Ross v. Commissioner of Internal Revenue, 4281.

Citation169 F.2d 483
Decision Date13 July 1948
Docket NumberNo. 4281.,4281.
PartiesROSS v. COMMISSIONER OF INTERNAL REVENUE.
CourtUnited States Courts of Appeals. United States Court of Appeals (1st Circuit)

COPYRIGHT MATERIAL OMITTED

Stanley M. Brown, of Manchester N. H. (McLane, Davis & Carleton, of Manchester, N. H., on the brief), for petitioner.

Abbott M. Sellers, Sp. Asst. Atty. Gen. (Theron Lamar Caudle, Asst. Atty. Gen., Helen R. Carloss, Robert N. Anderson, and Maryhelen Wigle, Sp. Assts. to Atty, Gen., on the brief), for Commissioner of Internal Revenue.

Before FRANKFURTER, Circuit Justice, and MAHONEY and WOODBURY, Circuit Judges.

FRANKFURTER, Circuit Justice.

Lewis H. Ross petitions for review of a decision of the Tax Court of the United States entered February 11, 1947, determining a deficiency of $6,611.15 in his income tax liability for the year 1939. This deficiency represents the tax due on amounts which, having been previously credited to petitioner's account as salary in the years 1927 to 1932, inclusive, on the books of a corporation of which he owned half the common stock, were received by him in cash in the years 1939, 1940, and 1941.

Most of the facts are stipulated and adopted as findings of fact by the Tax Court. In December, 1925, Ross entered the firm of E. M. Chase Co., Inc., in Manchester, N. H., under the terms of an agreement with his uncle, Edward M. Chase, who then owned and controlled the company. The firm was engaged in the retail installment sale of furniture and household appliances. The agreement, effective on January 4, 1926, provided, among other things, that Ross was to buy 50 of the 100 outstanding shares of common stock of the company, that the company was to purchase each year from Chase $10,000 of his preferred stock, and that after all of Chase's preferred stock was retired, he was to sell to Ross his half of the common stock. It was further agreed that for two years Chase was to receive a weekly salary of $100 and Ross of $75, and that subsequent salaries were to be determined later by mutual agreement. Prior to the effective date of the agreement, the capital stock of the company amounted to $110,000, consisting of $100,000 in 6% preferred stock and $10,000 in common stock, and the books of the corporation showed a surplus of $38,000. On or about January 4, 1926, it was voted to increase the preferred stock to $138,000 by capitalizing the surplus. Fifty shares of common stock were thereafter transferred to Ross.

The subsequent salary agreement contemplated by Ross and Chase was entered into on January 1, 1927, fixing the salary of Chase at $10,400 per year and that of Ross at $7,800 per year. It provided, further, that one half of these salaries was to be paid in cash weekly and that the remaining half was to be credited weekly on the books of the company to Ross and Chase, but allowed to remain in the treasury of the corporation as working capital until all the preferred stock held by Chase was redeemed by the company, at which time the balance of accrued salaries due to Chase and Ross was to become payable. Another agreement, on January 2, 1928, increased the salary of Chase to $17,500 per year, and that of Ross to $10,000 per year, and again restricted the withdrawal of salaries, this time providing that $75 weekly be paid in cash to each and that the remainder of the salaries be credited weekly on the books of the company and allowed to remain in the treasury as working capital until the preferred stock held by Chase was entirely redeemed.

Under the terms of these salary agreements, Ross and Chase thereafter withdrew in cash only a portion of their salaries, and allowed the remainder to accrue on the books of the company. The amounts actually paid to Ross and the amounts accrued to his credit on the company's books from 1927 to 1932 were:

                Total
                Year Ended Salary Withdrawn Accrued Accrued
                  December 31, 1927 ................  $ 7,800    $ 3,900    $ 3,900    $ 3,900
                  December 31, 1928 ................   10,000      3,900      6,100     10,000
                  December 31, 1929 ................   10,000      4,800      5,200     15,200
                  December 31, 1930 ................   10,000      5,100      4,900     20,100
                  December 31, 1931 ................   10,000      5,100      4,900     25,000
                  December 31, 1932 ................    9,400      4,500      4,900     29,900
                                                      _______    _______    _______
                                                      $57,200    $27,300    $29,900
                

Ross included in his federal income tax returns for the years 1927 through 1932, filed on a cash receipts and disbursements basis, only the amounts of salary which he received in cash. Thus, as of December 31, 1932, $29,900 in salaries was accrued to the credit of Ross which had not been included in his income tax return for any year, and on which no federal income tax had been paid. Meanwhile, E. M. Chase Company, in its corporate income tax returns filed on the accrual basis of accounting, claimed, and was allowed, deductions for the full amount of all salaries paid and credited to Chase and Ross.

The preferred stock held by Chase was gradually retired by the company by payments in cash and by the issuance of promissory notes, so that by April, 1932, redemption was complete, removing the prohibition effected by the salary agreements against full cash payment of the salaries of Chase and Ross.

The financial status of E. M. Chase Company, as shown by its balance sheets for the years 1926 through 1941, was also stipulated and referred to by the Tax Court as perhaps bearing on the question of the company's ability to have paid the accrued salaries. As of December 31, 1932, when the accrued salaries of Chase and Ross amounted to $98,400, the company had a cash overdraft of $477.09, its accounts receivable were $265,393.95, and its surplus was $62,994.84. The Tax Court found, though not stipulated, that the company had "a line of bank credit of $50,000. It had a policy of not selling its accounts receivable, which could have been sold, and the only accounts receivable ever sold by the company were sold to Chase under the agreement of December 30, 1925." But the Tax Court made no finding on the company's actual ability to pay the accrued salaries.

In the years 1933 and 1934 Ross continued to include in his income tax returns only the amount of salary paid to him. There were no accruals in 1935. In 1936, the Commissioner of Internal Revenue assessed a deficiency against Ross's income for 1933 and 1934,1 on the theory that amounts accrued on the books of the company to Ross's credit in those years were constructively received by him. Thereafter, Ross included in his income tax returns all salaries earned by him, whether or not received. The Tax Court found as a fact, though not stipulated, that in connection with the deficiency assessments for 1933 and 1934, a letter to Ross from the office of the Commissioner, signed by a representative of the Technical Staff, enclosed a copy of a report of the Revenue Agent, stating:

"Since a claim for bona fide salary has precedence over the retirement of preferred stock, it follows that the reversed procedure followed in this case could have been done only with the consent of the taxpayer who not only had a complete knowledge of all those procedures but actually was a party in arranging them. The entire salary from E. M. Chase Company is therefore included in income of the current year. * * *"

Apparently the Tax Court found from this letter knowledge on the part of the Commissioner in 1936 at the time of the assessments for 1933 and 1934 of the ability of Ross to have withdrawn the accrued salary in 1932. The Court also found that Ross at the time of these assessments believed that the company could not have paid the accrued salaries (though it is not clear whether the Court was referring to Ross's opinion as to the company's financial ability in 1933 and 1934 alone, or from 1927 through 1932 also), but that Ross's opinions somewhat reflected those of Chase who was "more or less in charge of the financial operations of the company."

Beginning in 1936, Ross began to make withdrawals from his accrued salary account in the following amounts:

                Withdrawals from
                Year Accrued Account
                  1936 ......................   $707.22
                  1937 ......................     592.72
                  1938 ......................     604.01
                  1939 ......................  13,007.85
                  1940 ......................   9,447.70
                  1941 ......................  12,755.01
                

In his income tax returns for the years 1936 through 1941, though now reporting salary currently accrued as well as salary received in cash, Ross did not report any part of the withdrawals from his accrued salary account.

The Commissioner thereupon, on October 25, 1945, notified Ross of a deficiency of $8,988.15 in income tax liability for the years 1939,2 1940, and 1941, representing the tax due on the income represented by these withdrawals, as follows:

                Year Liability Assessed Deficiency
                  1939 ... $4,190.12   $1,542.90   $2,647.22
                  1940 ...  7,876.00    4,332.20    3,543.80
                  1941 ... 10,363.93    7,566.80    2,797.13
                           __________  __________  _________
                  Totals   $22,430.05  $13,441.90  $8,988.15
                

Though the withdrawal made during 1941 was $12,755.01, the Commissioner included only $5,545.50 of this amount in computing the deficiency for that year, on the theory that the latter amount, added to the withdrawals made in prior years, was sufficient to total the full $9,900 accrued and not reported from 1927 through 1932.3

On January 17, 1946, Ross filed a petition with the Tax Court seeking a redetermination of the deficiency computed by the Commissioner. At the hearing before the Tax Court on June 21, 1946, evidence was introduced that on the returns for 1939, 1940, and 1941 a typewritten "X" appeared in the squares indicating that the returns were filed on the accrual basis of accounting. The Commissioner, therefore, moved for leave to file an amendment to his answer in...

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