*4257 1. Certain amounts paid to tenants as their share of proceeds from sales of crops allowed as deductions from gross income.
2. For excess-profits-tax purposes, an individual, who, in the year 1917, owned and managed an enterprise that had invested capital, is entitled to deduct from gross income a reasonable amount as salary for services rendered to such enterprise.
3. Negligence penalty sustained; fraud penalty disallowed.
*1273 The Commissioner has determined deficiencies in income and profits taxes for the years 1917, 1918, and 1919, in the respective amounts of $3,863.68, $4,985.48, and $1,455.33, and has added thereto a penalty of 50 per cent of the excess-profits tax determined for 1917 in the amount of $1,839.16 as a penalty for failure to make an excess-profits-tax return; a penalty of 100 per cent of the income tax determined for 1917 in the amount of $858, and a penalty of 50 per cent of the income tax determined for 1918, in the amount of $2,515.60, for false and fraudulent returns made for such years. The total amount*4258 in controversy, including deficiencies and penalties, is $15,517.25. The issues involved are: (1) The imposition of the negligence and fraud penalties above set forth; (2) petitioner's claim for a deduction from gross income for 1917 of the amount of $6,000, as a reasonable salary for the management of a business with invested capital; (3) the Commissioner's alleged overstatement of the petitioner's gross and net income for each of the taxable years; and (4) the disallowance of certain deductions from gross income for the year 1919, on account of bad debts ascertained to be worthless and charged off, and of losses alleged to have been sustained in transactions entered into for profit in such year. The parties agreed that the two appeals should be consolidated for hearing and decision.
FINDINGS OF FACT.
The petitioner is an individual who resided at Vienna, Ga., during the taxable years, and, for all the time involved in this proceeding, was engaged in the operation of farm which consisted of about 700 acres, of which approximately 600 acres were in cultivation.
The business methods and business operation of the petitioner were similar to the practice of many cotton growers*4259 in the South. The farm was worked on the share crop system. The petitioner divided *1274 his cultivated land into tracts of 25 or 35 acres, each of which was farmed by a share cropper. He furnished a house and garden for the corpper, the mules, seed, and tools necessary to make the crop and paid for one-half of all the fertilizer used. Cotton was the principal source of cash income. Corn, hay, and other minor crops were practically all consumed on the farm, and added very slightly to the income thereof.
The croppers planted, cultivated, and harvested the crops. The petitioner ginned the cotton and sold the cotton and cotton seed. The chsh returns from all crops were divided fifty-fifty between the owner and the croppers, most of whom were negroes. It was the petitioner's practice to deposit all receipts from the sale of crops to his own credit in banks, and to pay each cropper by check the proceeds of the sale of one-half the crop produced, after first deducting all amounts advanced to such cropper during the year.
For the convenience and service of his croppers, the petitioner maintained a small store or commissary on his farm from which he sold supplies of various*4260 sorts to his tenants, and, in a very small way, to others. The sales from the commissary never exceeded $4,000 in amount in any one of the taxable years, and the gross profit was never more than 10 per cent of the total volume of such transactions. The petitioner also bought cotton seed, usually on commission, and earned not more than $500 a year in this way. He also operated a small cotton gin, from which he derived some income, but not more than $1,000 net in any one year.
The petitioner can read and write, but is a man of very limited education. In response to a notice, published in a local paper, he went to Vienna on February 23, 1918, for the purpose of reporting his income for the year 1917. He gave what he believed was a complete statement of his income to one Andrews, a deputy collector of internal revenue, and signed and swore to the return made out for him by the said Andrews. At the time he had never heard of an excess-profits tax or excess-profits-tax return. He executed the only return required of him by the deputy collector, and paid the tax indicated by the computation thereon, which was made by Andrews. He was not told at that time that the law required an*4261 excess-profits-tax return.
In 1919 the petitioner employed a public accountant, reputed to be well versed in the income-tax law and in the preparation of returns thereunder, to prepare his income-tax returns. To the best of his knowledge and belief, he furnished the accountant with all the facts concerning his income for the year 1918, and signed and swore to the return which was duly filed, with a check attached in payment of the amount of tax indicated by the computation made *1275 by the accountant. His income-tax return for 1919, showing no taxable income, was prepared in a similar manner, and was not filed until after request by the Commissioner in 1924, because he believed that he had sustained substantial losses in his operations in that year.
In his income-tax return for 1917, the petitioner claimed no deduction from gross income on account of salary for himself as manager of a business employing invested capital, but subsequently, in conference with representatives of the Commissioner, asserted his right to such deduction, which has never been allowed, and is one of the issues of this proceeding. A reasonable salary for the petitioner's services as farm manager*4262 during the year 1917 was $5,000.
Upon audit of the income-tax return of the petitioner for the years 1917, 1918, and 1919, the Commissioner held that the accounts and methods of reporting employed did not reflect truc income for the taxable years, and redetermined income and tax liability for the years 1917 and 1918 by using total bank deposits as a basis for determining gross income and deducting therefrom all non-income items, and such other amounts as were deemed to be proper allowances in the computation of the tax liability. He redetermined income for 1919 on the basis of bank deposits and withdrawals. For the years 1917 and 1918 the respondent determined that the petitioner's bank withdrawals indicated payments to share croppers on account of crops sold in the respective amounts of $10,000.81 and $17,215.21, but deducted 25 per cent of such amounts, or $2,500.20 and $4,303.80, from such alleged payment as profits realized from the sale of merchandise.
In his original income and profits-tax return for the year 1919, the petitioner deducted the following list of accounts as bad debts ascertained to be worthless and charged off during the taxable year:
| Frank Robinson | $365.48 |
| Boss Willard | 32.24 |
| Matildy Bryant | 293.35 |
| George Martin | 95.66 |
| Addie West | 190.71 |
| Turner Taylor and English | 295.10 |
| Turner Taylor (individually) | 659.78 |
| Ed Kellum | 932.35 |
| Mattie Gurden | $1,152.05 |
| Pig West | 152.96 |
| Preacher Wilson | 31.05 |
| Abe Frank | 285.56 |
| Arthur Williams | 35.17 |
| John West (bond forfeiture) | 150.00 |
| 4,671.46 |
*4263 All the persons listed above were share croppers on the petitioner's farm in 1919. The amounts indicated represent advances in cash and merchandise made to such croppers during the year. At December 31, each was wholly without resources. Most of them moved off the petitioner's land, and none has ever paid any of the amounts received by then during the taxable year. The debt of John West is on account of a bail bond on which the petitioner was surety. *1276 West left the State and soon after died. This bond was forfeited, and the amount thereof paid by the petitioner. Each of these accounts was ascertained to be worthless and charged off in the taxable year. During the year 1919, the petitioner sustained a loss in the amount of $5,039.76 in connection with transactions on the New York Cotton Exchange.
The petitioner's plantation produced 201 bales of cotton of 500 pounds each in 1917, which were sold for an average price of 20 cents per pound. In 1918 the production was 140 bales, which were sold at varying prices, but in no case for more than 22 cents per pound. The corn and other crops produced were consumed on the plantation. During such years the petitioner*4264 expended large amounts for fertilizer and labor.
OPINION.
LANSDON: The petitioner knows nothing of bookkeeping or of the science of accounting. Such records of his business as were considered by the Commissioner in the determination of the deficiencies and penalties here in question or produced at the hearing of this proceeding are no more than fragmentary and inconclusive memoranda from which it is impossible to determine true taxable income and assess tax liability. In the absence of books of account containing a reliable record of the petitioner's business operations, the Commissioner undertook to determine tax liability by taking total bank deposits for each of the years 1917 and 1918 as a basis for computing gross income for such respective years, which he reduced to net income by deducting some amounts known to be nonincome items and others that were either conceded or proved to be proper deductions.
The evidence discloses that the petitioner deposited in certain banks all receipts from the sale of crops, and that he paid practically all his obligations by checking on such banks. If such deposits represented all the elements of gross income and withdrawals all the*4265 expenses incurred in the production of such income, it is obvious that the difference between deposits and withdrawals, less nonincome items, statutory credits, exemptions and deductions, would be the petitioner's net taxable income. It is equally obvious that such a situation is all but inpossible, since there are likely to be many unidentified deposits of other than income items and many withdrawals for other than crop-production expenses. The Commissioner endeavored to identify and deduct all nonincome deposits, and to allow such deductions and exemptions as are authorized by law, and there is no proof that he did not do so except as to matters in which, upon the record, he appears to have been in error.
For the years 1917 and 1918 the Commissioner reduced the petitioner's payments to share croppers in the respective amounts of *1277 $2,500.20 and $4,303.80, and for the year 1917 disallowed any deduction on account of salary of the petitioner for the management of his farm as provided in section 5(a) of the Revenue Act of 1917, and specifically authorized in article 39 of Regulations 41. The amounts deducted from the petitioner's payments to croppers, and thereby automatically*4266 added to taxable income, are alleged by the Commissioner to represent profits realized by the petitioner from sales of merchandise to his croppers. The evidence does not support this procedure. It was proved at the hearing that the yearly sales of merchandise by the commissary conducted by the petitioner never exceeded $4,000, and that the gross profits from such business were never more than 10 per cent of the turnover. We are satisfied that no net profits were realized from such transactions. In any event, we are unable to see any relation between profits on merchandise sold to the petitioner's share croppers and the amounts due such croppers from the proceeds of the sale of crops produced by them. We hold, therefore, that the respondent overstated the petitioner's income for the years 1917 and 1918 in the respective amounts of $2,500.20 and $4,303.80.
It is not disputed that the petitioner was the manager of a business enterprise that used invested capital in its operations in the amount of $48,906.45, as computed by the Commissioner for excess-pr0fits purposes for 1917. In such circumstances the individual owning and operating such an enterprise is entitled, for excess-profits-tax*4267 purposes, to deduct from gross income all ordinary and necessary expenses. In article 39 of Regulations 41, the Commissioner thus applies that provision to individual owners and operators:
An individual carrying on a trade or business having an invested capital may in computing net income of the trade or business, for the purposes of the excess profits tax, deduct a reasonable amount designated by him as salary or compensation for services actually rendered by him in conduct of such trade or business.
The evidence is convincing that the petitioner is a highly competent farm operator, with many years of successful experience; that his gross annual income from his business was large; and that he devoted his entire time "from daylight to darkness" to the enterprise. A witness thoroughly conversant with farming in Georgia and with the nature, quantity, and quality of the crops produced by the petitioner, testified that he considered Morris's services as farm manager worth a minimum of $5,000 in the year 1917. The only reason suggested for disallowance of salary as claimed is that the petitioner lived on the farm, and that the values of the products thereof which he consumed were*4268 not returned as income. The Commissioner argues that the value of the farm products consumed by *1278 the petitioner, in all probability, was an adequate payment for the services rendered. We can not assent to this assumption, which we believe has no support in the statutes or the regulations. Products of a farm consumed by the operator thereof and his family do not appear to come within any of the categories of income enumerated in the taxing statutes and the administrative regulations of the Commissioner. To include the value of such products, even if it could be determined, in the deduction allowable for excess-profits-tax purposes to a farmer as compensation would automatically subject such amounts to normal tax and in effect include in income something which Congress did not intend should be so regarded. If products of a farm consumed thereon are income to the producer, it would seem to follow that the rental value of the farmer's home, the gratuitous services of his wife and children, and the value of the power derived from draft animals owned by the farmer and used without cost should also be so considered. It is obvious that such items are comparable to the rental*4269 value of a private residence, which has never been regarded as income or as a factor in the determination of tax liability.
The deduction claimed here relates only to excess-profits-tax and is authorized by statute and regulations solely for the purpose of equalizing the tax liability of an individual engaged in a business employing invested capital with that of a partnership or corporation in which compensation for managerial services is an ordinary expense. Whatever amount is so deducted remains in income and is subject to tax at normal rates. We have heretofore held that farming conducted for profit is a business enterprise entitled to all deductions allowed other industrial enterprises in the computation of tax liability. ; see also . We are of the opinion that $5,000 is a reasonable salary for the services rendered in the year 1917, and that such amount is a proper deduction from gross income for such year in the computation of income subject to excess-profits tax.
With respect to the deduction from gross income claimed for the year 1919 on account of losses*4270 and bad debts, the respondent contends that as the petitioner's taxable income for that year was found by comparing bank deposits with bank withdrawals, such amounts were withdrawn from the bank before they could be advanced to croppers or used in cotton deals on the New York market, and that they have already been allowed in the total of bank withdrawals credited against deposits. This reasoning is sound. On this point we approve the determination of the respondent.
Having disposed of all the questions relating to gross income and deductions therefrom upon which the evidence is sufficient to enable us to reach any sound conclusion, it remains only to discuss and decide *1279 the allegations of delinquency and fraud made by the respondent. The penalties imposed are set forth in our preliminary statement, and need not be recounted here. The petitioner contends that as more than five years have elapsed since the penalties, if any, were incurred and as he has signed no waivers in respect thereto, the statute of limitations has run, and that, even if properly predicated on facts and law, such penalties can not now be collected. It is a well established rule of law that the*4271 statute of limitations does not run against frauds. This, we believe, disposes of the petitioner's contention as to the 100 per cent and 50 per cent fraud penalties imposed for the years 1917 and 1918, respectively.
The penalty for failure to make an excess-profits-tax return for 1917 was imposed for delinquency. To sustain his contention as to the statute of limitations, the respondent argues that, once having been imposed, such a penalty became a part of the tax, and relies on section 3176 of the Revised Statutes, which expressly provides that "the amount so added to any tax shall be collected at the same time and in the same manner and as a part of the tax." These respective contentions of the parties raise two interesting questions of law, but the record of this proceeding requires no decision on either. The waivers are not in the record. The petitioner, having produced no evidence in support of his contention, has failed to sustain the burden of proof necessary to overcome the presumption that the statute does not bar the respondent from collecting the penalty for delinquency. There is also another factor in this matter, not referred to by either party in evidence or argument, *4272 which supports the contention of the respondent. The penalty for delinquency was imposed for failure to make a return. Since the petitioner made no excess-profits-tax return for the year 1917, there is no date from which the statute of limitations begins to run, either against the deficiency or the penalty for delinquency. .
The petitioner further argues that section 1004 of the Revenue Act of 1917 does not clothe the Commissioner with authority to impose penalties for either delinquency or fraud. This, of course, is correct, since that provision is a penal section which prescribes penalties only after trial and conviction in court. The Commissioner did not impose the penalties in question under section 1004, but under section 3176 of the Revised Statutes, which was incorporated in section 16 of the Revenue Act of 1916, and reenacted as a part of the Revenue Act of October 3, 1917. This section provides as follows:
In case of any failure to make and file a return or list within the time prescribed by law or by the collector, the Commissioner of Internal Revenue shall add to the tax fifty per centum of its amount*4273 except that, when a return is *1280 voluntarily and without notice from the collector filed after such time and it is shown that the failure to file it was due to a reasonable cause and not to willful neglect, no such addition shall be made to the tax. In case a false or fraudulent return or list is willfully made, the Commissioner of Internal Revenue shall add to the tax one hundred per centum of its amount.
This excerpt from the statutes disposes of the petitioner's contention that the fraud penalties were imposed without authority of law, but leaves undetermined the legal basis for the 50 per cent penalty for failure to file an excess-profits-tax return for 1917. The excess and war-profits-tax Acts of 1917, for the first time, included invested capital as an element for consideration in computing tax liability. This necessarily involved many new administrative problems that could not, in the circumstances, by written into the law. Congress, therefore, conferred rather large powers on the Commissioner in section 213 of the Act, which is as follows:
That the Commissioner of Internal Revenue, with the approval of the Secretary of the Treasury, shall make all necessary*4274 regulations for carrying out the provisions of this title, and may require any corporation, partnership, or individual, subject to the provisions of this title, to furnish him with such facts, data, and information as in his judgment are necessary to collect the tax imposed by this title.
The petitioner, assisted by a deputy collector, made an income-tax return on February 20, 1918. Among other instructions to taxpayers, printed on the form used, was the following:
If your total income from all sources exceeded $6,000 and you received any income from a trade or business with invested capital you should get a copy of the excess profits tax return (Form 1101) and calculate the amount of your tax, if any, as directed therein.
Regulations 41, which contains the provision relating to excess-profits-tax return based on the authority of section 213 of the Revenue Act of 1917, was promulgated not later than February 4, 1918, and therefore was in effect on February 20, when the petitioner made his return on Form 1040. That neither the deputy collector nor the petitioner appears to have known of the requirement for an excess-profits-tax return is not material. The Act authorized the*4275 Commissioner to make such a regulation. It had been made, approved by the Secretary, and promulgated, both in Regulations 41 and in income-tax-return Form No. 1040. It was necessary both to safeguard the revenues and to protect taxpayers. It must be presumed that every taxpayer who used Form 1040 was advised of the existence of the regulation and of the penalty that might be imposed for failure to conform to its requirements. It is not disputed that this petitioner failed to make the required return. In the light of the law, the regulations, and of the facts disclosed by this record, we hold that the penalty for delinquency was legally imposed and may be collected in an amount not greater than 50 per cent of the excess-profits *1281 tax, if any, of the petitioner for the year 1917, which shall be determined by recomputation in conformity with this opinion. ; .
Penalties of 100 per cent of the income tax determined by the Commissioner for the year 1917, and of 50 per cent for 1918, are also asserted on account of false and fraudulent returns made by the petitioner. *4276 After careful consideration of the entire record, we are of the opinion that the petitioner did not willfully and fraudulently understate his income for such years. The penalties for fraud should not be collected.
Reviewed by the Board.
Judgment will be entered on 15 days' notice, under Rule 50.
STERNHAGEN and MURDOCK dissent.