T.C. Memo. 2001-197
UNITED STATES TAX COURT
DAMRON AUTO PARTS, INC., Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 5661-00. Filed July 30, 2001.
Ronald J. Russo, for petitioner.
William R. McCants, for respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
FOLEY, Judge: By notice dated February 17, 2000, respondent
determined deficiencies and section 6651(a)(1) additions to
petitioner’s Federal income taxes as follows:
Sec. 6651(a)(1)
Year Deficiency Addition
1993 $269,956 $63,464
1994 502,174 24,859
1995 482,736 --
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All section references are to the Internal Revenue Code in effect
for the years in issue, and all Rule references are to the Tax
Court Rules of Practice and Procedure. The issues are whether
petitioner is entitled to section 162 deductions relating to
compensation payments in excess of the amounts determined by
respondent and whether petitioner is liable for section
6651(a)(1) additions to tax.
FINDINGS OF FACT
I. Background
Petitioner was incorporated in 1982. It had its principal
place of business in Florida when the petition was filed. From
1982 until 1992, Leonard A. Damron, III, and his sister, Sharon
Owen, owned 51 and 49 percent, respectively, of petitioner’s
stock. Mr. Damron and Mrs. Owen’s husband, Ronald, operated
petitioner, which recycled and sold used auto parts. In 1984,
petitioner’s stock was worth approximately $200,000. On August
12, 1992, Mrs. Owen sold her stock in petitioner and related
corporations to Mr. Damron for $250,000, and Mr. Owen entered
into an employment contract with petitioner. On October 31,
1995, petitioner declared and paid a $7,589 dividend to Mr.
Damron. In 1998, Mr. Damron sold, for $12,500,000, all of
petitioner’s stock to, and became an employee of, LKQ Corporation
(LKQ), a national provider of recycled auto parts. Petitioner’s
gross receipts were as follows:
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Year Amount
1993 $9,108,625
1994 10,552,652
1995 11,355,749
1998 13,000,000
II. Operations
Mr. Damron upgraded petitioner’s business from a basic
salvage yard to a modern state-of-the-art showroom. Under his
leadership, petitioner purchased wrecked cars from insurance
companies and auctions, dismantled the cars, tested and cleaned
the parts, indexed the parts in a computer data base, and shelved
the parts for sale. Thus, the parts could be sold to customers
without employees’ scavenging the salvage yard.
From 1984 through 1995, Mr. Damron typically worked 90 to
100 hours per week, did not go out for lunch, and took only three
vacations of a few days each. Mr. Damron attended the auctions,
purchased wrecked cars, priced all the parts, determined when to
crush dismantled vehicles, arranged the sale of crushed hulks,
negotiated with vendors, reviewed accounts receivable and
payable, and designed petitioner’s facility.
During the years in issue, petitioner had 40 to 60
employees. Mr. Damron interviewed, hired, evaluated, and
terminated the employees; trained and supervised the dismantlers;
and was responsible for employee benefits, health plans, bonuses,
workers’ compensation, insurance, employee safety, and hazardous
waste disposal.
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On October 24, 1994, Mr. Damron and his wife entered into a
Marital Settlement Agreement which stated that petitioner’s stock
was worth $1,200,000. In 1995, Mr. Damron and his wife were
divorced as a result, in part, of his grueling work schedule. In
July 1996, Mr. Damron and his wife were remarried.
III. Compensation
During 1985 through 1991, petitioner’s accountant formulated
compensation for Mr. Damron and Mr. Owen reflecting base salaries
and bonuses. Mr. Damron’s bonus was 10 percent of wholesale
sales. Petitioner paid Mr. Damron only a portion of the
compensation thus formulated, resulting in underpayments of
$191,251, $278,963, $359,903, $430,370, $437,280, $587,340, and
$364,332, relating to 1985 through 1991, respectively. Effective
February 20, 1990, Mr. Damron, his wife, and Mr. and Mrs. Owen
signed a Capital Accumulation Verification (Verification)
forgiving any debts petitioner owed them.
During 1992 through 1995, petitioner’s accountant formulated
Mr. Damron’s bonus as 10 percent of wholesale sales or, if less,
50 percent of any excess of petitioner’s income (i.e., after
wages) over $500,000, or 25 percent of any such excess over
$250,000. Petitioner’s payments to Mr. Damron and gross profits
were as follows:
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Payment for Total Petitioner’s
Year Salary Bonus Past Services Compensation Gross Profits
1993 $480,000 $387,073 $482,927 $1,350,000 $3,779,338
1994 961,500 520,648 354,966 1,837,114 4,693,741
1995 1,000,000 496,386 406,160 1,902,546 5,080,865
During the years in issue, Mr. Damron was not a participant in
any pension, profit-sharing, or executive compensation plan.
In 1998, pursuant to his sale of petitioner’s stock to LKQ,
Mr. Damron became vice president (Southeast Region) of LKQ. In
addition, he remained president of petitioner. Mr. Damron earned
about $500,000 per year, which included base compensation of
$250,000 per year and additional compensation dependent on
revenue generated in the region. He also received incentive
compensation based upon “corporate and regional financial and
operating objectives”. The Southeast Region generated about
$90,000,000 annually. As an LKQ employee, Mr. Damron was
entitled to 30 days of vacation every year.
IV. Other Corporations
During the years in issue, Mr. Damron was the sole
shareholder of the following nine corporations: Damron
Management Corporation; Damron Used Auto Parts Stores, Inc.;
Yuppie Euro, Inc.; Damron Service, Inc.; Damron Land Holdings,
Inc.; Damron Trucking, Inc.; Damron Parts Replacement Corp.;
Damron Used Auto Parts of Gainesville, Inc.; and Damron Auto
Parts of Georgia, Inc. He rendered 10 percent of his services to
these corporations but did not receive salary from them.
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V. Returns
On July 15, 1994, and July 17, 1995, petitioner’s respective
1993 and 1994 returns were due (i.e., after extensions). On
November 18, 1994, and August 2, 1995, respondent received the
respective 1993 and 1994 returns. Respondent determined that Mr.
Damron’s compensation should be adjusted as follows:
Year Amount Allowed Adjustment
1993 $468,946 $881,054
1994 492,373 1,344,741
1995 517,004 1,385,532
OPINION
I. Compensation
Section 162(a) allows a deduction for salary expense if the
amount is reasonable and the expense relates to compensation for
services actually rendered. Elliotts, Inc. v. Commissioner, 716
F.2d 1241, 1243 (9th Cir. 1983), revg. T.C. Memo. 1980-282. An
expense “may be deductible as reasonable compensation for current
and past services rendered.” R. J. Nicoll Co. v. Commissioner,
59 T.C. 37, 50 (1972).
We note at the outset that 10 percent of the compensation
paid, during the years in issue, to Mr. Damron, was directly
attributable to services performed for the nine other
corporations he controlled. These amounts should have been paid
by such corporations and, accordingly, are not deductible by
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petitioner. Thus, we must determine whether petitioner is
entitled to deduct 90 percent of the compensation paid.
Citing petitioner’s payment of only one dividend over 16
years, respondent contends that the disallowed payments were not
reasonable compensation. Dividend history, however, is only one
of many factors in determining reasonableness of compensation.
See Estate of Wallace v. Commissioner, 95 T.C. 525, 553 (1990),
affd. 965 F.2d 1038 (11th Cir. 1992). During the years in issue,
Mr. Damron performed several functions for petitioner in numerous
roles (i.e., purchasing, selling, supervising, etc.). He worked
incessantly and exercised sound business judgment which had a
direct and significant impact on petitioner’s profitability. Mr.
Damron transformed petitioner’s business from a basic salvage
yard to a modern state-of-the-art showroom. Petitioner’s
facility, according to respondent’s expert, “is reported to be
the largest of its kind.” In addition, our analysis of the
return on equity in petitioner reveals that petitioner had a high
rate of return despite its failure to pay dividends. See
Elliotts, Inc. v. Commissioner, supra at 1244 (rejecting the
automatic dividend rule). Accordingly, Mr. Damron’s
qualifications; the nature, extent, and scope of his
responsibilities; and the size and complexities of petitioner’s
business all lead us to conclude that his compensation was
reasonable. See Estate of Wallace v. Commissioner, supra.
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From its incorporation until its purchase by LKQ, petitioner
consistently and rapidly increased in fair market value (FMV).
Under the guidance and management of Mr. Damron, a corporation
valued at $200,000 in 1984 grew to $12,500,000 in 1998.
Respondent’s expert opined that FMV increased from $3,755,510 in
1993 to $6,267,846 in 1995.1 Moreover, respondent’s expert found
that the maximum compensation (i.e., including bonus) should be
$786,000, $1,145,000, and $1,144,000, relating to the respective
years in issue (i.e., 68, 133, and 121 percent more than
respondent allowed, respectively).
In essence, Mr. Damron rendered extensive and intensive
services to petitioner that, according to petitioner’s expert,
resulted in a compound rate of return, from 1984 to 1998, of more
than 39 percent per year. Respondent’s expert believed that
investors in a firm like petitioner would expect a 14.3-percent
return on their investment. We conclude that an independent
1
In an addendum submitted at trial, respondent’s expert
explained that when he prepared his original report he did not
know petitioner had been sold in 1998 for $12,500,000. The
expert stated: “Given the subsequent price paid for DAP [i.e.,
petitioner], our original returns analysis underestimated the
value of DAP and, thus, overestimated the compensation available
to Mr. Damron between 1993 and 1995.” Consequently, the expert
presented an alternative analysis indicating that FMV increased
from $7,357,619 in 1993 to $9,667,382 in 1995. The expert added,
however, that “The analysis based on the subsequent sale of DAP
does not alter the conclusions in our original report”.
Therefore, we do not accord great weight to the expert’s
alternative analysis and accept his original conclusion that FMV
increased 67, rather than 31, percent from 1993 to 1995.
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investor would have been quite satisfied with petitioner’s
consistent growth, solid management, and other indications that
gains would continue.
Respondent contends that petitioner’s accountant performed
yearend planning “to severely limit petitioner’s taxable income”.
The bonus calculations were performed at yearend because it was
then that petitioner’s accountant had all the information
required to determine the appropriate amount of the payments.
Our focus is on the reasonableness of the amounts, not the
payment dates, of the compensation. The timing of the payments
does not lead us to conclude that Mr. Damron’s compensation was
unreasonably high. See Owensby & Kritikos, Inc. v. Commissioner,
819 F.2d 1315, 1323, 1329 (5th Cir. 1987) (stating that “No
single factor is decisive of the question * * * [although] such
substantial bonuses declared at year-end when the earnings of a
business are known usually indicate the existence of disguised
dividends”), affg. T.C. Memo. 1985-267.
Respondent also contends that the amounts he allowed are “in
line with” Mr. Damron’s compensation as an LKQ employee. All the
evidence presented at trial, however, established that Mr.
Damron’s responsibilities to LKQ were fewer, less stressful, and
less time-consuming than his previous work for petitioner. In
short, LKQ paid Mr. Damron less than petitioner paid because at
LKQ he delegated more of his responsibilities.
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Respondent contends that petitioner did not pay Mr. Damron
to make up for past undercompensation because he had signed the
Verification. We conclude that the Verification is irrelevant
and that it did not preclude petitioner from paying for past
services. See Lucas v. Ox Fibre Brush Co., 281 U.S. 115, 119
(1930) (stating that “compensation for past services, it being
admitted that it was reasonable in amount in view of the large
benefits which the corporation had received as the fruits of
these services, the corporation had a right to pay, if it saw
fit”). Even if portions were not attributable to past services,
our conclusion would not change.
Accordingly, we hold that Mr. Damron’s salary during the
years in issue was reasonable.
II. Additions to Tax
Section 6651(a)(1) imposes an addition to tax for failure to
file a required return on the date prescribed, unless it is shown
that such failure is due to reasonable cause and not willful
neglect. Petitioner’s 1993 and 1994 returns were due on July 15,
1994, and July 17, 1995, but not filed before November 18, 1994,
and August 2, 1995, respectively. Petitioner presented no
evidence relating to this issue and did not address it on brief.
It has not been shown that such failure is due to reasonable
cause and not willful neglect. Accordingly, petitioner is liable
for the section 6651(a)(1) additions to tax.
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Contentions we have not addressed are moot, irrelevant, or
meritless.
To reflect the foregoing,
Decision will be entered
under Rule 155.