Pulsar Components International, Inc. v. Commissioner

• Decision Date: 14 March 1996
• Docket Number: Docket No. 15172-92.
• Citation: 71 T.C.M. 2436
• Court: U.S. Tax Court
• Parties: Pulsar Components International, Inc. v. Commissioner.

71 T.C.M. 2436

T.C. Memo. 1996-129

Pulsar Components International, Inc. v.Commissioner.

Docket No. 15172-92.

United States Tax Court.

Filed March 14, 1996.

Charles R. Goulding, Syosset, N.Y., and Michael S. Press, for the petitioner.Halvor N. Adams III and Thomas J Kerrigan, for the respondent.

MEMORANDUM FINDINGS OF FACT AND OPINION

LARO, Judge:

Pulsar Components International, Inc., petitioned the Court to redetermine respondent's determination of a $382,771 deficiency in its income tax for its taxable year ended July 31, 1985.Respondent determined that $822,000 of the $2,922,000 claimed by petitioner as officers' compensation was unreasonable.In an amendment to her answer, respondent asserted that $2,324,170 of the claimed compensation was unreasonable, increasing the claimed deficiency to $1,089,369.Respondent also asserted in the amendment that petitioner was liable for an addition to tax under section 6661.

We must decide the amount of compensation paid by petitioner that is reasonable and thus deductible as a business expense under section 162.We hold all of it is.¹Unless otherwise stated, section references are to the Internal Revenue Code in effect for the year in issue.Rule references are to the Tax Court Rules of Practice and Procedure.We separately refer to Thomas F. Laviano and Peter T. Woll as Mr. Laviano and Mr. Woll, respectively.We collectively refer to them as the Officers.

FINDINGS OF FACT

Some of the facts have been stipulated and are so found.The stipulations and attached exhibits are incorporated herein by this reference.Petitioner's principal office was in Hicksville, New York, when it petitioned the Court.Petitioner filed its Federal income tax return based on a fiscal year ending July 31, 1985, and it used the cash receipts and disbursements method.

1.Petitioner

Petitioner is a "third-tier chip broker" that locates, purchases, and sells computer chips electronic components, and integrated circuits.²Petitioner and its predecessor, Pulsar Components, Inc.(Components), developed a niche in their field that enabled them to take advantage of supply and demand imbalances caused by the production capacities of microchip manufacturers and the production needs of computer manufacturers.Petitioner located scarce parts during periods of low supply and high demand by using a network of brokers, surplus houses, distributors, and manufacturers, of which it had a working knowledge, and by using the sources of supply that were developed therefrom.

Unlike its competitors, petitioner derived economies by copying the trading operations of some of the large securities firms on Wall Street in New York, New York.Petitioner's traders worked out of a trading pit where purchasing and selling transactions were brokered in a matter of seconds.Petitioner's traders did not have a set markup on parts sold; instead, they worked off market prices; i.e., petitioner profited on the spread between the purchase and selling price when it was able to match a customer's need with the integrated circuits that petitioner could locate.Petitioner carried minimal inventory, had a high inventory turnover rate, and had no written agreements with manufacturers.Petitioner generally did not order goods for which it did not have a buyer, and in the rare cases that it did, it always had the option of selling the goods before they were delivered or canceling the order.

2.Petitioner's Owners

The Officers were longtime friends who met in grade school.They organized Components in October 1979 by contributing a total of $2,000 in cash in return for all of its stock.Mr. Laviano received 75 percent of the stock, and Mr. Woll received the other 25 percent.The business of Components was headquartered in the basement of the home of Mr. Laviano's parents.The Officers used card tables and folding chairs as furniture, and they rented telephones.

With the Officers at the helm, Components prospered and became a successful entity.Although its gross receipts varied greatly from year to year, based on the volatility of the industry, Components reported the following results for the taxable years ended November 30, 1979, through November 30, 1982:

Nov. 30, 1979   Nov. 30, 1980   Nov. 30, 1981   Nov. 30, 1982
                Sales .........................      $251,588       $5,061,159      $1,876,555      $2,061,989
                Gross profit on sales .........        $5,349       $1,499,411        $779,655        $832,036
                Gross profit on sales as a
                  percentage of sales .........           2.1%            29.6%           41.5%           40.4%
                Taxable income (loss) .........         ($110)         ($4,592)         $4,136         $32,967
                Retained earnings (deficit) ...         ($110)        ($14,691)       ($11,562)        $23,806
                

In the fall of 1982, the Officers agreed to transfer Components to petitioner so that Mr. Woll could increase his ownership percentage and John Laviano, Mr. Laviano's younger brother, could become a shareholder.Petitioner was organized on August 3, 1982.From petitioner's organization through July 31, 1985, Mr. Laviano owned 55 percent of its stock, Mr. Woll owned 40 percent, and John Laviano owned the remaining 5 percent.Petitioner's board of directors consisted of Mr. Laviano, Mr. Woll, and John Laviano.Petitioner commenced business on December 1, 1982.

Petitioner conducted the same business as Components; the only changes were the addition of the word "International" to the name and the change in ownership percentages.All of Components' accounts and sources of supply that were developed prior to petitioner's organization, and all employees who were trained prior to the organization of petitioner, were transferred to petitioner.

a.Mr. Laviano

Mr. Laviano was petitioner's president.He received a bachelor of science degree in accounting from St. John's University in 1977.After graduating from college, Mr. Laviano worked for Semi-Specialists of America, Inc.(SAI), one of the largest and most profitable semiconductor brokerages in the nation.SAI was an electronics business that functioned as a middleman for computer chips and other electronic components, much as petitioner did.Mr. Laviano worked for SAI for approximately 1 year.While he was employed there, Mr. Laviano learned SAI's business well enough to go into the business for himself.During the year in issue, Mr. Laviano worked for petitioner approximately 60 to 80 hours per week, 52 weeks per year.Mr. Laviano was a devoted workaholic who was committed to petitioner's business and success.

b.Mr. Woll

Mr. Woll was petitioner's secretary and treasurer.He graduated from Yale University, cum laude, in 1977, receiving his bachelor of arts degree in economics and political science.After graduating from college, Mr. Woll worked on Wall Street as a trader in U.S. Treasury securities, first for A.G. Becker, Inc., for about 1 year, and then for First International Money Markets.At A.G. Becker, Inc., he placed third on its list of top salesmen for the month in which he left.Mr. Woll also did very well at First International Money Markets.He left First International Money Markets in September 1979 to organize Components with Mr. Laviano.During the year in issue, Mr. Woll worked for petitioner for approximately 50 to 80 hours per week.Like Mr. Laviano, Mr. Woll was a devoted employee who was totally dedicated and committed to petitioner's business and its success.

c. The Officers' Duties

The Officers were involved in every aspect of petitioner's business.They performed all of its executive and managerial functions, oversaw all of its employees, and were directly responsible for its success.The Officers served as co-chief traders, overseeing all of petitioner's purchases and sales and approving all of its deals.The Officers bought and sold parts for petitioner, quoted all of its prices, and supervised all of its traders.The Officers recruited, interviewed, hired, and trained petitioner's employees.

The Officers also were petitioner's executive officers and managers.They were directly responsible for profit maximization, long-term business planning, office automation, cash management, physical plant expansion, marketing, and all other management functions.When not trading, Mr. Woll focused on administrative functions and was in charge of cash disbursements, cash receipts, billing, receivables, and investigating credit.Mr. Woll also dealt with petitioner's accountants, lawyers, and bankers, and he supervised petitioner's bookkeeping staff.The Officers supervised the shipping staff, and they personally inspected every part received by petitioner in order to ensure that the parts were not counterfeit or defective.

3.Petitioner's Operations

For the 3-year period ended with the year in issue, petitioner's gross receipts (net of returns and allowances), gross income, book income, taxable income, Officers' compensation, Officers' compensation percentages, and Officers' equity were (rounded to the nearest dollar):

Gross
                Taxable Year                  Receipts     Net Income   Taxable Net     Officers'
                Ended July 31                   (Net)       Per Books     Income1 Compensation
                19832 ....................   $ 2,671.061   $   88,903    $   88,903    $   26,000
                1984 .....................    29,763,657    1,796,032     1,823,904     1,449,000
                1985 .....................    10,693,635    3,546,647     3,546,647     2,922.000
                1 Before deduction of officers compensation
                2 This year, petitioner's first, represents approximately 8 months of operation
                Officer Compensation Percentages
                                                     --------------------------------
                                                     Officer Compensation Divided by
                                               -------------------------------------------
                                                 Gross
                Taxable Year                   Receipts    Gross   Net Income     Taxable
                Ended July 31                    (Net)

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