*346 This is a proceeding for a redetermination of deficiencies in income taxes for the year 1924 in the amount of $182.16, and for the year 1925 in the amount of $358.22, making a total of $540.38, only part of which is in controversy.
The part of the deficiencies in controversy arises from the respondent's inclusion in the petitioner's taxable income for 1924 and 1925 of $1,457.22 and $1,326.59, respectively, representing net rentals from certain property in both years, and also the profit upon the sale of the property in 1925, which amounts were not included by the petitioner in its returns for these years. The petitioner admits that these *347 amounts should have been included in its gross income, but alleges that a part os such amount was deductible from gross income as additional compensation paid to officers.
FINDINGS OF FACT.
The petitioner is a corporation, organized prior to 1902 under the laws of the State of Washington, with its principal office at Tacoma. During the taxable years it was engaged in the real estate brokerage and insurance*1325 business, having four departments - a real estate and mortgage loan department, a rental department, a fire insurance department, and a casualty and miscellaneous insurance department, each under its own manager. Practically all its earnings were derived from commissions in selling insurance, real estate, etc., and were attributable to the individual efforts of the stockholders and employees rather than to the use of capital, which was small in amount.
Prior to 1918 R. E. Anderson was president of petitioner. Due to the fact that the profits were attributable to the individual efforts of the stockholders and employees, Anderson, about 1902 or 1903, had instituted the system of paying compensation to the employees and heads of the departments on the basis of a percentage of the earnings of the corporation attributable to their activities.
During the taxable years W. H. Miller was president of the petitioner; W. H. Van Horn, manager of the fire insurance department, and P. V. Caesar, manager of the liability department. Of the 207 shares of stock outstanding of the par value of $100 per share, Miller owned 157; Van Horn, 30; and Caesar, 20. Caesar had become a stockholder in*1326 1923 and the others had been stockholders for a number of years prior to that date.
During the taxable years a written contract was in force between the petitioner as employer, on the one hand, and Miller, Van Horn and Caesar as employees, on the other, which provided that after paying out of the receipts of the business, office rent, salaries of other office help and general office expenses, a reserve fund of 5 per cent of the net profits should be set aside for depreciation; an amount equal to 10 per cent of the remainder after the deduction of the reserve fund should be set aside in a "stock dividend account" for the payment of dividends, and that Miller should receiver 50 per cent of net profits after such deductions and Van Horn and Caesar 25 per cent each.
When Caesar became a stockholder it was orally agreed between him and the other two stockholders that he would not share in either the profits or losses from any investments that had been made *348 by the petitioner prior to that date. The profits from any such property were to be divided between Miller and Van Horn.
In August, 1919, the petitioner had acquired an undivided one-third interest in a piece of*1327 real estate. Rentals were received from this property during 1924 and 1925 which were not included by the petitioner in its gross income on its income-tax returns for those years. The property was sold in 1925 at a profit and the petitioner's one-third share of this amount was not included on the petitioner's income-tax return for that year. The net rentals and profit on the sale were credited directly on the petitioner's books to the personal accounts of Miller and Van Horn and were not reflected in the accounts going into profit and loss of petitioner. Miller reported the amounts credited to him in his personal income-tax return and paid the tax thereon.
During the years 1924 and 1925 the petitioner, in accordance with the written contract above referred to, paid and deducted in its income-tax returns for such years the following salaries to the three individuals who were its sole stockholders:
| 1924 | 1925 | |
| Miller | $17,295.59 | $22,905.02 |
| Van Horn | 8,647.81 | 11,452.52 |
| Caesar | 8,647.80 | 11,452.51 |
These amounts were allowed by the respondent as deductions in computing the deficiency. They did not include any of the rentals or profit received from the*1328 property mentioned above.
During the year 1924 the petitioner paid cash dividends of $4,211.89, and during 1925, $5,464.92.
OPINION.
MATTHEWS: The petitioner in this proceeding, while admitting that it erred in not including in its income the rentals and profits from the sale of the real estate in question, contends that it is entitled, after setting aside a part of such amounts for dividends and reserves, to a deduction of the remainder, amounting to $1,202.21 for 1924 and $1,094.44 for 1925, as additional compensation paid to Miller and Van Horn.
The three stockholders of the petitioner entered into a written contract, by the terms of which they were each to be paid a percentage of the profits as salaries. The evidence shows that the respondent has allowed amounts paid under this contract to be deducted in previous years as salaries and also in the taxable years. There is no controversy as to these amounts. The only contention is whether the petitioner is entitled to deduct the additional amounts *349 which were credited on the petitioner's books to Miller and Van Horn. The respondent contends that these amounts are not deductible, (1) since there is no evidence*1329 as to whether they were actually paid to the officers; (2) that such amounts did not constitute compensation, but a distribution of profits; and (3) that they were not reasonable compensation for services rendered.
On the other hand, the petitioner contends that, since these amounts were paid under the contract and according to a policy which it had followed for many years, they are deductible as reasonable compensation for services rendered, citing the case of . With regard to this contention, it should be noted that the amounts in question were not paid under the written contract, but were credited to Miller and Van Horn under an oral agreement that Caesar should not share in the profits or be liable for losses on any investment which had been made prior to his becoming a stockholder. The amounts of the rentals and of the profit upon the sale were not carried through the petitioner's profit and loss account but were credited directly to the accounts of Miller and Van Horn. They were not included in any way in the petitioner's gross income and were not deducted either on its books or on its returns as compensation. *1330 Neither the rent nor the profit on the sale of the property was income derived by the corporation from the activities of its stockholders. The manner of handling the amounts on the books of the corporation was an informal way of carrying out the oral agreement between all the stockholders that Miller and Van Horn alone were to share in any profits from investments made prior to the time Caesar became a stockholder. It was a short-cut way of distributing certain profits to two stockholders.
Under such circumstances, it is unnecessary to consider the further contentions of the respondent. We hold that the petitioner is not entitled to the deduction claimed.
Judgment will be entered for the respondent.