1928 BTA LEXIS 4224">*4224 Salaries accrued to officers and employees of a corporation upon the books of the corporation, subject to payment when the funds were available without prejudice to banks and general creditors, held not to be taxable income to the officers and employees, who kept their accounts upon a cash receipts basis, where, in addition to the above limitation on payment, each had signed an agreement to allow such accrued salaries to be considered as loaned to the company for the purpose of assuring payment of a loan owing from the company to the bank, the financial condition of the company being such that this agreement amounted to relinquishing the right to such unpaid salaries.
9 B.T.A. 1404">*1404 These are proceedings for the redetermination of deficiencies in income and profits taxes for the year 1921 in the following amounts: Estate of L. Bach, $587.42; W. D. Millar, $534.36; W. H. Elliott, $1,068.02; W. F. Cummings, $767.93; and C. Galumbeck, $411.72.
The deficiencies result from the determination by the Commissioner that certain amounts1928 BTA LEXIS 4224">*4225 accrued as salaries on the books of a corporation, of which the petitioners were stockholders and directors, were constructively received by petitioners in the year 1921. By agreement of counsel the five cases were consolidated for hearing and decision.
FINDINGS OF FACT.
The petitioners were directors and employees of the Elliott-Cummings Co., Inc., a corporation which was organized under the laws of Virginia on May 1, 1919, to engage in business as a wholesale dealer in dry goods and notions. The corporation filed income and excess-profits-tax returns on a fiscal year basis for the years ended April 30, 1920, 1921, and 1922. Its books of account were consistently kept upon an accrual basis during those years.
Each of the petitioners filed his income-tax returns on a calendar year basis for the years ended December 31, 1920, 1921, and 1922, 9 B.T.A. 1404">*1405 and kept his books of account upon a cash basis for the entire period. The petitioners held the following positions with the Elliott-Cummings Co.:
W. H. Elliott, president. W. F. Cummings, vice president. L. Bach, secretary-treasurer. W. D. Millar, buyer.Charles Galumbeck, salesman.
At a special meeting1928 BTA LEXIS 4224">*4226 of the board of directors of the Elliott-Cummings Co., held April 24, 1920, the following salaries were approved for the fiscal year ended April 30, 1920:
| W. H. Elliott, president | $10,000 |
| W. F. Cummings, vice president | 9,000 |
| L. Bach, secretary-treasurer | 8,000 |
The minutes of the meeting contained this paragraph:
It is understood that the salaries previously drawn as provided for in minutes of meeting of May 17, 1919, shall be deducted from the foregoing amounts, and that any balances unpaid at April 30, 1920 are to be credited on the books to the respective officers subject to payment when the funds therefor are available.
At a special meeting of the board of directors held April 16, 1921, the following salaries were approved for the fiscal year ended April 30, 1921:
| W. H. Elliott, president | $7,500 |
| W. F. Cummings, vice president | 6,750 |
| L. Bach, secretary-treasurer | 6,000 |
The minutes of the meeting contained the following paragraph:
It was further ordered that any part of said salaries remaining unpaid at April 30, 1921, be credited to the respective officers on the books of the corporation subject to payment when the funds are available1928 BTA LEXIS 4224">*4227 without prejudice to banks and general creditors.
The company's place of business was destroyed by fire on February 25, 1922, and the insurance being insufficient to cover the loss sustained, the company proceeded to liquidate.
An audit of the Elliott-Cummings books for the fiscal year ended April 30, 1921, was submitted to its bankers, who, as the result of the financial condition shown, requested that the Elliott-Cummings Co. grant the bank preference in the payment of a large debt owing from the Elliott-Cummings Co. to the bank, and the following letter was written at the request of the president of the bank:
JUNE 1, 1921.
NATIONAL BANK OF COMMERCE,
Norfolk, Va.
GENTLEMEN: In compliance with your request that we furnish you a statement of our financial condition, we enclose, herewith, a balance sheet showing our condition at April 30, 1921, as prepared and certified to by our auditors.
9 B.T.A. 1404">*1406 While we have a book deficit of $21,489.84, we call your attention to the fact that our inventory was very conservatively priced at market.
Included in our liabilities are two items amounting to $56,448.33, which represent loans from our stockholders and they, 1928 BTA LEXIS 4224">*4228 hereby agree not to withdraw these loans as long as they are needed to finance the business and by leaving them in the business, it in effect for credit purposes, gives the Company a surplus of $34,958.59 and a net worth of $82,958.59.
We also carry a joint insurance policy among our members for the benefit of the Company to the amount of $29,000.
Yours very truly,
ELLIOT-CUMMINGS CO., INC.,
(Signed) W. H. ELLIOTT,
President,
(Signed) W. F. CUMMINGS,
Vice President,
(Signed) L. BACH,
Sec-Treas.,
(Signed) W. D. MILLAR,
Director.
(Signed) CHARLES GALUMBECK,
Director.
At the bank's request the items appearing in the audit report under "Special Account, $56,448.33," were eliminated from the current liabilities and set out in the deferred section of the balance sheet. This, it was suggested by the bank, would make the company's paper eligible for discount at the Federal Reserve Bank.
This item consisted of loans from stockholders, primarily from W. H. Elliott, the president, in the amount of $20,448.33, which was carried in the deposit account, and salaries accrued in the amount of $36,000. The financial condition of the Elliott-Cummings1928 BTA LEXIS 4224">*4229 Co., on April 30, 1921, is shown by the following statement which was prepared from entries upon the books of the company:
| Cash per ledger | $1,959.02 | |
| Accounts receivable: | ||
| Trade debtors | $48,705.01 | |
| Officers (Bach) | 1,129.30 | |
| Advances to salesmen | 3,360.02 | |
| 53,194.33 | ||
| Notes receivable: Trade debtors | 4,291.40 | |
| 59,444.75 | ||
| Current liabilities: | ||
| Accounts payable | 19,393.59 | |
| Notes payable | 56,175.43 | |
| 75,569.02 | ||
| Excess of current liabilities over assets | 16,124.27 | |
| Additional liabilities per books Apr. 30, 1921, to stockholders and for accrued salaries: | ||
| Loans from stockholders | $20,448.33 | |
| For salaries accrued | 36,000.00 | |
| 56,448.33 | ||
| Inventories | 94,789.36 |
9 B.T.A. 1404">*1407 The company was unable to pay the accrued salaries as provided in the resolution passed by the directors and the settlement of the accrued salary account was not made until 1922 when the company was liquidated. All accrued salaries were deducted by the corporation as business expenses in ita tax returns for the fiscal years in which the salaries were voted.
The total accrued salaries as of April 30, 1921, were $37,031.91. They were transferred from the drawing account1928 BTA LEXIS 4224">*4230 on that date, to the account "Loans from Stockholders" with a credit balance of $36,000 as of April 30, 1921, as follows:
| W. H. Elliott | $7,500 |
| W. F. Cummings | 7,500 |
| L. Bach | 7,500 |
| C. Galumbeck | 7,500 |
| W. D. Millar | 6,000 |
There was also a credit balance in the drawing account of $1,031.91.
This entry bore the following notation: "The company has not the money available to pay these salaries and they are, therefore, loaning the money to the company until such time as the company has the money with which to pay the indebtedness."
The books of the company were kept by L. Bach, now deceased, and the other directors knew nothing of the manner of keeping the records, especially as to charging the accrued salaries as loans.
The following salaries were drawn by the petitioners:
| 1920 | 1921 | |
| Elliott | $448.22 | $2,825.31 |
| Cummings | 4,020.84 | 3,433.09 |
| Bach | 4,783.46 | 3,713.91 |
| Millar | $4,377.03 | $2,872.25 |
| Galumbeck | 4,720.30 | 3,511.64 |
On or about November 7, 1925, each of the petitioners received from the respondent a notice of deficiency in tax for the year 1921, in which the respondent included the following amounts as taxable income, as accrued1928 BTA LEXIS 4224">*4231 salaries:
| L. Bach | $6,216.54 |
| W. H. Elliott | 10,051.78 |
| W. D. Millar | 6,247.97 |
| W. F. Cummings | 8,729.16 |
| C. Galumbeck | 6,279.70 |
9 B.T.A. 1404">*1408 OPINION.
SIEFKIN: All of the petitioners were directors and employees of the corporation, which had a fiscal year ended April 30, 1921. During that fiscal year of the corporation certain salaries were voted to the petitioners, but with the limitation that withdrawals against the salaries could be made only as the needs of the business permitted. The corporation was not prosperous and was heavily indebted to banks and to its principal stockholder and president, and withdrawals were made only for a portion of the amounts voted. Such amounts that were actually paid are not in controversy, the petitioners all being upon the basis of cash receipts and disbursements in reporting income and making their returns on a calendar year basis. The amounts which were not withdrawn are the subject of this controversy, the respondent's contention being that the transaction with the corporation's bank centering around June 1, 1921, resulted in converting the accounts of the petitioners with the corporation into income to the petitioners1928 BTA LEXIS 4224">*4232 even though respondent concedes that such amounts were not income up to that time. It is necessary, therefore, to examine into the nature of the transactions around June 1, 1921.
An audit of the corporation's books by its auditors late in April, 1921, disclosed an unfavorable financial position, and this situation being made known to the bank to which the corporation was heavily indebted, it was suggested by the president of the bank that the accounts of the corporation be recast so that the amounts shown as credited to the petitioners be deferred to the right of the bank to obtain its money. To this all of the petitioners agreed. It was also suggested that the recasting of the accounts of the corporation be done in such a manner as to permit rediscount of the corporation's paper under the Federal Reserve system. The various petitioners then, in order to carry out this suggestion of the bank, whether as individuals or as directors and officers (although they signed as directors and officers) is not conclusive, agreed by letter to the bank to consider the credits due them for unpaid salaries as loans subject to the right of prior payment by the bank. Shortly thereafter the auditors1928 BTA LEXIS 4224">*4233 for the corporation changed the audit to conform with this agreement and changed the books of the corporation so as to carry the accrued salaries into a so-called "loan account," although an actual loan by Elliott, one of the petitioners who was also president of the corporation, was carried in another account known as "deposit account." The letter to the bank, the change in the audit of the corporation's affairs and the change of the corporation's books are the facts relied on by the respondent as changing the situation between the corporation and the petitioners so as to render petitioners liable to tax upon the unpaid but accrued salaries.
9 B.T.A. 1404">*1409 In determining the deficiency the respondent made this statement:
The amount of accrued salary undrawn on June 1, 1921 at which time you acknowledge such amount as a loan to the corporation and waived your right of preference should be included as income for 1921.
We can not agree with this contention. It seems quite clear that, although the petitioners signed a letter using the word "loan," and although auditors of the company treated the amounts of accrued salaries as though they were loans to the corporation, the transaction, 1928 BTA LEXIS 4224">*4234 in fact, did not constitute a loan. All of the petitioners who were still living testified as to the purpose of the letter to the bank and to complete ignorance of the change in audit and the books as the result of the letter. It is clear from their testimony and from all of the circumstances surrounding the transaction that it did not result in making available to the petitioners any additional income from that already received. On the contrary, it appears that the petitioners were in a less advantageous position than before. Before the conference with the bank and the letter to the bank they had an outstanding credit on the books subject to the needs of the business. After June 1, 1921, such amounts were inferior to claims of the bank. Under similar circumstances we have held in many cases that the petitioners were not in receipt of income constructively or otherwise. See ; ; ; 1928 BTA LEXIS 4224">*4235 ; .
At the hearing it was conceded by the petitioners that certain amounts actually drawn by petitioners, as set forth in our findings of fact above, were properly taxable as income.
Judgment will be entered on 15 days' notice, under Rule 50.