Putoma Corp. v. C. I. R.
| Decision Date | 27 August 1979 |
| Docket Number | No. 77-1591,77-1591 |
| Citation | 601 F.2d 734 |
| Parties | 79-2 USTC P 9557 PUTOMA CORP., Successor by Merger of Pro-Mac Company, et al., Petitioners- Appellees Cross-Appellants, v. COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellant Cross-Appellee. |
| Court | U.S. Court of Appeals — Fifth Circuit |
M. Carr Ferguson, Asst. Atty. Gen., Gilbert E. Andrews, Act. Chief, Dept. of Justice, Tax. Div., Washington, D. C., Michael L. Paup, Richard Farber, Attys., Tax Div., Dept. of Justice, Washington, D. C., for respondent-appellant cross-appellee.
Richard Lee Brown, Fort Worth, Tex., for petitioners-appellees cross-appellants.
Appeals from the Decisions of the United States Tax Court.
Before GODBOLD, Circuit Judge, SKELTON, Senior Judge *, and RUBIN, Circuit Judge.
This is an income tax case that involves an appeal by the Commissioner of Internal Revenue (Commissioner or Government) from a decision of the United States Tax Court, and cross-appeals by Putoma Corporation (Putoma), successor by merger of Pro-Mac Company (Pro-Mac), with J. M. Hunt and wife, Inez Hunt, as appellees in the appeal of the Commissioner.
At all times pertinent to this case, Putoma Corporation and Pro-Mac Company were Texas corporations using the accrual basis of accounting.
The Commissioner of Internal Revenue appeals from decisions of the Tax Court in which the court ruled that taxpayers Pro-Mac Company 1 and Putoma Corporation did not realize taxable income as the result of the cancellation by J. M. Hunt of their liability for accrued interest due him on Putoma's notes. The two corporations have filed cross-appeals from the portions of the Tax Court's decisions disallowing certain deductions claimed for accrued salaries and bonuses for J. M. Hunt and Lee Roy Purselley. The Tax Court filed its findings of fact and opinion on June 30, 1976 (reported at 66 T.C. 652) and entered its decisions on December 15, 1976.
The issues on appeal are as follows:
THE ISSUE PRESENTED BY THE COMMISSIONER IS:
(1) Whether the Tax Court erred in holding that said accrual basis corporations, which previously had accrued and deducted interest which they owed, but never paid, to J. M. Hunt, one of their shareholders, did not realize taxable income when the shareholder cancelled their liability for the accrued interest.
THE ISSUE PRESENTED BY THE TAXPAYERS IS:
(2) Whether the Tax Court erred in holding that said accrual basis corporations, which accrued certain compensation for their officer shareholders, Lee Roy Purselley and J. M. Hunt, under a fixed formula, but which was not paid, were not entitled to deduct such compensation on the ground that their obligation for same was conditional and not properly accruable during the years in question.
We affirm the decision of the Tax Court on both issues.
We consider first the second issue involving the accrued compensation for officer-shareholders Purselley and Hunt, which was never paid but was deducted by the corporations.
The facts relevant to this appeal by taxpayers were found by the Tax Court as follows:
At a meeting of Putoma's directors held in July, 1964, Purselley's 2 salary was set at $600 per month, retroactive from July 1, 1963. This salary was not to be paid, but was to accrue to his credit until such time as, in the judgment of the majority of directors, corporate earnings were sufficient to justify payment of the salary. In addition, as part of his compensation, Purselley was to receive 25 percent of the corporation's net profits. Compensation from July 1, 1964, was to be determined at a future meeting.
The minutes of the board of directors' meeting for Putoma held on August 23, 1965, contain the following statement relating to salary:
Upon motion duly made and seconded, the salary of Lee Roy Purselley for the current year was fixed at $2,000.00 per month plus 25% Of the net profit of the corporation after deduction of the $2,000.00 monthly salary, but before deduction for any bonus or Federal income taxes. This salary is to be retroactive from July 1, 1965. Such salary in excess of the $2,000.00 per month is not to be paid but to accrue to his credit until such time as in the judgment of the majority of the directors of the company, the company has such cash reserve in order to pay the additional salary.
Upon further motion duly made and seconded, the salary of J. M. Hunt was established at 10% Of the net income of the company before the deduction of any bonus or Federal income taxes. This salary is to be retroactive from July 1, 1965. Such salary is not to be paid, but to accrue to his credit until such time as in the judgment of the majority of the directors of the company, the company has sufficient cash reserve in order to pay the salary.
The compensation formula set out above remained unchanged until January 1, 1970. At a meeting of Putoma's directors held on December 10, 1969, bonuses for Purselley and Hunt were discontinued as of December 31, 1969, and Purselley's salary was set at $3,000 per month beginning January 1, 1970.
The following schedule shows salary and bonus accruals, and cash payments for Purselley and Hunt recorded on Putoma's books for fiscal years ended June 30, 1964, through calendar year December 31, 1971:
LEE ROY PURSELLEY
-----------------
RECORDED ON BOOKS
-----------------
CASH
PERIOD ENDED YEARLY SALARY YEARLY BONUS PAYMENTS
------------ ------------- ----------------- -----------
6/30/64 $ 7,200 $ 2,763.64 $ --
6/30/65 7,200 2,791.59 10,335.94
6/30/66 24,000 21,408.42 11,210.00
6/30/67 24,000 45,115.41 29,909.32
6/30/68 24,000 85,324.03 38,004.57
6/30/69 24,000 43,833.66 3 33,269.86
6/30/70 30,000 -- 25,480.44
12/30/70 18,000 -- 14,000.00
12/31/71 -- -- 15,473.75
------------- ----------------- -----------
$158,400 $201,236.75 $177,683.88
J. M. HUNT
----------
6/30/64 $ -- $ -- $ --
6/30/65 -- -- --
6/30/66 -- 8,563.87 --
6/30/67 -- 6,711.92 --
6/30/68 -- 34,129.61 --
6/30/69 -- 17,533.46 --
6/30/70 -- -- --
12/31/70 -- -- --
12/31/71 -- -- --
------------- ----------------- -----------
$ -- $66,938.86 $ --
Pro-Mac was formed on December 1, 1966. Article V, Section 4 of Pro-Mac's by-laws provides that the salaries of corporate officers are to be fixed by the board of directors. The minutes of the organizational meeting of Pro-Mac's board of directors, however, contain no mention of officer compensation. Further, there were no board of directors' minutes for Pro-Mac during the period November 30, 1966, through July 18, 1969. Nevertheless, Pro-Mac's books and records for that period reflect that the corporation consistently recorded a salary expense of $1,000 per month for both Hunt and Purselley, and further recorded a bonus expense equal to 25 percent of profits for Purselley and bonus expense equal to 10 percent of profits for Hunt. The Tax Court found, however, that the salaries and bonuses for Purselley and Hunt recorded by Pro-Mac on its books were not payable until Pro-Mac's earnings were sufficient to permit payment.
The first minutes to discuss compensation for Pro-Mac's officers were those of a directors' meeting held December 10, 1969. At that time, it was decided to discontinue the bonuses for Purselley and Hunt and to fix Purselley's salary at $3,000 per month commencing January 1, 1970. At a subsequent meeting held August 27, 1970, a $1,000 per month salary was also voted for Hunt, retroactive to January 1, 1970. Due to the low cash condition of the corporation, Hunt's salary was to be recorded in his "accrued salary account," but was not to be paid until a later date when the corporation was "financially able."
The following schedule shows when salary and bonus amounts and cash payments for Purselley and Hunt were recorded on Pro-Mac's books for fiscal years ended July 31, 1967, through August 31, 1971 (R. 104):
LEE ROY PURSELLEY
-----------------
RECORDED ON BOOKS
-----------------
CASH
PERIOD ENDED YEARLY SALARY YEARLY BONUS PAYMENTS
------------ ------------- ------------ ----------
7/31/67 $ 8,000 $ 9,366.11 $ --
7/31/68 12,000 27,466.04 --
7/31/69 12,000 14,575.63 30,097.54
7/31/70 12,000 4,753.85 --
7/31/71 -- -- --
8/31/71 -- -- --
------------- ------------ ----------
$49,000 $56,161.68 $30,097.54
J. M. HUNT
----------
7/31/67 $ 8,000 $ 3,746.44 $ --
7/31/68 12,000 10,986.41 --
7/31/69 12,000 5,830.25 30,097.54
7/31/70 12,000 1,208.20 --
7/31/71 5,000 -- --
8/31/71 -- -- --
------------- ------------ ----------
$44,000 $21,771.30 $30,097.54
At a meeting of Putoma's board of directors on July 9, 1970, a...
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