*50 Decision will be entered under Rule 50.
Where prior to the close of the taxable year 1942 the petitioner entered into an agreement with the other officers and directors of the corporation of which he was president, limiting his salary and bonus for 1941 to the amount allowed by the Commissioner as a deduction to the corporation in that year, and gave the corporation his promissory note for the difference between such amount, as tentatively agreed upon by representatives of the Commissioner and the corporation, and the compensation for 1941 already paid to him in that year and 1942, held, that the petitioner is not taxable in 1942 on that portion of the compensation which, prior to the close of the taxable year, he agreed to return to the corporation.
*673 The respondent has determined a deficiency of $ 24,287.58 in the petitioner's income and victory tax for 1943. The year 1942 is involved because of the forgiveness provisions of the Current Tax Payment Act of 1943.
The sole question in issue is whether the petitioner is taxable in 1942 on the entire amount of compensation which he received in that year from a corporation of which he was president and a principal stockholder, although during the taxable year he undertook to repay to the corporation a portion of the compensation by promissory note.
Most of the facts have been stipulated. The written stipulation is incorporated herein by reference.
FINDINGS OF FACT.
The petitioner is a resident of Shaker Heights, Ohio. He filed his income tax returns for the years involved with the collector of internal revenue for the eighteenth district of Ohio, at Cleveland. The returns were made on a cash basis.
The petitioner is and for many years has been the president and general*52 manager of the Dingle-Clark Co., hereinafter sometimes referred to as the company, an Ohio corporation engaged in the business of constructing electrical installations for industrial establishments. The company had outstanding in 1942 5,353 shares of capital stock, of which the petitioner owned 2,168 shares, his wife 72 shares, Howard Dingle 2,240 shares, and several other stockholders not related to the petitioner the remaining 873 shares. Howard Dingle was vice president and secretary of the company, but did not actively participate in its operation. He and the petitioner and one of the other stockholders were the directors.
The petitioner had an employment contract with the company, entered into in 1939, which provided for payment to him as president and general manager a salary of $ 24,000 a year, plus a bonus of 20 per cent of the net profits. The contract was to run for an indefinite time, but could be canceled by either party at the end of any calendar *674 year on ninety days' written notice. Howard Dingle had no employment contract with the company. He and some of the other officers and employees received a salary and bonus based on the profits. These bonuses *53 were fixed near the end of the year when the profits became ascertainable.
During 1941 the company paid the petitioner his base salary of $ 24,000 and a bonus of $ 60,000, based on its estimated profits for that year. On March 5, 1942, it paid him an additional bonus of $ 34,208.14, based on the 1941 profits as finally determined. Also, during 1942, the petitioner received a salary and bonus for that year of $ 90,000.
Howard Dingle received a salary and bonus for 1941 of approximately $ 28,000.
In its returns for 1941, which were made on an accrual basis and for a calendar year, the company claimed a deduction of $ 118,204.14 * as compensation paid to the petitioner for that year.
A revenue agent made an examination of the company's 1941 returns a few months after they were filed and in a report dated June 3, 1942, recommended the disallowance of a portion*54 of the compensation paid to the petitioner and Howard Dingle. The petitioner discussed the matter with the other directors and it was agreed among them at the petitioner's suggestion that he, the petitioner, would refund to the company any compensation for 1941 in excess of that finally allowed by the Commissioner as a deduction to the company. It was also agreed that the petitioner's compensation in future years would not exceed the amounts so allowed in those years. The petitioner felt that it would be unfair to the other officers and stockholders for him to draw more compensation than the company was permitted to deduct in its returns.
After several conferences between representatives of the Commissioner in the Cleveland office and the company, it was agreed that the reasonable compensation for the petitioner for 1941 was $ 90,000 and for Howard Dingle $ 15,000. This agreement was finally approved by the Commissioner on January 21, 1943.
Pursuant to his agreement with the other officers and directors the petitioner, on or about December 31, 1942, gave the company his promissory note for $ 28,208.14, representing the disallowed portion of his 1941 compensation. The note was*55 payable on demand, without interest. The petitioner did not have sufficient funds in his checking account to pay the amount in cash at that time, although he had several times that amount in savings accounts. His associates agreed to accept the note in full satisfaction of his agreement to repay the excessive compensation.
*675 No such agreement was made with respect to the compensation of Howard Dingle and he did not repay to the company any of his compensation for 1941.
The company entered the petitioner's note in its books, along with other notes receivable, early in 1943 and has continued to carry it as an asset up to the present time. The petitioner is and has been at all times able to pay the note, but has not done so. The company has not been in need of the funds and the other officers and directors have not sought its payment. The petitioner and his associates all regard the note as a binding obligation and expect it to be paid in full.
Since 1942 the petitioner has not received compensation in excess of $ 90,000 for any one year, although a larger amount would have been due him in some years under the original terms of his employment contract with the company.
In*56 his 1942 return the petitioner reported $ 96,000 as his total compensation from the company, including the $ 90,000 of salary and bonus for that year and $ 6,000 of the $ 34,208.14 received as bonus for 1941. He had already received $ 84,000 of his 1941 salary and bonus in that year, leaving him only $ 6,000 short of the $ 90,000 agreed upon as his compensation for 1941.
The respondent has determined that the petitioner is taxable on the entire amount paid to him as compensation by the company in 1942, including the salary and bonus of $ 90,000 for 1942 and the $ 34,208.14 additional bonus on the 1941 profits.
OPINION.
Ordinarily, a taxpayer reporting on a cash basis is taxable in each year on all of the income received in that year under a claim of right and without restriction as to its use. North American Oil Consolidated v. Burnet, 286 U.S. 417">286 U.S. 417.
However, where prior to the close of the taxable year there has been an adjustment of the contract or obligation and a repayment of a portion of the amount received, the tax liability has been determined on the basis of such adjusted amount. For instance, in Albert W. Russell, 35 B. T. A. 602,*57 the taxpayer received during 1930 a duly authorized salary of $ 8,400 from a corporation of which he was president. On December 24, 1930, he agreed with the other officers of the corporation, who were also directors, that in view of the low earnings of the corporation for that year his salary should be reduced to $ 4,200. Accordingly, on that date he repaid the corporation by check $ 4,200 of the salary already paid to him. We held that he was taxable in 1930 on the remaining $ 4,200 only, saying:
* * * Since the 1930 salary of the petitioner was reduced by agreement in 1930 and the petitioner in that year returned one-half of the $ 8,400 to the *676 company, he actually received in the taxable year only $ 4,200 as salary from the Detroit Bevel Gear Co. The action of the respondent in increasing the petitioner's 1930 salary from $ 4,200 to $ 8,400 in 1930 is, therefore, disapproved.
See also Huntington-Redondo Co., 36 B. T. A. 116; Guy Fulton, 11 B. T. A. 641; H. B. Hill, 3 B. T. A. 761; H. C. Couch, 1 B. T. A. 103.
The facts here would be identical*58 to those in Albert W. Russell, supra, if the petitioner had repaid the company the excessive compensation in 1942 in cash instead of by note. The evidence is undisputed that the note was given and accepted in good faith and that the parties regarded it as effectuating the adjustment of compensation agreed upon.
The petitioner contends that he is taxable in 1942 on only $ 6,000 of the $ 34,208.14 of the 1941 bonus paid to him in 1942, making his total compensation for 1941 $ 90,000, as agreed upon prior to the close of the taxable year 1942.
The petitioner and the other officers and directors of the company agreed several months before the close of 1942 that the petitioner would refund to the company any compensation for 1941 in excess of that finally allowed as a deduction to the company. We think that agreement must be regarded as a modification of the petitioner's employment contract of 1939, and that it had the effect of placing a ceiling on the compensation payable to the petitioner for 1941, as well as subsequent years. That this was a bona fide agreement is shown by the fact that the petitioner was not paid more than $ 90,000 for any subsequent year. The amount of petitioner's*59 compensation for 1941 was ascertainable, with reasonable certainty, in 1942 when the agreement was reached with the Commissioner's representative fixing the amount of the allowable compensation at $ 90,000. At least, the petitioner knew at that time that the allowance would not exceed $ 90,000 and that he would have to return to the company at least $ 28,208.14 of the $ 118,204.14 which he had received for 1941.
Even if the note may not be regarded as actual repayment, we think that there was a definite obligation on petitioner's part at the close of the taxable year to return the $ 28,208.14 to the company. In effect, he had overdrawn his authorized compensation by that amount.
In Commissioner v. Wilcox, 327 U.S. 404">327 U.S. 404, the Supreme Court said that:
* * * a taxable gain is conditioned upon (1) the presence of a claim of right to the alleged gain and (2) the absence of a definite, unconditional obligation to repay or return that which would otherwise constitute a gain.
Continuing, the Court further said:
* * * Without some bona fide legal or equitable claim, even though it be contingent or contested in nature, the taxpayer cannot be said to have*60 received any gain or profit within the reach of Section 22 (a). See North American Oil v.*677 , 286 U.S. 417">286 U.S. 417, 424. Nor can taxable income accrue from the mere receipt of property or money which one is obliged to return or repay to the rightful owner, as in the case of a loan or credit. Taxable income may arise, to be sure, from the use or in connection with the use of such property. Thus if the taxpayer uses the property himself so as to secure a gain or profit therefrom, he may be taxable to that extent. And if the unconditional indebtedness is cancelled or retired taxable income may adhere, under certain circumstances, to the taxpayer. But apart from such factors the bare receipt of property or money wholly belonging to another lacks the essential characteristics of a gain or profit within the meaning of Section 22 (a).
The facts here fit the situation which the Court identified as not constituting taxable gain; that is, the petitioner received property (money) which he was definitely obligated to repay and of which he made no use for his own gain. We think that the Commissioner erred in including the amount in petitioner's taxable*61 income.
Decision will be entered under Rule 50.
Turner, J., dissenting: It seems to me that in this case the majority of the Court has decided a case different from the one here present. This is not the situation which was involved in any of the cases cited, where the adjustment of salary authorized for a particular year was made within the year. In the instant case, long after both the year and the services for which the compensation was paid had been concluded and the compensation had been paid, the petitioner voluntarily agreed to return a part of the amount received to the corporation. The compensation had been paid to him by the corporation subject to no condition and received by petitioner as his own and under claim of right. It was his to do with as he saw fit and the corporation had no claim upon him with respect thereto. It was his income and taxable to him. North American Oil Consolidated v. Burnet, 286 U.S. 417">286 U.S. 417. If the salary adjustment had been that of a current year, salary for a year in which the services were not yet complete and the transaction so-called between the officer and his corporation had not become a*62 closed transaction, then there would be adequate basis for bringing this case within the cases cited in the majority opinion. As stated, however, the services had been wholly completed and petitioner had received the salary as his own and under claim of right and his subsequent voluntary return after completion of all acts with respect thereto between the parties can in no way serve to convert the amounts involved into something other than income. Cf. Corliss v. Bowers, 281 U.S. 376">281 U.S. 376. I accordingly note my dissent.
Footnotes
*. This amount is $ 4 less than the amount due and paid to the petitioner under his employment agreement. The discrepancy is not explained in the evidence before us.↩