ten thousand ($210,000) Dollars in book value, exclusive of good will, trade marks, trade names or labels. It being agreed that if the parties of the first part should refuse to deliver the said stock as security after the incorporation of the business, the party of the second part may at his option, call and declare due all of the aforesaid notes delivered to him in addition to any remedy that he may have to recover the said securities. It being understood that the parties of the first part may anticipate the said payments or any of them. And also as payments are made that the party of the second part will surrender to the parties of the first part five per cent (5%) of the said stock deposited as collateral. Should the parties of the first part default in carrying out this contract in accordance with either of the foregoing alternatives, then the party of the second part may retain as liquidated damages, the sum of Ten thousand ($10,000) Dollars out of the amounts theretofore paid by the parties of the first part on account hereof and the balance shall then be returned to the parties of the first part and this contract shall cease and be void, and the interest of the party of the second part in said business to remain unimpaired. The partnership of Lang & Lewin was forthwith organized on November 1, 1922, the books of the old partnership being continued and not closed. The individuals, Carl Lang and Lewin, exercised the option stated in their agreement with Hoffman to pay the amount of $225,000 for Hoffman's interest in the partnership assets of Lang & Hoffman, and $100,000 was paid on account during 1922, the balance of $125,000 being covered by notes delivered in 1922 but payable over 1923 and 1924. The profits of the partnership of Lang & Hoffman were divisible between: Hoffman. Lewin Per cent. 45 45 10 The profits of the partnership of Lang & Lewin were divisible between: Carl Lang Abraham Lang-. Per cent. 60 20 20 The aggregate net profits of both partnerships, Lang & Hoffman, and Lang & Lewin, for the year 1922, were $72,233.74. In arriving at the value of Hoffman's interest as of November 1, 1922, the profits for the entire year were estimated at $75,000 and Hoffman's interest therein at $34,412.50. The taxpayers subtracted this amount from the aggregate net profits of the two partnerships, and then deducted $15,000 as interest, the balance being returned by them according to their respective interests. The Commissioner treated both partnerships as a single business unit during the year 1922 and computed the net income as a unit. As the actual amount of net income was $72,233.74, instead of $75,000, the Commissioner determined that the taxable income of each partner was: Hoffman's profits were first computed by the Commissioner and subtracted from the aggregate net profits of the two partnerships, the remainder being allocated to the taxpayers in proportion to their interests in the new partnership. The Commissioner conceded at the hearing that an amount of $8 interest, withheld at the source on tax-free covenant bonds, was erroneously included in the income of Carl Lang. DECISION. The deficiencies should be computed in accordance with the foregoing findings of fact and the following opinion. Final determination will be settled on 10 days' notice, under Rule 50. OPINION. MORRIS: The taxpayers contend that the difference between $210,000 which Carl Lang and Lewin might have paid under the agreement with Hoffman, and the $225,000 which they in fact paid, or $15,000, was in the nature of interest and deductible by the partnership of Lang & Lewin in determining its income for 1922. The best evidence of its nature is the contract itself. The language is specific: The parties of the first part shall have the option upon the first day of December, 1922 * to purchase the interest of the party of the second part in said business at the price of $225,000 instead of the price of $210,000. Under the first option the purchasers were obligated to pay the entire sum of $210,000 by December 1, 1922, with interest at the rate of 6 per cent from November 1, 1922, on the installment pay-. ments provided for under that option. Under the second option, fixed and flat amounts were provided for, $100,000 by December 1, 1922, against which the $25,000 paid at the execution of the agreement of November 1, 1922, would be credited, and the balance of $125,000 in five payments of $25,000 each on February 1, May 1, August 1, and November 1, 1923, and February 1, 1924. The in stallments were "to be evidenced by the promissory negotiable notes of the parties of the first part, payable at said respective dates without interest." The fact that interest at 6 per cent was provided for under the first option and no interest on deferred payments under the second, might be the basis for the argument that the $15,000 was in the nature of interest, but it is just as conceivable that, by reason of the higher purchase price, Hoffman was willing to waive any claim to interest. The parties were free to make such arrangement and provide such terms as they saw fit-interest under situation, no interest under another. The taxpayers, Carl Lang and Lewin, elected to pay a higher price, obtain a longer period for completing the payment and to save themselves from any interest obligations during that period. one The second question raised in the appeal is solved by a correction of what, in our opinion, is an improper allocation by both the taxpayers and the Commissioner of the aggregate net profits of the two partnerships to the various partners. The evidence shows a different interest in the partnership income of the two partnerships than that determined by the Commissioner. It also appears that, upon the dissolution of the old partnership, the books were not closed to determine the profits for the ten-month period. The aggregate net profits for the year 1922 were $72,233.74, but the net income of each partnership can not be determined. Under these circumstances, it is our opinion that ten-twelfths of the net profits for the year should be allocated to the partnership of Lang & Hoffman and two-twelfths to the partnership of Lang & Lewin, and should be accounted for by the taxpayers in proportion to their respective interests therein, as set forth in the findings of fact. Docket No. 3247. APPEAL OF MAX LEVY & CO. Submitted July 6, 1925. Decided January 21, 1926. Additional salary held to be reasonable and a proper deduction for the year 1920. Fred L. Van Dolsen, Esq., for the taxpayer. Before GREEN and MORRIS. This is an appeal from the determination of a deficiency of $4,012.80 in income and profits taxes for the calendar year 1920. The taxpayer alleges error on the part of the Commissioner in disallowing as a deduction the sum of $10,000 as additional salaries to officers. FINDINGS OF FACT. 1. The taxpayer is a close corporation, having its principal place of business in Chicago, Ill., and is engaged in the business of purchasing, collecting, assorting, selling, and shipping broken glass. 2. This business was organized and developed solely through the efforts of Maxwell Levy, who started it in 1895. He developed the business from the Atlantic seaboard to Texas, the greater portion of the business, however, being transacted in Chicago. The method of doing business was as follows: A glass factory would find that it had a surplus of some color of glass. It would sell this to the taxpayer, who would resell it to some other factory which was short of that particular color. It would be shipped in the name of the taxpayer to this second person, the bill of lading being made in the name of the taxpayer. In Chicago the glass was hauled to the taxpayer's plant by truck, where it was assorted as to color, all foreign substances removed, loaded into box cars and shipped to the factories for remelting and manufacturing. Only that gathered in Chicago went into the Chicago plant. The term "cullet" is applied by the company to the commodity. This name was copyrighted in 1913 and is the taxpayer's trade-mark. 3. In 1917 Levy organized the present taxpayer corporation with a capital stock of $75,000, divided into 750 shares of a par value of $100 each. Of the capital stock he owned 749 shares and his wife owned one share. The wife was secretary but took no active part, except to sign necessary legal papers. Levy was president, treasurer, and general manager, performed all the official duties relating to the corporation and had sole charge of the business. He was in complete charge of all its finances and gave all his time and attention to the business. 4. In its original income-tax return the taxpayer deducted $15,000 as salaries to officers. The Commissioner allowed but $3,600, the same as in prior years. At the hearing it developed that a portion of the $15,000 was intended to include additional salary for the prior year and that it was intended to claim $10,000 additional for 1920, making a total of $13,600 for salaries for that year. The taxpayer did not hold any regular directors' or stockholders' meetings, nor were there any official records of corporation proceedings. During 1920 and prior years, Levy withdrew from the corporation for living expenses amounts considerably in excess of the regular salary allowed him. In the year 1920 he drew out approximately $10,500 for such expenses. In December, 1920, he directed the bookkeeper to enter an additional salary allowance of $10,000 for the year 1920. An entry of $10,000 was made as of December 31, 1920. The taxpayer's gross purchases in 1920 amounted to $60,570.42 and its gross sales to $108,825.53. The net earnings of the taxpayer, after deducting the additional salaries as expenses, exceeded 16 per cent of the invested capital. 5. The taxpayer's books were kept on the accrual basis. DECISION. The deficiency should be computed in accordance with the following opinion. Final determination will be settled on 10 days' notice, in accordance with Rule 50. OPINION. MORRIS: The sole question in this appeal is whether the $10,000 additional salary should be deducted as an expense of the taxpayer for the year 1920. To be a proper deduction the liability for the additional salary must have been incurred in the year 1920 and the amount must be reasonable. Section 234 of the Revenue Act of 1918 provides as follows: Sec. 234. (a) That in computing the net income of a corporation subject to the tax imposed by section 230 there shall be allowed as deductions: (1) All the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business, including a reasonable allowance for salaries or other compensation for personal services actually rendered. In this appeal there was some question as to when the liability was incurred. This was a one-man corporation with very incomplete records. The entries on the books of the taxpayer as of December 31, 1920, are ambiguous and there might possibly be a question whether, according to bookkeeping methods, a proper charge was made for the additional salary. There was some confusion as to whether this was a charge for salary or an adjustment of good will. However incomplete and ambiguous the entries in the books were, the testimony is clear that Levy, the president and manager, in December, 1920, directed his bookkeeper to make such an entry and that the bookkeeper did attempt to do so. Under the circumstances we must conclude that this was a corporate act. As to the reasonableness of the amount, it appears that in prior years Levy regularly allowed himself as salary from $3,000 to $3,600, using the remainder of the profits as dividends. It also appears, however, that he was the moving spirit and sole factor in building up this profitable business and that, even by allowing the additional salaries, there would be a net earning of over 16 per cent. We feel |