*56 Decisions will be entered for the respondent.
Deduction -- Rent -- Section 23 (a) (1) (A). -- The excess of rent, payable to the wife of the sole owner of the taxpayer corporation, over the rent the husband had to pay to the owners of property occupied by the corporation was not deductible under section 23 (a) (1) (A).
*556 The Commissioner determined deficiencies as follows:
| Stanwick's, Inc. | |||
| Alperstein | |||
| Period | Income | Excess | income |
| tax | profits tax | tax | |
| 1943 | $ 14,016.76 | $ 6,388.71 | |
| 1944 | 15,135.63 | 12,680.79 | |
| 1945 | 17,272.67 | 11,887.99 | |
| 1946 | $ 7,411.51 | 8,968.79 | |
| 1947 | 4,132.23 | ||
| Jan. 1947 | 102.68 | ||
| Year ended 1-31-48 | 1,384.12 |
The question for decision in these cases is whether the Commissioner erred in disallowing a part of the deduction which Stanwick's, Inc. claimed in each year as rental for the premises occupied by it.
FINDINGS OF FACT.
Fred H. Alperstein and his wife, Ruth, were married in 1925. Stanwick's, Inc., was incorporated in 1927 under a different name and changed to its*57 present name in 1930. The returns of both petitioners for the periods here involved were filed with the collector of internal revenue for the district of Maryland.
Fred H. Alperstein has owned the stock of Stanwick's, Inc., and it has been engaged in the operation of a specialty shop or store for the retail sale of women's apparel at 204 West Lexington Street in Baltimore, Maryland, at all times since 1927. There is on the property a three-story and basement building, 16 feet wide and 80 feet deep. The location is excellent.
Six individuals, unrelated to Alperstein, have been the owners of the premises at that address and have leased the premises to Alperstein *557 for a fixed annual rental under a succession of leases. They insisted upon leasing to him rather than to his corporation although the understanding was that the premises were to be used by the corporation.
The corporation never had a written agreement with Alperstein and never had any minutes referring to its occupancy of the premises. Alperstein, as sole stockholder and president, considered that Stanwick's, Inc., had assumed the lease which he had with the owners. Alperstein never paid any rent to the owners. *58 The corporation paid the rent direct to the owners until July 1, 1943, after which it was paid by Ruth.
The agreement between the owners and Alperstein under which Stanwick's, Inc., was occupying the property in April 1943 was to expire on May 31, 1946. The agreement required Alperstein to pay annually as rent $ 10,500 and all real estate taxes in excess of $ 2,400. The agreement prohibited subletting without the consent of the owners and they were to receive three-fourths of any excess of the rent, under a sublease, over the rent to be paid them under the lease with Alperstein.
Alperstein went to the owners on April 26, 1943, and told them of a plan which he had to sublet to his wife and then she would sub-sublet to Stanwick's, Inc., but his personal liability under the lease to the owners would remain unaffected. He told the owners that he wanted to give his wife some income of her own and have her connected in a way with the business. He requested the owners to enter into a new lease, extending beyond the period of the existing lease, which would permit him to sublet to his wife and his wife to sub-sublet to Stanwick's, Inc., without the owners receiving any excess of the *59 rent payable by Stanwick's, Inc., to Ruth over the amount payable under the lease between Alperstein and the owners. The owners agreed because of a $ 15 per month increase in the rent and the reduction from $ 2,400 to $ 2,000 of the maximum amount of real estate taxes which they were to pay.
They entered into a new lease with Alperstein dated June 18, 1943, for a term beginning July 1, 1943, and expiring December 31, 1949. The annual rent was to be $ 10,680 plus real estate taxes on the property in excess of $ 2,000. The premises were to be used for the sale of ladies' wearing apparel, millinery, and kindred lines, and not for other purposes.
Alperstein requested the landlords to consent to the assignment of that lease to Ruth and their consent was given on June 28, 1943. Alperstein and Ruth, at Alperstein's suggestion, entered into an agreement dated June 29, 1943, whereby Alperstein subleased the premises to Ruth from July 1, 1943, through December 30, 1948. Ruth was required to pay Alperstein the amounts which he was required to pay to the owners. Ruth was given the right to sublet the premises but was *558 to remain liable to Alperstein for the performance of the sublease*60 and the original lease. The petitioner, acting as president of Stanwick's, Inc., and Ruth, as an individual, at Alperstein's suggestion, entered into an agreement dated June 30, 1943, whereby Stanwick's, Inc., leased the property from Ruth under the same terms as those in the original lease except that the rent was to be the equivalent of 6 per cent of the gross sales made on the premises beginning July 1, 1943. The sub-sublease was to begin on July 1, 1943, and was to expire December 29, 1948.
Leases based upon a percentage of gross sales came into use at the beginning of the depression in the early 1930's when vacancies began to occur and landlords had difficulty obtaining tenants at the rentals which they had been receiving. The percentage system was devised so that the rent would depend on the amount of business done. Some leases were on a straight percentage basis and some had a minimum guarantee of the larger part of the former rent. Alperstein had notified the owners during the depression that he would have to close his business unless they reduced the rent and they made temporary straight reductions in the rent to help him out for several years. There was no discussion*61 between Alperstein and the owners in 1943 of a lease between them based upon a percentage of gross sales.
Alperstein decided that the rental to be paid by Stanwick's, Inc., to Ruth under the sub-sublease dated June 30, 1943, was to be straight 6 per cent of gross sales. He made that decision having in mind the gross sales of the business up to that time and after giving consideration to existing conditions, his estimate of the prospects of the business, views expressed in trade publications, and the opinions of two local real estate men who knew nothing of the lease from the owners or of the gross sales of Stanwick's, Inc.
Alperstein told Ruth that she would take some risk and might realize a profit under the subleases. Ruth decided the arrangement would be a good one for her. It does not appear that she knew, at the time she entered into the sublease, what the gross sales of the business had been prior to that date or that she gave any consideration to the gross sales.
Ruth's total gross income, as reported for 1942, was $ 3,825 from compensation for personal services. She reported similar income of $ 3,900 for 1943, plus $ 10,767.35 of rent. She owned assets having a value *62 of $ 20,000 or $ 25,000 in 1943. She had a separate bank account and kept her property separate from that of her husband. The excess rent from the percentage lease, after payment of the rent to the owners and income taxes, was used by Ruth to buy government bonds for herself. No part of the rent received by Ruth under the percentage lease with Stanwick's, Inc., over and above the amount paid to the *559 owners of the property as rental, has ever been received by the petitioner, directly or indirectly, or used to discharge his obligations, including household and family living expenses.
Alperstein received a salary of $ 16,415.83 from Stanwick's, Inc., for 1942 and a slightly larger salary for 1943. His net income, as reported for 1942, was $ 35,262.75 and $ 37,430 for 1943.
The gross sales of Stanwick's, Inc., from 1928 through 1940 ranged from a low of $ 126,866.64 in 1933 to a high of $ 240,856.42 in 1929 and averaged $ 175,209.46. The rent paid by Stanwick's, Inc., during that period ranged from a low of $ 8,058.35 in 1933 to a high of $ 15,793.08 in 1930 and averaged $ 11,026.70.
The following table shows the gross sales of Stanwick's, Inc., the rent paid by it, the rent*63 received by the owners, and the book net profits of and the federal income taxes paid by Stanwick's, Inc., during the period from 1941 through 1949.
| Rent paid | Rent received | ||
| by Stanwick's | by the | ||
| Period | Gross sales | Inc. | owners |
| 1941 | $ 243,361.71 | $ 10,552.11 | $ 10,552.11 |
| 1942 | 353,960.60 | 11,004.47 | 11,004.47 |
| 1943 | 523,478.06 | * 21,372.35 | 10,590.00 |
| 1944 | 496,357.41 | 29,625.44 | 11,523.48 |
| 1945 | 467,668.19 | 28,046.22 | 11,561.78 |
| 1946 | 432,391.08 | 25,868.45 | 11,638.37 |
| Month of Jan. 1947 | 24,737.46 | ||
| 1947 | ** 18,553.67 | 12,124.34 | |
| 1948 | ** 19,173.05 | 12,013.24 | |
| Year ended Jan. 31 -- | |||
| 1948 | 297,770.98 | ||
| 1949 | 315,673.89 |
| Federal | ||
| Book net | income | |
| Period | profits | taxes |
| 1941 | $ 13,694.72 | $ 1,187.03 |
| 1942 | 32,729.23 | 3,049.78 |
| 1943 | 62,705.57 | 20,343.81 |
| 1944 | 34,891.11 | 45,664.39 |
| 1945 | 31,834.19 | 13,977.51 |
| 1946 | 28,891.49 | 7,927.99 |
| Month of Jan. 1947 | 445.07 | 94.03 |
| 1947 | ||
| 1948 | ||
| Year ended Jan. 31 -- | ||
| 1948 | 13,704.61 | 3,052.06 |
| 1949 | 17,353.42 | 7,772.60 |
The gross sales of Stanwick's, Inc., for the first*64 six months of 1943 were $ 262,143.81.
The following table shows for each taxable period the deduction for rent claimed by Stanwick's, Inc., on its return, the amount allowed by the Commissioner, and the amount disallowed:
| Claimed | |||
| Period | on rent | Allowed | Disallowed |
| 1943 | $ 21,372.35 | $ 10,590.00 | $ 10,782.35 |
| 1944 | 29,625.44 | 11,523.48 | 18,101.96 |
| 1945 | 28,046.22 | 11,561.78 | 16,484.44 |
| 1946 | 25,868.45 | 11,638.37 | 14,230.08 |
| January 1947 | 1,484.25 | 1,010.36 | 473.89 |
| Year ended 1-31-48 | 17,841.28 | 12,114.96 | 5,726.32 |
The Commissioner explained that excessive rentals had been disallowed as deductions because they "were not required to be paid as a condition to the continued use or possession of property for business *560 purposes but constitute rather distributions of profits of the corporation."
The Commissioner, in determining the deficiencies against Fred H. Alperstein, added the following amounts to income as dividends:
| 1943 | $ 10,782.35 |
| 1944 | 18,101.96 |
| 1945 | 16,484.44 |
| 1946 | 14,163.24 |
| 1947 | 6,429.33 |
He explained that excessive rentals paid by Stanwick's, Inc., to Ruth Alperstein represented distributions of profits taxable to Fred H. Alperstein as dividends.
*65 OPINION.
Section 23 (a) (1) (A) allows a deduction for ordinary and necessary expenses paid or incurred during the taxable year in carrying on the taxpayer's business. The deduction includes "rents or other payments required to be made as a condition to the continued use or possession, for purposes of the trade or business, of property." The rentals payable to the owners of the property were required to be made as a condition to the continued use of the property for the purposes of the business of Stanwick's, Inc., and deductions from those amounts have been allowed. The principal question in this case is whether Stanwick's, Inc., is entitled to a deduction for the excess over those amounts which it paid to Ruth under the percentage of gross profits lease.
The taxpayer has the right to conduct his business according to his own desires and the form he chooses will generally be respected. However, transactions involving a husband, a wife, and a wholly owned corporation, having the obvious effect of reducing taxes, may be questioned by the Government and should be subjected to special scrutiny to see whether the form employed to carry out the challenged tax event is genuine or sham. *66 Higgins v. Smith, 308 U.S. 473">308 U.S. 473; Helvering v. Clifford, 309 U.S. 331">309 U.S. 331; Commissioner v. Court Holding Co., 324 U.S. 331">324 U.S. 331; Commissioner v. Tower, 327 U.S. 280">327 U.S. 280; Home Furniture Co. v. Commissioner, 168 Fed. (2d) 312; 1432 Broadway Corporation, 4 T.C. 1158">4 T. C. 1158, 1165. The inference here is inescapable that the leases were designed for the avoidance of taxes and were lacking in substance.
The statute does not expressly refer to the reasonableness of rent paid for the use of property, but payments do not constitute ordinary and necessary expenses or payments required to be made as a condition to the continued use of property, where they are in excess of the amount which the taxpayer should be required to pay and where there is a close relationship between the taxpayer and the one collecting the *561 excessive rent. Limericks, Inc., 7 T. C. 1129, 1134, affd., 165 Fed. (2d) 483. The Appellate Court, in that case said "The statute *67 does not permit the deduction of an amount which is in no sense a legitimate business expense." Here motives other than the necessities of the business motivated the leases between Alperstein and his wife and between Alperstein's wholly owned corporation and his wife. They were not at arm's length and would not have been entered into by parties not intimately related. Cf. Wilhelmina Dauth, 42 B. T. A. 1181; Granberg Equipment, Inc., 11 T. C. 704. The fact that the obligation would be enforceable between the parties does not make the payments deductible under section 23 (a) (1) (A). Interstate Transit Lines, 44 B. T. A. 957, affd., 130 Fed. (2d) 136, affd., 319 U.S. 590">319 U.S. 590; Deputy v. duPont, 308 U.S. 488">308 U.S. 488.
Stanwick's, Inc., had never had a lease on the property prior to the one here in question. Alperstein had leased the property from the owners and then, without any written agreement or corporate minutes, had allowed the corporation to occupy the premises and had had it pay the rent. The lease, in effect*68 at the beginning of June 1943, had about three years to run and apparently Stanwick's, Inc., could have continued indefinitely with the same satisfactory arrangement which had been in effect since its incorporation in 1927. Its gross sales for 1941, 1942, and the first part of 1943, were increasing. Six per cent of those sales was far in excess of the rent which Stanwick's, Inc., was paying. No business reason would have prompted it to seek a new lease under which it would pay 6 per cent of its gross sales instead of the fixed rental which it had theretofore paid. The change resulted from no difficulty between lessor and lessee or between Alperstein and his alter ego, Stanwick's, Inc. Alperstein deliberately brought about the change to suit his own convenience, for his own purposes, and at great loss to Stanwick's, Inc. Ruth did not seek the arrangement but merely acquiesced in the suggestions of her husband. The evidence does not indicate that Ruth had any idea of what her chances would be under the sublease. Actually, the prospects were that her profits would be large and entirely at the expense of Stanwick's, Inc. The obvious result of such an arrangement, if it was to*69 be effected, would be to give the corporation a large deduction, thus avoiding high taxes on its part and, at the same time, syphoning earnings of the corporation into the hands of Ruth, whose taxes were low as compared to those of her husband. Alperstein was aware of the tax aspects.
Alperstein went to some lengths in an effort to establish the reasonableness of a lease based upon 6 per cent of gross sales. Perhaps such a lease might have been entered into during a depression or in case of necessity. However, the two real estate men who were consulted by *562 Alperstein did not know that there was no necessity to change an existing lease, and were not familiar either with the terms of the existing lease or with the gross sales and the trend in those gross sales at the time they were consulted. Alperstein testified that he thought such a lease would be beneficial to the corporation because it would protect it if sales fell off, and, further, that he would have made it with a stranger. There was no depression and no necessity for such a lease, and his testimony in the light of the other evidence overstrains credulity. It is difficult to believe that Alperstein would have*70 allowed his corporate business to benefit at the expense of the small amount of property which Ruth owned. But the most damaging evidence would seem to be the sales. Alperstein testified that he expected sales to decline, but he obviously did not expect them to decline sufficiently that during the period of the new lease 6 per cent of gross sales would average less than the amount payable to the owners. That is inconsistent with his testimony that he expected his wife would have a profit. It was obvious that rent based upon 6 per cent of gross sales would far exceed that being paid the owners, and actually it resulted in payments to Ruth which were more than twice the amount payable to the owners. The whole arrangement was superficial, artificial, and not an arm's length transaction between people having different interests dealing for some genuine business purpose. It was lacking in reality and was merely a device to reduce taxes.
The taxability to Alperstein of the excessive amounts paid to his wife by Stanwick's, Inc., is not separately argued. His command of the income of Stanwick's, Inc., thus paid to his wife, makes it taxable to him. Harrison v. Schaffner, 312 U.S. 579">312 U.S. 579;*71 Helvering v. Horst, 311 U.S. 112">311 U.S. 112. Excessive rent may be dividends, Limerick, Inc. v. Commissioner, supra, and that is true where the sole stockholder exercises his control to have the funds paid to his wife for his own satisfaction. Cf. Ingle Coal Corporation, 10 T. C. 1199, affd., 174 Fed. (2d) 569.
The Commissioner, in determining the deficiencies against Fred H. Alperstein, reduced the deductions claimed on the returns for medical expenses solely because of increased income resulting from other adjustments. The petitioner assigned that action of the Commissioner as error so that it could be adjusted in case the income was not as great as determined by the Commissioner. The parties have indicated that if any change in income is made they will make the necessary adjustments in the deduction for medical expenses. However, the holding herein is for the Commissioner on the income question and, consequently, his reduction of the medical expense deduction was proper.
Decisions will be entered for the respondent.