*2532 Salaries held to be reasonable and deductible as a business expense.
*648 This appeal involves deficiencies in income and excess-profits taxes for the years 1920 and 1921 in the amounts of $9,009.58 and $18,045.08, respectively.
The petitioner alleges as error on the part of the Commissioner (1) his refusal to allow as a business expense the full amount paid to its three officers as compensation for services performed and (2) the reduction of invested capital due to undetermined taxes for prior years.
*649 FINDINGS OF FACT.
The petitioner is a New Jersey corporation with its official place of business in Paterson, and since the time of its incorporation in 1907 has been engaged in the business of dyeing and finishing silk on a commission basis.
The business was started by three brothers, Charles P. Cole, George W. Cole, Jr., and William S. Cole, who were experienced and technical men in the silk-dyeing industry.
The corporation's original stock was issued to, and in 1920 and 1921 was held by, the following persons:
| Charles P. Cole | 160 shares |
| George W. Cole, Jr | 1 share |
| William S. Cole | 160 shares |
| Catherine C. Cole | 159 shares |
*2533 Catherine C. Cole, wife of George W. Cole, Jr., paid in to the corporation at its organization approximately $2,500, for which she received 159 shares of stock and the money so paid in constituted the corporation's entire working capital at the time it started to transact business.
During the early part of the petitioner's existence the three brothers did all of the work necessary in the business and drew only nominal salaries. As business increased and it became necessary to employ help, the officers continued to perform the technical and skilled work of the business instead of delegating it to highly paid technical men and overseers, as was frequently done by other concerns in the silk-dyeing-and-finishing business.
Charles P. Cole, as vice president, had direct supervision of the weighting department of the plant, that is, the branch which removed the gum from raw silk by washing it in boiling soap and increased the weight of the material by passing the washed silk through a solution of bichloride of tin. He perfected the system used in his department to weight silk; employed no technicians or chemists to assist him in his work, and due to his methods, skill, and close*2534 supervision of the work of his department no silk was spoiled or damaged in 1920 and 1921 during the process of weighting it.
George W. Cole, Jr., was the corporation's president and treasurer and as such acted as a general overseer of the business, did all of the sales work for the petitioner; kept the taxpayer's books; handled the corporation's financial matters; helped adjust claims and assisted his brothers in the technical phases of their work when required. By performing or supervising the work himself, he saved his employer approximately $30,000 per year.
As secretary and general manager William S. Cole was in charge of the petitioner's dyeing and finishing departments; did all of the *650 buying; had charge of the receiving, piecing and shipping departments; was responsible for the silk from the time it left the weighting department until it was shipped to the owner, and did this without the aid of technical assistants. Purchases made by him personally in 1920 and 1921 amounted to $453,426.94 and $540,196.86, respectively.
Each officer had a working knowledge of the duties being performed by the other officers and in case of need, could assume their work and*2535 responsibilities. Due to the fact that each officer acted in the capacity of an overseer or foreman of branches or departments of the business, they were required to, and did, work early and late almost every day, and often on Sundays.
The stockholders were also the directors of the corporation. The directors and stockholders at a special meeting held on March 22, 1919, reduced the annual salary of each officer from $75,000 to $50,000, due to the termination of the World War and the uncertainty of the dyeing business as the result therfof. During 1920 and 1921 the petitioner paid each of its officers a salary of $50,000, and the compensation so received was reported by the recipients as such in their personal tax returns for those years.
For the taxable periods in question the commissions received by petitioner for the years 1920 and 1921 and reported in the returns for those years under the heading "Gross sales, less returns and allowances" were $1,405,230.14 and $1,575,568.04, respectively. Petitioner's net income, after deducting salaries paid to its officers and all other expenses, was for the year 1920 and 1921, $34,056.76 and $120,124.99, respectively.
No dividends*2536 were paid by the petitioner in 1920 or 1921.
On an audit of the petitioner's books the Commissioner allowed each officer an annual salary of $40,620 and disallowed the balance of $9,380. Such disallowances for the taxable periods amount to $56,280.
OPINION.
ARUNDELL: From the testimony introduced at the hearing we are convinced that the growth and success of the petitioner corporation is primarily due to the competency and resourcefulness of its officers and their system of superintending every phase of the business personally instead of intrusting such duties to subordinates. This practice saved the petitioner the expense of paying htgh salaries to chemists, purchasing men, foremen, technicians and others to do or supervise the work of the various branches of the business and enabled it to economize and reduce claims for inferior workmanship to a minimum. All of the officers were experienced dyers and finishers before the corporation was organized and were qualified to supervise the work of any department of its business.
*651 The Commissioner questions only the reasonableness of the salaries and finds that these officers were not worth $50,000 each, but only*2537 $40,620. He disallows as a deduction the difference between what was actually paid and what he has determined to be reasonable. We find no evidence in the record that warrants the substitution of the Commissioner's judgment for that of the petitioner's board of directors, even though it be in the matter of authorizing their own salaries. The amounts paid appear reasonable and we think their deduction should be allowed.
While the payment of large salaries to officers of a corporation who own and control all of its stock may well prompt an inquiry into the question of whether the amount paid as salary is such in fact rather than a distribution of profits in the guise of salary, still that question was not raised by the Commissioner and no facts are present in the record which would lead us to that conclusion.
The errors alleged with respect to the reduction of invested capital on account of prior years' taxes are disposed of by section 1207 of the Revenue Act of 1926, except insofar as a change in invested capital for 1921 may result from the additional allowance of salaries for 1920, which may be settled under Rule 50.
Judgment will be entered on 10 days' notice, under*2538 Rule 50.
Considered by LANSDON, STERNHAGAN, and GREEN.