Decisions will be entered for the respondent.
Petitioner received $ 12,000 in 1945 and $ 6,000 in 1946 from his employer in addition to his regular salary, which sums were reported as back pay under section 107 (d) of the Internal Revenue Code to be allocated over the years 1942, 1943, 1944, and 1945. The Commissioner determined that the sums in question constitute gross income pursuant to section 22 (a) of the Code, in the years received. Held, the statutory definition of back pay, section 107 (d) (2) of the Code, is not satisfied because there was no legal liability or agreement on the part of the employer to pay any compensation other than petitioner actually received in the years 1942, 1943, and 1944, and moreover none of the prescribed statutory events occurred to prevent payment.
*792 In Docket No. 28092 the Commissioner has determined a deficiency in the income tax of Albert L. Sedlack, deceased, and Elsie L. Sedlack, surviving wife, on their joint return for the year 1945 of $ 636.61. In Docket No. 28091 the Commissioner has determined a deficiency in the income tax of *41 Albert L. Sedlack, deceased, for the taxable year January 1, 1946, to November 9, 1946, of $ 2,525.50. In Docket No. 28090 the Commissioner has determined a deficiency against Elsie L. Sedlack, as transferee, for the taxable year January 1, 1946, to November 9, 1946, of $ 2,525.50. In the deficiency notice to Elsie L. Sedlack, as transferee, the Commissioner states:
The above-mentioned amount represents your liability as transferee of assets of Albert L. Sedlack, Deceased, c/o Estate of Albert L. Sedlack, Deceased, Elsie L. Sedlack, Administrator, * * * for deficiency of income tax due from Albert L. Sedlack, Deceased, for the year January 1, 1946 to November 9, 1946.
These proceedings have been consolidated.
These deficiencies result from several adjustments to petitioners' net incomes. The only contested adjustments are explained in the deficiency notice for the year 1945, as follows:
(a) It has been determined that the $ 12,000.00 received by Albert L. Sedlack during the year 1945, in addition to his compensation for services rendered during that year, from Burson Knitting Company, Rockford, Illinois, is includible in your gross income for that year pursuant to the provisions of section 22 (a) of the Internal Revenue Code*42 and that such amount is not back pay within the purview of section 107 (d) of the Internal Revenue Code.
The same explanation is given for the Commissioner's inclusion of an additional $ 6,000 in the gross income of the tax period of 1946. By appropriate assignments of error petitioners contest these adjustments.
The case of Elsie L. Sedlack, Docket No. 28090, was predicated upon the determination by the Commissioner that Elsie L. Sedlack was liable for the income tax liability of Albert L. Sedlack, deceased, for the taxable year January 1, 1946, to November 9, 1946, as transferee of the assets of the said Albert L. Sedlack. The question concerning *793 the transferee liability of Elsie L. Sedlack was not raised in the pleadings or at the hearing, except to the extent of denying that the estate of Albert L. Sedlack owed any deficiency in tax for the period involved.
FINDINGS OF FACT.
Many of the facts have been stipulated and they are found accordingly.
The returns in question were filed with the collector of internal revenue for the first district of Illinois. Petitioners were on the cash basis.
Albert Sedlack was employed with the Burson Knitting Company, hereinafter referred to as the *43 Company, in 1928. On September 13, 1930, the Company and Sedlack entered into an agreement whereby his annual salary as sales manager would increase from $ 12,000 in 1931 to $ 14,000 for the calendar year 1933. Sedlack continued his employment with the Company as sales manager until his death on November 9, 1946.
Sometime in June 1932, because of the depressed condition of the Company's business, a serious shrinkage of its cash position, and an outstanding bond issue of $ 500,000 due in 1935, the Company was compelled to reduce salaries of all of its officers and some of its employees, including Albert L. Sedlack. In January 1933, Sedlack's salary was reduced to $ 6,000. At the time of the salary cuts, Hinchliff, then president of the Company, had general conversations with employees who took salary cuts, including Sedlack, assuring them that they would eventually be recompensed for their sacrifices. The Company's policy had always been that there were no formal contracts with employees and officers.
R. S. Williams, an officer of the Company, negotiated with the First National Bank of Chicago, the trustee for the bondholders, for an extension of the maturity date of the bonds. *44 At no time was the Company insolvent, bankrupt, or in receivership. It was not a condition of the extension of the maturity date of the bonds that the salaries of the officers and employees of the Company be reduced, though the trustee knew of the salary reductions. No restrictions by bondholders prevented increases in Sedlack's salary in 1942, 1943, and 1944. The bonded indebtedness of the Company was retired by May 31, 1943, and the dividends to stockholders resumed on March 26, 1943. From 1937 through 1946, in salary negotiations with Sedlack, R. S. Williams represented the Company.
On December 21, 1937, the Company increased Sedlack's salary to $ 6,600 and paid him $ 2,000 as added compensation for prior years. A memorandum signed by Sedlack on that day provided:
I accept this check for $ 2,000.00 and also the basis of compensation for the year 1938 as outlined in your memo. above. While I have talked of legal claims *794 regarding compensation, I assure you these are out and are hereby waived. I trust the yearly future earnings of the company will permit it to add to my compensation and I am leaving this to your sense of fairness.
With the approval by letter dated June 22, 1943, *45 from the Salary Stabilization Unit, the Company paid Sedlack $ 5,000 to avoid threatened litigation on salary claims arising during 1932 and 1933. An agreement between Sedlack and the Company provided in part:
THEREFORE, for and in consideration of the payment by the company to Sedlack of the sum of $ 5,000.00, which Sedlack hereby confesses that he has received, Sedlack hereby acknowledges said sum in full payment and settlement of and from all manner of actions, cause and causes of actions, suits, debts, dues, sums of money, accounts, reckonings, contracts, controversies, agreements, promises, claims and demands whatsoever in law or in equity which he now has against the company or ever has had against the company, or which his heirs, executors or administrators hereinafter can, shall or may have for, upon or by reason of any matter, cause or thing whatsoever from the beginning of the world to the date of these presents.
A letter was written by R. S. Williams for the Company to the Salary Stabilization Unit on November 29, 1944, to raise Sedlack's salary. After outlining the facts above about lowering salaries in 1933 and $ 5,000 paid in 1943, the letter reads:
Mr. Sedlack has insistently *46 maintained that the above settlement was subject to and dependent on the fulfillment by the Company of the terms of the salary agreement, and that he did not waive the Company's contractual liability in his agreement to the settlement of May 29, 1943 which affected the unpaid amounts due him for the years 1932 and 1933, that he was given assurance by the president of the Company repeatedly during the years 1938, 1940, and 1941 that the salary of $ 12,500.00 a year would be reinstated under this contract as soon as the sales and earnings of the Company were again equal to the year 1930 and when the outstanding bonded indebtedness of the Company was retired and when the stockholders again received dividends. The entire bonded debt of the Company was retired in 1942, payment of dividends was resumed, and the sales and earnings continued to exceed the base figures underlying the agreement stated above. In view of the above and to avoid litigation, the Company on November 27, 1944, has agreed to pay Mr. Sedlack $ 12,000.00 in complete settlement of his claim for unpaid salary due him for the years 1942, 1943, and 1944, and to establish his remuneration for 1945 at $ 12,500.00.
The above *47 request was denied in its entirety. On December 1, 1944, a letter from R. S. Williams to Sedlack included the following which is supported by the evidence:
Our request to make these payments is based entirely upon your contentions and upon your claims and statements, and the writer wants it clearly understood that the Company in this request does not admit there exists any basis or grounds for your contentions and claims, and, further, it must be understood that the President of the Company does not admit ever giving you any assurances in the past as to the specific salary to be paid for your position at a future date.
In October 1945, the Company decided to pay Sedlack $ 18,000 in addition to his regular salary, $ 12,000 being paid in 1945 and $ 6,000 *795 in 1946. The $ 18,000 was paid to Sedlack on a retroactive basis in recognition of prior services to the Company, but not to settle an outstanding legal obligation. After the 1943 second release and payment of $ 5,000, the Company reasonably believed Sedlack had no prior salary claims. The $ 18,000 paid to Sedlack in 1945 and 1946 was to bring his compensation up to $ 14,000 for each of the years 1942, 1943, 1944, and 1945. The Company *48 had no obligation during any of the years 1942, 1943, or 1944 to pay Sedlack any compensation in excess of the amounts he actually received. Furthermore, had there been any additional liability for compensation to Sedlack in 1942, 1943, or 1944 the evidence shows that petitioner could have paid it. In fact, by April 1942, adequate funds were on hand to retire all outstanding bonds. The schedule below shows the compensation Sedlack received during the years in question:
| Year | Amount |
| 1930 | $ 10,750.08 |
| 1931 | 12,000.00 |
| 1932 | 11,649.94 |
| 1933 | 6,000.00 |
| 1934 | 6,000.00 |
| 1937 | 8,000.00 |
| 1938 | 6,212.50 |
| 1939 | 6,300.00 |
| 1940 | 6,500.00 |
| 1941 | 7,125.00 |
| 1942 | 8,500.00 |
| 1943 | 8,788.46 |
| 1944 | 8,788.46 |
| 1945 | 24,333.30 |
| 1946 | 16,583.30 |
The Company's net earnings and losses during the following years were:
| Year | Net loss | Net profit |
| 1930 | $ 41,197.71 | |
| 1931 | 59,264.16 | |
| 1932 | 107,568.94 | |
| 1933 | 12,530.97 | |
| 1934 | 56,621.21 | |
| 1935 | 37,231.71 | |
| 1936 | 4,799.51 | |
| 1937 | 2,278.91 | |
| 1938 | 30,701.61 | |
| 1939 | $ 4,094.63 | |
| 1940 | 19,179.10 | |
| 1941 | 103,909.10 | |
| 1942 | 147,081.68 | |
| 1943 | 92,130.81 | |
| 1944 | 94,179.07 | |
| 1945 | 99,583.11 |
OPINION.
In this proceeding the issue is raised of whether the petitioners are entitled to treat the additional income of $ 12,000 in 1945 and $ 6,000 in 1946, as back pay under section 107 (d), I. R. C., to be allocated to *49 prior years, 1942, 1943, 1944, and 1945.
Petitioners have failed to show that the payments fall within the definition of back pay in section 107 (d) (2). Their only argument is to satisfy subsection A of the statute. Petitioner Elsie L. Sedlack in Docket No. 28090 does not deny that she is liable as transferee for any deficiency in tax which the estate of Albert L. Sedlack may owe for the period January 1, 1946 to November 9, 1946. She does deny and contest the determination of the Commissioner that the estate of Albert L. Sedlack owes any deficiency in income tax for that period.
*796 The applicable statute, printed in the margin, 2*50 requires that the remuneration "would have been paid prior to the taxable year except for the intervention of one of the following events." The four enumerated events are bankruptcy or receivership, a dispute as to liability, lack of funds appropriated to a governmental agency, or an event similar in nature. The inference is inescapable that there must have been a legal liability which arose in the prior years to which the taxpayer wishes to allocate the salary and then payment was delayed for one of the enumerated reasons.
Payments of $ 12,000 in 1945 and $ 6,000 in 1946, were not pursuant *51 to a legal claim or an agreement in the prior years 1942, 1943, or 1944. All earlier salary claims of Sedlack had been settled by two releases and settlements in 1937 and 1943. No release as to legal liability was signed by Sedlack for receipt of the $ 18,000 above. Originally, the only basis of Sedlack's claim was verbal general assurances in 1933 that when business would improve, his salary would be increased. Though the Company tried unsuccessfully to obtain permission for additional compensation from the Salary Stabilization Unit by adopting Sedlack's argument, the Company did not recognize any legal obligation to Sedlack. No evidence indicates that a liability was recognized on the Company books or in any other way during 1942, 1943, and 1944, the prior years in question.
Where no legal obligations were found to exist in prior years section 107 (d) (2) (A) would not apply. Cowan v. Henslee (C. A. 6), 180 F.2d 73">180 F. 2d 73, affirming 84 F. Supp. 813">84 F. Supp. 813; United Statesv. Borton, (D. C., N. J.), February 28, 1950. Regulations 111, section 29.107-3, is very specific in saying that "the term 'back pay' does not include * * * additional compensation for past services where there was no prior *52 agreement or legal obligation to pay such additional compensation." We think this regulation is a reasonable one and correctly interprets the law. Moreover the payments in 1945 and 1946 of $ 18,000 to Sedlack *797 were not to satisfy a legal dispute for the years 1942, 1943, and 1944, within the meaning of section 107 (d) (2) (A) (ii). Merely recognition of prior service alone is not enough since many salary increases would then be included. Furthermore, in addition to a legal obligation, taxpayers who have been successful have proved severe financial problems of their employers during the prior years in question which prevented payment to come within section 107 (d) (2) (A) (iv). Frederick H. Hagner, 14 T. C. 643; Estate of R. L. Langer, 13 T. C. 419, revd. (C. A. 9) 183 F. 2d 758, under remand 16 T.C. 41">16 T. C. 41; Norbert J. Kenny, 4 T.C. 750">4 T. C. 750.
Petitioners have failed to show that during the prior years in questions, 1942, 1943, and 1944, financial problems prevented payment to Sedlack. In fact the evidence available indicates the employer was in a position to make payment in those years. Since the remaining subsections 107 (d) (2) (A) (i) and (iii) are clearly not applicable, none of the *53 required statutory events prevented payment.
Decisions will be entered for the respondent.
Footnotes
1. Proceedings of the following petitioners are consolidated herewith: The Estate of Albert L. Sedlack, Deceased, Elsie L. Sedlack, Administrator; Estate of Albert L. Sedlack, Deceased, Elsie L. Sedlack, Administrator, and Elsie L. Sedlack, Surviving Wife.↩
2. INTERNAL REVENUE CODE.
SEC. 107. COMPENSATION FOR SERVICES RENDERED FOR A PERIOD OF THIRTY-SIX MONTHS OR MORE AND BACK PAY.
* * * *
(d) Back Pay. --
* * * *
(2) Definition of back pay. -- For the purposes of this subsection, "back pay" means (A) remuneration, including wages, salaries, retirement pay, and other similar compensation, which is received or accrued during the taxable year by an employee for services performed prior to the taxable year for his employer and which would have been paid prior to the taxable year except for the intervention of one of the following events: (i) bankruptcy or receivership of the employer; (ii) dispute as to the liability of the employer to pay such remuneration, which is determining after the commencement of court proceedings; (iii) if the employer is the United States, a State, a Territory, or any political subdivision thereof, or the District of Columbia, or any agency or instrumentality of any of the foregoing, lack of funds appropriated to pay such remuneration; or (iv) any other event determined to be similar in nature under regulations prescribed by the Commissioner with the approval of the Secretary; and * * *↩