author: Teammell Phillips,

text:
    Appeal of JOHN POLACHEK.
    Docket No. 828.
    Submitted November 28, 1925.
    Decided March 30, 1926.
    A taxpayer is not entitled to an amortization deduction in 1919 on buildings entirely erected in 1918 which were not used for war purposes after the end of that year.

      E. H. Reichart, Esq., for the taxpayer.

      John D. Foley, Esq., for the Commissioner.
    Before GbatjpneR and Trammell.
    This appeal is from a determination of a deficiency in income tax for 1919, in the amount of $2,788.68. The deficiency arises from the disallowance by the Commissioner of a deduction in the amount of $12,668.80, claimed by the taxpayer for the amortization of wartime facilities.
    FINDINGS OP PACT.
    The taxpayer is an individual residing at New York City, N. Y.
    The taxpayer in May, 1910, engaged in the business of designing, casting, and erecting ornamental bronze and iron work, under the name John Polachek Bronze & Iron Works, with a capital of $23,000, and maintained and operated a plant for such purposes at Long Island City, N. Y. About September, 1910, he lost about $16,000, due to the failure of two banks in which he had money on deposit, and was left with machinery, equipment, and materials that had cost him about $7,000, but without any money to meet his pay roll and other expenses. He then went to his brother, Charles N. Polasky, and requested a loan of sufficient money to enable him to continue his business. Polasky at first refused to lend the taxpayer any money, but finally agreed to lend and did lend him $7,000, on the following conditions:
    That Polasky should receive one-half of the net profits of the business; that neither the taxpayer nor Polasky should withdraw any profits from the business during the period of 10 years; that if the business did not produce any profits the taxpayer would, in any event, pay to Polasky the said sum of $7,000, with interest at the rate of 6 per cent; and that the business should be carried on under the sole direction of the taxpayer.
    The business was conducted by the taxpayer, under the agreement of 1910, until March 1, 1919. Shortly before that date Polasky became dissatisfied because he was not entitled to withdraw any money from the business and had not received any return on his loan, and he therefore proposed that the taxpayer buy him out, and the taxpayer did buy out his interest in the business for $50,000.
    During the year 1918 the John Polachek Bronze & Iron Works received orders for castings which were not of the kind ordinarily made in the business then carried on by it and which were to be used in the building of ships for the United States Shipping Board Emergency Fleet Corporation, and thereby to contribute to the prosecution of the World War. In order to provide for the production of these castings the John Polachek Bronze & Iron Works constructed, during the year 1918, an additional building to be used as an iron foundry. The building was begun in April, 1918, and was completed in December, 1918. The building was never actually used in the production of articles contributing to the prosecution of the World War, all orders on hand for the production of such articles having been canceled immediately after the signing of the Armistice in November, 1918. The building in question cost $50,155.28, and the land on which it was erected cost $8,400. Of the construction cost of the building, the amount of $16,186.14 was actually paid in the year 1918, and the balance, $34,569.09, was paid in the year 1919. The building was not in use from the time it was completed until about September 1, 1921, at which time about 40 per cent of its capacity was put into use as an iron foundry.
    The John Polachek Bronze & Iron Works filed an income and profits-tax return for the year 1918 as a partnership. Its books of account were kept on the accrual basis.
    The taxpayer, in computing his net income for the year 1919, deducted for the amortization of the building in question, the amount of $12,688.80. The deduction was disallowed by the Commissioner, on the ground that the amortization period of the taxpayer ended December 31, 1918, and that deduction for amortization should be allowed only for the year 1918.
   OBINION.

Teammell

: The question presented by this appeal is whether the taxpayer, in computing his net income for the year 1919, is entitled to a deduction for the amortization of the building constructed by the John Polachek Bronze & Iron Works for the production of articles contributing to the prosecution of the World War. It is agreed by the Commissioner and the taxpayer that the building was constructed at a cost of $50,755.23, and there appears to be no dispute as to the postwar value in use. The Commissioner contends, however, that the taxpayer’s amortization period expired December 31, 1918, and that the entire deduction for amortization of the building in question should be allowed for the year 1918. The taxpayer contends that the allowance should be spread ratably over the period April, 1918, to September, 1921.

In the year 1918 the John Polachek Bronze & Iron Works constructed a building for the production of articles contributing to the prosecution of the war, at a cost of $50,755.23. The building was completed during that year, although payments therefor continued to be made until some time in 1919.

The building was never used for the purpose for which it was constructed. On the signing of the Armistice the orders which taxpayer had for articles which were to be used in the production of vessels were canceled, and the building was not used for any purpose until September, 1921, when it was partially used for peace-time purposes. It was agreed between the Commissioner and the taxpayer that it was used from September, 1921, to the extent of 40 per cent of its capacity. No question is raised by the Commissioner as to the amount of the amortization allowance. The taxpayer claimed in his 1919 return $12,688.80. The only question is whether the entire deduction should be taken in 1918 or should be spread over a longer period.

The facts in this case are similar to those presented in the Appeal of Walcott Lathe Co., 2 B. T. A. 1231. In that case the taxpayer constructed during 1918, among other things, a building and cranes for the production of articles contributing to the prosecution of the war. The facilities were never used for the purpose for which constructed, the taxpayer’s contracts for the production of such articles having been canceled after the signing of the Armistice. Nor were such facilities used subsequent to 1918 in the taxpayer’s regular business. The Board, holding that the entire deduction should be allowed for 1918, said:

The purpose of the so-called amortization section in the Revenue Act of 1918 was fully explained in committee reports and on the floor of the House and Senate at the time the Revenue Act of 1918 was under. consideration. That Act imposed profits taxes as high as 80 per cent, to which was added a normal tax for the year 1918 of 12 per cent, bringing the maximum rate of tax to 82.4 per cent of the profits of a business in the highest bracket.- Taxation as drastic as this could be imposed without serious hardship and obstruction of industry only if all proper deductions in determining profits were granted. The purpose of the high rates was, in effect, to confiscate so-called war profits and to prevent the making of extortionate profits from the war, but it was recognized that in many cases facilities had been provided for the production of articles for war use which would be useless, or nearly so, upon the termination of hostilities. Manifestly, the cost of such facilities could not be regarded as recoverable over a long life of wear and tear, but could be regarded as recoverable only against the articles which that capital was invested to produce. In other words, the extraordinary investment on account of war facilities was properly recoverable out of war profits, and Congress in sections 214 (a) (9) and 234 (a) (8) so provided.

Where facilities which were erected, constructed, or acquired in 1918 for the purpose of producing articles contributing to the prosecution of the war were not actually used for such purpose, we see no reason why there should be a different amortization period permitted with respect to such facilities from that allowed in the case of facilities actually used but abandoned at the end of 1918. If there are not sufficient war profits from which a deduction might bé taken, that fact should not permit the deduction from peace-time profits.

From a consideration of the purpose and history of the amortization section contained in the Revenue Act of 1918, we are of the opinion that article 185 of Regulations 45, promulgated by the Treasury Department, is reasonable and is in accordance with the spirit and intent of the statute.

Article 185 of Regulations 45 provides in part:

Amortization period. — The amortization allowance shall be spread in proportion to the net income (computed without benefit of the amortization allowance) between January 1, 1918, (or if the property was acquired subsequent to that date, January 1st of the year in which acquired) and either of the following dates:
(a) If the claim is based on (1) of article 184, the date when the property was or will be sold or permanently discarded as a war facility; or (b) if the claim is based on (2) of article 184, the actual or estimated date of cessation of operation as a war facility.

The facilities involved in this appeal were acquired by the John Polachek Bronze & Iron Works during the year 1918, and they were not used for the purpose of producing articles contributing to the prosecution of the war, or in the production of vessels for the transportation of men or materials for the prosecution of the war. From the time of the completion of the facilities until September, 1921, they were not used for any purpose. From that time they were used in peace-time business. The fact that the building was used to a certain per cent of its capacity in 1921 does not alter the amortization period. The deduction is to be spread, in any event, only over what may be designated as the amortization period, and this period is determined by the time when the taxpayer abandoned the facilities or ceased producing articles contributing to the prosecution of the war. Since the amortization period did not extend beyond 1918, there can be no spread of the deduction beyond the end of that year.

Since we have held that the taxpayer is not entitled to a deduction in the year 1919 for amortization of the building in question, it is not necessary to discuss whether or not he and his brother, Charles N. Polasky, were partners in the John Polachek Bronze & Iron Works from January 1 to March 1, 1919. The question would be important in the event there was a deduction allowed in 1919. in order to determine who was entitled to the benefit thereof. There was no question as to whether a partnership existed in 1918, the year in which we hold the deduction is allowable.

The deficiency of $&,788.68 as determined by the Commissioner is approved. Order 'Will be entered accordingly.

On reference to tbe Board, Stebnhagen and Love dissent.

Phillips,

dissenting: I can not agree with the conclusion which has been reached. The statute provides for the allowance of a reasonable deduction for the amortization of such part of the cost of these facilities as had been borne by the taxpayer. What is a reasonable allowance in each case must depend upon the facts of that case. It is obvious that a very wide discretion was vested in the taxing authorities to determine what was reasonable in the case of each taxpayer, the object of Congress being to allow each taxpayer to take as a deduction in his returns the excess of the cost of war facilities over their postwar value to him.

This taxpayer had no income whatever from articles produced in the plant which it has sought to amortize, nor did he have any profits from war contracts. The amount of the amortization determined by the Commissioner is approximately $85,000. Taxpayer’s income for the year 1918 is about one-half of that amount. If it is held that the deduction can be taken only in 1918, the taxpayer is allowed as a deduction only approximately one-half of the amount which should be allowed. He is permitted to recover in his income-tax return only one-half of the excess cost of such facilities, while it was the purpose with which the section was enacted to permit him to recover the full amortization. To me it does not seem that the decision allows a reasonable deduction for amortization.

The property which taxpayer constructed for the manufacturing of war facilities was of no use to him until June, 1920. In the circumstances of this appeal I believe that it would be reasonable to distribute the amortization over the period from the date when the erection of the plant was started to the date when it was put into use in the taxpayer’s postwar business.

That Congress intended that the amortization should be spread over a period of years seems apparent from the fact that under the 1921 Act it may be allowed for the year' 1921. Obviously, a plant would not be in use in 1921 for the construction of articles contributing to the war, nor would there be income from the manufacture of such articles in 1921. It seems clear that Congress did not intend that the amortization must be restricted to those years in which there was income from the manufacture of war facilities, but rather intended that there should be determined in each case what was a reasonable allowance in view of all the circumstances.

Smith and Tettssell concur in the foregoing dissenting opinion.


source: Caselaw Access Project

author: Geaupner:

license: Public Domain

text:
    Appeal of JASPER Y. BRINTON.
    Docket No. 4067.
    Submitted December 10, 1925.
    Decided March 30, 1926.
    Salary of justice of the Court of Appeals of the Mixed Courts of Egypt, held, to be subject to income tax.

      Jasper Y. Brinton pro se.

      M. N. Fisher, Esq., for the Commissioner.
    Before GeaupneR, Teammell, and Phillips.
    This is an appeal from the determination of a deficiency in income tax in the amount of $515.32 for the year 1923. The sole issue is whether the Commissioner erred in holding the salary paid to the taxpayer by the Egyptian Government for services as justice of the Court of Appeals of the Mixed Courts of Egypt to be taxable income.
    FINDINGS OF FACT.
    The taxpayer is a citizen of the United States with residence in Philadelphia, Pa., but sojourning in Alexandria, Egypt, where he holds the office of justice of the Court of Appeals of the Mixed Courts of Egypt. The taxpayer was appointed to that office on October 31, 1921, by the Sultan (now King) of Egypt .upon the nomination of the Egyptian Minister of Justice.
    Under the procedure of nomination and appointment of such justices, the power entitled to representation on the Court (in this instance the United States) presents the names of three qualified persons. The Egyptian Government selects one of the three, who, when appointed, becomes an official of that Government.
    The taxpayer was appointed at an initial salary of £1,600, Egyptian. Under the provisions of the law fixing the salaries of magistrates of the Mixed Courts, increases of salary occur automatically every two years in the amount of £100, Egyptian. The salary of the taxpayer for the year involved, translated into its equivalent in American exchange by the Commissioner, was $7,762.50.
    The taxpayer made no return of the amount of the salary received by him from the Government of Egypt. The Commissioner added the amount of $7,762.50 to the gross income of the taxpayer as reported in his income-tax return for the taxable year, and determined a deficiency of $515.32 on such additional income.
   OPINION.

Geaupner:

The taxpayer contends that the Revenue Act of 1921 £an not fairly be interpreted as having intended to interfere with the international engagement between the United States and the Egyptian Government, and that to tax him on his salary would be in violation of an existing treaty, engagement.

The Commissioner asserts that under the provisions of the Revenue Act of 1921 all citizens of the United States are taxable on all net income of whatever kind, except such items as are specifically exempted from taxation by section 213 (b) and other kinds of income which by statute and fundamental law are free from tax. He further asserts that, since the amount received by the taxpayer as justice of the Court of Appeals of the Mixed Courts of Egypt is not exempt by the Revenue Act or any statute or fundamental law of the United States, the salary should be included as taxable income in the 1923 return.

Under the Treaty of May 7,-1830, between the United States and the Ottoman Empire, 18 Stat., Pt. 2, p. 583, in Article IV, it was provided:

Citizens of the United States of America, quietly pursuing their commerce, and not being charged or convicted of any crime or offence, shall not be molested; and even when they may have committed some offence they shall not be arrested and put in prison, by the local authorities, but they shall be tried by their Minister or Consul, and punished according to their offence, following, in this respect, the usage observed towards other Franks.

This treaty was the basis for the exercise by the United States of extraterritorial jurisdiction through consular courts of Egypt.

By Act of Congress approved March 23, 1874, 18 Stat., Pt. 3, p. 23, the President was authorized to accept jurisdiction of certain tribunals when organized in Ottoman dominions and Egypt and to suspend consular courts therein. This acceptance was to be evidenced by presidential proclamation and notification to the government of the Sublime Port and that of Egypt. On March 27, 1876, 19 Stat. 662, the President, by proclamation, suspended the operation of the consular courts of Egypt.

The Mixed Courts of Egypt were instituted on June 28, 1875, and began to hold sessions on February 1, 1876, after a number of the powers interested had informed the Egyptian Government that they consented to their institution for a period of five years. The consent of the United States was given subsequent to the issuance of the President’s proclamation of March 27, 1876. The continuance of the Mixed Courts has been repeatedly consented to by the interested powers from time to time for varying periods. The consent of the United States to the continuance of such courts, for the various periods of extension, has been presented to the Egyptian Government through its diplomatic officer stationed at Cairo. A primary inducement to the powers to accept the Mixed Courts was the provision of the Egyptian Government that a majority of the judges in all of the several courts making up the system should consist of foreigners whose appointments should be subject to the approval of the power to which each was accredited. In regard to the Court of Appeals, it was provided that each of the great powers, including' the United States, should at all times be entitled to one justice. Egypt undertook to maintain the courts and to compensate the judges thereof.

The Eeglement D’Organization Judiciare of Egypt constitutes and defines the Mixed Courts of Egypt, and it was this law which the United States recognized when it suspended the consular courts and consented to its citizens being tried in such courts. Article 5 of the Eeglement, as translated, reads as follows:

Art. 5: The nomination and the choice of the judges shall remain the function of the Egyptian Government; but, in order to be reassured itself under-the guarantees which the persons whom it shall choose shall present, it will address itself officially to the Ministers of Justice abroad, and will engage only the persons empowered with the acquiescence and the authorization of their government.

The practice under article 5 has been for the power entitled to representation on the Mixed Courts to suggest to the Egyptian Government, for each position to which it is entitled, the names of three qualified persons. The Egyptian Minister of Justice selects one of the three, who, when appointed, becomes an official of the Egyptian Government.

The taxpayer seeks exemption from taxation of the salary received by him as a justice of a court thus constituted and to which he was appointed in accordance with the above-described practice. We are without the advantage of brief or argument in behalf of the-taxpayer, and therefore must depend upon statements contained in his petition to determine the legal source upon which he relies-for relief. As an assignment of error he avers that to include his salary as justice of the Court of Appeals in taxable income would “ conflict with an international engagement between the United States and Egypt.” As a proposition of law he asserts that “ an Act of Congress will not be construed so as to violate an existing treaty engagement in the absence of convincing proof that such was the design of that body.”

There is no formal treaty or convention under which the United States recognizes or accepts the Mixed Courts of Egypt, unless it can be said that the suspension of a treaty right to ministerial and consular courts constitutes a treaty or convention, and we do not believe that this interpretation of the action of the United States-is possible. The powers originally consented to the institution and accepted the jurisdiction of the Mixed Courts for a period of only-five years. The system has been continued by a series of renewals, the period of continuation being sometimes for five years, but at others only for one year, but the right to revert to the system previously in existence has been reserved and is always in suspense. Scott on the Law Affecting Foreigners in Egypt, 210. There is neither statutory nor treaty warrant for considering the taxpayer in any other capacity than that of an official of the Egyptian Government.

The taxpayer, as a justice of the Court of Appeals of the Mixed Court's of Egypt, is not entitled to exemption from tax under section 1, Article III, of the Constitution of the United States, because he is not a judge of a court created under the authority of that section. Nor is he entitled to an exemption as a judicial officer of a State under section 213 (b) of the Revenue Act of 1921, because he is not such an officer of a State of the Union. Nor, for the same reason, can he claim exemption under section 8 of Article I of the Constitution of the United States as interpreted in The Collector v. Day, 11 Wall. 113. We are unable to find any treaty or capitulary agreement between the Governments of the United States and Egypt which gives the taxpayer any right of exemption under the Revenue Act or under any statute or fundamental law.

All citizens of the United States, wherever resident, are taxable on net income, excepting on ^uch items as are specifically exempted by the Act or are free from tax on fundamental law. Cook v. Tate, 265 U. S. 47; Lawrence v. Wardell, 270 Fed. 682; 273 Fed. 405. There is nothing in the Act to exempt from taxable income the salary paid to a citizen of the United States by a foreign government, whether such citizen is a civil or judicial officer. The mere fact that the taxpayer occupies a position which the Egyptian Government, under its Reglement, is required to fill by the appointment of an American who is nominated by a department of the Government of the United States does not, in our opinion, give him a special status and thus enable him to escape taxation on that part of his income which is salary paid by such Government.

The deficiency is redetermined to be the amovmt of $515.32. Order will be entered accordingly.


author: Lansdon:

text:
    Appeal of J. HUDSON McKNIGHT.
    Docket No. 4048.
    Submitted November 27, 1925.
    Decided March 30, 1926,
    Value of land in question at March 1, 1913, determined from the evidence adduced at the hearing to be $125,000.

      W. E. Holmes and D. W. Eaton, Esqs., for the taxpayer.

      A. H. Fast, Esq., for the Commissioner.
    Before SteRNhagen, LaNSdoN, and ARTJNDell.
    This appeal is from the determination of a deficiency for the year 1919 in the amount of $15,376.52, of which $12,301.22 is assessed as a deficiency in tax and $3,075.30 as a penalty for failing to make an income-tax return for the year in question. Two issues are involved: (1) The gain realized from the sale of a certain parcel of real estate in 1919; and (2) whether a delinquency penalty should be assessed.
    FINDINGS OF FACT.
    For many years prior and subsequent to March 1, 1913, J. Hudson McKnight owned, resided on, and operated a farm of about 124 acres, located approximately 1 mile east of the business center of Wichita, Kans., a city that had a population of more than 70,000 at January 1, 1920. This farm was bounded on the north by English Street for a distance of 1,268.3 feet; and by Douglas Avenue, the main east and west business thoroughfare of Wichita, for a distance of 1,163.45 feet; on the east by Grove Street for a distance of approximately 2,640 feet; on the south by Kellogg Street for a distance of approximately 2,640 feet; and on the west by Hydraulic Avenue for a distance of approximately 2,000 feet.
    At March 1, 1913, the residential district of Wichita, plotted and solidly built up, extended for a distance of more than one mile to the eastward of the east line of the farm, and for about the same distance north and south from Douglas Avenue and Kellogg Street, respectively. The owner made no attempt to plot or sell any part of the land as city lots.
    A small stream, known as Chisholm Creek, originally meandered through the western part of the farm, but, prior to 1913, had been straightened into a drainage canal, 150 feet in width, extending north and south. This canal divided the entire farm into two tracts, of which the western portion, bounded by English Street, the canal, Kellogg Street, and Hydraulic Avenue, contained approximately 54 acres, and the eastern portion, bounded by Douglas Avenue, Grove Street, Kellogg Street, and the canal, contained approximately 70 acres. That part of the farm to the east of the canal is the land the value of which at March 1, 1913, is in controversy in this appeal. It is rectangular in form, extending one-half a mile north and south between Douglas Avenue and Kellogg Street, and approximately one-fourth of a mile east and west between Grove Street and the canal.
    In flood seasons the canal overflows some- of the adjacent land, and at all times it carries considerable surface drainage. Prior to March 1, 1913, a city sewer, adequate in size to replace the canal for sewerage purposes, had been authorized but not constructed. The waters of the creek, later straightened and connected into the canal, sometimes had an offensive odor, due to large quantities of water used for flushing certain packing houses to the northward.
    In the year 1919 the Board of Education of Wichita caused all that part of the farm located east of the drainage canal to be condemned as sites for school buildings and grounds. The owner protested the condemnation award ánd began a court action to have the same set aside. The controversy thus arising was settled by a' payment to the owner of $150,250 by the board. The transfer of the 70-acre tract by J. Hudson McKnight was not a voluntary sale. The condemnation settlement was not, in his judgment, equal to the value of the land, either at March 1, 1913, or at the date of the transfer.
    The taxpayer’s income for the year 1919, other than the gain realized from the sale in question, was less than $2,000.
    Upon audit of the taxpayer’s income-tax returns for 1920 and 1921 the Commissioner determined a deficiency for 1919 in the amount of $1,832.88, and so notified the taxpayer in a so-called 30-day letter dated July 26, 1924. No hearing or action of any kind in respect to this letter is disclosed by the record. This alleged deficiency was based on a valuation of the land of $125,000 as of March 1, 1913, which was the result of a retrospective appraisal made by a committee of the Wichita Beal Estate Board. On March 13, 1925, the Commissioner addressed a second letter to the taxpayer, in which the deficiency now in controversy, in the amount of $15,376.52, was asserted. Of this total deficiency, the amount of $3,075.25 is asserted as a penalty for failure to make any income-tax return for the year 1919. The deficiency now asserted is based on alleged gain in the amount of $57,504.50 realized from the transfer of the land in question to the Board of Education, and on a value of the tract at March 1, 1913, of $84,775.84.
    The land involved in this appeal had a fair market value of $125,000 at March 1, 1913. The taxpayer realized gain from the payments made in the condemnation proceedings in the amount of $25,250.
   OPINION.

Lansdon:

In this appeal the Board determines: (1) The value at March 1, 1913, of the land described in the findings of fact; and (2) whether a penalty shall be assessed against the taxpayer for his failure to make an income-tax return for the year 1919.

In support of his contention that the land in question had a fair market value of not less than $125,000 at March 1,1913, the taxpayer Introduced the depositions of 11 reputable business men of Wichita. Bight of the deponents are real-estate dealers in Wichita, and all are members of the real estate board of that city. Seven of these ■witnesses fixed the market value of the land at $125,000 at March 1, 1913. The eighth witness testified that the value was at least $140,-000 at that date, and that he would have paid that amount for the tract if the owner had been willing to sell. Three witnesses, a banker and two lumber dealers, all of whom have lived in Wichita for many years, placed the value of the tract at $145,900, $145,000, and $140,000 on March 1,1913. The average of values placed on the tract by eight real-estate men was $126,875, and by the men in other lines of business was $143,633, and the average of values determined by all the taxpayer’s witnesses was $131,445.

The Commissioner introduced the depositions of two witnesses, of whom one is a real-estate dealer who was not in Wichita at March 1,1913, and the other is a city official who was deputy county assessor in 1912. The real-estate man testified that prior to 1913 he had the taxpayer’s consent to sell the entire farm for $50,000, and that in his judgment the tract in question was worth $45,000 at March 1, 1913. Mrs. McKnight testified that she was at all times familiar with the business of her husband, and that to her knowledge he had never listed the farm with any dealer, and that he always regarded the entire tract as worth at least $300,000.

The second witness for the Commissioner testified that he had assessed the entire farm for state taxation purposes in 1912 at $175,000, and that the actual value of the farm at that time was somewhere between $180,000 and $200,000. He also testified that the eastern portion of the farm, the tract involved in this appeal, was worth considerably more, relatively, than the part west of the drainage canal.

In the light of all the evidence, the Board is of the opinion that the fair market value of the tract in question at March 1, 1913, was not less than $125,000.

It is not disputed that the taxpayer failed to make an income-tax return for 1919. Section 3176, Bevised Statutes of the United States, as amended, provides as follows:

In ease of any failure to make and file a return or list within the time prescribed by law, or prescribed by the Commissioner of Internal Revenue or the collector in pursuance of law, the Commissioner of Internal Revenue shall add to the tax 26 per centum of its amount, except that when a return is filed after such time and it is shown that the failure to file it was due to reasonable cause and not to willful neglect, no such addition shall be made to the tax.

We are of the opinion that such a penalty, based on the tax determined by the valuation that we have found, must be assessed against the taxpayer.

Order of redetermination will be entered on 15 days1.notice, under Bule 50.


text:
    Appeal of Estate of AUGUSTA G. SOUTHACK.
    Docket No. 6359.
    Submitted February 9, 1926.
    Decided March 30, 1926.

      James Van Steenberg, Esq., for the taxpayer.

      A. H. Fast, Esq., for the Commissioner.
    Before Aiiundell and LaNsdok.
    This is an appeal from the determination of a deficiency in income tax for the taxable period beginning February 27, 1921, the date of the death of the decedent, and ending December 31, 1921. The amount of the deficiency is $385.67, income tax for 1921. The sole question involved in the appeal is whether the New York State transfer tax may be deducted in the determination of the net income of an estate.
   FINDINGS OF FACT.

Augusta G. Southack died a resident of the State of New York on February 27, 1921. Letters testamentary were duly issued to Gladys S. Christy and the Farmers’ Loan & Trust Co., as executors thereunder, in the Surrogate’s Court of New York County on April 27, 1921. The executors paid the transfer tax assessed by the State of New York against the estate in the sum of $17,259.60. On February 8, 1923, there was refunded to the estate $2,336.53, making the total tax paid to the State of New York $14,923.07.

The executors filed an income-tax return for the estate, covering the period from the date of death of the decedent to December 31, 1921, and in that return deducted $17,259.60, which was the amount paid to the State of New York as a transfer tax. This deduction was disallowed by the Commissioner.

Net income will be computed by deducting $11¡,,9'B3.07* Order of redetermination will be entered on 15 ddys’ notice, under Bule 50.


author: Smith:

text:
    Appeal of TRANSATLANTIC CLOCK & WATCH CO.
    Docket No. 4897.
    Submitted December 7, 1925.
    Decided March 30, 1926.
    The taxpayer corporation set up a reserve for bad debts at the close of its fiscal year ended September 30, 1922, in the amount of $5,000. In its income-tax return for such fiscal year it deducted from gross income $4,302.14 on account of bad debts ascertained to be worthless and charged oft during the year, and in addition the $5,000 set up as a reserve for bad debts at the close of the year. Held, that the taxpayer was entitled to the deduction of only a reasonable addition to a reserve for bad debts and not to the deduction of debts ascertained to be worthless plus an addition to the reserve.

      Barnett Briskin, G. P. A., for the taxpayer.

      F. O. Graves, Esq., for the Commissioner.
    Before Smith, LittletoN, and Trussell.
    This is an appeal from the determination of a deficiency for the fiscal year ended September 30, 1922, in the amount of $1,093.76. The point in issue is the right of the taxpayer to deduct from gross income $5,000, representing a reserve for bad debts set up at the close of the year, in addition to $4,302.14, representing bad debts ascertained to be worthless and charged off during the year.
    FINDINGS OF FACT.
    The taxpayer is a New York corporation with its principal office at New York City.
    The taxpayer’s books were kept and its income-tax returns made on a fiscal year basis ending September 30, 1921, September 30, 1922, and September 30, 1923.
    It is engaged in the business of importing and selling clocks and watches. Its customers are located throughout the United States. Its gross sales for the year ended September 30, 1921, September 30, 1922, and September 30, 1923, were $292,033.22, $756,-902.53, and $783,914.62, respectively. Its accounts receivable at the close of the years indicated were $75,312.42, $114,872.46, and $133,345.50, respectively.
    In its income-tax return for the fiscal year ended September 30, 1921, it claimed as a deduction from gross income $2,858.42 on account of debts ascertained to be worthless and charged off within' the taxable year. In its return for the succeeding fiscal year it claimed as, a deduction for bad debts $9,302.14, of which amount $4,302.14 Represented accounts ascertained to be worthless and charged off within the year,, and the balance represented a reserve for bad debts set up at the close of the year, this return being the first one made by it after the enactment of the Revenue Act of 1921, which permitted taxpayers to set up a reserve for bad debts. In a schedule attached to the taxpayer’s return for this fiscal year (ended September 30, 1922), the taxpayer said:
    After charging off to Expense $4,302.14 for Bad Debts, there were still over $11,000.00 of the accounts receivable over 90 days past due, and it is estimated that not more than half of this amount will he collected, and since the total amount of the accounts receivable is over $109,000, we believe $6,000 will be no more than enough to cover the losses through bad debts.
    In its income-tax return for the fiscal year ended September 30, 1923, the taxpayer claimed as a deduction on account of bad debts $8,996.76. In a schedule attached to its return and made a part thereof it explained the bad debts deduction as follows:

      Schedule IS — Bad, Debts.

    Beserve for Bad Debts, Oct. 1, 1922_$6, 000.00
    Bad Debts, previously reported as Income, ascertained to be worthless through failure, etc., charged against Beserve for Bad Debts during taxable year_ 8> 996. 76
    Balance, September 30, 1923_$3, 996.76
    Add: Provision for Bad Debts — 1.16% of Sales-'— 8, 996. 76
    Balance in Beserve, September 30, 1923_$6, 000.00
    This Beserve is to take care of an outstanding accounts receivable of $133,345.50, of which $12,615.53 is doubtful accounts from which it is expected not more than 50% will be realized.
    The taxpayer’s books of account for the fiscal year ended September 30, 1922, showed a reserve for bad debts at the close of the year in the amount of $5,000. In submitting a balance sheet to the Commissioner in connection with its income-tax return for that year, it did not show the reserve for bad debts specifically as such, but deducted from the accounts receivable the $5,000 in question.
   OPINION.

Smith:

During the years 1920 to 1923 the taxpayer’s business increased rapidly. The taxpayer dealt with customers throughout the United States. Its experience showed that a considerable percentage of accounts which had been uncollected for more than 90 days were never collected. Prior to the enactment of the Revenue Act of 1921 it was not permitted to deduct from gross income any amount set up as a reserve for bad debts. In lieu thereof it claimed in its returns the deduction from gross income of debts actually ascertained to be worthless and charged off during the taxable year. When it came time for it to make up its return for the fiscal year ended September 30, 1922, the Commissioner’s Regulations 62 had. been promulgated, which permitted a taxpayer, under certain circumstances, to set up a reserve for bad debts and deduct the addition thereto from gross income. The provision of the Revenue Act of 1921 which permits a corporation taxpayer to deduct from gross income a reserve for bad debts is section 234 (a) (5), which reads as follows:

Debts ascertained to be worthless and charged off within the taxable year (or in the discretion of the Commissioner, a reasonable addition to a reserve for bad debts) ; and when satisfied that a debt is recoverable only in part, the Commissioner may allow such debt to be charged off in part.

In his answer to the taxpayer’s petition the Commissioner alleges that the deduction by the taxpayer of a reasonable addition to a reserve for bad debts is allowable only in the discretion of the Commissioner; that when a taxpayer elects to claim as a deduction an addition to a reserve for bad debts there should be set up at the beginning of the year a reserve for the doubtful accounts already contained in the accounts receivable, and the net addition to this reserve should be made during the taxable year and prior to the date of the closing of the books for that year.

The real question presented by this appeal is whether a taxj>ayer changing from the basis of claiming as a deduction from gross income debts actually ascertained to be worthless to a deduction of a reasonable addition to a reserve for bad debts may, for the year in which the change is made, deduct both debts ascertained to be worthless during the year and a reserve set up for bad debts at the close of the year. We are of the opinion that the statute does not permit such a deduction. The income tax and excess-profits tax are each computed upon the basis of a 12-month period. A return for such period must reflect the actual gains, profits, and income of such period. Manifestly, a taxpayer which claims the deduction of a greater amount for debts ascertained to be worthless than properly belongs to such year is claiming a benefit not warranted by the statute. In the instant appeal the taxpayer has elected to deduct from gross income a reasonable addition to a reserve for bad debts. We are of the opinion that it is entitled to such deduction, but not to the deduction of such an addition to a reserve for bad debts and also debts ascertained to be worthless during the year.

The evidence of record shows that for the fiscal years ended September 30, 1921 to 1923, inclusive, gross sales were $292,033.22, $756,902.53, and $783,914.62, respectively. Debts ascertained to be worthless during the period total $16,157.32, or approximately .0088 per cent of gross sales. This computation does not take into .account the large increase in gross sales during the last two years of the three-year period. We think that a reserve of 1 per cent of gross sales is a reasonable addition to a reserve for bad debts for each of the fiscal years ended September 30, 1922, and September 30, 1923. Upon this method of computation the taxpayer’s bad-debt reserve at the close of each of the fiscal years ended in 1922 and 1923 would be as follows:

Tear ending Sept. 30, 1922:
Bad-debt reserve, 1 per cent of sales_§7, 669.03
Amount charged against such reserve_ 4,302.14
Balance in reserve_ 3,266. 89
Tear .ending Sept. 30, 1923:
Additions to bad-debt reserve, 1 per cent of sales_ 7, 839. IS
Total-11,106.04
Amount charged against reserve_ 8,996.76
Balance in reserve_ 2,109.28

We think, therefore, that the taxpayer is entitled to a deduction of a reasonable addition to reserve funds for the fiscal year ended September 30, 1922, of $7,569.03, and that this amount is inclusive of $4,302.14 claimed as a deduction for debts ascertained to be worthless and charged off within the year.

Order of redet&rmination will l>e entered on 10 days’ notice, under Bule 50.


text:
    Appeal of THE FRED CANTRELL CO.
    Docket No. 3141.
    Submitted June 17, 1925.
    Decided March 31, 1926.

      J. T. Menefee, O. P. A., for the taxpayer.

      ETlis W. Manning, Esq., for the Commissioner.
    Before James, LittletoN, Smith, and Trussell.
    This is an appeal from the determination of deficiencies in income and profits tax for the years 1919, 1920, and 1921, amounting to $2,740.05. They result from the disallowance of certain deductions made for exhaustion, wear and tear of property, and from the exclusion of certain amounts from the taxpayer’s claimed invested capital for the years in question.

      FINDINGS OF FACT.
    The taxpayer is a Tennessee corporation with its principal office in Chattanooga, and is engaged in the business of contracting and dealing in plumbing, heating, and electrical supplies. The business was previously conducted as an individual enterprise by Fred H. Cantrell.
    The taxpayer was incorporated April 1, 1918. The assets of the individual business conducted by Cantrell, with the exception of accounts receivable, were paid in to the corporation in exchange for its entire issue of capital stock in the amount of $150,000. Immediately prior to the date of incorporation, Cantrell, who had been in business for 25 years, had made an inventory of his stock of merchandise, furniture, fixtures, tools, machinery, etc. In the making, of the inventory, depreciation upon depreciable property was taken into account. The assets inventoried had cost from $10,000 to $15,000 more than the amount of the inventory, which totaled $140,000. The assets were inventoried and placed upon the taxpayer’s books of account as follows:
    Merchandise-$130, 000
    Tools and machinery- 6, 000
    Autos and trucks_ 2, 500
    Furniture and fixtures- 1, 500
    Cash_ 10, 000
    Total_ 150, 000
    The principal reason for incorporating the business was to enable employees to acquire an interest in the business. Some of these employees were permitted to acquire stock at a price of $66% a share. Each employee subscribing for shares of stock gave Cantrell notes in payment therefor. It was supposed that the notes would be paid by the employees from dividends and from salaries. Cantrell also attempted to interest certain prominent business men in Chattanooga in the enterprise, and offered to sell certain business men shares at a price of $66% a share. Only one of the business men, however, purchased any shares of stock at that price.
    By reason of the fact that certain shares of capital stock of the corporation were sold at a price of two-thirds of the par value, the Commissioner held that the actual cash value of the assets paid in for shares of stock was only two-thirds of the par value of the shares, and reduced invested capital accordingly. He also held that the value of the depreciable assets paid in for such shares was only two-thirds of the amount claimed and reduced the depreciation claimed in like proportion.

      Order of redetermination will he entered on 15 days’ notice, under Rule 50.


text:
    Appeal of SIMON ENGLAND.
    Docket No. 4221.
    Submitted February 10, 1926.
    Decided March 31, 1926.

      Laurence Graves, Esq., for the taxpayer.

      Robert A. Littleton, Esq., for the Commissioner.
    Before James, Littleton, Smith, and TRUssell.
    This is an appeal from the determination of a deficiency in income tax for the calendar year 1921 in the amount of $1,465.59. Only so much of the deficiency is in controversy as arises from the disallowance of a claimed loss of $8,000 upon the sale in August, 1921, of a building located upon land purchased in May of that year.
   FINDINGS OF FACT.

The taxpayer is a resident of Pittsfield, Mass. In May, 1921, he purchased' as an investment a lot 160 by 260 feet, upon which was located a dwelling house, a servants’ cottage, and a stable, for which he paid $18,000. For 1921 and for several years prior thereto this property was assessed for local taxation as follows:

Land-$12,406
Dwelling-- 9, 000
Cottage and stable- 3, 000

The taxpayer had lived on a lot adjoining this property for about 16 years. The buildings on the property were in such a dilapidated condition that they could not be rented without extensive repairs and improvements. The dwelling house was uninhabitable by reason of neglect covering a period of several years. It had not been occupied for two years, and it was estimated that it would be necessary to expend $12,000 to make it suitable for occupancy. In August, 1921, the taxpayer sold the dwelling to a building contractor for $1,000, who agreed to remove it from the land. At the date of purchase the value of the land, without the dwelling, was greater than it was with the building upon it.

The deficiency is redetermined to be $7,^65.59. Order will be entered accordingly.


text:
    Appeal of WILLIAM CHISHOLM’S SONS CO. (now the CHISHOLM SHOVEL CO.)
    Docket No. 1840.
    Submitted April 20, 1925.
    Decided March 31, 1926.

      H. A. Eauxlmrst for the taxpayer.

      B. H. Saunders, Esq., for the Commissioner.
    Before Sternhagen, Trammell, Phillips, and Love.
    This appeal is from the determination of a deficiency in income and profits tax for the year 1918 in the sum of $5,428.37. The deficiency arose by reason of the disallowance by the Commissioner of the item of good will as a part of invested capital, valued by the taxpayer at $63,725.70.
    In the return made by the taxpayer for the year 1918, it listed its invested capital at $203,140.40, included in which was good will valued at $63,725.70. The Commissioner allowed invested capital as follows:
    Capital stock issued_$200,000. 00
    Surplus_'_ 3,140.40
    Total_i_ 203,140. 40
    From which he deducted_ 63, 725. 70
    Leaving as invested capital- 139,414. 70
    on which he made the calculations to determine the amount of taxes due, and which resulted in the deficiency determined by him.
   FINDINGS OP FACT.

In 1908 there was being conducted a business in Cleveland, Ohio, known as the William Chisholm & Sons Co., William Chisholm, Sr., being the sole owner.

In 1908, William Chisholm, Sr., died. In February, 1910, a corporation was formed, with an authorized capital stock of $200,000, to take over the assets of the William Chisholm & Sons Co. business, and known as the William Chisholm’s Sons Co. William Chisholm, Sr., left a large estate separate and apart from the assets recognized as pertaining to the business of the William Chisholm & Sons Co.

In a written agreement filed by the beneficiaries under the will of William Chisholm, Sr., in 1910, in the administration proceedings, the properties recognized as incident to and comprising the William Chisholm & Sons Co. business were inventoried and appraised at $119,686.79.

Immediately after said agreement was made and approved by the court, the corporation was formed and began to operate. The first entry on the journal of the corporation was dated March 1. 1910, and listed the tangible properties taken over at an aggregate value of $147,148.83. There was then made an entry of “good will ” at a valuation of $58,122.53. The taxpayer assumed obligations of $5,271.36. On December 31, 1910, an entry was made on the journal as follows:

<3ood will account: Debit. credit. Surplus- $5,603.17 $5,603.17

The above entry is made to correct entry made in March, 1910. Proper amount allowed for the good will was $63,725.70, not $58,122.53, as made by Mr. Boyal.

Under the agreement hereinbefore referred to, Mrs. Chisholm, the widow, was to get 465½ shares of the 2,000 shares of the capital stock of the William Chisholm’s Sons Co., and a contract was entered into between Mrs. Chisholm and H. A. Chisholm by which she was granted an option to require H. A. Chisholm to purchase her stock at any time within three months at 92.8 per cent of its face value. In the event Mrs. Chisholm did not exercise said option within said three months, she obligated herself not to sell to anyone except H. A. Chisholm, and, in the event she decided to sell after said three months, he was to purchase it at 68 per cent of its face value.

C. S. Chisholm also agreed to sell to H. A. Chisholm, and H. A. Chisholm agreed to buy, the 431 shares of stock allotted to said C. S. Chisholm at 92.8 per cent of their face value.

Immediately after the organization of the corporation, H. A. Chisholm sold to A. E. Cook, who was secretary of the company, 100 shares of said stock for $96 per share.

Good will had a value of at least $43,700.

Order of redetermination will be entered on 10 days’ notice, wader Rule 50.


author: Tkussell

text:
    Appeal of COGHLIN ELECTRIC CO.
    Docket No. 1879.
    Submitted April 21, 1925.
    Decided March 31, 1926.
    1. One of taxpayer’s department sales managers, whose compensation was based in part upon a percentage of the net profits of his department, left the service of the taxpayer in August, 1916, with his account unadjusted. On or before December 31, 1916, taxpayer computed and accrued on its books of account for said year the amount owing to said salesman. The salesman, upon being advised of the adjustment in 1917, disputed the computation. This resulted in negotiations under which a new basis for computing the profits of the department was agreed upon and additional compensation for the salesman which was accrued upon the books of the company for the close of the year 1917. Helé, the amount accrued in 1917 was an allowable deduction for that year.
    2. A corporate taxpayer which for many years had consistently kept its accounts and closed its books on the basis of fiscal years ending February 28, but which had prior to 1918 made income-tax returns on the basis of calendar years, was compelled by the Beve-nue Act of 1918 to change the basis upon which its returns must he thereafter made to its fiscal year and to make a separate income-tax return for the two months of January and February, 1918, is entitled to have its tax liability for that two-month period determined on the basis of an independent return for such period. Appeal of Henry D. Weed, 2 B. T. A. 84.

      Merrill S. June, Esq., for the taxpayer.

      Laurence Graves, Esq., for the Commissioner.
    Before James, Smith, and Trttssell.
    This is an appeal from the determination of deficiencies in income and profits tax for the calendar year 1917 in the amount of $940.11; for the two-month period ended February 28, 1918, $632.28; and for the fiscal year ended February 28, 1921, $150, totaling $1,722.39. At the hearing the taxpayer waived allegations of error respecting the fiscal year ended February 28, 1921, and all errors respecting adjustments of taxable income, except as to the disallowance of an item of certain commissions claimed as a deduction for the calendar year 1917 in the amount of $1,518.46. The only other issue presented for consideration involves the method of computing the tax liability for the two-month period ended February 28, 1918.
    FINDINGS OF FACT.
    1. The taxpayer is a corporation having its principal place of business at Worcester, Mass., and having an authorized and paid-in capital of $10,000. The taxpayer has for many years consistently kept and closed its books of account upon an accrual basis and for fiscal years ended February 28. Prior to 1918 it made its income and profits-tax returns, as required by the taxing authorities, for the calendar year periods. For the two months of January and February, 1918, it made a separate return, and thereafter it made returns on the basis of its regularly established fiscal periods.
    2. The taxpayer did a large retail and wholesale jobbing business. It also engaged in contracting, electric construction, and repair work, including residences, factories, and large office buildings. The business extended throughout the New England States and occasionally into New York and New Jersey. For 1917 the gross sales amounted to $307,832.89. To facilitate and stimulate the business the work of the corporation was departmentalized, with the head of each department engaged on the basis of salary and commission. At the head of one of these departments one Peter A. Coghlin, a brother of the president of the taxpayer, was employed. He occupied this position for a number of years, ceasing his employment in August, 1916, at which time he went into business for himself. He was paid a salary and a percentage of the profits of his department. His employment ceased in August, 1916. On December 30, 1916, the taxpayer entered upon its books an adjustment of Peter A. Cogh-lin’s account, showing a balance due to him of $939.64. This closed Peter A. Coghlin’s account, and in January, 1917, he was given a check for the amount above stated. Later Coghlin was not satisfied with this adjustment, claiming there had not been a proper apportionment of charges against his department.
    As a result of this situation, in the year 1917, the controversy was compromised and adjusted, and the taxpayer, in order to arrive at a final settlement, agreed to pay to Peter A. Coghlin the additional amount of $1,518.46, and this amount was entered upon the books of the taxpayer as a liability on December 30, 1917. The Commissioner disallowed this item as an expense for the calendar year 1917.
    3. The taypayer’s paid-in capital and undivided profits were inadequate for the volume of business transacted. It financed its extensive business through the personal credit of J. P. Coghlin, who was president of the corporation. Most of the purchases of supplies and materials were obtained from the American Steel & Iron Co. .and the Westinghouse Electric Manufacturing Co., its two largest creditors. At times the account with the American Steel <& Iron Co. was around $50,000, and the Westinghouse account was somewhat less, but it was necessary for Coghlin personally to guarantee these accounts. He was also required personally to indorse paper for loans at the banks. He received no compensation for these guarantees of credit or for his indorsement upon bank loans. ' He also kept with the taxpayer a comparatively large credit balance, which was used in the taxpayer’s business. The adjusted balance sheets for the periods from December 31, 1916, to February 28, 1918, showed liabilities as follows: ,

    4. The Commissioner computed the excess-profits tax for 'the calendar year 1917 under the provisions of section 210 of the Revenue Act of 1917.
    For the two-month period of January and February, 1918, the Commissioner computed the tax liability upon the basis of the adjusted taxable income for the twelve-month period from March 1, 1917, to February 28, 1918; applied thereto the tax rates of the Revenue Act of 1918, and found the tax liability for the two months by taking one-sixth of the total computation of tax as so found.
   OPINION.

Tkussell

: Peter Coghlin, some time prior to 1916, had been a department sales manager employed in the taxpayer’s business. He had had an understanding that his compensation should consist in part of the percentage of the net profits of the sales of the department over which he had presided. When, in 1917, he was advised of the adjustment made by the taxpayer, he complained that it was unfair to him, and, as a result of such complaint, he and the taxpayer arrived at and agreed upon a new basis for computing the profits of the department upon which he was entitled to a percentage, which resulted in the taxpayer’s then agreeing to pay to him additional compensation in the amount of $1,518.46. This amount was arrived at on a basis of accounting agreed upon in 1917; it was accrued upon the books of the taxpayer in that year; and it was in effect a compromise adjustment made in'the year 1917, and as such is a proper deduction-from gross income for that year.

Sections 239' and 226 of the Revenue Act of 1918 provide that, when a corporation finds it necessary to make an income-tax return for a fraction of a year, “ a separate return shall be made for the period between the close of the last calendar year for which return was made and the date designated as the close of the fiscal year.”

The Board has held in the Appeal of Henry D. Weed, 2 B. T. A. 84, that this provision meant a separate return for such fractional portion of a year entirely unrelated to any prior or future tax return. 'The reasoning in that opinion applies with equal force in the case of a corporation. We are, therefore, of the opinion that in the instant case the taxpayer should make income and profits-tax return reporting the items of gross income for the months of January and February, 1918, and the items of deduction for the same time; that the specific credit allowed by section 236 (c) should be adjusted to two-twelfths of $2,000; and that the invested capital for the period should be computed in accordance with section 326 (d)..

Order of redelermmation will ~be entered on 10 days’ notice, wider Rule SO.


text:
    Appeal of THEODORE A. KOHN & SON.
    Docket No. 5364.
    Submitted January 21, 1926.
    Decided March 31, 1926.

      Morris L. Ernst, Esq., for the taxpayer.

      George G. Witter, Esq., for the Commissioner.
    Before James, Littleton, Smith, and Teussell.
    This is an appeal from the determination of a deficiency in income and profits tax for the fiscal year ending February 28, 1920, in the amount of $7,987.57, arising from the disallowance by the Commissioner as a deduction for that year of $28,203.43, representing the total of undrawn portions of regular salaries of the president and the vice president and treasurer of the corporation for each of the years 1910 to 1918, inclusive.
   FINDINGS OP PACT.

Taxpayer was incorporated in New York in 1907, as the successor of a partnership of the same name, organized in 1889, and engaged in business as a retail dealer in jewelry. At the date of organization the capital stock was of the par value of $100,000, all common. In 1918 certain bonds of the corporation were converted into first and second preferred stock of $34,000 and $243,000, respectively. The assets of the corporation have always been of the approximate value of $300,000.

The officers and principal stockholders were Albert M. Kohn, president, and Emil W. Kohn, vice president and treasurer, each of whom devoted his entire time to the conduct of the business, the former having charge of all purchases and the latter of all sales. They were assisted by a number of employees, some of whom were stockholders. From the date of incorporation to 1919, inclusive, the regular annual salaries of Albert M. and Emil W. Kohn were $6,000 each. The full amounts of these salaries, during the period from 1910 to 1919, inclusive, were not drawn each year, for the reason mentioned in the minutes of the stockholders and directors, hereinafter set forth. In the year 1920 the salary of A. M. Kohn was fixed at $12,000 and that of Emil W. Kohn was fixed at $9,000. In addition, the corporation authorized the payment to them of unpaid salaries for prior years in the total amounts of $13,079.93 and $15,123.50, respectively. The Commissioner allowed as a deduction for 1920 the salaries for that year, and disallowed as a deduction from gross income for 1920 the amounts totaling $28,203.43, representing undrawn salaries for prior years. The gross sales for 1920 amounted to $367,966.69, resulting in a gross income of $176,560.53 and a net income of $36,801.78, as computed by the Commissioner.

At the annual-meeting of the officers and stockholders on April 11, 1910, the annual report of the treasurer stated—

Tour treasurer regrets to announce that the business of the year just failed of meeting all expenses, including salaries of your officers. The actual loss amounted to $2,360.97. So as to begin the year with a clean record your president and treasurer advanced this amount to the treasury as a loan, which, however, does not show to their credit on their respective accounts. A resolution will be in order to reimburse Albert M. Kohn with $1,180.48 and Emil W. Kohn with $1,180.49 from any subsequent profits of the corporation.

On the same date the following resolution was adopted:

On motion duly seconded, the treasurer’s report was accepted and ordered entered on the minutes. On motion duly seconded, it was ordered that the president and treasurer should be reimbursed from the subsequent profits of the corporation as follows: Mr. Emil W. Kohn $1,180.49, Mr. Albert M. Kohn $1,180.48, being the amounts advanced by them to the treasury as a loan.

The annual meeting of the officers and stockholders was held on April 10,1911, and the annual report of the treasurer of the financial condition of the business on March 1, 1911, contained the following:

Your treasurer regrets to announce that the fiscal year closing February 28, 1911, has not been a profitable one. The net loss amounts to $4,640.20. So as not to carry forward any item of loss, your president and vice-president have each assumed one-half (½) of the loss which has been charged to their respective accounts. They have each now assumed a loss of $3,500.59 to March 1, 1911 ($1,180.48 having been charged to their respective accounts on March 1, 1910).
A resolution will be in order to reimburse Albert M. Kohn with $3,500.59 and Emil W. Kohn with $3,500.59 from any subsequent profits of the corporation. This amount is the total indebtedness owing these officers by the corporation to March 1, 1911. This amount does not show as a credit on their respective accounts, nor is it treated as a liability of the corporation.

At the same meeting the following resolution was adopted:

On motion duly seconded it was ordered that the president and treasurer should be reimbursed from the subsequent profits of the corporation as follows : Mr. Albert M. Kohn $3,500.59; Mr. Emil W. Kohn, $3,500.59; this being the total amount owing to these officers to March 1, 1911.

At a meeting of the board of directors held on April 8, 1912, the following resolutions, among others, were adopted :

It was resolved that as the business of the corporation has not met the fixed charges for the year, that no dividends be declared or paid on the stock.
It was regularly moved and carried that as the president and treasurer had voluntarily paid the sum of $1,023.65 each, that they be repaid this amount from any subsequent profits of the corporation.

At the annual meeting of the stockholders held on April 14, 1913, the report of the treasurer as to the financial condition of the business on March 1, 1913, contained the following:

Your treasurer regrets to announce that the fiscal year closing February 28, 1913, has not been a profitable one. The net loss amounts to $2,646.05. So as not to carry forward any item of loss your president and vice-president have each assumed one-half (½) of the loss which has been charged to their respective accounts, thus cancelling the deficit. They have each now assumed a loss of $5,847.26 to March 1, 1913 ($4,524.24 having been charged to their respective accounts up to March 1, 1912).
A resolution will be in order to reimburse Albert M. Kohn with $5,847.26 and Emil W. Kohn with $5,847.26 from any subsequent profits of the corporation. It' is understood however that these amounts have been contributed freely to cancel the deficit. This amount does not show as a credit on their respective accounts, nor is it treated as a liability of the corporation. The above amount is the total sum to date contributed by the president and the treasurer, respectively.

At the same meeting the following resolution was adopted:

It was regularly moved and carried that the president and treasurer be reimbursed $5,847.26 each, that being the total amount which they have contributed to the funds of the corporation to date.

At the annual meeting of the stockholders held on April 27, 1914, the report of the treasurer showing the financial condition of the business on March 2, 1914, contained the following:

Your treasurer regrets to announce that the fiscal year closing February 28, 1914, has not been a profitable one. The net loss amounts to $13,867.90. Your president and vice-president have each assumed one-half (½) of the loss which has been charged to their respective accounts, thus cancelling the deficit. They have each now assumed a loss of $12,781.21 to March 2, 1914 ($5,847.26 having been charged to their respective accounts up to March 1, 1913).
A resolution will be in order to reimburse Albert M. Kohn with $12,781.21 and Emil W. Kohn with $12,781.21 from any subsequent profits of the corporation. It is understood however that these amounts have been contributed freely to cancel the deficit. This amount does not show as a credit on their respective accounts, nor is it a liability of the corporation.

On the same date the following resolution was adopted:

It was regularly moved and carried that the president and treasurer be, each of them, reimbursed $12,781.21 from any subsequent profits of the corporation; this being the total amount each has contributed to the corporation to date.

At the annual meeting of the stockholders held on April 12, 1915, the report of the treasurer relative to the financial condition of the business on March 1, 1915, contained the following:

Your treasurer regrets to announce that the fiscal year closing February 28, 1915, has not been a profitable one. The net loss amounts to $13,140.88, Your president and vice-president have each assumed one-half (½) of the loss which has been charged to their respective accounts, thus cancelling the deficit. They have each now assumed a loss of $19,351.65 to March 1, 1915 ($12,781.21 having been charged to their respective accounts up to March 2, 1914).
A resolution will be in order to reimburse Albert M.- Kohn with $19,351.65 and Emil W. Kohn with $19,351.65 from any subsequent profits of the corporation. It is understood however that these amounts have been contributed freely to cancel the deficit. This amount does not show as a credit on their respective accounts, nor is it a liability of the corporation.

On the same date the following resolution was adopted:

It was regularly moved and carried that the president and treasurer he, each of them, reimbursed $19,351.65 from any subsequent profits of the corporation; this being the total amount each has contributed to the corporation to date.

At the annual meeting of the stockholders on April 10, 1916, the treasurer’s report contained the following;

Xour treasurer begs to report that although the profit and loss account shows no loss, it should be reported that your president and vice-president have accepted reduced salaries for the past year so that the corporation may end the year without loss. During the past fiscal year your president, Albert M. Kohn, has accepted $3,543.56 as his salary; your vice-president and treasurer, Emil W. Kohn, has accepted a salary of $1,500.
Although not treated as a liability of the corporation it will be in order to vote that out of any subsequent profits of the corporation Albert M. Kohn be reimbursed to the amount of $21,808.09 and Emil W. Kohn be reimbursed to the amount of $23,851.65. It is, of course, understood that these amounts are not a liability of the corporation and that these respective officers make no claim whatsoever for any part of these amounts on the corporation. They do not appear as a credit to their respective accounts, nor as a debt against the corporation.

At the same meeting the following resolution was adopted:

It was regularly moved and carried that the president, Albert M. Kohn, be reimbursed to the amount of $21,808.09 and that the treasurer, Emil W. Kohn, be reimbursed to the amount of $23,851.65. These amounts are to be paid from subsequent profits of the corporation. This being the total up to date and inclusive of any amounts voted at any previous meeting.

The annual report of the treasurer to the officers and stockholders at a meeting held April 9, 1917, contained the following:

This statement shows the net profits of the past fiscal year to be $23,456.31. In accordance with a resolution passed at the last annual meeting, the net profits have been apportioned in equal amounts to Messrs. Albert M. Kohn and Emil W. Kohn in view of their assumption of losses for several years and should be regarded as extra compensation in consideration of said officers having waived their right to immediate collection of salary and interest due them in the preceding years from 1910 to 1916.
Although not regarded as a debt of the corporation and with the distinct understanding that no claim is made or will be made upon the corporation for these amounts, it will be in order to pass a resolution that out of any subsequent profits Albert M. Kohn is to receive $10,079.93 and Emil W. Kohn is to receive $12,123.50; these amounts being the sums voluntarily assumed by the stated officers of the losses of the corporation.

At the same meeting the following resolution was adopted:

It was regularly moved and carried that the president, Mr. Albert M. Kohn, be reimbursed to the amount of $10,079.93 and that the treasurer, Mr. Emil W. Kohn, be reimbursed to the amount of $12,123.50; these amounts being the sums voluntarily assumed by the stated officers of the losses of the corporation. It was distinctly understood however that these amounts are not ■considered as debts of the corporation and that no claim is made or will be ¡made upon the corporation for these amounts. The amounts stated are to be paid only out of any subsequent profits of the corporation.

At the meeting of the officers and stockholders on April 8, 1918, the treasurer’s annual report contained the following:

This statement shows a net loss for the past fiscal year of $4,930.58, which amount was assumed in equal amounts by Mr. Albert M. Kohn and Mr. Emil ~W. Kohn. It should be noted that for the past fiscal year your president has accepted a reduced salary, namely, $3,000. It should be noted, also, that the vice-president and treasurer has also accepted a reduced salary, namely, ⅜3,000.
Although not regarded as a debt of the corporation and with the distinct nmderstanding that no claim is made or will be made on the corporation for these amounts it will be in order to pass a resolution that out of any subsequent profits Albert M. Kohn is to receive $15,545.22 and Emil W. Kohn is to receive $17,588.79; these amounts being the total sums voluntarily assumed by these respective officers of the losses of the corporation.

At the same meeting the following resolution was adopted:

It was regularly moved and carried that the president, Mr. Albert M. Kohn, be reimbursed to the amount of $15,545.22 and that the treasurer, Mr. Emil W. Kohn, be reimbursed to the amount of $17,588.79 out of any subsequent profits of the corporation. It is distinctly understood however that these amounts are not assumed as debts of the corporation and that no claim is made or will be made upon the corporation for these amounts.

At the annual meeting of the stockholders on April 14, 1919, the ■following resolution was adopted:

The directors having decided, and their action being approved, to reimburse Albert M. Kohn with $2,465.29 and Emil W. Kohn with $2,465.29, being part •of the amount they voluntarily assumed from previous losses sustained by-the corporation, it was duly moved and adopted to reimburse Albert M. Kohn with $10,079.93 and Emil W. Kohn with $12,123.50 out of any subsequent profits of the corporation; being the amounts they severally assumed from previous losses of the corporation. It is distinctly understood however that these amounts are not assumed to be and are not to be regarded as debts •of the corporation.

At a special meeting of the board of directors, held on January 20, 1920, the following proceedings were had:

Robert D. Kohn then read the following statement:
At the annual meeting of the stockholders of the corporation held April 8, 1918, the following resolution was adopted: “ That the president, Albert M. Kohn, be reimbursed to the amount of $15,545.22 and that the treasurer, Emil W. Kohn, be reimbursed to the amount of $17,588.79 out of any subsequent profits of the corporation. It is distinctly understood, however, that ■these amounts are not assumed as debts of the corporation and that no claim is made or will be made upon the corporation for these amounts.”
Subsequently at the’ annual meeting of the stockholders of the corporation held April 14, 1919, the action of the directors was approved reimbursing Albert M. Kohn with $2,465.29 and Emil W. Kohn with $2,465.29. These are the only and total amounts paid to Albert M. Kohn and Emil W. Kohn respectively on account of unpaid salaries accumulated up to March 1, 1919.
At the same annual meeting held April 14, 1919, it was voted to reimburse Albert M. Kohn with $10,079.93 and Emil W. Kohn with $12,123.50 out of subsequent profits, etc., etc. These amounts are in error as $2,465.29 is the only and total amounts paid to Albert M. Kohn and Emil W. Kohn respectively towards the total amount recognized by resolution of April 8, 1918, the totals remaining unpaid on April 14, 1919, should therefore be $3,000.00 additional. To correct that error Robert D. Kohn offered the following motion: “That Albert M. Kohn be reimbursed with $13,079.93 and Emil W. Kohn with $15,123.50 out of any subsequent profits to March 1, 1919. These amounts being the total amounts they have respectively assumed at various times previous to March 1, 1919, the same being unpaid salaries. It is distinctly understood however, that these amounts are not assumed to be and are not regarded as debts of the corporation.” The motion was duly seconded and adopted.
On motion duly made and seconded it was voted that Albert M. Kohn, president of the corporation, is to receive a salary of $12,000.00 per annum for the fiscal year ending March 1, 1920.
On motion duly made and seconded it was voted that Emil W. Kohn, vice-president and treasurer of the corporation, is to receive a salary of $9,000 per annum for the fiscal year ending March 1, 1920.

At the annual meeting of the board of directors, held on April 14, 1920, the following resolutions were adopted:

It was duly moved and carried that for the fiscal year ending March 1, 1921 the president receive a salary of $12,000 per annum and the vice-president receive a salary of $9,000 per annum. These amounts to be credited pro rata at the end of each month.
Motion duly made and carried that the previous unpaid salaries of the president amounting to $13,079.93 and the vice-president and treasurer amounting to $15,123.50 be now paid.

The taxpayer kept its books and rendered its returns on the accrual basis.

The deficiency for the fiscal year ending February £8, 19£0, is $7,937.57. Order of redetermination will be entered accordingly.


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    Appeal of RICE AND FIELDING, INC.
    Docket No. 5219.
    Submitted December 3, 1925.
    Decided March 31, 1926.

      Elisha F. Nunan, G. P. A., for the taxpayer.

      J. Arthur Adams, Esq., for the Commissioner.
    Before Littleton, Smith, and Trussell.
    This is an appeal from the determination of a deficiency in income and profits tax for the calendar year 1917 in the amount of $1,685.86, arising from the refusal of the Commissioner to classify the corporation as one having no invested capital, or not more than a nominal capital, under section 209 of the Revenue Act of 1917.
   FINDINGS OF FACT.

The taxpayer is a Massachusetts corporation engaged in business as foreign freight contractors, forwarding agents, and custom-house brokers, with principal office at Boston. It was organized in February, 1917, with a capital stock of $5,050, all of which was paid in in cash by two stockholders, each of whom devoted his entire time to. the business and received an annual salary of $5,200.

During the taxable year the entire income was derived from commissions received from steamship companies and charges made to shippers for services as a broker. The gross income and deductions were as follows:

Brokerage and service on shipments_$26, 633.68
Profit and commission on trucking_ 1,125. OO
Profit and commission on warehousing_ 368.00
Services on customs entries_ 2, 650.00
33, 773.58
Deductions:
Labor and wages_ 3, 356.00
New furniture and fixtures_ 860.00
Donations, gratuities, etc_ 1, 000.00
Bent- 900.00
Telephone_ 1,260. 00
Printing- 1, 585.00
Postage_ 2, 650.00
Traveling_ 2,409.17
13,120.17

The balance sheets at the beginning and end of 1917 were as follows:

The item of cash and accounts receivable represents outstanding charges against shippers for brokerage and advances made for freight, insurance, etc.

The item of accounts payable represents obligations to steamship, insurance, and cartage companies for amounts advanced on shipments for account of clients; also, amounts due for office expenses. The taxpayer used its capital in the payment of general expenses. Occasionally, it made small advances on freight charges to steamship and railway companies for the account of its clients, to avoid delay and as a part of its service. These advances were promptly remitted by the shipper upon receipt of statement of the amount thereof. In all cases where advances were not made by the taxpayer amounts sufficient to care for such charges were obtained in' advance from shippers.

During the year 1917 the taxpayer’s capital was nominal.

Order of redetermination will ~be entered on 15 days' notice, under Rule 50.


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    Appeal of MARINDA LEITH.
    Docket No. 3594.
    Submitted January 19, 1926.
    Decided March 31, 1926.

      Hewitt Griggs Robertson, Esq., for the taxpayer.

      E. G. Lalce, Esq., for the Commissioner.
    Before James, Littleton, Smith, and Tetjssell.
    This is an appeal from the determination of a deficiency in income tax for the calendar year 1919 in the amount of $4,962.21, arising from the inclusion in the gross income of the taxpayer of certain amounts alleged to have been received from the estate of William Leith.
   FINDINGS OF FACT.

The taxpayer is a resident of Hew Jersey. Upon the death of her husband on May 15, 1919, she qualified as one of the executors and trustees under the will and has acted as such since that time.

The will of William Leith, executed December 24, 1918, after directing that his debts and funeral expenses be paid, provides :

I give and bequeath to my executors and trustees the sum of One Hundred and Fifty Thousand ($150,000) Dollars unless the value of my estate at the time of my death shall be less than One Million ($1,000,000) Dollars, that is, unless the value of my assets, at the time of my death, after deducting my liabilities, shall be less than One Million ($1,000,000) Dollars, in which event, I give and bequeath to my executors and trustees the sum of One Hundred Thousand ($100,000) Dollars, instead of the said sum of One Hundred and Fifty Thousand ($150,000) Dollars, in trust nevertheless, to pay the income therefrom to my beloved wife, Marinda, until my daughter, Katherine, attains the age of thirty-five (35) years, at which time I direct my executors and trustees to pay the principal of this trust to my daughter Katherine. Should my beloved wife die during the lifetime of my daughter Katherine, and before my daughter Katherine attains the age of thirty-five (35) years, this trust shall immediately cease, and the principal thereof be paid to my daughter Katherine. Should my daughter Katherine die before she attains the age of thirty-five (35) years and during the lifetime of my beloved wife, then upon the death of my daughter Katherine this trust shall cease, and the principal thereof shall be paid to her issue, should she leave issue her surviving; should she die without leaving issue her surviving, and leaving her surviving her two sisters, Margaret and Dorothy, then the principal of this trust shall, upon her death, be divided equally between my said daughters, Margaret and Dorothy; should she die without leaving issue her surviving, and leaving her surviving a sister and issue of a deceased sister, then the principal of this trust shall upon her death be equally divided between her surviving sister and the issue of her deceased sister, per stirpes and not per capita; should she die without leaving issue her surviving and leaving her surviving a sister and no issue of a deceased sister, then the principal of this trust, upon her death, shall be paid to such surviving sister; should she die without leaving issue or a sister her surviving and leaving her surviving issue of a deceased sister or sisters, then upon her death the principal of this trust shall be divided between the issue of such deceased sister or sisters; if there be issue of two-deceased sisters, such issue shall take per stirpes and not per capita.

In paragraphs 4 and 5 of the will, the decedent created similar trusts for his daughters Margaret and Dorothy.

In paragraph 6 he bequeathed $15,000 to his executors and trustees,, in trust to pay the income therefrom to his nephew, Sidney Leith,, during his life, and upon his death to divide the sum equally between the decedent’s surviving children and the issue of any deceased child, per stirpes.

In paragraph 7 he bequeathed to his executors the sum of $6,000, in trust to pay the income therefrom to his niece, Camilla Opper, luring her life, with remainder to his surviving children and the issue of any deceased child.

In paragraph 8 he bequeathed $3,000 to his niece, Dora Fishel Popper, and, in paragraph 9, the sum of $2,000 to his nephew, Henry Levy.

In paragraph 10 he bequeathed to his executors and trustees the sum of $20,000, in trust—

To pay from the income thereof to Alice Levy, widow of my deceased jrother, Samuel Levy, the sum of Eighty ($80) Dollars per month during her ife, she having given to me the sum of Thirteen Thousand One Hundred md Ninety-four ($13,194) Dollars, and I having agreed in consideration thereof :o pay to her during her life the sum of Eighty ($S0) Dollars per month, md at her death this trust shall cease, and if at that time she shall not lave received from me and from my executors and trustees, from June 1st, 916, on account of said agreement or otherwise the sum of Six Thousand ¡five Hundred and Ninety-seven ($6,59T) Dollars, then I direct my executors and trustees to pay from the principal of this trust to my nephew, Sidney Leith, formerly known as Sidney Levy, the difference between the amount she shall have received and said sum of Six Thousand Five Hundred and Ninety-seven ($6,597) Dollars.

In paragraph 11 he bequeathed to his gardener, Peter Juliano, $300.

In paragraph 12 he devised and bequeathed all the rest, residue and remainder of his estate, of whatsoever kind or nature, to his wife, Marinda Leith.

The executors filed a fiduciary return of income, Form 1041, for the period May 15 to December 31, 1919, which showed the taxpayer as the sole beneficiary of the estate and that certain income during that period was distributable to her. Subsequently, the executors filed an amended return for the estate on Form 1040, showing the income to be that of an estate in process of administration and settlement and the tax thereon to be payable by it. The Commissioner increased the taxpayer’s income in the amount of $10,694.03, representing the income from a business conducted by the executors of the estate, and $7,112.50 and $531.59, dividends and Liberty bond interest, respectively, upon stocks and bonds held by the estate.

During the period May 15 to December 31, 1919, the estate was in the process of administration and settlement and the executors had not rendered final statement and received their discharge as executors. During this period certain amounts of money not disclosed by the record were paid over by the executors to the taxpayer.

The deficiency for the calendar year 1919 is $¡¡.,96231. Order of redetermination will be entered accordingly.


text:
    Appeal of MERKLE BROOM CO.
    Docket No. 4953.
    Submitted November 15, 1925.
    Decided March 31, 1926.

      John F. McOarren, Esq., for the taxpayer.

      Ellis W. Manning, Esq., for the Commissioner.
    Before Smith, James, Littleton, and Trtxssell.
    The taxpayer appeals from the determination of a deficiency in income and profits tax for the years 1918 and 1919 in the aggregate amount of $4,147.62. The question in issue is proper depreciation rates upon (1) buildings, (2) machinery and equipment, and (3) automobiles for the tax years 1918 and 1919.
   BINDINGS OB BACT.

The taxpayer was incorporated in 1892 under the laws of Illinois, ' and is engaged in the manufacture of brooms from broom corn. In its original return for 1911 the taxpayer deducted from gross income $2,451.15 for depreciation, which was approximately 3 per cent of its plant account, which account was not segregated on its books into (1) buildings, and (2) machinery and equipment. No claim for depreciation was made in its return for 1918. In its return for 1919 it deducted depreciation at the rate of 5 per cent on its plant account, and at the rate of 33⅜ per cent on automobiles. In its return for 1920 depreciation was claimed at the rate of 3 per cent on the plant account and nothing on automobiles. The Commissioner has determined proper rates of depreciation for the years 1918 and 1919 to be as follows:

Per cent.
Buildings_ 3
Machinery and equipment_ 6
Automobiles_ 20

A proper segregation of the plant account as between buildings, on the one hand, and machinery and equipment, on the other, is 54.7 per cent of the total for buildings and 45.3 per cent of the total for machinery and equipment.

The taxpayer’s main building is 200 feet long by 200 feet wide; it has two stories and a basement. The first building erected was 40 feet wide by 100 feet long, three stories high; the buildings were destroyed by fire around 1900. The present buildings are all of brick construction and are kept in a fair state of repair.

In the manufacture of brooms the taxpayer uses many kinds of machinery, such as a sizing machine, which sorts the corn into various lengths; a bumping machine, which makes the corn stop at the proper length; a corn-cutting machine, which cuts off the fibers; a cutting machine, which separates the fiber as it is grown on the corn; a heading machine, which takes the seeds off the corn, known as a reel by the farmers; a tying machine, by which the brooms are tied with wire; a clipping machine, which clips off the ends of the brooms; a hand-polishing machine, and many others. Some of the machines vibrate excessively when in use. The degree of vibration varies with the different machines. The average life of all the different machines of the taxpayer is from 5 to 10 years. Some of the machines may last more than 10 years and some less than 5 years.

The taxpayer uses in its business automobiles, such as Dodges, Hupmobiles, Buicks, and Fords. These are used by salesmen in traveling throughout the country. As a rule, automobiles are exchanged for new ones at the end of the second year.

Proper rates of depreciation for the years 1918 and 1919 are:

Per cent.
Buildings--- 3
Machinery and equipment_ 10
Automobiles_ 25

Order of redet&mdinoMon will be entered on 10 donjá notice, under Rule 50.