*3233 In January, 1922, petitioner authorized additional salaries for its officers and employees for the years 1920 and 1921 and paid such additional compensation in the years 1922 and 1923. Held, that in the absence of proof that the combined regular and additional salaries paid in 1922 and 1923 were no more than reasonable compensation for personal services rendered, the payments so made are not deductible from petitioner's income in the respective years as ordinary and necessary operating expenses.
*545 The respondent has asserted deficiencies in income and profits tax for the years 1920, 1921, 1922, and 1923, in the respective amounts of $3,640.84, $5,394.92, $196.55, and $745.95. The only issue is whether certain amounts alleged to have been incurred or paid as salaries of officers in the taxable years are deductible from gross income in the respective years as ordinary and necessary business expenses.
FINDINGS OF FACT.
At the hearing the following stipulation was filed by the parties and is hereby accepted and adopted as our findings*3234 of fact:
1. Petitioner was organized under the laws of the State of Minnesota for the purpose of engaging in the business of manufacturing ice cream, butter, and cheese, and in the sale of milk and cream, and commenced business in the early part of the year 1919 in the City of Mankato, Minn.
2. That the business of petitioner prior to incorporation was carried on by two competing partnerships composed of five members, *546 and that upon the incorporation of petitioner all of the members of such partnerships became the officers of petitioner and were actively engaged in the conduct of its business.
3. The salaries drawn by the officers and stockholders during the years 1920 to 1923 are as follows:
| 1920 | 1921 | 1922 | 1923 | |
| Robert Rasmussen | $3,342.75 | $3,600.00 | $4,500.00 | $4,500.00 |
| Einer B. Nelson | 2,900.25 | 500.00 | ||
| Edwin Hed | 2,411.25 | 2,525.00 | 3,600.00 | 3,600.00 |
| K. Hauge | 2,411.25 | 2,400.00 | 2,700.00 | 2,700.00 |
| Chas. J. Nelson | 1,886.25 | 2,525.00 | 3,600.00 | 3,600.00 |
| H. J. Currier | 1,927.50 | 2,100.00 | 2,260.00 | 2,280.00 |
| Total | 14,879.25 | 13,650.00 | 16,660.00 | 16,680.00 |
4. That at a meeting of the board of directors, held on March 9, 1920, the*3235 following resolution was approved:
* * * The matter of wages was thoroughly gone over. It was decided for the present to keep the payroll down to a living wage and leave all the funds possible in the treasury as a working capital to be drawn out as a salary when the Company's finances would warrant such a move. This was due to the fact the Corporation needed all the funds it could spare in remodelling and equipping the new plant at 118-120 E. Cherry St.
5. That at a meeting of the board of directors, held on March 8, 1921, the following resolution was approved:
* * * Motion made and carried that the salary for the active stockholders be moderate as heretofore. Under the present money situation it was deemed advisable not to pay the back salary for 1920, but leave it as working capital until annual meeting in 1922. * * *
6. That at a meeting of the board of directors, held on March 14, 1922, the following resolution was approved:
* * * On motion made and carried it was decided to pay the 1920 back salary on the following schedule:
| Robert Rasmussen | 100% |
| Einer B. Nelson | 80% |
| Edwin Hed | 60% |
| Chas. J. Nelson | 60% |
| K. Hauge | 60% |
| H. J. Currier | 60% |
*3236 figuring same on 1921 drawing account. Motion made and carried that the same percentage be used to figure the back pay for 1921, this to be paid in 1923, provided funds could be obtained without crippling the business. * * *
7. During the first year of operations the company kept a record of its disbursements and sales, but had not installed a journal or general ledger, but the necessity for a system of accounts was seen *547 and in January, 1920, one H. J. Currier, the present treasurer, was employed to open up a set of books, act as the bookkeeper, and prepare its corporate tax returns. In view of the fact that the records of the company were in such bad shape at the time Currier became associated with the petitioner, and because of the ever increasing volume of business, he found it impossible to install a set of books and analyze the transactions entered into prior to his employment. Toward the end of 1921, public accountants were then employed, who installed an accounting system and wrote up the books to December 31, 1921, and for the month of January, 1922.
8. The said H. J. Currier prepared petitioner's income and excess-profits-tax return for the taxable*3237 year 1920 from the incomplete records at hand.
9. For the taxable year 1921 the said public accountants prepared tentative and final returns for petitioner, and also prepared an amended return for the taxable year 1920 based upon the books as written up by said public accountants.
10. That pursuant to the resolution of the board of directors, dated March 14, 1922, the following additional salaries were voted for the year 1920:
| Robert Rasmussen | $3,600 |
| Edwin Hed | 1,620 |
| C. J. Nelson | 1,620 |
| K. Hauge | 1,440 |
| H. J. Currier | $1,260 |
| E. B. Nelson | 2,400 |
| Total | 11,940 |
11. The foregoing amounts were paid to the respective parties specified in the preceding paragraph during the year 1922, and were not paid in accordance with their stockholdings.
12. In the amended return for 1920 the said public accountants set up the said additional salaries specified in paragraph 10 hereof as an accrual liability of the year 1920.
13. That pursuant to the resolution of the board of directors, dated March 14, 1922, the following additional salaries were voted for the taxable year 1921:
| Robert Rasmussen | $3,000 |
| Edwin Hed | 1,620 |
| C. J. Nelson | 1,620 |
| K. Hauge | 1,440 |
| H. J. Currier | $1,260 |
| E. B. Nelson | 2,400 |
| Total | 11,940 |
*3238 14. The foregoing amounts were paid to the respective parties specified in the preceding paragraph during the year 1923, and were not paid in accordance with their stockholdings.
15. In the final return for 1921 the said public accountants set up the said additional salaries specified in paragraph 13 hereof as an accrued liability of the year 1921.
*548 16. The deficiency taxes in controversy are income and excess-profits taxes for the taxable years 1920, 1921, 1922 and 1923, as follows:
| 1920 | $3,640.84 |
| 1921 | 5,394.92 |
| 1922 | 196.55 |
| 1923 | 745.95 |
| Total | 9,978.26 |
17. In determining the deficiency taxes set forth in his deficiency letter dated July 15, 1926, respondent refused to allow as a deduction in the years 1920 and 1921 the said additional salaries of $11,940, referred to in paragraphs 10 and 13 hereof, on the ground that said additional salaries were not authorized or set aside subject to demand of its officers in the years 1920 and 1921.
18. In determining the deficiency tax set forth in his deficiency letter dated July 15, 1926, respondent refused to allow as a deduction in the years 1922 and 1923 the said additional salaries referred*3239 to in paragraphs 10 and 13 hereof, on the ground that said salaries were authorized "for the years 1920 and 1921 and were not accrued on the books of petitioner as a liability of the years 1922 and 1923."
19. From the foregoing determination of respondent petitioner appeals, claiming that the additional compensation referred to in paragraphs 10 and 13 hereof is either a deduction for the years 1920 and 1921, the years in which such amounts were accrued by said public accountants on petitioner's returns, or a deduction in 1922 and 1923, the years in which said amounts were paid.
OPINION.
LANSDON: In its brief the petitioner concedes that the additional compensations of officers and stockholders in the amounts of $11,940, paid in 1922 and 1923 respectively, are not proper deductions from gross income for the respective years 1920 and 1921. It remains, therefore, only for us to determine whether such payments may be deducted from the gross income of the petitioner as ordinary and necessary business expenses in 1922 and 1923, respectively.
Since the petitioner abandons its contentions as to the years 1920 and 1921, the Revenue Act of 1921 is applicable to the situation here. *3240 It provides in section 234 as follows:
(a) That in computing the net income of a corporation subject to the tax imposed by section 230 there shall be allowed as deductions:
(1) All the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business, including a reasonable allowance for salaries or other compensation for personal services actually rendered, and including rentals or other payments required to be made as a condition to the continued use or possession of property to which the corporation has not taken or is not taking title, or in which it has no equity.
*549 An examination of the statutory provisions upon which the petitioner relies indicates that for Federal tax purposes deductions from income on account of the salaries of officers must be paid or incurred in the taxable year, and must be reasonable compensation for personal services actually rendered. The proof that the amounts in question were authorized by proper corporate action in 1922 and paid in 1922 and 1923 is conclusive and therefore this phase of the controversy requires no discussion.
There remains then only the question of reasonableness. Counsel*3241 for the petitioner argues that the Commissioner has not raised this question either as an administrative officer or as the respondent in this proceeding. This may be true but it is also true that the respondent, neither in his answer nor in open court, has admitted the reasonableness of the salaries claimed as deductions in the years 1922 and 1923. He has asserted the deficiencies here in question and the parties are in agreement that the basis for such deficiencies is the disallowance of the amounts alleged to have been paid as additional salaries to the officers of the petitioner in each of the taxable years. It appears, therefore, that petitioner must accept the burden of proving that the additional salaries in question were no more than reasonable compensation for the personal services rendered to the petitioner by the recipients thereof.
The record of this proceeding does not show the petitioner's invested capital, its annual business turnover in the years involved, its gross or net earnings for such years, or the nature and extent of the personal services rendered by its officers and stockholders. The stipulation does indicate, however, that the regular salaries for the*3242 years 1922 and 1923 were as follows:
| 1922 | 1923 | |
| Robert Rasmussen | $4,500 | $4,500 |
| Edwin Hed | 3,600 | 3,600 |
| K. Hauge | 2,700 | 2,700 |
| Charles J. Nelson | 3,600 | 3,600 |
| H. J. Currier | 2,260 | 2,280 |
If to the above amounts are added the amounts of additional compensation authorized for 1920 and 1921 and paid in 1922 and 1923, the total salaries claimed as deductions for such years as ordinary and necessary business expenses are as follows:
| 1922 | 1923 | |
| Robert Rasmussen | $8,100 | $8,100 |
| Edwin Hed | 5,220 | 5,220 |
| K. Hauge | 4,140 | 4,140 |
| Charles J. Nelson | 5,220 | 5,220 |
| H. J. Currier | 3,520 | 3,540 |
*550 We are not impressed by the petitioner's argument that the question of reasonableness is not involved in this proceeding because it was not the ground upon which the Commissioner disallowed the additional salaries for 1922 and 1923 and because it was not pleaded in the respondent's answer to the petition herein. In our opinion, regardless of the pleadings, the law makes this question an issue here. In every instance in which we have allowed additional salaries for a given taxable year on account of services rendered in previous years, we have*3243 held that the combined regular and additional salaries for such year were no more than reasonable compensation for services rendered. ; ; . We have also disallowed such additional compensation where reasonableness has not been shown. . Upon the record here we are unable to determine that the total deductions claimed on account of salaries for the years 1922 and 1923 were reasonable compensation for the services rendered.
Decision will be entered for the respondent.