*1087 During 1935, 1937, and 1938, the petitioner made payments to its former assistant secretary-treasurer, who had suffered a nervous breakdown in 1934 and was receiving mental treatment in a veterans' hospital. Held, that the payments so made are not deductible from petitioner's gross income as ordinary and necessary expenses.
*1181 These proceedings, consolidated for hearing, are for the redetermination of deficiencies in income and excess profits taxes for the fiscal years ended January 31, 1936, 1937, and 1938, as follows:
| Deficiency | |||
| Docket No. | Fiscal year ended - | Income tax | Excess profits tax |
| 99409 | Jan. 31, 1936 | $330.00 | |
| 99952 | Jan. 31, 1937 | 435.86 | $144.00 |
| Do | Jan. 31, 1938 | 453.26 | 48.42 |
The only question in issue is whether the petitioner is entitled to deduct from gross income for each of the taxable years $2,400 credited as salary to Gus Berman, from which his personal expenses were paid by petitioner. If so, there are no deficiencies in either income or excess profits*1088 tax.
FINDINGS OF FACT.
The petitioner is a Virginia corporation organized in 1917, with its principal office and place of business at Lynchburg, Virginia, where it operates a retail department store. It is a family corporation and since 1921 all of its 510 shares of stock (increased to 660 in 1934) have been owned by Hyman Berman and his three sons, Harry Berman, Fred Berman, and Gus Berman. Each of the sons has owned 25 shares since 1931. The remaining outstanding shares were owned by Hyman Berman until his death on February 19, 1938, since which time they have been owned by his estate.
Hyman Berman was president of the corporation from 1922 until his death in 1938. His sons have also been officers and employees of the corporation for many years.
Gus Berman was in the military service of the United States during the World War. In 1919 he entered the employ of the petitioner corporation and from July 7, 1922, to February 15, 1928, was secretary-treasurer and a director. In 1928 he left the employment of petitioner and moved to Montgomery, Alabama, where he was employed by the Solomon Bros. Co. In December 1929, at his father's request, he returned to Lynchburg and*1089 reentered the employment of the petitioner as assistant secretary-treasurer. From December 1929 until July 1934 he was actively employed by the petitioner, and assisted in the buying and management of the store and also supervised the bookkeeping and office work.
In July 1934 Gus Berman suffered a nervous breakdown, with mental complications, and from that date up to the present time he has not been actively engaged in the service of the petitioner. In November 1935 he was treansferred from the Enoch Shepherd Pratt *1182 Hospital in Baltimore to the veterans' administration hospital at Roanoke, Virginia, where he has since remained.
Although not actively employed by the petitioner after July 1934, Gus Berman was reelected to the office of assistant secretary-treasurer of the petitioner at a directors' meeting held May 15, 1935, and his salary was fixed at the same amount as the prior year. Thereafter, he continued to hold this office until July 1, 1938. On the latter date the board of directors of the petitioner adopted the following resolution:
Whereas Gus Berman has been an officer of this corporation since July 7, 1922 and also an active employee until about July, *1090 1934, at which time he became incapacitated to perform any services; and
Whereas said Gus Berman has been carried on the pay-roll since he became incapacitated to perform any services;
NOW, THEREFORE, BE IT RESOLVED:
That said Gus Berman continue to receive a pension of $200.00 per month.
At a meeting of the board of directors of the petitioner corporation held on April 28, 1939, the following resolution was adopted:
Harry Berman, President, stated that the Corporation had paid to Gus Berman compensation at the rate of $2,400.00 a year from the time he was taken sick in 1934 through the year ended January 31, 1938; that it was his opinion that some reduction should be made in these payments, therefore, he had instructed the bookkeeper to pay only $400.00 to Gus Berman for the year beginning February 1, 1938.
Upon motion duly seconded, the action of the President in reducing Gus Berman's compensation to $400.00 for the fiscal year beginning Februarty 1, 1938, was approved, and he was authorized to continue the payment of this amount each year until further action is taken.
The payroll records of the petitioner are not available to show the compensation paid Gus Berman*1091 for the fiscal years ended January 31, 1932, and 1933. He was paid a salary of $3,900 for 1930, a salary of $300 for the month of January 1931, a salary of $2,860 for the fiscal year ended January 31, 1934, and payments aggregating $2,440 for the fiscal year ended January 31, 1935. For the taxable years the petitioner paid Gus Berman and its other officers the following salaries, which were claimed as deductions on its returns:
| Fiscal year | Hyman Berman, president | Harry Berman, vice president | Fred Berman, sec. & treas. | Gus Berman, assistant sec. & treas. |
| 1936 | $5,000.00 | $2,947.50 | $2,080.00 | $2,400.00 |
| 1937 | 5,000.00 | 2,860.00 | 2,080.00 | 2,400.00 |
| 1938 | 5,000.00 | 3,110.00 | 2,180.00 | 2,400.00 |
The petitioner paid Gus Berman's salary for the taxable years by crediting the $2,400 to his personal account on the books. It used the amounts so credited to pay his personal expenses and to provide for *1183 the support and maintenance of his wife and child. In April 1938 Harry Berman was appointed a committee for Gus Berman, and thereafter the amounts formerly credited to Gus Berman were paid to his committee.
Gus Berman was married and had one child. *1092 After 1934 his wife and child lived in Alabama. His wife obtained a divorce in September 1937. The officers of the petitioner did not learn of this fact, however, until some time in 1938. The $400 which was voted to him in 1938 was used for the most part for the support of his son.
During the first years of Gus Berman's illness the officers of the petitioner expected and believed that he would recover his health and resume his employment with the corporation. In the latter part of 1938, however, the petitioner's president, Harry Berman, consulted the head psychiatrist at the veterans' administration hospital, at Roanoke, Virginia, and was informed that there was little likelihood that he would ever recover his health; that patients similarly afflicted, as a rule, did not recover after the third year of their disability.
Within the last few months, however, Gus Berman's condition has shown marked improvement and at the date of the hearing of these proceedings in February 1940, there was reason to except that he would be able to return to his duties as an officer of the petitioner corporation within a period of from 60 to 90 days.
In the determination of the deficiencies*1093 involved herein the respondent has disallowed the deduction from gross income of the $2,400 credited each year to Gus Berman. In his deficiency notice the respondent states:
Mr. Berman was for many years secretary and treasurer of the corporation. Due to ill health, his brother, Fred Berman, secceeded him as Secretary and Treasurer in April, 1931. Mr. Gus Berman continued intermittently in the service of the corporation until 1934. Since that time, he has been confined to hospitals.
The Regulations provide that a corporation may deduct from its gross income salaries paid to officers for services actually rendered. In this case, no services were rendered and therefore the deduction is disallowed.
OPINION.
ARNOLD: Petitioner contends that the foregoing facts entitled it to deduct $2,400 in each of the taxable years as an ordinary and necessary business expense under section 23(a) of the Revenue Acts of 1934 and 1936. 1 It is urged that these payments are in the nature of a pension to a valued employee who had been paid a small salary in *1184 prior years and who was expected to return to the corporation upon his recovery. Stress is laid upon the provisions of*1094 section 23(q), Revenue Act of 1934, and section 23(p), Revenue Act of 1936, which relate to pension trusts and permit deductions by an employer of payments thereto under circumstances not here material. Petitioner likewise cites the provisions of Regulations 86 and 94 relating to pensions.
In our opinion the present facts fail to support the pension theory advocated by petitioner. It does not appear that any employee of the company had been paid a pension at any time during its long existence as a business organization, nor does it appear that a pension trust had been set up for the benefit of petitioner's employees. In fact it wasn't until after the last taxable year before us that Gus Berman was voted a pension as such. Prior thereto his account was credited with a salary as an officer of the company, and it wasn't*1095 until the resolution adopted in July 1938 that petitioner's disbursements were referred to as a pension. Certainly, there is no indication here that Gus Berman was employed with the understanding that he would be paid regardless of whether he rendered any personal services. His disability did not grow out of his employment, and we can see no valid reason to characterize these credits to and disbursements for Gus Berman as pension payments.
We are persuaded by the facts of record that the father and other brothers of Gus Berman used the family corporation to satisfy an obligation that would otherwise have fallen upon them individually. By continuing Gus Berman on petitioner's payroll as an officer and employee the necessary funds were provided to meet Gus Berman's personal expenses and the expenses of his family. The evidence establishes that the funds thus provided were in fact used for this purpose by the petitioner. It is undisputed that Gus Berman rendered no personal services to the petitioner during any of the taxable years which would entitle him to these salary credits, and evidence is lacking to establish that his personal services from December 1929 to July 1934 were*1096 of sufficient value to the corporation to merit the additional compensation of $2,400 claimed for each of the taxable years.
In weighing the evidence adduced we have recognized that the acts of the directors and the entries on petitioner's books of account are consistent with the theory advanced. Nevertheless, it is our opinion that the disbursements here involved were neither ordinary nor necessary for the conduct of petitioner's business. The disbursements were extraordinary in character, and the corporate directors were influenced in authorizing them by family considerations and blood relationship. . In voting these disbursements to Gus Berman it was not the business interest of the petitioner which *1185 primarily concerned its directors, but the welfare of a son and brother and those dependent upon him. The revenue acts specifically declare that personal and family expense items are not deductible, section 24, Revenue Acts of 1934 and 1936, and this petitioner can not be used as a means of deducting personal and family expense items of Gus Berman under the guise of a salary paid to him as an officer and employee.
*1097 The cases cited by petitioner have been considered, but are deemed distinguishable on their facts. Petitioner particularly relies upon our decision in , as being precisely in point. We think the decision demonstrates the fallacy of petitioner's position. One issue in that case involved an annuity to be paid to any member of the Wildermann family who had been continuously employed by the company for a term of 15 years. The provision for the annuity had been adopted in 1912 and pursuant thereto the company paid its retired president an annuity during the taxable years 1920 and 1921. We allowed the corporation to deduct the annuity payments as ordinary and necessary business expenses. The facts in that case further show, however, that additional sums were paid by the corporation for the benefit of its retired president which it attempted to deduct as ordinary and necessary expenses. We denied the deduction of these amounts because the retired president had "rendered no services to the corporation during the taxable year." Our holding in the instant case is, therefore, in accord with our holding in the Wildermann case, as no*1098 corporate policy has been adopted by the instant petitioner respecting retired, injured, or incapacitated employees. Similar distinctions exist as to the petitioner's other citations.
Reviewed by the Board.
Decision will be entered for the respondent.
SMITH, dissenting: The Revenue Acts of 1934 and 1936 permit the deduction from gross income of "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."
Article 23(a)-9 of Regulations 86 and 94 provides in part as follows:
ART. 23 (a)-9. Pensions - Compensation for injuries. - Amounts paid by a taxpayer for pensions to retired employees or to their families or others dependent upon them, or on account of injuries received by employees, and lump-sum amounts paid or accrued as compensation for injuries, are proper deductions as ordinary and necessary expenses. Such deductions are limited to the amount not compensated for by insurance or otherwise. * * *
One *1186 of the petitioner's officers became ill in 1934. The petitioner's*1099 officers, believing that his illness would be only temporary, continued to pay him a salary at a reduced rate ($2,400 per annum). The petitioner's president testified that during the taxable years the ill officer:
* * * was a valuable employee, and he had been paid a small salary in the past years that he had been working, and didn't have any particular amount of money saved, or didn't accumulate anything, and we wanted his good will, and we wanted him to come back to work, when and if he did recover. We thought, in fairness to him and in the interest of the business, we should continue these payments of $2,400.
I think that these payments constituted ordinary and necessary expenses of carrying on a trade or business within the intendment of the statute and the Commissioner's regulations. I can not believe that the respondent would have disallowed the deduction of the salary paid if he had had before him the evidence before the Board in this record.
BLACK and LEECH agree with this dissent.
Footnotes
1. SEC. 23. DEDUCTIONS FROM GROSS INCOME.
In computing net income there shall be allowed as deductions:
(a) EXPENSES. - 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; * * * ↩