*623 Within 2 1/2 months after the close of the taxable year petitioner, on the accrual basis, issued to its officers notes for accrued but unpaid salaries. The notes were issued and accepted with intent they should constitute payment of the salaries. Held, the notes did not constitute payment within the meaning of section 24(c), Revenue Acts of 1936 and 1938 and the Internal Revenue Code; held, further, on the facts, that the conditions of subparagraphs (1), (2), and (3) of section 24(c) coexist and that deduction should be denied for the part of salaries unpaid within the time above described.
*967 This proceeding is for a redetermination of deficiencies determined by the Commissioner in the following amounts:
| Calendar year | Income tax | Excess profits tax |
| 1937 | $3,283.99 | $679.20 |
| 1938 | 590.17 | None |
| 1939 | 535.80 | 180.00 |
The only adjustment made by the Commissioner in each taxable year was the disallowance of a deduction for salaries of officers accrued but unpaid at the end of the taxable year, which he contends*624 were not paid within 2 1/2 months after the end of the taxable year.
FINDINGS OF FACT.
Petitioner is an Ohio corporation engaged in the metal working business and has its principal office at Celina, Ohio. Its returns for the periods involved were filed on the accrual basis with the collector of internal revenue for the tenth district of Ohio.
During the taxable years 1937, 1938, and 1939 the president and vice president of the petitioner devoted their full time to the conduct and management of the business. These officers were brothers and between *968 them owned 305 shares out of a total of 520 shares of outstanding capital stock of petitioner.
The salaries authorized for the president and vice president were as follows:
| 1937 | 1938 | 1939 | |
| President | $10,000 | $9,000 | $10,000 |
| Vice president | 10,000 | 9,000 | 10,000 |
On December 31, 1937, the authorized salaries for 1937 were accrued on the books of the petitioner, but on February 28, 1938, there was due and unpaid the amount of $7,000 on each of these officers' salaries. On February 28, 1938, promissory notes were executed by the petitioner to the officers for $7,000 each. On March 14, 1938, $500*625 was paid on each of these notes, leaving unpaid a total balance of $13,000 on March 15, 1938. These notes were paid in full by June 13, 1938.
On or before February 28, 1939, petitioner paid to each of the officers upon his authorized salary for 1938 the amount of $7,000, leaving a balance of $2,000 owing to each officer. On February 28, 1939, promissory notes in the sum of $2,000 were issued to each of the two officers. There notes were paid in full during the months of April and May 1939.
In February 1940 the petitioner issued notes for 1939 accrued but unpaid officers' salaries in the amount of $3,000. These notes were paid during the months of April and May 1940.
The financial condition of the petitioner at the end of each of the taxable years is shown by the balance sheets which follow:
| Dec. 31, 1937 | Dec. 31, 1938 | Dec. 31, 1939 | |
| ASSETS: | |||
| Cash | $956.77 | $3,775.91 | $6,596.93 |
| Accounts receivable, less reserve for bad debts | 24,731.06 | 27,852.21 | 28,107.50 |
| Inventories | 58,322.83 | 37,421.34 | 55,738.14 |
| Prepaid taxes, insurance. etc | 949.15 | 842.35 | 1,299.90 |
| Capital assets, less reserves for depreciation | 56,395.11 | 53,688.29 | 52,076.41 |
| Rent receivable | 65.00 | 100.00 | |
| Total | 141,419.92 | 123,680.10 | 143,818.88 |
| LIARILITIES AND CAPITAL: | |||
| Accounts payable | 7,157.03 | 9,051.99 | 6,528.39 |
| Bonds. notes and mortgages payable, with maturity less than one year | 1,500.00 | ||
| Accrued expenses | 1,580.87 | 2,859.31 | 3,670.33 |
| Unpaid salaries | 31,410.00 | 12,000.00 | 13,500.00 |
| Provision for Federal taxes | 3,860.80 | 2,376.16 | 7,392.10 |
| Capital stock | 52,000.00 | 52,000.00 | 52,000.00 |
| Earned surplus and undivided profits | 43,911.22 | 45,392.64 | 60,728.06 |
| Total | 141,419.92 | 123,680.10 | 143,818.88 |
*626 On February 28, 1938, petitioner had cash on hand of $1,565.19On February 28, 1939, it had cash on hand of $5,638.02, and on January 31, 1940, it had cash on hand of $3,564.78.
*969 Prior to the taxable years petitioner had followed the custom of merely crediting the monthly salary to the account of each officer and the officers withdrew at will from their accounts. Petitioner was on the accrual basis of accounting in those years as well as in the taxable years here involved, and it accrued the full amount of the salaries for each year. The officers in their income tax returns reported the full amount of their salaries for the year in which they were accrued by petitioner.
In the latter part of 1937 petitioner was advised by its tax adviser, a certified public accountant, of a change in the law and was further advised that the salary of each officer for the taxable year would have to be paid within the taxable year or 2 1/2 months thereafter. After several conferences among the officers on this matter, wherein the method of payment was discussed, petitioner adopted the plan of issuing its notes as above set forth, with the intent that they should constitute payment*627 of that part of the salaries not paid in cash. The notes were then credited to the "Notes payable" account and debited to the salary accounts of the officers. In each of the taxable years petitioner deducted from gross income the full amount of salaries accrued. The minutes of a meeting of the board of directors held February 18, 1938, contain the following:
It was further moved by W. E. Touvelle, and seconded by S. D. Hattery, that a note for $7,000 be issued to each, R. R. Hattery, S. D. Hattery, and E. P. Kriemendahl for unpaid salaries due for 1937 and which amount remained unpaid on March 1, 1938, to each, R. R. Hattery, S. D. Hattery, and E. P. Kriemendahl. Motion carried unanimously. * * *
Petitioner intended that the notes should be payment and not merely evidence of indebtedness. The officers accepted the notes with the intent that they should constitute payment of the remainder of their unpaid accrued salaries.
Petitioner had done its banking business with a local bank for a period of about fifteen years. That bank would have loaned petitioner up to $30,000 in any one of the taxable years. It would have discounted the notes for the officers if they had asked*628 it to do so. However, the officers personally held the notes until they received payment. If the petitioner owed the bank anything during the taxable years, it was very little. The notes given in payment of the balances owed to each officer on his accrued salaries were worth face value.
All facts stipulated but not set forth herein are incorporated by reference.
OPINION.
HILL: The sole issue of this proceeding is whether or not petitioner is to be allowed a deduction for salaries accrued but not paid in cash within the taxable year or 2 1/2 months thereafter.
*970 Respondent disallowed for each taxable year that part of the salaries which petitioner did not so pay in cash. The disallowance was made under the provisions of section 24(c) of the Revenue Act of 1936 as amended by section 301 of the Revenue Act of 1937, the Revenue Act of 1938, and the Internal Revenue Code. 1 He contends that the notes were not payment but merely represented a change in the name of the liability accounts.
*629 The petitioner contends that, since the officers accepted the notes in full payment of the accrued but unpaid salaries, petitioner paid within 2 1/2 months after the close of the taxable years all salaries due.
Petitioner rests its case solely on the contention that section 24(c)(1) does not apply to the facts here. It makes no claim that 24(c)(2) or (3) does not apply. From this we may reasonably assume that petitioner acknowledges that section 24(c)(2) and (3) are applicable. Unquestionably subdivision (3) of such section so applies. The record is silent as to whether the officers of petitioner are on an accrual or cash basis of accounting. We, therefore, resolve the question of whether subdivision (2) of such section is applicable to the facts here against the petitioner and hold that it is so applicable.
We have then for determination only the question whether the issuance and acceptance of the notes here involved constitute payment within the meaning of section 24(c)(1). On the authority of the principle announced in *630 , and , we hold that the issuance and acceptance of the notes here involved do not constitute payment within the meaning of such statute. We hold, further, that subdivisions (1), (2), and (3) of section 24(c) coexist under the facts of this proceeding and that, therefore, the determination of the respondent herein should in all respects be sustained.
Decision will be entered for the respondent.
Footnotes
*. Prior to October 22, 1942, this report was approved for promulgation. ↩
1. SEC. 24. ITEMS NOT DEDUCTIBLE.
* * *
(c) UNPAID EXPENSES AND INTEREST. - In computing net income no deduction shall be allowed under section 23(a), relating to expenses incurred, or under section 23(b), relating to interest accrued -
(1) If such expenses or interest are not paid within the taxable year or within two and one-half months after the close thereof; and
(2) If, by reason of the method of accounting of the person to whom the payment is to be made, the amount thereof is not, unless paid, includible in the gross income of such person for the taxable year in which or with which the taxable year of the taxpayer ends; and
(3) If, at the close of the taxable year of the taxpayer or at any time within two and one-half months thereafter, both the taxpayer and the person to whom the payment is to be made are persons between whom losses would be disallowed under section 24(b). ↩