United Mercantile Agencies, Inc. v. Comm'r of Internal Revenue, Docket Nos. 40028

• Decision Date: 31 March 1955
• Docket Number: Docket Nos. 40028,40030.,40029
• Citation: 23 T.C. 1105
• Parties: UNITED MERCANTILE AGENCIES, INCORPORATED, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.F. W. DRYBROUGH, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.L. N. SIMPSON, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
• Court: U.S. Tax Court

23 T.C. 1105

UNITED MERCANTILE AGENCIES, INCORPORATED, PETITIONER,
v.
COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.F. W. DRYBROUGH, PETITIONER,
v.
COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.L. N. SIMPSON, PETITIONER,
v.
COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

Docket Nos. 40028

40029

40030.

Tax Court of the United States.

Filed March 31, 1955.

[23 T.C. 1106]

Donald V. Hunter, Esq., for the petitioners.

Lyman G. Friedman, Esq., and Melvin L. Sears, Esq., for the respondent.

1. The two principal officers of a corporation, who owned or controlled all of the outstanding capital stock, removed checks from the corporation's incoming mail basket, cashed the checks, and divided the proceeds in ratio to the amount of common stock owned or controlled. Held, the diverted funds are taxable as ordinary income to the corporation which is not entitled to an offsetting embezzlement loss under section 23(f) of the 1939 Code. Held, further, accrued but unpaid Federal taxes are not deductible in determining the amount of the earnings and profits of a cash basis corporation. Held, further, the diverted funds are taxable as dividends to the office-stockholders receiving them except that funds received by one office-stockholder on behalf of his wife and with respect to her stock were not taxable to him. Held, further, the corporation and the stockholders participating in the diversion of funds were liable for additions to tax because of fraud under section 293(b) of the 1939 Code.

2. The petitioner corporation purchased a mixed aggregate of claims from the liquidators of four insolvent banks. Allocation of the cost among the claims purchased from a particular liquidator was impractical. Held, no profit was realized on the claims purchased from a particular liquidator until the cost of those claims was recovered.

3. The petitioner corporation purchased cashier's checks in 1945 which it sent to its agent in Chicago to be used for the payment of real estate taxes. The checks were not turned over to the local tax officials, but were returned to the corporation in a subsequent year. Held, as a cash basis taxpayer, the corporation was not entitled to a deduction for taxes paid.

Respondent determined deficiencies in the tax of the petitioners and additions to tax as follows:

+------------------------------------------------+
                ¦United Mercantile Agencies, Inc. ¦
                +------------------------------------------------¦
                ¦ ¦ ¦Addition to tax ¦
                +------+-----------------------+-----------------¦
                ¦Year ¦Income tax deficiency ¦Sec. 293 (b) ¦
                +------+-----------------------+-----------------¦
                ¦1942 ¦$1,532.60 ¦$807.69 ¦
                +------+-----------------------+-----------------¦
                ¦1943 ¦ ¦78.27 ¦
                +------+-----------------------+-----------------¦
                ¦1944 ¦ ¦628.08 ¦
                +------+-----------------------+-----------------¦
                ¦1945 ¦ ¦1,071.92 ¦
                +------+-----------------------+-----------------¦
                ¦1946 ¦9,522.39 ¦4,761.20 ¦
                +------+-----------------------+-----------------¦
                ¦ ¦ ¦ ¦
                +------------------------------------------------+
                

 Declared value
                 excess-profits tax
                 deficiency
                1942 $4,395.83 2,197.92
                1943 7,602.00 3,834.00
                1944 8,776.92 4,592.25
                1945 5,408.85 3,548.91
                1946
                

 Excess profits
                 tax deficiency
                1942 $33,157.82 16,578.91
                1943 54,722.31 27,550.26
                1944 59,340.55 32,093.55
                1945 35,034.58 25,377.51
                1946
                

F. W. Drybrough
                

 Income tax deficiency
                1942 $20,994.83 10,497.42
                1943 17,194.94 8,004.57
                1944 70,294.45 35,147.23
                1945 38,287.68 19,143.84
                1946 24,929.67 14,464.84
                

L. W. Simpson
                

 Income tax deficiency
                1942 $5,643.25 2,821.63
                1943 13,557.09 6,472.94
                1944 10,404.75 5,202.38
                1945 8,544.95 4,272.48
                1946 5,448.69 2,724.35
                

[23 T.C. 1107]

The foregoing amounts are those set forth in the statutory notices of deficiency. In addition thereto respondent by motion duly made and granted has made claim for increased deficiencies in the case of F. W. Drybrough, Docket No. 40029, and in the case of L. W. Simpson, Docket No. 40030.

The proceedings were consolidated for hearing and opinion. The issues in controversy are as follows:

1. Whether respondent correctly determined that funds taken from the incoming mail basket of the corporate petitioner by its principal stockholders and officers were income to the corporation and that the corporation is not entitled to an offsetting ‘embezzlement’ loss under section 23(f) of the 1939 Code;

2. Whether respondent correctly determined that the diverted funds were taxable as dividends to the officer-stockholders receiving them;

3. Whether a cash basis corporation may deduct accrued but unpaid Federal taxes in determining the amount of its earnings and profits;

4. Whether the respondent correctly determined that the corporate and individual petitioners were liable for additions to tax because of fraud under section 293(b) of the 1939 Code;

5. Whether as to any of the petitioners, any of the taxable years involved are barred by the statute of limitations;

6. Whether respondent was correct in increasing the corporate petitioner's taxable income because receipts from a mixed aggregate of claims purchased from the liquidators of insolvent banks were first applied to a recovery of cost before reporting any profit; and

7. Whether respondent correctly determined that the corporate petitioner was not entitled in 1945 to a deduction for real estate taxes not actually satisfied until 1947.

FINDINGS OF FACT.

The stipulated facts are so found. United Mercantile Agencies, Incorporated (hereinafter referred to as United), is a Kentucky corporation with its offices in Louisville, Kentucky. F. W. Drybrough (hereinafter referred to as Drybrough), and L. N. Simpson (hereinafter referred to as Simpson), are individuals residing in Louisville, Kentucky. All of the petitioners kept their books and filed their Federal tax returns on a cash receipts and disbursements basis. Their returns in each of the taxable years were filed with the collector of internal revenue for the district of Kentucky.

United was organized in 1917 by Drybrough to engage in the business of conducting a collection and mercantile agency. The entire capital contribution of $1,500 was made by Drybrough. Marion S. McHenry, who married Drybrough in 1919 and is hereinafter referred

[23 T.C. 1108]

to as Drybrough's wife, was issued 5 per cent of the original stock. She was elected secretary of the corporation and has continuously held that office. Until 1933 she worked for United as a salaried officer, but thereafter she took no active interest in the management or affairs of the corporation.

During the taxable years involved Simpson, Drybrough, and the latter's wife were the directors of the corporation. The corporate officers were Drybrough, president, Simpson, vice president and treasurer, and Drybrough's wife, secretary. The common stock was held 55 per cent by Drybrough, 25 per cent by Simpson, and 20 per cent by Drybrough's wife. Simpson's stock had all been transferred to him by Drybrough at various times prior to 1941 in recognition of his services to the corporation or had been received as a stock dividend. The stock held by Drybrough's wife represented her original holding, stock received as a dividend, and shares which her husband had given her in 1935. There were also 222 shares of outstanding preferred stock. Drybrough owned 187 shares and Simpson owned 35 shares.

United declared and paid cash dividends on its common stock during the 1930's, but no dividend on common stock was formally declared subsequent to 1938. United paid a small dividend on its preferred stock in 1941 and 1942 and paid a 6 per cent dividend on its preferred stock in 1944, 1945, and 1946.

During the taxable years involved Drybrough managed and conducted all of his wife's business affairs. He had in his possession blank, signed, stock transfer forms which gave him the power to sell her corporate stock. Her corporate stock was kept in a safety-deposit box which was in their joint names. Drybrough collected all income on his wife's business properties. He could draw checks on her business bank account. She took no active part in the management of United and expected her husband to act on her behalf in all matters concerning the corporation. The stock in United owned by Drybrough's wife was controlled by Drybrough.

When mail was received by United in the years involved it was placed in the mail basket of the receptionist. Included among the mail would be checks payable on claims which the corporation had purchased and checks for fees on collections for others. In each of the taxable years Drybrough and Simpson from time to time removed checks from the mail basket, endorsed them or had them endorsed, and cashed the checks at the bank. Checks in excess of $500, which by custom were placed upon the desk of Simpson by the receptionist, were similarly endorsed and cashed. Checks taken by these officers for cashing in the manner stated above were not reflected in any manner upon the accounting records of United nor were they at any

[23 T.C. 1109]

time on deposit in the bank to the credit of United. Generally the checks taken represented final collections on purchased assets. The proceeds of the cashed checks were divided in the ratio of 75 per cent to Drybrough and 25 per cent to Simpson.

The aggregate amounts¹ in checks taken by Drybrough and Simpson, representing collections, fees, and miscellaneous items, were as follows:

+----------------------------------------+
                ¦Year¦Collections¦Fees ¦Miscellaneous¦
                +----+-----------+---------+-------------¦
                ¦1942¦$32,232.78 ¦$5,085.80¦ ¦
                +----+-----------+---------+-------------¦
                ¦1943¦53,758.97 ¦10,164.52¦$3,034.37 ¦
                +----+-----------+---------+-------------¦
                ¦1944¦54,649.81 ¦21,114.36¦1,856.80 ¦
                +----+-----------+---------+-------------¦
                ¦1945¦26,097.74 ¦5,221.66 ¦1,532.59 ¦
                +----+-----------+---------+-------------¦
                ¦1946¦22,909.31 ¦2,427.25 ¦ ¦
                +----------------------------------------+
                

Only Drybrough and Simpson knew of their practice of taking checks from the incoming mail basket and...