden of this danger.However, Schulman did not categorically state that if his demands were not met, he would put the company into receivership.

Both Smart and Elden were concerned that a continuation of the controversy with Bertha would adversely affect Plastic's business.Both felt that if news of the dispute became known, it would impair the effectiveness and loyalty of key personnel; Elden also felt that customers would react unfavorably to news of the dispute and would take their business elsewhere.Both Smart and Elden were concerned about the difficulty of operating a business which dissension existed between two groups of stockholders, each of whom owned 50 percent of the stock.

The parties were unable to come to any agreement regarding the amount to be paid by Plastic to Bertha until the intercession of William M. Funck(Funck) of Continental.He was aware of the negotiations that had taken place and had participated in some of the discussions.By December of 1960, he was concerned about the inability of the parties to settle their dispute and its effect upon the value of the Plastic stock.In that month, he met with Smart and Davis in New York and urged that a settlement be reached with Bertha in order to avoid damage to Plastic's business.Funck recommended as a basis for settlement that Plastic pay $45,000 to Bertha, that Smart be elected president of Plastic, and that Joseph Rapp(Rapp), son-in-law of Bertha, be elected to fill the vacancy on the board of directors.

Early in January...