*947 In 1925 the Commissioner made jeopardy assessments against petitioner as executrix of the estate of C. C. Knowlton, deceased, for additional income taxes claimed to be due from decedent for *948 the years 1920 to 1924, inclusive. Claims for abatement were duly filed and petitioner notified of the action of the Commissioner thereon. Upon receipt of such notices petitioner instituted these proceedings to redetermine the tax liability of the decedent. The amounts of additional taxes assessed, the amounts sought to be abated, and the amounts of the abatement claims rejected by the Commissioner are as follows:
| Year | Additional amount assessed | Amount of abatement claims | Amount rejected |
| 1920 | $4,498.43 | $4,248.40 | $3,978.40 |
| 1921 | 6,371.91 | 4,488.53 | 4,100.76 |
| 1922 | 6,983.13 | 6,158.15 | 5,990.15 |
| 1923 | 1,532.25 | 1,532.25 | 1,428.75 |
| 1924 | 2,740.73 | 2,790.27 | 2,742.27 |
Separate notices having been mailed by the Commissioner for each of the years involved, separate petitions were filed for each year. The same issues are*2293 involved in each proceeding and they were consolidated for hearing and decision.
It is alleged that the Commissioner erred (1) in failing to allow as a deductiom from net income of the respective years certain payments made by Charles C. Knowlton to George C. Hammond during each of the years in question; and (2) in the method of computing the capital net gain derived through the sale of certain common stock of the H.K.H. Silk Co. The second issue has been settled by stipulation of the parties.
FINDINGS OF FACT.
Charles C. Knowlton was a natural born citizen of the United States and died on the 12th day of October, 1924, a resident at the time of his death and for more than five years prior thereto of West Ashford, in the County of Windham and State of Connecticut. Isabelle Hammond-Knowlton, the petitioner herein, is the duly appointed administratrix with the will annexed de bonis non of the estate of said Charles C. Knowlton.
Clarence A. Hammond-Knowlton was the foster son of said Charles C. Knowlton and a nephew of one George A. Hammond. Charles C. Knowlton and his cousin, said George A. Hammond, were associated as partners in the business of silk manufacturing*2294 for about twenty-seven years prior to 1904 under the firm name of Hammond, Knowlton & Co. In 1904 they formed a Connecticut corporation under the same name, which succeeded to the business of the firm. Two shares of the stock of the corporation were held by Clarence A. Hammond-Knowlton, and the remaining stock was held equally *949 by the former partners. Hammond was president of the corporation and was in charge of the manufacturing operations at the plant in Putnam, Conn., and Knowlton and Hammond-Knowlton were in charge of the selling end of the business, with offices at New York City.
Prior to 1910 Knowlton and Hammond became involved in a family quarrel and ceased speaking to one another. In 1909 Hammond wrote a letter to Hammond-Knowlton, threatening to apply for a receiver of the corporation. His resignation as president of Hammond, Knowlton & Co. was demanded by Knowlton and Hammond-Knowlton who, together, held control of the stock. By the terms of an agreement between Hammond, Knowlton & Co. and Hammond, dated January 5, 1910, Hammond was retired from active participation in the business. This agreement, which was approved by the board of directors, provided*2295 among other things that Hammond was retained by Hammond, Knowlton & Co. for the remainder of his life as consulting expert to the corporation. He was not to engage in any business hostile to or which might interfere with the business of that corporation or to act as consulting expert for any such business. The corporation agreed to pay him an annual compensation of $8,000, which amount was to cover his services as vice president if elected to that office. At the same time Hammond transferred to Hammond-Knowlton 263 shares of stock of Hammond, Knowlton & Co. and Hammond-Knowlton executed and delivered a declaration of trust in favor Hammond. Under the terms of this trust the voting power of the stock was vested in the trustee; the dividends, if any, were to be paid to Hammond. The trust was to continue for the joint lives of the petitioner and Hammond, and to terminate upon the death of either. From and after the making of this agreement and declaration of trust, Hammond, Knowlton & Co. paid to George A. Hammond, according to the terms of the agreement, $8,000 per annum up to and including December 31, 1917. During all this time the relations between Hammond and Knowlton continued*2296 to be unfriendly and they never saw or spoke to each other.
During 1917 negotiations were commenced for the consolidation of Hammond, Knowlton & Co. and its subsidiary corporations, Eureka Silk Manufacturing Co. and Incorporated New London Wash Silk Co. (hereinafter called the Knowlton companies), with M. Heminway & Sons Silk Co. (hereinafter called the Heminway Co.). These negotiations were carried on by Hammond-Knowlton and Knowlton, the principal stockholders of the Knowlton companies, and H. Morton Merrimen and others, the principal stockholders of the Heminway Co. The proposed consolidation involved the formation of a new corporation to be known as the H.K.H. Silk Co. It was agreed that *950 Knowlton should become president of the new company to be formed by the consolidation. No formal contract of employment was made with Knowlton by the H.K.H. Silk Co. His total salary as president of Hammond, Knowlton & Co., Eureka Silk Co., and Incorporated New London Wash Silk Co. for the years 1913 to 1917, both inclusive, was $12,000 per year. In 1917 he also received from Hammond, Knowlton & Co. an additional $15,000 for his services in 1916. His salary as president of*2297 the H.K.H. Silk Co. was, for the year 1918, $12,000; for 1919, $22,000; and thereafter, until the date of his death in 1924, $24,000 per annum.
In the course of the negotiations for consolidation it was disclosed that Hammond, Knowlton & Co. had made the contract referred to above to pay George A. Hammond $8,000 per annum for life, and the parties representing the Heminway interests refused to allow the H.K.H. Silk Co. to assume this contract.
Knowlton deemed the consolidation advantageous on account of the expected enhancement in value of his stockholdings in the new corporation. There was also an understanding that his salary as president of the new corporation would be greater than that previously paid him. Knowlton and Hammond-Knowlton entered into a new contract with Hammond, dated October 1, 1917, which provided as follows:
Memorandum of agreement made and entered into by and between Charles C. Knowlton and Clarence A. Hammond-Knowlton, both of the City of New York, State of New York, of the first part, and George A. Hammond of Putnam, Conn., of the second part, and declaration of trust hereinafter set forth.
Whereas a certain Declaration of Trust, signed by the*2298 said Clarence A. Hammond-Knowlton and in favor of the said George A. Hammond was duly made and entered into on the first day of January, 1910, and
Whereas on the 5th day of January, 1910, a certain agreement was made and entered into between Hammond, Knowlton & Co., a corporation existing under the laws of the State of Connecticut, and located in said Putnam, and the said George A. Hammond, a duplicate of said declaration of trust and of said agreement being now in the hands of each of the contracting parties hereto, and being hereby especially referred to; and
Whereas it is the desire of all of said parties that said trust and contract shall terminate, and a new arrangement between them be made with reference to the subject matter thereof, and
Whereas the said Clarence A. Hammond-Knowlton now holds in his name as such trustee, 200 shares of the capital stock of said Hammond, Knowlton & Co., and said George A. Hammond now holds in his name one share of the capital stock of said Hammond, Knowlton & Co., and one share of the capital stock of the Hampton Silk Co., and
Whereas it is intended that a corporation shall be formed under the name and style of The H.K.H. Silk Co., taking*2299 over by consolidation or otherwise, among other corporations, those hereinbefore named;
Now Therefore, for a valuable consideration each to the other paid, and for the further consideration of the benefits to each hereinafter set forth, the parties hereto agree and declare as follows:
*951 Upon the formation of said The H.K.H. Silk Co., and its existence as a going concern said above mentioned trust created under date of January 1st, 1910, and said contract dated January 5th, 1910, shall be thereby dissolved by mutual consent.
For the purpose of the organization of said The H.K.H. Silk Co. the said Clarence A. Hammond-Knowlton is hereby authorized and empowered by the said George A. Hammond to convey to said The H.K.H. Silk Co. said 200 shares of stock of said Hammond, Knowlton & Co., now held by him as trustee, and the said George A. Hammond agrees to convey to said Clarence A. Hammond-Knowlton as trustee, or to said The H.K.H. Silk Co., as the parties of the first part may indicate, said shares held by him in said respective corporations.
Upon the organization of said The H.K.H. Silk Co. as hereinbefore provided, and upon the preformance by the said George A. Hammond*2300 of the acts to be done and performed by him as hereinbefore set forth, and in consideration thereof, the said parties of the first part agree with the party of the second part as follows:
That they will cause to be issued, when and if said The H.K.H. Silk Co. shall be duly and legally created, two hundred and fifty shares of the stock of said The H.K.H. Silk Co., to the parties of the first part, as trustees, the same to be held by them and voted on by them at all meetings of the corporation in accordance with their own views and wishes, as fully as if they were the absolute owners thereof, and they to receive for their own benefit all dividends and income from such stock except as hereinafter provided; said stock to be received by them, as such trustees, in lieu of the stock now held by the said Clarence A. Hammond-Knowlton under the deed of trust of January 1st, 1910, and in substitution for the shares to be transferred by the said George A. Hammond individually.
In lieu of the dividends and income from said two hundred and fifty shares of said The H.K.H. Silk Co., the the parties of the first part jointly and severally guarantee and agree to pay to the party of the second part, *2301 during his lifetime, eight thousand dollars ($8,000) per annum, in monthly payments, beginning thirty days after the organization and commencement of actual business of said The H.K.H. Silk Co.
Said two hundred and fifty shares of the stock of said The H.K.H. Silk Co. is to be held by the parties of the first part, or the survivor of them in trust, until the death of the party of the second part, and then to be distributed by them, or the survivor, as follows: Ninety shares to Annie Hammond Edmond of Storrs, Connecticut; ninety shares to Helen Hammond Mathews of Wailuku, Maui, T.H.; thirty-five shares to Luella Phinney Breckenridge, of Williamsburg, Mass.; and thirty-five shares to Lora Spafford Phinney of Haydenville, Mass. Provided, however, that if William H. Hammond of Hampton, Conn., and his wife, Alice Sharpe Hammond, or either of them, shall survive the said George A. Hammond, the income and dividends upon the one hundred and eighty shares to be ultimately distributed to the said Annie Hammond Edmond and Helen Hammond Mathews shall be paio to the said William H. Hammond and Alice Sharpe Hammond equally, during their joint lives, and to the survivor during his or her life, *2302 and the distribution of said one hundred and eighty shares to said Annie Hammond Edmond and Helen Hammond Mathews as hereinbefore provided shall be postponed until the death of the said William H. Hammond and his said wife.
This trust shall terminate upon the death of said trustees, or the survivor of them, but, they or one of them living, shall continue until the death of the said George A. Hammond, William H. Hammond and Alice Sharpe Hammond, *952 except as to the shares to be distributed to the said Luella Phinney Breckenridge and Lora Spafford Phinney, which shares shall be distributed to them upon the death of the said George A. Hammond; subject, however, to this proviso, that if the said George A. Hammond shall survive both of said trustees, and the trust so terminating, the whole of said stock of the H.K.H. Silk Co., held in trust as aforesaid, shall be transferred to said George A. Hammond.
In case of the death of either of said trustees, his rights and obligations hereunder shall accrue to and be obligatory upon such survivor.
Upon the death of the surviving trustee, all obligations under this contract and trust shall immediately terminate, having especial*2303 reference to the payment of said eight thousand dollars per annum to the said George A. Hammond, and upon the transfer of said stock as hereinbefore provided said trust shall end, and all obligations of said trustees thereunder shall terminate.
Nothing in this agreement contained shall bind said Charles C. Knowlton and Clarence A. Hammond-Knowlton, or either of them, in any respect, either as to the value of the stock of said The H.K.H. Silk Co., or the amount of dividends or income to be received therefrom, other than to the extent of the eight thousand dollars per annum to be paid to the said George A. Hammond during his lifetime, guaranteed as hereinbefore stated, and the payment of such income and dividends as shall be received by them on said stock, and payable hereunder to William H. Hammond and wife.
This agreement and trust are intended primarily to carry into effect the following purposes:
First: To provide an income of eight thousand dollars per year to George A. Hammond during his lifetime, provided one or both of the trustees survive him, and is dependent upon the formation of the H.K.H. Silk Co., and its existence as a going concern.
Second: To provide for the*2304 transfer of the stock of The H.K.H. Silk Co. to George A. Hammond, provided he shall survive said trustees.
Third: To provide an income for William H. Hammond and his said wife, and to continue the trust after the death of George A. Hammond to such extent as may be necessary to carry into effect such purpose, provided said trustees or one of them shall survive.
Fourth: To provide for the transfer of said shares of stock to the parties named as final beneficiaries in accordance with the terms of the trust, and in discharge thereof.
Fifth: To provide that the eight thousand dollars a year, payments to the said George A. Hammond shall be in lieu of all claims by him upon the dividends and income upon said stock, held under this trust.
Sixth: That such income and dividends, except as payable to William H. Hammond and wife, are the absolute property of the trustees, or the survivor of them, by way of compensation for said guaranteed payment of eight thousand dollars a year, and for the execution of the trust.
This instrument, therefore, however expressed, shall be so construed as to effectuate the purposes intended as above enumerated.
In addition to the trust provisions*2305 hereinbefore contained the parties of the first part agree to pay to the party of the second part five thousand two hundred dollars ($5,200), within thirty days after the organization and commencement of business of said The H.K.H. Silk Co.
*953 IN WITNESS WHEREOF, the parties have hereunto set their hands and seals, and to a duplicate instrument of like tenor and date, this first day of October, A.D. 1917.
(Signed) GEORGE A. HAMMOND. [SEAL.]
C. A. HAMMOND-KNOWLTON. [SEAL.] C. C. KNOWLTON. [SEAL.]Witness as to G.A.H. and C.A.H.K.:
ELIZABETH SPRECHER.
As to C.C.K.:
M. BROCK.The negotiations for consolidation of the Knowlton companies with the Heminway Co. culminated with the organization of the H.K.H. Silk Co. under the laws of Connecticut, on January 2, 1918.
The amounts of dividends received by Charles C. Knowlton from the shares of the H.K.H. Silk Co. common stock held in trust under the above agreement and the amounts paid by Charles C. Knowlton to George A. Hammond during the calendar years 1920 to 1924, both inclusive, were as follow:
| Year | Dividends | Amounts paid to George A. Hammond |
| 1920 | $2,000 | $8,000 |
| 1921 | 2,000 | 8,000 |
| 1922 | 2,200 | 8,000 |
| 1923 | 2,800 | 8,000 |
| 1924 | 2,100 | 6,000 |
| Total | 11,100 | 38,000 |
*2306 OPINION.
PHILLIPS: It is alleged that the respondent erred in refusing to allow as a business expense the payment by Charles C. Knowlton of $8,000 to George A. Hammond in each of the taxable years 1920 to 1923, inclusive, and $6,000 in the year 1924.
The taxing acts allow as deductions "all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business." If the payments by the decedent to Hammond do not meet this requirement, they may not be deducted and it is unnecessary to inquire further in an attempt to classify them. That the payment related to the business interests of the taxpayer and was to be made annually under a contract is insufficient to permit the deduction. We must go back and learn the purpose and result of the contract under which the payments were made.
The obligation which the decedent assumed in 1917 was properly that of the corporation of which he was the principal stockholder. It is conceivable that the consolidation might have proceeded and such corporation might have been continued in existence for the sole purpose of holding the stock of the new corporation and paying its *954 obligation*2307 to Hammond. The assumption of the corporation's obligation by the decedent accomplished several purposes. It permitted the corporation to be dissolved and its assets distributed; it gave decedent greater voting rights in the new corporation; it permitted the consolidation to take place and thereby increased the dividends on his stock and at the same time served to strengthen his financial position and increase the value of his capital. The contract with Hammond and the payments thereunder appear to be classified more properly as transactions relating to adjustments in the capital of the decedent than as ordinary and necessary expenses of any business carried on by him. To the extent, however, that decedent, by reason of such payments, received dividends on the stock of Hammond, these payments are in the nature of a price paid to purchase such dividends, served directly to increase income and to that extent they are deductible. Regarded in another light, these dividends were purchased for value and it seems clear that the decedent should not be required to include as income the dividends so purchased and refused any deduction of the purchase price.
Decision will be entered*2308 under Rule 50.