*148 Decision will be entered under Rule 50.
1. During the taxable year the petitioner performed the work of constructing a building in all important particulars called for by the contract, but at the close of the year several minor defects in workmanship remained to be corrected. The architect issued his certificate during the taxable year authorizing a final payment to the contractor and stating that a small amount was retained for final adjustment. Held that within the meaning of art. 42-4. Regulations 101, the contract was "finally completed" in the taxable year; and that the architect's certificate supports the Commissioner's determination that the contract was "accepted" in that year.
2. The acceptance within the taxable year of a contract for the reconstruction and repair of a hotel building held established by the conduct of the owner in taking possession immediately upon completion of the work, without questioning the sufficiency of the performance.
3. Amount allowable as reasonable compensation for services rendered by the petitioner's officers and sole stockholders, determined.
*25 The respondent determined deficiencies of $ 9,957.04 in income tax and $ 6,996.90 in excess profits tax for the year 1938. The deficiencies are due in part to the inclusion in the petitioner's income for the taxable year of profits from building construction contracts in the amount of $ 46,643.71, and to the disallowance of $ 12,000 of a deduction claimed for salaries paid to the petitioner's officers. The questions for determination are (1) whether the contracts were completed and accepted within the taxable year; and (2) whether the officers' salaries were reasonable in amount.
The proceeding was submitted upon the pleadings, testimony, documentary evidence, and a stipulation of facts. The stipulated facts which are not set forth in our findings of fact are included therein by reference.
*26 FINDINGS OF FACT.
The petitioner is a corporation of the State of New Jersey which, from the time of its incorporation in 1929 up to the time of the hearing, has been engaged in business as a building contractor, with its principal office at Asbury Park. The petitioner has regularly made its returns on the calendar year basis and has kept*150 its books and reported its income on the basis of completed contracts. It filed its return for the calendar year 1938 with the collector for the first district of New Jersey.
The petitioner was organized by William C. Ehret and Stephen J. Day. They are the president and secretary-treasurer, respectively, of the petitioner, and, since the organization of the petitioner, they have been its only officers and have owned the four shares of its outstanding capital stock in equal proportions. Day did not pay anything for his shares. Ehret originally paid in to the petitioner $ 5,000, but he withdrew all but $ 1,700 of that amount prior to 1938. The petitioner's business in 1938 was carried on principally with rented machinery and equipment.
The petitioner entered into a contract with Ruth Keator Fredericks on July 16, 1937, for the construction of a building at 532-558 Cookman Avenue, in Asbury Park, at a contract price of $ 127,578. The negotiations preceding the signing of the contract and all matters relating to the performance of the work and the payment therefor were handled under power of attorney by George J. Fredericks, husband of Ruth Keator Fredericks. The building was to*151 contain nine stores and twenty offices. The contract covered the excavation work, the foundations, the steel, stone, and brick work, and the roofing, but did not include the erection of the store fronts or the partitioning and finishing of the offices. The work was to be performed in accordance with drawings and specifications prepared by Frank Grad & Sons, architects, and was to be substantially completed by January 15, 1938. The contract contained the following provisions:
Article 4. Progress Payments -- The owner shall make payments * * * as follows: On or about the fifth day of each month ninety per cent of the value, based on the Contract prices, of labor and materials incorporated in the work and of materials suitably stored at the site thereof up to the last day of that month, as estimated by the Architect, less the aggregate of previous payments; and upon substantial completion of the entire work, a sum sufficient to increase the total payments to ninety-five per cent of the Contract price.
Article 5. Acceptance and Final Payment -- Final payment shall be due thirty days after substantial completion of the work provided the work be then fully completed and the Contract *152 fully performed.
Upon receipt of written notice that the work is ready for final inspection and acceptance, the Architect shall promptly make such inspection, and when he finds the work acceptable under the Contract and the Contract fully performed *27 he shall promptly issue a final certificate, * * * stating that the work provided for in this Contract has been completed and is accepted by him * * * and that the entire balance found to be due the Contractor, and noted in said final certificate, is due and payable. * * *
The contract price of $ 127,578 included a charge of $ 16,500 for heating, but Mrs. Fredericks made a subcontract for the heating on which the petitioner had no "set-up" for handling charges. The contract price was subsequently, on August 8, 1938, increased to $ 159,923.72 on account of additions, including electrical work, duct work, ice water lines, one store front, and partitioning and finishing several offices. The cost to the petitioner of performing the contract, exclusive of the salaries paid to its officers, was $ 127,590.97. The petitioner realized a profit of $ 32,332.75 from the contract.
Between October 26, 1937, and July 26, 1938, the petitioner*153 received payments on the contract in the total amount of $ 131,819.76. On September 23, 1938, Frank Grad & Sons issued and delivered to Fredericks a certificate stating that the petitioner was entitled to a payment of $ 16,617.96. The certificate contains the following:
| Amount of contract | $ 111,078.00 | ||
| Additions to date | 23,900.10 | ||
| Total | $ 134,978.10 | ||
| Deductions to date | 2,504.89 | ||
| Net total | $ 132,473.21 | ||
| Am't of this Cer. | $ 16,617.96 | ||
| Previously authorized | 114,008.60 | ||
| Total authorized to date | $ 130,626.56 | ||
| Balance | $ 1,846.44 | ||
| Final sum subject to further adjustments of | $ 1,846.44 | ||
| approximately $ 2,000.00. retained (10%) for final | |||
| adjustment. |
After the issuance of the architect's certificate mentioned above, and on September 26, 1938, the petitioner received a payment of $ 26,257.52, leaving $ 1,846.44 as the unpaid balance on the total contract price of $ 159,077.28. The petitioner received a further payment of $ 1,000 on December 3, 1938, leaving $ 846.44 unpaid at the close of 1938.
Fredericks inspected the building weekly as the work progressed. In November or December 1938, he notified Day that the terrazzo flooring in the main*154 entrance of the building was cracked and pointed out certain minor imperfections in the steel work and in the work on one of the upper floors. Except for the adjustment of those matters, all of the work provided for in the contract had been completed prior to the close of the year 1938. Two of the nine stores were occupied by tenants in the latter part of the year 1938. Fredericks withheld payment *28 of the balance of $ 846.44 because of the above mentioned defects. In February 1939 Fredericks, Day, and the architect spent about a half day in making an inspection of all parts of the building, and Fredericks at that time told Day that the work was acceptable. A few days later he entered into a contract with the petitioner for the completion of the store fronts and offices. Fredericks did not, in February 1939 or at any other time, deliver to the petitioner a formal acceptance of the building in writing.
The sum of $ 846.44 remained unpaid in January 1940, and, on January 4, 1940, in response to an inquiry from one of his office employees concerning it, Fredericks wrote a letter in which he stated: "I have not as yet accepted the building nor do I intend to accept it until*155 Ehret-Day Company makes the terrazzo floors good which have cracked and are failing in a number of places and several other items I have talked with Mr. Day about many times."
The respondent determined that the work under the contract of July 16, 1937, was completed and accepted in the year 1938 and he included the profit of $ 32,332.75 in the petitioner's income for that year.
The petitioner entered into a contract on April 19, 1938, with the Ocean Grove Camp Meeting Association for the reconstruction, alteration, and repair of the North End Hotel, situated in Ocean Grove, New Jersey, which had been damaged by fire. The contract, evidenced by letters between the petitioner and Joseph A. Thoma, manager of the association, provided for the payment to the petitioner of a guaranteed price not to exceed $ 70,811. The hotel is situated on the seashore and its foundation rests on piles driven into the sand. After the petitioner had begun work under the contract, it discovered that the foundation had been damaged by the shifting sand and the action of the tides, and the parties orally amended the contract to include the work of replacing the footings, concrete, and piles. The total cost*156 of the work on the hotel was determined by June 30, 1938, to be $ 107,093.58.
Between May 20 and November 9, 1938, the petitioner received payments on the contract amounting to $ 105,058.36. The balance of the contract price, amounting to $ 2,035.22, remained unpaid at the close of the year 1938. The petitioner's profit from the contract was $ 14,310.96.
The petitioner completed the work under the contract by July 1, 1938, and, on or about that date, the association took possession of the hotel and operated it continuously throughout the remainder of the year 1938. The association, through its building committee, inspected the work in April 1939 and then indicated to Day that the work was satisfactory. The delay in making such inspection was due to the fact that the committee was not scheduled to meet until April 1939 *29 and to the fact that they desired to ascertain whether the foundations would withstand the high tides during the winter of 1938-1939. The petitioner did not at any time execute a formal or written guarantee of the work done under the contract. On January 9, 1941, Thoma wrote the petitioner as follows:
* * * we wish to advise that the Association never *157 took into consideration that this work was accepted until such time as the 1 year maintenance clause or the usual 1 year guarantee period had expired, which would have brought the date to approximately July, 1939.
This was especially important on this particular job insofar as the foundations you installed to carry the heavy steel loads were to be abused and buffetted by the high seas of the late winter of 1938 and early 1939. We are pleased to advise that the building has withstood this treatment and we accordingly accepted the building in July, 1939.
The amount of $ 2,035.22 which remained unpaid at the close of 1938 was withheld by the association not by reason of any failure of the petitioner to meet the requirements of the contract, but merely to take care of certain minor adjustments. The petitioner allowed the association a credit of $ 600 against that amount in 1939.
The respondent determined that the work under the North End Hotel contract was completed and accepted in the year 1938 and he included the profit of $ 14,310.96 in the petitioner's income for that year.
William C. Ehret has been engaged in the building construction business for thirty years, and, in addition *158 to his interest in the business of the petitioner, he operated a similar business during 1938 and for some years prior thereto at Trenton, New Jersey, as sole proprietor. Day is a construction engineer and is a member of the American Association of Engineers, with the rank of senior engineer. He was employed in the building construction business at various times as mechanic, foreman, and superintendent, and has been engaged in the business for twenty-five years. Prior to 1929 he was engaged in the building business at Trenton in partnership with his father. The business of the partnership differed from that of the petitioner in that it did not require as much experience and specialized knowledge. Day owned a 35 percent interest in the partnership and in one year, not disclosed by the record, the partnership made a profit of about $ 75,000.
Ehret devoted practically all of his time and attention to his individual business at Trenton during the years 1934 to 1937, and the only service which he performed on behalf of the petitioner consisted of signing checks, notes, and bonds. Day devoted his entire time to the management and operation of the petitioner's business during those *159 years, and during the year 1937 he drew a regular weekly salary of $ 115 and received a total salary for the year of $ 7,056.29.
*30 During the year 1938 Ehret devoted from two to three days per week to the business of the petitioner, including time required in traveling between Trenton and Asbury Park. He solicited some of the petitioner's contracts and frequently bought materials for its contracts. He conferred frequently with Day, in person and by telephone, concerning bids and other matters, checked estimates and bills, signed all bids, contracts, checks, notes, and bonds, and administered the office work. He also inspected work in progress and assisted Day in financing the petitioner's operations. During 1938 he devoted from three to four days per week to his individual construction business, in which the number of men employed varied from ten to twenty. His individual income tax return for 1938 reported gross receipts of $ 182,135.99 and a net profit of $ 8,829.79 from his individual business, and it further discloses that he paid $ 4,832 in salaries to his field and office employees. During the year 1938 Day devoted his entire time to the business of the petitioner, *160 often working seven days per week and from twelve to fifteen hours per day. All of the petitioner's construction work in the field was under his direct and exclusive supervision, including the work of the estimating engineers, and in addition he solicited contracts, purchased materials, and executed all subcontracts.
Day had no source of income other than his salary from the petitioner. Early in 1938 Ehret and Day agreed that, in view of the fact that he was devoting his entire time to the business, Day should continue for the year 1938 to withdraw regularly a salary of $ 115 per week because of the necessity of his paying current living expenses, but that no salary should be withdrawn by Ehret in such manner; and, further, that Ehret should receive $ 8,000 for his services for that year and Day a like amount in addition to his weekly salary. However, in order to avoid borrowing money and to assist the petitioner in financing its current operations, they agreed that the amounts of $ 8,000, respectively, should not be paid until the latter part of 1938 after some of the work had been completed.
During the year 1938 the petitioner paid Day, at the rate of $ 115 per week, the sum *161 of $ 5,980; and it also paid him $ 1,602.15 to reimburse him for expenses which he had paid on its behalf. On October 14, 1938, the petitioner paid Ehret and Day $ 3,000 each; and on December 20, 1938, it paid them $ 5,000 each. For the year 1939 Day received payments from the petitioner of $ 115 per week and on December 21, 1939, Day received an additional payment of $ 7,000. On the latter date Ehret also received a payment of $ 7,000.
The gross receipts and gross profits of the petitioner from building contracts, the gross income, the net income or net loss, and the salaries *31 paid by it to each of its two officers for the years 1929 to 1939, as shown on its income tax returns for those years, were as follows:
| From building contracts | ||||
| Year | Gross | Net | ||
| income | income | |||
| Gross | Gross | |||
| receipts | profit | |||
| 1929 | $ 40,477.00 | $ 8,149.03 | $ 8,461.55 | $ 3,582.84 |
| 1930 | 98,563.00 | 6,101.49 | 6,225.87 | * 8,197.18 |
| 1931 | 134,396.27 | 21,873.73 | 22,207.00 | * 439.81 |
| 1932 | 318,789.56 | 64,241.34 | 64,614.36 | 36,668.70 |
| 1933 | 28,904.15 | 6,303.75 | 6,344.10 | * 6,279.14 |
| 1934 | 59,314.62 | 9,900.82 | 10,068.58 | * 569.17 |
| 1935 | 40,173.80 | 2,550.04 | 2,550.04 | * 9,194.27 |
| 1936 | 176,786.66 | 19,773.12 | 19,870.87 | 700.40 |
| 1937 | 132,871.11 | 20,989.27 | 21,294.57 | 4,499.88 |
| 1938 | 172,199.72 | 44,003.94 | 44,959.29 | 8,988.88 |
| 1939 | 409,659.62 | 62,507.01 | 64,485.88 | 32,107.40 |
| Salaries paid to officers | |||
| Year | |||
| Ehret | Day | Total | |
| 1929 | $ 550.00 | $ 1,100.00 | $ 1,650.00 |
| 1930 | 3,525.00 | 3,525.00 | 7,050.00 |
| 1931 | 6,500.00 | 6,500.00 | 13,000.00 |
| 1932 | 6,500.00 | 6,500.00 | 13,000.00 |
| 1933 | 2,435.00 | 4,900.00 | 7,335.00 |
| 1934 | 5,200.00 | 5,200.00 | |
| 1935 | 4,420.00 | 4,420.00 | |
| 1936 | 5,200.00 | 6,500.00 | 11,700.00 |
| 1937 | 7,056.29 | 7,056.29 | |
| 1938 | 8,000.00 | ** 15,582.15 | 23,582.15 |
| 1939 | 7,000.00 | 12,980.00 | 19,980.00 |
The only dividends paid by the petitioner during the period 1929 to 1939, as shown by its returns for those years, were paid in the years 1930 and 1931, in the amounts of $ 13,598.52 and $ 24,233.72, respectively.
The amount of income tax paid by the petitioner for each of the years 1929 to 1939, as shown by its returns for those years, was as follows: 1929, $ 64.11; 1932, $ 3,854.36; 1936, $ 101.14; 1937, $ 918.18; 1938, $ 1,466.10; 1939, $ 6,379.33; no tax being paid for the years 1930, 1931, 1933, 1934, and 1935.
The petitioner credited to officers' salaries account on its books the salaries of $ 8,000 and $ 13,980*163 which it paid, respectively, to Ehret and Day during the year 1938, and it claimed a deduction for those amounts on its income tax return for that year. It also claimed a deduction for the $ 1,602.15 which it had repaid to Day. The respondent disallowed $ 12,000 of the total deductions of $ 23,582.15 thus claimed by the petitioner, and he determined that $ 11,582.15 constituted a reasonable allowance for salaries for the petitioner's officers.
The services rendered to the petitioner by Ehret during the year 1938 were reasonably worth $ 5,000; and the services rendered to it by Day during that year were reasonably worth $ 13,980.
OPINION.
The first question presented is whether the income from the two construction contracts described in the findings of fact should be taxed as part of the petitioner's income for the year 1938. Article 42-4 of Regulations 101, promulgated under the Revenue Act of 1938, permits the reporting of income from long term contracts "for the taxable year in which the contract is finally completed and accepted if the taxpayer elects as a consistent practice so to treat such *32 income, provided such method clearly reflects the net income." The provisions*164 of that article, which have been in force without change since the enactment of the Revenue Act of 1921, are set forth in the margin. 1 The respondent determined that the contracts were "completed and accepted" in 1938, and he included the profit in the petitioner's income for that year. The amount of the profit realized from each contract has been stipulated; and, although the North End Hotel contract covered a period of about three months, the respondent does not question the petitioner's right to report the income from that contract under the provisions of the regulations. See .
*165 The petitioner opposes the inclusion of the income from the contracts in its income for 1938 on the grounds that the contract for the store and office building (hereinafter referred to as the Fredericks contract) was neither completed nor accepted until 1939, and that the North End Hotel contract was not accepted until 1939, its theory being that, under the cited regulations, the inclusion of the profit in income is conditioned upon both completion and acceptance and that where completion occurs in one year and acceptance occurs in a later year, the reporting of the income must be deferred to the year of acceptance.
On the question of the time of the completion of the Fredericks contract there is dispute and we shall first consider this question, since if, as the petitioner contends, that contract was not completed within the meaning of the regulations until 1939, that fact alone is sufficient to preclude the inclusion of the profit therefrom in petitioner's income for 1938. ; affd., , and . With respect to *166 the Fredericks contract the evidence shows that the building had been completed prior to the close of 1938, but that because of certain minor defects in the workmanship, payment of the balance of $ 846.44 of the total contract price for construction was withheld for the purpose of adjustment with regard to such defects. Fredericks, the only witness called to testify concerning the condition of the building, stated that the matter of the defects was "ironed out" to his satisfaction in January *33 or February of 1939. There is no evidence whatever of the amount of labor or material, if any, used in correcting the defects or of the cost thereof; nor is there any evidence as to how the matter of the defects was "ironed out."
The regulations provide for the reporting of the gross income in the taxable year in which the contract is "finally completed." The word "completed," according to its definition in Webster's New International Dictionary, has the following meanings:
Filled up; with no part, item, or element lacking; free from deficiency; entire; perfect; consummate.
Brought to an end or to a final or intended condition; concluded; completed; as, the edifice is complete.
To*167 bring to a state of entirety or perfection; to fulfill; finish; as to complete a task.
As these meanings embrace the element of finality, the use in the regulations of the word "finally" immediately preceding the word "completed" is redundant in that such use does not enlarge the meaning of that word, unless it is used for the purpose of distinguishing the cases falling within paragraph (b) of the regulations from those cases involving contracts which are partially completed and are covered by the preceding paragraph (a). This being so, we can eliminate consideration of the word "finally" as applied to the facts of this case. In so far as the term "completed" applies to contracts for the construction of buildings, we do not think the regulations were intended to require a completion within the ordinary meaning of the word as defined above any more than it was so intended by the courts in establishing the rule hereinafter quoted. With regard to building contracts, the courts have modified the rule requiring an absolute completion and strict performance of a contract before the right to payment thereon can be enforced. The rule is thus stated in 17 C. J. S., § 509, pp. 1087-1089:
*168 The hardship of the rule requiring strict performance in order to permit recovery on a contract generally, when applied to a contractor who has undesignedly violated his contract, and the inequitable advantage that it gives to an owner who receives and retains the benefit of the builder's labor and materials have led to its qualification; and it is generally held that, where the compensation is due only on the performance of the contract, a literal and strict performance is not required, and if the builder, acting in good faith and intending and attempting to perform his contract, does so, he may recover the contract price, notwithstanding slight and trivial defects or deviations in performance, for which compensation may be made, in all its material and substantial particulars, by an allowance to the owner; but the owner is entitled to an allowance for the damages he may suffer by reason of the failure to perform strictly, such as the cost or expense of putting the structure or work in the condition called for by the contract; * * *
The rule is recognized in New Jersey where the contract in question was made and performed. ;*169 ; ; (N. J.); ; . In the Feeney case the court approved an instruction given the jury by the lower court which was as follows: "If the contractor has substantially performed his contract, even though he has failed to do so in some minor particulars, he is entitled to recover the contract price, less what will be a fair allowance to the owner to make good the defects in the performance of the contract."
The facts in the present case clearly show that during the year 1938 the petitioner was, under the above rule of law, entitled to recover the unpaid portion of the contract price of the Fredericks building, subject to such allowance or set-off as might be shown to be proper for the repair of the minor defects complained of. There is nothing in the record showing, or tending to show, that the defects involved *170 were occasioned by lack of good faith or lack of intention or attempt to perform its contract by petitioner so as to preclude application of the quoted rule. In our opinion, the regulations do not contemplate that a building contract which has been completed in all important particulars, except for minor defects, as was the Fredericks contract, shall be regarded as being uncompleted until such time as the minor defects may actually be corrected or adjustment made therefor. We hold that the Fredericks contract was finally completed in 1938 within the meaning of article 42-4 (b) of Regulations 101.
We are also of the opinion, and so hold, that the building under the Fredericks contract was accepted in 1938 within the intendment of the regulations. To overcome the determination of respondent that the Fredericks contract was accepted in 1938 petitioner relies solely on the testimony of Fredericks to the effect that he, in company with Day and the architect, made an inspection of the entire structure in February 1939 and, finding that the building complied with the contract, he, Fredericks, at that time accepted the building. This testimony is not in accord with Fredericks' position*171 as disclosed in his letter of January 4, 1940, to his office employee stating that he had not "yet accepted the building." Even if it is material as to when Fredericks accepted the building, the theory of petitioner that it was accepted in 1939 is not established by such directly contradictory testimony; nor could testimony of such unreliable nature overcome the determination of respondent that the building was accepted in 1938.
However, we think it immaterial when Fredericks accepted the building. Reference to article 5 of the contract discloses that the parties contracted respecting the manner of the acceptance, leaving the decision as to the acceptability of the work and the full performance of the contract to the architect. That such a finding was made in September 1938 is indicated by the certificate of the architect authorizing *35 payment of $ 16,617.96 and stating the final sum thereafter due on the contract to be $ 1,846.44, which however was retained merely for purposes of final adjustment. In December 1938, $ 1,000 was paid, leaving a balance due for final adjustment of $ 846.44 on the total contract price of $ 159,923.72. The petitioner contends that the certificate*172 was not a final certificate, for the reason that it shows on its face that the cost of the work under the contract and of the additions are shown to be lower than the amount stipulated by the parties. This discrepancy is one which it was within the power of the petitioner to explain, but it has failed to do so. It may be that the difference is due to the work performed by subcontractors. However this may be, the amount of the final payment retained for adjustment is identical with the amount which the parties stipulated as being unpaid on the entire contract as of September 27, 1938. The certificate of the architect was conclusive and it was a condition precedent to payment, unless waived. (N. J.); (N. J.). It supports the respondent's determination that performance of the contract was accepted in the year 1938, and we sustain that determination.
On the question of the time of its completion there is no dispute in so far as the North End Hotel is concerned. The evidence shows, and the petitioner concedes, that it was completed on*173 or about July 1, 1938, but petitioner contends that it was accepted in April 1939 and not in the year 1938.
We are of the opinion, and so hold, that the North End Hotel was accepted in 1938.
The evidence shows that the Ocean Grove Camp Meeting Association took possession of the hotel on or about July 1, 1938, and that from that date the building was continuously occupied and operated as a hotel, and that the entire contract price, except $ 2,035.33, was paid before the close of 1938. Nothing remained to be done on the contract after on or about July 1, 1938, and, so far as the record shows, the owner was entirely satisfied with the work and there was no controversy over any part of it. Thoma, manager of the owner, admitted there was no particular reason for withholding payment of the $ 2,035.33. These facts convince us that there was an acceptance of the work and the hotel in 1938, and we so hold. The petitioner's contention that acceptance occurred in 1939 is based on testimony to the effect that the building committee of the association inspected the work in April of that year and at that time accepted the building. The reason for the delay in making such inspection was said*174 to be due to the fact that the committee was not scheduled to meet until April 1939 and that it preferred to wait until then so that it could ascertain whether the foundations were adequate to withstand the heavy seas of the winter season. In his testimony Thoma stated that *36 when the letters constituting the original contract covering the work on the hotel building, as distinguished from the work on the foundation, were written in April 1938 he had an oral understanding with Day that the inspection and acceptance would not be made until the following year because of the desire to see how the foundation would withstand the winter storms, but the unreliability of this testimony is indicated by the fact that the original contract did not call for any work on the foundation. The letter written by Thoma on January 9, 1941, indicates that the inspection by the building committee related to what the committee claimed was petitioner's obligation for maintenance of the foundation rather than to the acceptance by the committee of the work under the contract. Cf. ; ;*175 ; and . We find nothing in this evidence to support petitioner's contention that acceptance of the hotel building was in 1939.
Even if we should be in error in our finding that the two contracts in question were accepted in the year 1938, the petitioner nevertheless would not be entitled to report the income from those contracts in the year 1939. In , a case in which the contract was completed and the contract price was collected in 1921, and the purchaser did not accept the subject matter of the contract until 1922, the court sustained the right of the contractor to account for the profit in the year of acceptance under regulations identical with those here involved. The taxpayer in that case was engaged in the business of manufacturing and selling specially designed machines under contracts which guaranteed the suitability of the machines for the purpose for which they were ordered. The machines were manufactured and shipped in units and were paid for upon delivery to*176 the carrier, and they were subject to tests for correct mechanical operation after they were assembled at the plant of the purchaser. In connection with the tests and before acceptance by the buyer it was necessary for the taxpayer to make costly alterations and adjustments. Because of the nature of its business the taxpayer had consistently followed the bookkeeping practice of not entering its profit on any contract until the machine was actually accepted by the purchaser, or on a "finished or accepted contract plan." The court, after stating that the purchaser had the right to reject the machine within a reasonable time and that the taxpayer could not know whether the machine had been finally accepted until the buyer had made an inspection, said:
* * * In any event the petitioner had consistently kept its books on the theory that, until this right was exercised, the contract was not "completed and accepted" within the meaning of section 36 of * * * regulation 62. Therefore, in accordance with its established practice of bookkeeping, the petitioner was warranted in accounting for the profits of the contract in the year *37 1922. It cannot be said that such a method does *177 not reflect the income of the petitioner whether accounted for in 1921 or 1922.
In the present case there is no proof that the petitioner accounted for its income in the year of acceptance by the other party to the contract. On the contrary, with respect to the petitioner's bookkeeping method, we are merely informed by the stipulation that the "method of keeping its books and reporting its gross income is on the basis of completed contracts." It is obvious that if the petitioner consistently accounted for its income from long term contracts as of the year of completion, as this language implies, there would be a distortion rather than a reflection of net income if it were now permitted to return the income from the two contracts in question in the year 1939, even if the contracts were accepted in that year.
The action of the respondent in including the profit from the two contracts in the petitioner's income for the year 1938 is approved.
The second and final issue is the proper allowance to be made for salaries of the petitioner's officers, Ehret and Day. The petitioner claimed a deduction of amounts actually paid to them -- $ 8,000 to Ehret and $ 15,582.15 to Day. The latter*178 amount included a payment of $ 1,602.15 in reimbursement of expenses of petitioner. The respondent allowed $ 11,582.15 and held that $ 12,000 of the claimed deduction was excessive, but his deficiency notice fails to reveal how much he determined to be a reasonable allowance as a salary for each officer. We are informed through his opening statement and brief that $ 2,000 was allowed for Ehret and $ 9,582.15 for Day, but, as the payment of $ 1,602.15 to Day admittedly was not for services actually rendered by him, we assume, for the purposes of decision, that the respondent allowed not more than $ 7,980 on account of Day's services. The question, therefore, is whether $ 2,000 and $ 7,980 constitute reasonable compensation for the services performed by Ehret and Day, or whether the petitioner has shown that such services were of greater value to it. The petitioner contends for an allowance of $ 8,000 with respect to Ehret and allowance of $ 13,980 with respect to Day.
Each of the officers in question testified as to the specific services rendered by him and to the time devoted to the business of the petitioner. All of the details are set forth in our findings of fact, together*179 with facts concerning their experience in the business in which they were engaged, and they need not be here repeated. Our findings also contain other relevant facts. Upon due consideration of all of the evidence we are of the opinion that the services rendered by Day were reasonably worth the amount claimed by petitioner, namely, $ 13,980. With respect to the services rendered by Ehret, they were rendered on a part time basis and they involved a lesser degree of responsibility and participation in the business and in the results accomplished. Moreover, Day was a qualified construction engineer. We think *38 Ehret's services were worth more than $ 2,000, particularly in view of the amount of business handled by the petitioner and the fact that some of its contracts were obtained through Ehret's efforts. The evidence, in our opinion, shows that the respondent's allowance of $ 2,000 for Ehret's services is inadequate, and, upon due consideration, we have found as a fact that the services of Ehret were reasonably worth $ 5,000. Cf. ; and .*180
We hold that the petitioner is entitled to a deduction of $ 5,000 for salary paid to Ehret and a deduction of $ 13,980 for salary paid to Day, exclusive of the amount of $ 1,602.15 hereinabove mentioned.
Decision will be entered under Rule 50.
Footnotes
*. Net loss.↩
**. This amount includes $ 1,602.15 which was paid to reimburse Day for expenses advanced on behalf of petitioner.↩
1. Art. 42-4. Long-term contracts. -- Income from long-term contracts is taxable for the period in which the income is determined, such determination depending upon the nature and terms of the particular contract. As used in this article the term "long-term contracts" means building, installaion, or construction contracts covering a period in excess of one year. Persons whose income is derived in whole or in part from such contracts may, as to such income, prepare their returns upon either of the following bases:
(a) Gross income derived from such contracts may be reported upon the basis of percentage of completion. * * *
(b) Gross income may be reported for the taxable year in which the contract is finally completed and accepted if the taxpayer elects as a consistent practice so to treat such income, provided such method clearly reflects the net income. If this method is adopted there should be deducted from gross income all expenditures during the life of the contract which are properly allocated thereto, taking into consideration any material and supplies charged to the work under the contract but remaining on hand at the time of completion.↩