*109 Decision will be entered under Rule 50.
1. Petitioner carried on a reporting business as a sole proprietorship under the name of Columbia Reporting Co. He filed with the district director of internal revenue a timely notice of election to have his sole proprietorship taxed as a domestic corporation under section 1361, 1954 Code. Petitioner also filed timely corporation income tax returns for the enterprise which contained statements that the returns were filed pursuant to section 1361. A statement of election as prescribed in the applicable regulation, T.D. 6124, was not filed with the district director. Held, petitioner complied with the essential statutory requirements for making an election under section 1361, and there was a substantial compliance with the applicable regulation.
2. Held, further, Columbia Reporting Co. is an enterprise in which capital is a material income-producing factor and therefore it is qualified to be taxed as a domestic corporation under section 1361.
3. Held, further, earnings from the contracts performed by Columbia Reporting Co., which were obtained with another reporter, are includable in the income of*110 Columbia Reporting Co. and not in petitioner's income.
*309 In his notice of deficiency respondent determined deficiencies in petitioners' Federal income tax for the years 1957 and 1958 in the respective amounts of $ 37,017.91 and $ 35,189.10. The deficiencies are based upon respondent's determinations that Columbia Reporting Co., a sole proprietorship owned by Fred J. Sperapani, was not entitled to be taxed as a domestic corporation pursuant*113 to section 1361 of the Internal Revenue Code of 1954, 1 and that income reported by Columbia Reporting Co. in each of the years in issue, including one-half of the net income of P. J. Sullivan & Associates, was includable in petitioners' gross income. Petitioners reported income from salary from Columbia Reporting Co. in each of the years in issue in the amount of $ 50,000. In making his determination that Columbia Reporting Co. was not entitled to report its income as a domestic corporation pursuant to section 1361, respondent attributed to petitioners all the income reported by Columbia Reporting Co. without any deductions therefrom on account of salaries paid. Accordingly, the salaries reported by petitioners from Columbia Reporting Co. were in effect eliminated from petitioners' income. In his answer to the petition respondent claims in the alternative increased deficiencies pursuant to section 6214 in the amounts of $ 29,433.21 and $ 17,605.54 for the years 1957 and 1958, respectively, if the Court determines that Columbia Reporting Co. is taxable as a corporation. Respondent alleges that a reasonable salary or compensation for the services rendered by Fred J. Sperapani*114 to Columbia Reporting Co. in each of the years in issue is $ 50,000, and in the event we find for petitioners that Columbia Reporting Co. is entitled to have its income for the years 1957 and 1958 taxed as a corporation as provided in section 1361, and also that petitioners' share of the distributive income of P. J. Sullivan & Associates for the years 1957 and 1958 is includable in petitioners' income as determined in the notice of deficiency, then petitioners' taxable income as reflected in the notice of deficiency should be increased to include in petitioners' income the salary from Columbia Reporting Co. which respondent in effect eliminated in his first determination. Prior to the trial herein, petitioners filed, by leave of the Court, an amendment to the petition *310 in which petitioners assigned error to the respondent's failure, in determining the amount of the deficiencies against petitioners, to give to petitioners credit for Federal income taxes paid by Columbia Reporting Co. for the years 1957 and 1958.
*115 The issues presented for our decision are whether the respondent correctly determined: (1) That petitioner, doing business as Columbia Reporting Co., failed to file a valid election to be taxed as a domestic corporation as provided in section 1361; (2) that, if such election was validly made, the proprietorship known as Columbia Reporting Co. failed to meet the qualification requirements of section 1361(a)(4) as an enterprise in which capital is a material income-producing factor; and (3) that, even if the proprietorship were taxable as a corporation under section 1361, the income reported by Columbia Reporting Co. in each of the years in issue from P. J. Sullivan & Associates was includable in petitioners' income and not in the income of Columbia Reporting Co. Because of a supplementary stipulation filed by the parties, it is not necessary for us to make a decision on the correctness of respondent's determinations with respect to the salary from Columbia Reporting Co. which petitioners included in their income. If we decide that Columbia Reporting Co. is not taxable as a domestic corporation, we must also decide whether the Federal income taxes paid by or on behalf of Columbia *116 Reporting Co. for the years 1957 and 1958 are to be credited against the deficiencies determined against the petitioners.
FINDINGS OF FACT
Some of the facts have been stipulated and the stipulations of facts, together with the exhibits attached thereto, are incorporated herein and made a part of our findings by this reference.
Fred J. Sperapani and Cecelia Sperapani are husband and wife residing in Silver Spring, Md. They filed joint Federal income tax returns with the district director of internal revenue at Baltimore, Md. Cecelia Sperapani is a party to this proceeding solely by reason of her participation in the joint returns. Fred J. Sperapani will be hereinafter sometimes referred to as petitioner.
At all times material herein petitioner conducted a verbatim reporting business in Washington, D.C., as a sole proprietorship, doing business under the name of Columbia Reporting Co., sometimes hereinafter referred to as Columbia.
Petitioner has been a reporter since 1933. He started his own business in 1947 in Washington, D.C., when he formed Columbia. While working as a reporter, petitioner was concerned only with the particular hearing to which he was assigned. When he started*117 his own business, petitioner had to bid for contracts to obtain work, and he *311 had to provide the staff and assets necessary to perform the contracts. The bulk of Columbia's business is reporting and transcribing administrative agency hearings. Columbia also performs reporting services for some congressional committee hearings, court hearings, business conventions, and in the taking of depositions.
Columbia obtains contracts to report agency proceedings by bidding competitively with other reporting companies. Pursuant to these contracts, Columbia obtains the concession of selling transcripts to the parties to the proceedings and to the public. In those instances where the agency is provided transcripts free of charge, Columbia's income depends entirely on the sale of transcripts to interested parties and the public. In some instances the agency pays for its own transcript. Then Columbia's income is derived from sale of transcripts to the agency and to the parties to the proceedings, and consequently the prices charged to the public for a transcript are less than prices charged in those cases where the agency pays nothing for its transcripts.
A contract to do reporting*118 work for an agency is customarily in force for a fiscal year from July 1 to June 30. The season for bidding customarily begins in the last week in May or the first week in June, and awards are usually made a week or two later. A bid for a contract contains, among other things, a price for producing the transcript for the agency and a price at which the transcript will be sold to the public. Where there is a mandatory "no charge" to the agency, then the bid is with regard to the price of the transcript to the public and, as hereinafter explained, with regard to the payment of a bonus in certain cases to the agency.
From approximately 1947 through approximately 1957 there was a practice under which reporting companies would offer bonuses to certain administrative agencies for the privilege of reporting. Competition among the reporters for contracts to report the proceedings of such agencies had driven down the prices bid to the Government for producing the agency's transcript so low that the Comptroller General ruled that the only additional way to determine the low bidder would be an amount offered to the agency as a bonus to perform the work. Such bonuses were paid into the U.S. *119 Treasury. The amounts of the bonuses varied. Petitioner, with another reporter, Patrick J. Sullivan, who will be referred to again in these findings, offered a bonus as high as $ 173,000 in 1957. The practice of offering bonuses by reporters to perform the work was largely discontinued on the initiative of the agencies. Thereafter, the prices to the parties and the public decreased. At the present time only three agencies, the Maritime Commission, the Home Loan Bank, and the Food and Drug Administration, accept bonuses from reporters.
*312 Prices charged to an agency and to other parties ordering transcripts also vary with the type of delivery required for transcripts. The agency or other parties may require immediate or night delivery, whereby the transcript is delivered by 7:30 p.m. on the day the testimony is given. This is the most expensive type of delivery to produce and purchase. Or, the agency or other parties may require, at slightly less cost, daily delivery of transcripts whereby the transcripts are delivered the morning following the hearing. Finally the agency or other parties may require regular or ordinary delivery in which case the transcript is delivered*120 between 10 and 15 days after the hearing. Regular or ordinary delivery is the least expensive type of delivery because it takes one person to prepare the transcript, whereas three or four persons are needed to produce a transcript for daily delivery. It was relatively simple for Columbia to produce transcripts for regular or ordinary delivery, but it required a great deal of effort, strain, and craftsmanship for Columbia to produce transcripts for immediate or night delivery.
The prices which are charged to an agency and to the public for transcripts vary with each agency and with each yearly contract. The prices charged for a transcript to the public and to the agency are based on a per-page charge which is determined by the prospective number of transcripts to be sold on the average for each particular hearing. For example, if the transcript will be ordered by the agency only, as in hearings before the National Labor Relations Board, then the cost of production must come out of that one copy. When the transcript is normally purchased by the agency and the interested parties only, the cost of production is spread among the several copies produced. In the case of the Federal*121 Power Commission, sometimes hereinafter referred to as FPC, transcripts are purchased by a segment of the public such as pipeline companies, natural gas companies, and stock brokerage companies, which are not parties to the proceedings before the agency but which are interested in being informed of the day-to-day activities of the agency. As a result the prices to the public for transcripts of FPC hearings in the fiscal year ended June 30, 1957, were as low as 15 cents per page for ordinary delivery, 35 cents per page for daily delivery, and 45 cents per page for immediate delivery, while there was no charge to the agency for its transcripts and the agency was paid a bonus of $ 131,100.
During the years here in issue Columbia's principal place of business was located at 939 D Street NW., in Washington, D.C. It occupied an entire floor in the building which was approximately 12,000 to 13,000 square feet. Approximately one-third of the space was allocated to the reporters, approximately one-third to transcribers, and approximately one-third to assembly of transcripts and administrative *313 and clerical offices. In addition to the normal office equipment used in Columbia's *122 office, there were approximately 30 electric typewriters, approximately 10 duplicating machines, 1 Multilith duplicating machine, and 1 Xerox machine. Columbia also used an automobile during the years in issue to transport court reporters, transcribers, and equipment to hearings held outside of the Washington, D.C., area.
The reporters own the reporting machines they use. At the end of each day or oftener, if immediate delivery is required, the reporters turn their tapes over to typists who transcribe the hearings from the tapes. Reporters and transcribers are paid on a per-page basis. Columbia employed approximately 15 transcribers and approximately 20 to 25 administrative, clerical, and supervisory personnel during the years in issue. It also engaged the services of approximately 15 to 20 reporters during this period, but reporters are independent contractors and did not work exclusively for Columbia. Columbia maintained a list of preferred reporters and when work was available it called upon them the night before scheduled hearings to assign them to the various hearings.
During the years in issue herein reporters were paid approximately 45 cents per page for ordinary copy, *123 50 cents per page for daily copy, and 55 cents per page for same night delivery. Transcribers received a nickel less, that is 40, 45, and 50 cents per page for ordinary, daily, and same night delivery, respectively. The number of copies of a particular transcript that would be sold did not affect the prices paid to the reporters and transcribers. In all cases the transcribers would produce only one master copy from which Columbia could produce as many copies as it needed.
Petitioner's brothers, M. A. Sperapani and R. J. Sperapani, work for Columbia. M. A. Sperapani is a part-time reporter and a bookkeeper. R. J. Sperapani has been serving as a supervisor of the reporting work done by Columbia for the Interstate Commerce Commission. Petitioner also employed an office manager who, under petitioner's supervision, was in charge of sending notices out to the field and making assignments of work in the Washington, D.C., office.
Many agencies have hearings outside of Washington, D.C., which Columbia handled itself or through subcontractors. Columbia handled work itself only on the eastern seaboard, but no further away from Washington, D.C., than New York City to the north and Norfolk, *124 Va., to the south. The subcontractors, who handled work outside of the area contiguous to Washington, D.C., were local reporters or firms of reporters. The subcontractors completed the process of transcribing the hearings and distributing the transcripts to the parties ordering them. The subcontractors billed Columbia on a per-page basis. Columbia was charged approximately *314 75 cents to $ 1 for each page produced by the subcontractors for use of the agencies. In addition, the subcontractors took a commission of approximately 20 to 25 percent on sales of transcripts to the parties to the hearings and the public. Accordingly, in order for Columbia to earn a profit when a subcontractor was involved, it was necessary to sell at least several copies of the transcript to the public.
It was customary for Columbia to incur a substantial amount of expense in performing its services before it received any income on a contract. Columbia made its billing, with respect to hearings in Washington, D.C., when the hearing was completed. Bills were not sent until the conclusion of the hearings even if a hearing ran for several months and notwithstanding the fact that Columbia delivered*125 transcripts on an immediate delivery basis. Reporters working for Columbia and transcribers and other employees were paid weekly, and Columbia's payroll aggregated between $ 7,000 and $ 10,000 per week. Columbia was also billed on the 5th and 25th days of each month by the subcontractors performing services outside of the Washington, D.C., area. When work was done by a subcontractor, Columbia billed the purchasers of transcripts approximately 30 days after the conclusion of the hearings. At the end of the taxable years 1956, 1957, and 1958, Columbia had outstanding accounts receivable, for which bills had been rendered by Columbia, in the amounts of $ 135,049.16, $ 183,793.16, and $ 46,671.46, respectively. Each of these amounts includes $ 10,287.60 of accounts receivable billed prior to January 1, 1955. It has been Columbia's usual experience to receive payment of accounts receivable from 15 to 45 days after billing.
Columbia did not receive any income on a contract until approximately 3 to 4 months after July 1 of the fiscal year, the beginning of the fiscal year, and the beginning date of hearings under a contract. If the contract to perform the reporting work was with an*126 agency having a great deal of work, such as the Interstate Commerce Commission or the National Labor Relations Board, each of which requires about 500,000 pages of transcript per year costing approximately $ 1 million per year to produce, Columbia had to spend between $ 50,000 to $ 100,000 before it began to receive income in the third or fourth month of the fiscal year.
If Columbia bids too low on a contract it loses money. On June 25, 1958, Columbia entered into a contract to report hearings for the fiscal year ended June 30, 1959, before the Federal Communications Commission, whereby Columbia promised to furnish transcripts to the agency at no charge and to the public, for hearings held in Washington, D.C., at $ 0.085 per page for ordinary copy, $ 0.2125 per page for daily copy, and $ 0.34 per page for immediate copy. Columbia lost between $ 30,000 and $ 40,000 on the contract, and although *315 it was known before performance of the contract was completed that the costs of performing the contract were not going to be recovered from sales of transcripts to the public, Columbia fulfilled its obligations under the contract. Columbia executed performance bonds to insure faithful*127 performance of its contracts. Performance bonds were obtained from bonding companies upon the payment of a premium. Columbia was usually able to satisfy the bonding companies that it was financially sound, and therefore was able to obtain performance bonds upon the strength of its financial statement and without putting up collateral.
Generally, however, Columbia has been a profitable enterprise. As an established reporting company in the Washington, D.C., area, it received unsolicited invitations from various agencies to bid on contracts to do reporting work. During the years here in issue Columbia was at various times the official reporter for a large number of Federal agencies, including the Interstate Commerce Commission, Securities and Exchange Commission, Civil Aeronautics Board, Department of Health, Education, and Welfare, Federal Communications Commission, Post Office Department, Department of the Interior, the Subversive Activities Control Board, and several committees of the House of Representatives.
A great deal of the success in making money on a contract depends on the amounts that are bid by the reporter to perform the contract. It takes experience and knowledge*128 of the requirements of a particular contract to know what amounts to bid. Petitioner possessed such experience and knowledge and his most important function in the Columbia organization was to bid on the reporting contracts. Petitioner was the only one in his company responsible for obtaining business and organizing and running Columbia so that it would make money on the business obtained. He set his bids low enough to win the contracts but sufficiently high to perform them profitably. Petitioner also was responsible for financing the contracts and providing the staff to perform them. He also supervised the reporting of hearings, the processing and distribution of transcripts, and Columbia's billing and collection. Petitioner is occupied from early morning until late at night with the business of Columbia all year around. The work load in the reporting business is heaviest during the first 6 months of the calendar year because fewer hearings are held during the summer and holiday seasons at the end of the year. At the beginning of the summer, petitioner is then occupied with the bidding of contracts for the next fiscal year. For the first 2 or 3 months at the commencement*129 of each contract on July 1, petitioner's time is devoted to setting up his staff and setting up procedures in order to get the contracts to run smoothly and in order to do all that is necessary to make sure the contracts are performed properly. Petitioner is required to do more *316 than set up a contract and get it working. For example, in the case of the FPC contract, where each day's transcript had to be delivered at the hotels of the parties to the proceedings by 7:30 p.m., and orders (and sometimes cancellations) were received daily for each transcript or parts of transcripts, petitioner was continually occupied with the production and distribution of the transcripts.
In order to be able to bid on the various agency contracts, it was also necessary that petitioner keep in touch with affairs in the business world and Government as these may affect the work of the agencies. Petitioner selected and negotiated with the subcontractors which performed Columbia's work outside of Washington, D.C., and the contiguous area. There are approximately five major reporting firms in Washington, D.C., and petitioner has maintained personal acquaintance with the owners and supervisory*130 personnel of these firms to keep informed of the trends in the reporting business. In short, petitioner is the keyman in Columbia and its existence depends upon him.
From the time that petitioner entered the reporting business in 1947 through the years in issue, it was a normal practice for reporting firms to join together to perform contracts for a particular agency. Such arrangements among reporting firms are entered into because the financial risk involved in a particular contract is too large for one firm to handle alone, or a firm may lack either operating facilities or financial backing to perform a contract, or, as in the case of a congressional hearing in which the chairman of the congressional committee may want to give the work to one of his constituents, there is a reporter with the concession or the privilege of doing the work but he is without an office in Washington, D.C., or a staff and, more often than not, without finances. This reporter usually makes an arrangement on a profit-sharing basis with an established reporting firm in Washington, D.C., to perform the contract.
During Columbia's existence, from 1947 to the time of trial herein, Columbia entered into approximately*131 20 arrangements to perform reporting contracts with other reporters. Petitioner alone obtained for Columbia all of the work performed with other reporters.
On June 10, 1954, petitioner, Patrick J. Sullivan, Jr., of Chicago, Ill., sometimes hereinafter referred to as Sullivan, and Arthur G. Previn of Washington, D.C., sometimes hereinafter referred to as Previn, entered into an agreement to make a joint bid under the name of P. J. Sullivan & Associates, sometimes hereinafter referred to as Associates No. 1, and, if accepted, to jointly perform the verbatim reporting contract for the FPC for the 1955 fiscal year ended June 30, 1955. Sullivan had his own reporting business in Chicago and Previn had a reporting business in Washington, D.C., through which he performed contracts which did not require a large staff. The contract provided, in pertinent parts, as follows:
*317 2. Each of the parties hereto jointly and severally agree with each other to contribute one-third of all of the actual expenses of performing the contract, and each shall be entitled to receive one-third of the net profits or pay one-third of the net losses.
* * * *
4. "Actual expenses" as stated in Par. 2 hereof*132 shall include the bonus which the parties shall pay upon award of the contract, cost of reporting and typing, equipment, travel, supplies, managerial, clerical and duplicating help, rent, applicable taxes, and incidental expenses such as telephone, telegraph, deliveries, etc.
5. Within 48 hours of notification of the award, if received, each of the parties shall deposit in the name of P. J. Sullivan & Associates, in the Washington Loan & Trust Co., Washington, D.C., the sum of $ 27,000 (less $ 333.33 each has already contributed to the required bid deposit with the Federal Power Commission) for the performance of the contract, and shall sign the performance bond of $ 10,000 called for by the invitation and contract. Withdrawals against such account shall be signed by Roy L. Smith, Jr., the manager of the contract (as provided for below) and such checks shall be countersigned by any of the parties hereto, except that no party hereto shall countersign any check made out to his own order.
6. Each of the parties agrees to give every possible assistance to the performance of the contract if awarded. Specifically (but not exclusively) Previn shall assign Roy L. Smith, Jr. to manage the*133 contract at his present remuneration of $ 6600 annually, and shall give P. J. Sullivan & Associates first call on the services of Charlotte Abbott Beebe as reporter, payment for her services to be at the same rate as paid to other reporters for the equivalent service. Specifically (but not exclusively) Sperapani shall give first call to the FPC contract of such of his reporting and typing personnel as the Manager may select. Arrangements for duplicating personnel and the operation of the duplicating department shall be agreed upon as circumstances best dictate, between the Manager and Sperapani. Sullivan agrees when called upon to supplement the reporting and typing personnel as above of the Sperapani and Previn offices for the FPC contract requirement and their other reporting commitments. All personnel used on the FPC contract shall be paid by P. J. Sullivan & Associates. Any actual reporting done by any of the parties hereto shall be paid for at the same rates as paid to other reporters for the equivalent service.
7. Should the 1955 reporting contract be awarded to the parties hereto, each of the parties agrees to advise the other two parties hereto, in writing, within 72 *134 hours of the date of issuance of the FPC 1956 reporting invitation whether or not he desires to renew the contract for the ensuing year, and the parties whose notification is in the affirmative shall bid the contract upon the same terms and conditions as between Themselves as this contract. Should one of the parties whose notification is in the negative thereby withdraw, he shall, not individually nor in association with others, bid upon or be interested directly or indirectly with any bid or contract for FPC reporting for a period of one year following the date of his notification. Should two of the parties decline to bid on the FPC reporting contract for 1956, the single party desiring to do so shall have the right to do so, either alone or in association with others. Each of the parties agrees that should he desire to disassociate himself from the FPC bid for the 1956 contract that he will not disclose to others any of the operating figures of the 1955 contract.
* * * *
*318 12. In addition to the amount specified in Par. 5 hereof, each of the parties hereby agrees to deposit ratably to his interest (one-third) of such additional sums as and when required and called for *135 by any two of the parties hereto, for operating expenses.
On August 10, 1954, the three individuals comprising Associates No. 1 and Roy L. Smith, Jr., sometimes hereinafter referred to as Smith, an employee in Previn's firm, entered into an agreement whereby Smith acquired a 10-percent participation in Associates No. 1, subject to all of the terms, conditions, obligations, and benefits of the agreement of June 10, 1954. Smith contributed $ 9,000 in cash to the capital of Associates No. 1.
Associates No. 1 submitted its bid to the FPC under cover of letter dated June 10, 1954, which provided as follows:
Herewith is submitted the bid of P. J. Sullivan & Associates in response to your Invitation to be opened this date, together with Cashier's Check of the Washington Loan & Trust Company to the order of the Treasurer of the United States, for $ 1,000. as required to be deposited with the bid.
P. J. Sullivan & Associates consists of:The writer, P. J. Sullivan, who for the past 15 years has conducted a general verbatim reporting business at 1 No. LaSalle St., Chicago, Ill., and at Springfield, Ill. I am presently the official reporter for the Illinois Commerce Commission, Chicago Transit*136 Authority, The City of Chicago, and various other State agencies. I have adequate personnel and equipment not only for my present business, but I have additional personnel available if needed for the FPC contract to supplement the facilities of my two Washington associates, who are:
Arthur G. Previn, d/b/a Acme Reporting Company, 1805 H St., N.W., Washington, D.C. Mr. Previn has handled the FPC reporting contract (among others) for several years, and I deem it unnecessary at this time to state anything further with respect to him and his organization except to say that under our agreement, all his facilities will be "first call" to the FPC contract.
Fred J. Sperapani, d/b/a Columbia Reporting Company, 939 D St., N.W. Mr. Sperapani was associated with Mr. Previn in prior years in performing the FPC and other reporting contracts. Mr. Sperapani is an outstanding reporter of long and varied experience, and is now and has for several years last past been the reporter for the House Banking & Currency Committee, the ICC, CAB, and other Government agencies. Mr. Sperapani has an extensive organization, and all his facilities, like Mr. Previn's, will be "first call" to the FPC contract *137 under our agreement.
All of the above-named parties will sign the contract and the performance bond.
P. J. Sullivan & Associates have the experience, personnel, equipment and capital to perform your contract not only at its current volume, but at an increased volume should that develop as a result of the Supreme Court decision in the Phillips case.
Associates No. 1 was successful in obtaining the FPC contract. The four individuals comprising Associates No. 1 contributed financial resources needed to perform the contract and to pay the bonus payable to the agency thereunder. Sullivan did nothing else. Columbia performed *319 the contract and Previn and Smith provided some supervisory and accounting work in connection with the contract. Associates No. 1 did the reporting work for the FPC for 2 years. In the spring of 1956 Previn and Smith had a disagreement with Sullivan and petitioner and withdrew from Associates No. 1. Thereupon petitioner and Sullivan entered into an agreement, dated May 31, 1956, to jointly bid under the name of P. J. Sullivan & Associates and, if accepted, perform the verbatim reporting contract of the FPC for the fiscal year ended June 30, 1957. The*138 agreement stated that it was an extension and continuation of the agreements of June 10 and August 10, 1954, among the four individuals of Associates No. 1 who bid for and performed the FPC reporting work. The association between petitioner and Sullivan will be sometimes hereinafter referred to as Associates No. 2.
Associates No. 2 began operating the FPC contract subsequent to the operation of that contract by Associates No. 1. The two groups were not in business simultaneously, although Associates No. 1 continued in existence for purposes of liquidation after Associates No. 2 had been formed. Some of the equipment of Associates No. 1 was taken over by Associates No. 2. This equipment, however, was insufficient to perform the FPC contract. Columbia, which performed the FPC contract for Associates No. 2, used its own office, equipment, and employees.
Petitioner and Sullivan agreed in their new contract to each "contribute one half of all the actual expenses of performing the contract, each being entitled to receive one half of the net profits or to pay one half of the net losses." In the agreement of May 31, 1956, as in the earlier agreement of June 10, 1954, which created Associates*139 No. 1, actual expenses were stated to mean "the bonus which the parties shall pay upon award of the contract, cost of reporting and typing, equipment, travel, supplies, managerial, clerical and duplicating help, rent, applicable taxes, and incidental expenses such as telephone, telegraph, deliveries, etc."
Petitioner consulted with the FPC's general counsel, engineering staff, and accounting staff and others who dealt with the FPC in order to know the extent of the FPC's workload and the prospective number of transcripts to be sold. Petitioner consulted with Sullivan, who provided half of the bonus and expenses for the FPC contract, on the amounts that Associates No. 2 would bid on the contract. Sullivan was more familiar with the reporting business in Chicago, Ill., than in Washington, D.C., and therefore it was petitioner's judgment for the most part which determined the amounts bid for the bonus and transcript charges on the FPC contract.
*320 Petitioner and Sullivan successfully bid on the FPC contract for the period from July 1, 1956, to June 30, 1957, in the name of Associates No. 2. Associates No. 2 agreed with the FPC to supply transcripts on an ordinary-, daily-, *140 or immediate-copy basis at the following prices per page to the parties named for hearings held in Washington, D.C.:
| Ordinary | Daily | Immediate | |
| copy | copy | copy | |
| 6 copies to FPC | 0 | 0 | 0 |
| Additional copies to FPC not to exceed 7 | 0 | 0 | 0 |
| Other Federal agencies | 0 | 0 | 0 |
| 1st copy to State regulatory commissions | .10 | .25 | .35 |
| Additional copies to State regulatory commissions | .05 | .10 | .15 |
| 1st copy to interested parties other than Federal | |||
| agencies or State regulatory commissions | .15 | .35 | .45 |
| Additional copies to interested parties other than | |||
| Federal agencies or State regulatory commissions | .10 | .20 | .25 |
For hearings held in the continental United States except Washington, D.C., Associates No. 2 agreed to supply transcripts on an ordinary-, daily-, or immediate-copy basis at the following prices per page to the parties named:
| Ordinary | Daily | Immediate | |
| copy | copy | copy | |
| 5 copies to FPC | 0 | 0 | 0 |
| Additional copies to FPC not to exceed 7 | 0 | 0 | 0 |
| Other Federal agencies | 0 | 0 | 0 |
| 1 copy to State regulatory commissions | .15 | .35 | .45 |
| Additional copies to State regulatory commissions | .10 | .20 | .25 |
| 1st copy to interested parties other than Federal | |||
| agencies or State regulatory commissions | .20 | .45 | .55 |
| Additional copies to interested parties other than | |||
| Federal agencies or State regulatory commissions | .15 | .30 | .35 |
*141 In further consideration for the award of the FPC reporting contract for the fiscal year ended June 30, 1957, Associates No. 2 paid a bonus of $ 131,100 in cash to the FPC. Associates No. 2 also gave the FPC a performance bond in the amount of $ 10,000 which it purchased upon payment of a premium of $ 50. The next lowest bid, which was tendered jointly by Previn and Smith, offered to pay a bonus to the FPC in the amount of $ 128,000.
Sullivan's participation in the contract consisted of contributing money pursuant to the agreement of May 31, 1956, with petitioner. Columbia was the operating arm of Associates No. 2 and the actual performance of the contract was done by its employees. However, withdrawals were made out of a bank account maintained by Associates No. 2 to meet the payroll. Petitioner could not have bid for nor obtained the FPC contract without the financial assistance of Sullivan. *321 In addition to supplying one-half of the bonus aggregating $ 131,100, Sullivan's financial assistance was also needed to defray the substantial expenses incurred before the contract began to produce any income. The FPC contract required most of Columbia's equipment and personnel, *142 and because Associates No. 2 was successful in bidding the FPC contract, Columbia did not seek new contracts to perform. The transcripts of hearings on the FPC contract were prepared and delivered on an immediate-copy basis by 7:30 p.m. on the same evening of the hearings. Frequently the FPC conducts 8 to 10 hearings a day, each of which was a full-day hearing. Hearings of the FPC were primarily held at its office in Washington, D.C., and only one or two hearings a year were held elsewhere. Petitioner devoted at least half of his time to administering the contract.
Petitioner received a salary of $ 50,000 from Columbia in each of the years 1957 through 1961, and $ 100,000 in the year 1962. This salary was paid by Columbia and it included compensation for the services performed by petitioner on all of Columbia's contracts and on the FPC contract. The salary paid to petitioner during the years in issue was reasonable. The parties have stipulated that if Columbia is entitled to be taxed as a domestic corporation pursuant to section 1361 and if one-half of the income of Associates No. 2 is includable in petitioner's income, then there is includable in petitioner's income for each*143 of the years in issue salary in the amount of $ 25,000 rather than $ 50,000 as reported in petitioner's returns.
For the fiscal year ended June 30, 1958, Associates No. 2 again bid on the FPC contract in which a bonus of $ 173,000 was offered. This was the most favorable bid received by the FPC, but it was rejected with all other bids because the FPC changed its policy of accepting bonuses. New invitations to bid were sent to reporters which required that transcripts be supplied to the agency at no charge and that no bonuses be offered to perform the work. Associates No. 2 submitted another bid to the FPC which was not the lowest bid and it was not accepted.
Petitioner and Sullivan did not break up their association in June 1957 when they ceased to be reporters for the FPC. The association continued in order to wind up their business under the FPC contract which consisted of collecting outstanding bills and completing the accounting on the contract. Petitioner and Sullivan, through Associates No. 2, also performed work for a Senate committee at this time. Associates No. 2 did not seek nor obtain any other work during the years in issue. Columbia, however, performed work for*144 Sullivan on a National Labor Relations Board contract to which Sullivan had contributed financial backing. Columbia or petitioner was not involved *322 in obtaining this contract. Petitioner promised the administrative officer of the National Labor Relations Board to perform the reporting work for the bidder who did not himself have the facilities to perform the contract.
On March 3, 1958, the district director of internal revenue at Baltimore, Md., received the following letter from petitioner:
February 28, 1958.
District Director
Internal Revenue ServiceBaltimore 2, MarylandRe: Declaration of Intent
Sec. 1361
Gentlemen: Since my unincorporated business enterprise complies and qualifies with regulations prescribed under Section 1361, I herein elect that my sole owned unincorporated business enterprise be taxed as a domestic corporation beginning for the taxable year ending December 31, 1957.
Very truly yours,
Columbia Reporting Company,
(S) Fred J. Sperapani,
Fred J. Sperapani,
Proprietor.
During the period beginning on January 1, 1957, and ending on March 3, 1958, petitioner was not a proprietor or partner having more than a 10-percent interest in profits *145 or capital of any unincorporated business enterprise (other than Columbia) taxable as a domestic corporation under section 1361.
At the time petitioner filed the letter with the district director of internal revenue purporting to make an election to have Columbia treated as a corporation for tax purposes, petitioner intended to include in Columbia's income all earnings from reporting on contracts bid directly or indirectly by Columbia and on contracts performed by Columbia alone or jointly with other reporters. Thus petitioner intended that the income from the FPC contract, which contract was obtained in the name of Associates No. 2, be included in the taxable income of Columbia which it reported as a domestic corporation pursuant to its election under section 1361.
Petitioner maintained a bank account in the National Bank of Washington under the name Columbia Reporting Co. Special Account, sometimes hereinafter referred to as the Special Account, a bank account in the Riggs National Bank under the name of Columbia Reporting Co., sometimes hereinafter referred to as the Riggs Account, and a bank account in the American Security & Trust Co. under the name of Fred J. Sperapani, sometimes*146 hereinafter referred to as the American Account. This latter account was carried in petitioner's name as a result of having been opened prior to the time petitioner *323 entered the reporting business. It was, nevertheless, one of Columbia's assets. The cash balances in the three accounts at the close of the years 1956, 1957, and 1958 were as follows:
| Dec. 31, 1956 | Dec. 31, 1957 | Dec. 31, 1958 | |
| Special account | $ 17,430.64 | $ 25,900.75 | $ 6,412.85 |
| Riggs account | 37,283.04 | ||
| American account | 60,534.44 | 74,922.73 | 61,705.02 |
| Totals | 115,248.12 | 100,823.48 | 68,117.87 |
The Riggs Account was opened in 1947 for use in connection with the development of a stenomask machine, a reporting device by which the reporter repeats into a recording machine all that is said at a hearing. Columbia undertook the venture with the inventor and other interested parties but subsequently withdrew after finding that the device was neither practical nor acceptable. The Riggs Account then became inactive and Columbia occasionally made some deposits to it. The balance in the Riggs Account of $ 37,283.04 on December 31, 1956, was closed out and deposited into Columbia's Special Account.
During*147 the years in issue Columbia used the Special Account as its primary operating account. Business expenditures of Columbia were paid by checks drawn on that account, and the gross receipts from the business conducted solely by Columbia were deposited in that account. The Special Account was also used for payment of most of petitioner's personal expenses and taxes. The check register of the Special Account reflects checks totaling $ 107,026.31 for 1957 and $ 90,696.63 for 1958, which were charged to petitioner's personal account. Included in such amounts were checks in payment of petitioner's Federal and State income taxes and in payment of premiums on a life insurance policy on petitioner's life, of which Columbia was sole owner and beneficiary. Some of the checks Columbia drew on the Special Account during the taxable year 1956 are as follows: $ 65,550 to U.S. Treasurer in part payment of the bonus of $ 131,100 made to the FPC in connection with the contract for the fiscal year ended June 30, 1957, $ 1,500 to Associates No. 2, $ 500 to cash, and $ 8,000 to Associates No. 2, all of which represented Columbia's investment in Associates No. 2. A check for $ 12,000, in favor of attorneys*148 for Previn and Smith, was drawn on the Special Account to guarantee to Previn and Smith an equitable distribution of amounts collected on bills for Associates No. 1.
During the year 1956 the total amount of $ 57,500 representing withdrawals from Associates No. 1 was deposited in the American Account, and $ 18,500 representing a withdrawal from Associates No. *324 2 was deposited in the American Account on November 27, 1956. A withdrawal from Associates No. 2 on December 26, 1956, was deposited in the Special Account. During the year 1957 the total amount of $ 105,000 representing withdrawals from Associates No. 2 was deposited in the American Account, and $ 5,000, which also was withdrawn from Associates No. 2, was deposited in the Special Account. During the year 1958 petitioner withdrew from Associates No. 2 the total amount of $ 63,500. Petitioner deposited the equivalent amount in the Special Account.
Withdrawals from the American Account, which were deposited in the Special Account (the daily operating account), totaled $ 20,000 in 1956, $ 80,000 in 1957, and $ 55,000 in 1959. Some of petitioner's personal living expenses were paid out of withdrawals from the American*149 Account.
All receipts of Associates No. 2 were deposited in its own separate bank account.
Columbia and Associates No. 2 filed separate employer's quarterly income tax (withholding) returns for their employees during the years in issue.
Timely partnership returns of income, Forms 1065, were filed for Associates No. 2 with the district director of internal revenue at Baltimore, Md., for the taxable years 1956, 1957, and 1958. The taxable income reported in each of these returns was computed under the cash receipts and disbursements method of accounting. Associates No. 2 reported gross receipts from reporting in excess of $ 400,000 in each of the taxable years 1957 and 1958.
Columbia filed timely corporation income tax returns, Forms 1120, for the taxable years 1957 and 1958 with the district director of internal revenue at Baltimore, Md., showing income taxes due in the amounts of $ 22,171.13 and $ 21,682.20, respectively. The taxable income reported in each of those returns was computed under the cash-receipts-and-disbursements method of accounting. The income tax liability reported for the year 1957 was paid at the time the return was filed. The income tax liability reported*150 for the year 1958 was paid in two installments: $ 10,841.10 on March 18, 1959, and $ 10,841.10 on September 24, 1959.
Columbia's corporation income tax returns for the years 1957 and 1958 were signed by petitioner and contained statements designating the returns as those of an unincorporated business electing to be taxed as a domestic corporation under section 1361. Columbia included in its income in these returns its earnings from reporting on contracts which it obtained and performed alone, and $ 93,479.45 and $ 75,927.80 in the years 1957 and 1958, respectively, representing *325 one-half of the net income earned by Associates No. 2. The returns show that petitioner was the proprietor of the unincorporated business electing to be taxed as a domestic corporation under section 1361, and that his residence was in Silver Spring, Md. They also show that the business owned and used depreciable personal property having a cost of over $ 25,000.
For the year 1956, which preceded petitioner's election to have Columbia taxed as a corporation pursuant to section 1361, petitioner included in his income all the net earnings of Columbia, his sole proprietorship, and his proportionate *151 share of the net earnings of Associates No. 1. Petitioner also reduced his taxable income on his 1956 individual income tax return in the amount of his proportionate share of the losses incurred in that year by Associates No. 2. On his individual income tax returns for the years 1957 and 1958, which were covered by the election, petitioner included in income in each year his salary of $ 50,000 paid to him as sole proprietor of Columbia, which he had elected be taxed as a domestic corporation under section 1361. No other income from the reporting business earned by Columbia or by Associates No. 2 was reported in petitioner's individual income tax returns.
OPINION
The issues presented for our decision are: (1) Whether petitioner filed a valid election to have his sole proprietorship taxed as a domestic corporation pursuant to section 1361; 2 (2) whether the proprietorship hereinafter referred to as Columbia *326 met the qualifications of section 1361 enabling it to be taxed as a domestic corporation and in particular the requirement of section 1361(b)(4) that the enterprise be one "in which capital is a material income producing factor"; (3) if Columbia is entitled to be taxed*152 as a domestic corporation, whether its income includes one-half of the earnings of Associates No. 2 or whether such earnings are taxable to petitioner; and (4) if Columbia is not entitled to be taxed as a domestic corporation and consequently it is not liable for any taxes and petitioner's income tax liability is increased, whether petitioner's tax liabilities for the years in issue may be reduced by the amounts of taxes paid by or on behalf of Columbia for such years.
*153 Petitioner contends that he duly elected and was qualified to elect to have his proprietorship taxed as a domestic corporation under section 1361. Petitioner also contends that Columbia properly included in its taxable income as a domestic corporation in each of the years in issue one-half of the earnings of Associates No. 2. Consequently, petitioner argues that his own only taxable income during each of the years in issue with respect to income from his reporting business is $ 50,000 received as salary from Columbia, which he reported on his income tax returns. Petitioner's position with respect to the fourth and last of the above-stated issues is that if respondent correctly determined Columbia is not a taxable entity, then it follows that the amounts paid to respondent for the years in issue by or on behalf of Columbia must have been paid by or on behalf of petitioner and accordingly petitioner should be given credit for such payments.
Respondent's position is that Columbia failed to make a valid election *327 to be taxed as a domestic corporation under section 1361 in the manner prescribed in the Commissioner's regulations, and that Columbia failed to meet the qualifications*154 prescribed in section 1361(b) to entitle it to make such election. Consequently, respondent has determined in his notice of deficiency and here contends that all income earned by petitioner from his reporting business conducted in the name of Columbia or jointly with Sullivan in the name of Associates No. 2 is includable in petitioner's gross income. Respondent argues alternatively that if we find that Columbia is entitled to report its income as a domestic corporation, then the income earned on business conducted by Columbia alone is taxable to it, but that one-half of the income earned by Associates No. 2 is not includable in Columbia's taxable income and should be included in petitioner's individual income. Respondent's position with respect to the fourth and last of the above-stated issues is that petitioner is entitled to no credit for any taxes paid by or on behalf of Columbia for the reason that any refund due on Columbia's account cannot be applied to petitioner's account.
During each of the years in issue Columbia deducted on its returns, and petitioner included in his taxable income salary in the amount of $ 50,000 paid to petitioner. Pursuant to his first determination*155 that all of the income of Columbia and one-half of the income of Associates No. 2 are includable in petitioner's gross income, respondent in effect decreased petitioner's taxable income in the amount of $ 50,000 in each of the years in issue.
The parties have agreed by stipulation that if Columbia is taxable as a domestic corporation but its income does not include one-half of the earnings of Associates No. 2 that there is includable in petitioner's income for each of the years in issue salary from Columbia in the amount of $ 25,000, rather than $ 50,000 as reported in the income tax returns filed by petitioner. If we determine that Columbia is taxable as a domestic corporation and its income includes one-half of the earnings of Associates No. 2, then the salary payable to petitioner from Columbia in each of the years in issue is $ 50,000 as reported in petitioner's returns and as alleged by respondent in his answer to the petition.
Section 1361(a) permits a sole proprietor of a business enterprise, subject to the qualifications in section 1361(b), to elect, in accordance with regulations prescribed by the Secretary or his delegate, to have the sole proprietorship taxed as a corporation.
*156 On March 3, 1958, when petitioner filed the purported election for Columbia, the manner of making the election under section 1361 was prescribed in temporary regulations promulgated as T.D. 6124, approved *328 and filed February 24, 1955. See T.D. 6124, 1 C.B. 719">1955-1 C.B. 719. 3*158 The regulations provide that the election shall be made by filing a statement that the proprietor elects under section 1361(a) to have the enterprise treated as a corporation, and by filing the return as prescribed. Paragraph 2 describes the statement of election which must be filed during the first 60 days after the close of the first taxable year of the proprietor. It requires that the statement shall give sufficient information to establish that the enterprise meets the qualifications of section 1361(b), which are that during the period on or after the first day of the taxable year to which the election applies, and on or before the date of election (1) the enterprise is owned by an individual or by a partnership consisting of not more than 50 individual members; (2) no proprietor or partner having more than a 10-percent interest in profits or capital*157 of such enterprise is a proprietor or a partner having more than a 10-percent interest in profits or capital of any other unincorporated business enterprise taxable as a domestic corporation; (3) no proprietor or partner of such enterprise is a nonresident alien or a foreign partnership; and (4) the enterprise is one in which capital is a material income-producing factor, or 50 percent or more of the gross income of such enterprise consists of gains, profits, or income derived from trading as a principal or from buying and selling real property, stock, securities, or commodities for the account of others. The statement must be signed by the electing proprietor or partners and must also contain an agreement *329 to notify the district director with whom the statement is filed if the interest of the electing proprietor or partners becomes 80 percent or less, or if the enterprise becomes a corporation. Finally, if a statement of election is timely filed, the election must be perfected by filing for such enterprise an income tax return on Form 1120 containing a statement that the return was filed in compliance with the regulations under section 1361. 4
The statement of election filed by petitioner stated that petitioner's "unincorporated enterprise complies and qualifies with regulations prescribed under Section 1361," but did not contain information to establish that the enterprise met the qualifications of section 1361(b), nor did it contain an agreement to notify the district director if petitioner's proprietorship interest in Columbia became 80 percent or less or if Columbia became a corporation. The statement of election filed by petitioner was timely filed with the district director and it was signed by petitioner. Corporate income tax*159 returns for the years 1957 and 1958 were timely filed for Columbia on Forms 1120, which were signed by petitioner and which contained statements that they were the returns of a section 1361 corporation. They stated that the petitioner was the proprietor of the business electing to be taxed as a corporation, that he resided within the United States, and that the business owned and used depreciable personal property costing over $ 25,000.
*330 Respondent argues that "not less than substantial compliance with the requirements of T.D. 6124 is necessary in order to make an election under section 1361," and that petitioner has not substantially complied with T.D. 6124. Petitioner argues that "filing an unequivocal election to have Columbia taxed as a domestic corporation followed by the filing of a corporation income tax return on behalf of Columbia for the taxable year 1957, both of which clearly set forth that Columbia was an unincorporated sole proprietorship electing to be taxed as a corporation pursuant to Section 1361, constituted substantial compliance with the Treasury Decision." Both parties rely on Van Keppel v. United States, 206 F. Supp. 42">206 F. Supp. 42,*160 affd. 321 F.2d 717">321 F. 2d 717, and Georgie S. Cary, 41 T.C. 214">41 T.C. 214. In our opinion these cases and the case of Pearce v. United States, 226 F. Supp. 702">226 F. Supp. 702 (W.D.N.Y. 1964), are not helpful in deciding the instant case. In these cases the petitioners inadvertently failed to file agreements which were required to be filed by section 302(c)(2)(A)(iii), "at such time and in such manner as the Secretary or his delegate by regulations prescribes." The applicable regulations prescribed that the agreement specified in the statute must be in the form of a separate statement in duplicate signed by the taxpayer and attached to his return timely filed for the year. In these cases the taxpayers' returns were audited, the absence of the agreements then was made known to them, and they filed amended income tax returns to which the agreements were attached or proffered such an agreement for filing. It was held in these cases that the statutory requirement to file an agreement was directory and not mandatory, and that the taxpayers had substantially complied with the statute when they filed the agreements with amended *161 returns or proffered such an agreement when its absence was made known to the taxpayer. In the instant case the statement filed by petitioner did not contain the detailed information or agreement prescribed by the regulation and no other statement was subsequently filed or offered for filing. Therefore, it is necessary in order for petitioner to prevail on this issue that we decide that the inclusion of such information and agreement in petitioner's statement was not of the essence of the statute and was not intended by the legislature to be mandatory.
Petitioner relies on Vaughan v. John C. Winston Co., 83 F.2d 370">83 F. 2d 370, wherein it was said:
Whether a statutory requirement is mandatory in the sense that failure to comply therewith vitiates the action taken, or directory, can only be determined by ascertaining the legislative intent. If a requirement is so essential a part of the plan that the legislative intent would be frustrated by a noncompliance, then it is mandatory. But if the requirement is a detail of procedure which does not go to the substance of the thing done, then it is directory, and noncompliance does not invalidate the act.
*331 *162 In 2 Sutherland, Statutory Construction, sec. 2802, p. 216 (3d ed.), the following appears:
Generally those directions which are not of the essence of the thing to be done, out which are given with a view merely to the proper, orderly and prompt conduct of the business, and by the failure to obey no prejudice will occur to those whose rights are protected by the statute, are not commonly considered mandatory. Likewise, if the act is performed but not in the time or in the precise manner directed by the statute, the provision will not be considered mandatory if the purpose of the statute has been substantially complied with and no substantial rights have been jeopardized.
In Indiana Rolling Mills Co., 13 B.T.A. 1141">13 B.T.A. 1141, 1144, cited with approval and distinguished on other facts in General Instrument Corporation, 35 T.C. 803">35 T.C. 803, 820, we framed the question of whether substantial compliance with a statute had been achieved as "What is the essence of the thing required to be done by this statute?"
In his brief, respondent states that the information and agreement required by the regulation are important in the administration of *163 section 1361 at the time the election is made for purposes of determining whether the qualification requirements of section 1361(b) have been met, and at the time of a change in ownership of 20 percent or more or upon incorporation of the enterprise, which events may result in a liquidation of the section 1361 corporation with concurrent tax effects. See sec. 1.1361-5(b) and -6(c), Income Tax Regs. On brief respondent sums up his discussion concerning the purpose of the regulation as follows:
Hence, the requirement that the owner of the enterprise make a representation of facts establishing prima facie that the enterprise meets the qualifications set forth in section 1361(b) serves an important administrative purpose. It is well known that the respondent is able to audit only a small percentage of the millions of tax returns which are filed every year. This necessitates that returns be classified for examination and that only audits of returns be made which appear to best serve the interest of the revenue collection system. The information which the regulation requires to be presented in the statement of election is necessary in order to permit an orderly classification of the*164 returns of section 1361 corporations in accordance with the standards of classifications of other corporate returns.
It is apparent from this argument of respondent that respondent himself considers that the requirements in the regulation relating to the contents of a statement of election are procedural and therefore directory, since they "are given with a view merely to the proper, orderly and prompt conduct of the business" (2 Sutherland, Statutory Construction, sec. 2802, p. 216 (3d ed.)), and do not relate to the substance or essence of the statute. Even if petitioner had made specific allegations of fact in his statement of election to substantiate his general allegation that the qualification requirements of section *332 1361(b) were met, the district director would still find it necessary to satisfy himself of the existence of such facts. Similarly, the same tax consequences follow upon a change in ownership, or upon incorporation of the enterprise whether or not the taxpayers have agreed to notify the district director of such changes. In spite of the general assertions in respondent's brief, there has been no satisfactory showing in this case that the filing of*165 the statement referred to by the regulation would materially contribute to "the proper, orderly and prompt conduct" of respondent's functions. There is certainly nothing in the record which would indicate that the respondent in actuality has been in any material way prejudiced by petitioner's failure to comply with that part of T.D. 6124 requiring the filing of a statement of election in addition to the election itself and the proper income tax returns. These returns which were filed by Columbia Reporting Co. contain statements that petitioner is the proprietor of the business and lives within the United States, thus clearly indicating that the "enterprise is owned by an individual" (sec. 1361(b)(1)), and that the proprietor is not "a non-resident alien" (sec. 1361(b)(3)). They also show that the business owned and used depreciable personal property having a considerable cost, which would tend to establish that capital was "a material income producing factor" (sec. 1361(b)(4)). Just what information respondent would consider desirable in order to establish the negative qualification of section 1361(b) which provides that no proprietor shall be a proprietor*166 or a partner of any other unincorporated business enterprise taxable as a corporation is not clear. It would seem that a mere negative statement would be sufficient and this is implicit in the statement in petitioner's notice of election to the effect that his business enterprise complied with the appropriate regulations. Obviously the respondent has not been prejudiced by petitioner's failure to file an agreement to notify respondent of certain events which have never occurred.
Reading section 1361 as a whole and the applicable temporary regulations thereunder, we conclude that the essence of the statute is that a notice of election be filed with the district director and that such election be perfected by filing a corporation income tax return containing a statement that it is the return of a section 1361 corporation. That part of the regulation requiring that the statement of election contain specific allegations of fact showing that the qualifications of section 1361(b) have been met, and an agreement to notify the district director in the event of incorporation of the enterprise or a change in ownership, relate to details of procedure and do not go to the essence of the statute. *167 Thus they are merely directory. Inasmuch as petitioner filed a timely election and timely corporation income tax returns for Columbia for the years 1957 and 1958, all of which clearly *333 set forth that Columbia was an unincorporated sole proprietorship electing to be taxed as a corporation pursuant to section 1361 and claiming that it was qualified to do so under the regulations, and these steps constituted the essential statutory requirements for an election, we conclude that there was a substantial compliance with the statute and temporary regulation, and that a valid election for Columbia to be taxed as a domestic corporation was made.
We are not persuaded to a different view by respondent's argument that Congress approved the manner in making the election as prescribed in T.D. 6124. Respondent's argument is based on legislative history which resulted in the Technical Amendments Act of 1958, 72 Stat. 1606, 1649, enacted on September 2, 1958, which is subsequent to the dates when petitioner filed the notice of election and corporation income tax return for Columbia for the year 1957. At most, such action by the Congress evidences congressional*168 approval of the temporary regulation and gives to it the effect of law. See Cammarano v. United States, 358 U.S. 498">358 U.S. 498; Helvering v. Winmill, 305 U.S. 79">305 U.S. 79. Even if the temporary regulation has the effect of law, it does not alter our view that the manner prescribed for making the election is directory, and not mandatory, and that petitioner substantially complied with the essential provisions of the regulation.
It is conceded by respondent that Columbia satisfies all of the qualification requirements of section 1361(b) but one. The parties disagree on whether or not Columbia was an enterprise in which capital was a material income-producing factor as required in section 1361(b)(4). Both parties rely on section 1.1361-2(e)(2), Income Tax Regs., which provides in pertinent part as follows: 5
(2) The determination of whether capital is a material income-producing factor must be made by reference to all the facts of each case. Capital is a material income-producing factor if a substantial portion of the gross income of the business (other than income excluded from gross income of the enterprise under section 1361(i)(1)) *169 is attributable to the employment of capital in the business conducted by the enterprise. Capital is not a material income-producing factor where gross income of the enterprise consists principally of fees, commissions, or other compensation for personal services performed by the owners or employees of the enterprise. Thus, an enterprise engaged in rendering professional services such as law, accounting, medicine, or engineering, ordinarily is not an enterprise in which capital is a material income-producing factor. On the other hand, capital is ordinarily a material income-producing factor if the operation of the business requires substantial inventories or substantial investments in plant, machinery, or other equipment.
There have not been any cases decided to date under section 1361 with respect to the requirement that capital be a material income-producing factor in the enterprise. However, both parties*170 have directed *334 us to several decisions construing analogous language as it appeared in section 200 of the Internal Revenue Acts of 1918 and 1921, section 725 of the Internal Revenue Code of 1939, relating to personal service corporations, and section 704(e)(1) of the Internal Revenue Code of 1954, relating to family partnerships and its predecessors, sections 191 and 3797(a)(2) of the Internal Revenue Code of 1939. The parties are in agreement that on the basis of such cases, capital will be deemed to be a material income-producing factor when it "gives character to a sizable portion of the operations of the corporation," but if capital is utilized merely in the form of salaries, wages, or office rent it is not a material income-producing factor. Edward P. Allison Co. v. Commissioner, 63 F.2d 553">63 F. 2d 553, 558, affirming 22 B.T.A. 1371">22 B.T.A. 1371. See also Graham Flying Service v. Commissioner, 167 F. 2d 91, affirming 8 T.C. 557">8 T.C. 557, certiorari denied 335 U.S. 817">335 U.S. 817; Hubbard-Ragsdale Co. v. Dean, 15 F.2d 410">15 F. 2d 410, affd. *171 15 F. 2d 1013. Petitioner argues that capital has been found to give character to a sizable portion of the operations of a corporation when it consisted of a plant and equipment necessary to the conduct of the business. Graham Flying Service v. Commissioner, supra;Atlanta-Southern Dental College v. Commissioner, 50 F. 2d 34, affirming 15 B.T.A. 1325">15 B.T.A. 1325; Beulah H. Nichols, 32 T.C. 1322">32 T.C. 1322, 1328-1329; Fairfax Mutual Wood Products Co., 5 T.C. 1279">5 T.C. 1279; or cash and accounts receivable, Wagner-Taylor-Edson Co., 7 B.T.A. 268">7 B.T.A. 268; W. J. Byrnes & Co., 5 B.T.A. 175">5 B.T.A. 175; Kossar & Co., Inc., 4 B.T.A. 1164">4 B.T.A. 1164; or contracts, leases, and formulae, Newam Theatre Corporation, 1 B.T.A. 887">1 B.T.A. 887; Scheffler Hair Colorine Co., 1 B.T.A. 61">1 B.T.A. 61; Cotton Hotel Co. v. Bass, 7 F. 2d 900; H. D. & J. K. Crosswell, Inc., 6 B.T.A. 1315">6 B.T.A. 1315; and Vermillion Coal Co., 12 B.T.A. 1161">12 B.T.A. 1161.*172 The types of businesses in which capital has been held to be a material income-producing factor include a flying school, Graham Flying Service v. Commissioner, supra; a dental school, Atlanta-Southern Dental College v. Commissioner, supra; a credit information service, Commercial Reference Co., 7 B.T.A. 384">7 B.T.A. 384; and a medical partnership where capital was needed to purchase X-ray equipment and supplies, Beulah H. Nichols, supra.
We agree with petitioner that these cases support the conclusion that "capital was necessary to the conduct of Columbia's business and gave character to a sizable portion of Columbia's operations." In order to operate successfully Columbia required financial resources, as we have set out in detail in our findings, to pay large bonuses in order to obtain contracts, to cover the cost of operating under such contracts during the first few months of the fiscal year before revenues were collected from such contracts, to enable it to deliver transcripts on an immediate-delivery basis even though a particular hearing would extend for several*173 months and Columbia would not bill for the transcripts delivered until sometime after the *335 conclusion of the hearings, to enable it to carry out its contractual obligations to remain as a reporter for an agency for an entire fiscal year even though it was known during the fiscal year that such contract would result in a substantial loss to Columbia, and for the purpose of obtaining performance bonds for the agencies with which it contracted upon the payment of a premium only and without having to post collateral. Columbia's capital consisted of cash on deposit in the amounts of $ 115,248.12, $ 100,823.48, and $ 68,117.07 on December 31, 1956, 1957, and 1958, respectively, and accounts receivable on these dates in the respective amounts of $ 135,149.16, $ 183,793.16, and $ 46,671.46. It also had during the years in issue a plant, machinery, and equipment necessary to produce transcripts, including electric typewriters, duplicating machines, a multilith duplicating machine, a Xerox machine, and an automobile. The contracts it owned to be the official and exclusive reporter for several of the major Federal agencies also constituted a part of its capital assets. Because of*174 such assets Columbia was able to obtain other contracts through unsolicited invitations from agencies to do their reporting work. Columbia also used its contracts as evidence of its ability to comply with the bids it made for new work.
Columbia's gross income consists principally of revenues derived from the sale of transcripts to the public, and in some instances to Federal agencies. As such, its gross income does not consist of fees, commissions, or other compensation for personal services performed by the owner or employees of the enterprise, as in enterprises engaged in rendering professional services, such as law, accounting, medicine, or engineering. Cf. Farnham Manufacturing Co., 13 T.C. 511">13 T.C. 511; Trout-Ware, Inc., 11 T.C. 505">11 T.C. 505; H. Newton Whittelsey, Inc., 9 T.C. 700">9 T.C. 700. Accordingly, we conclude that Columbia was an enterprise in which capital was a material income-producing factor and Columbia qualified in all respects to be treated as a domestic corporation under section 1361.
Respondent's next contention is that, even though petitioner's proprietorship Columbia should be properly taxed*175 as a domestic corporation under section 1361, its taxable income would not include any part of the net earnings of Associates No. 2 because "all of the partners owning an interest in such business enterprise [Associates No. 2] did not file an election under section 1361" and consequently the one-half of such earnings is taxable to petitioner. As we have found in our findings of fact, economic necessity made it customary in the reporting business for two or more reporters to join together for the purpose of bidding for and performing a particular reporting contract. Petitioner carried on his business in the form of a sole proprietorship trading as Columbia Reporting Co. Section 1361(c) provides that an unincorporated enterprise electing to be taxed as a domestic corporation *336 "shall * * * be considered a corporation * * * with respect to operation, distributions, sale of an interest, and any other purpose." This Court has interpreted this section to mean that although a proprietor owns the assets of his business enterprises, for purposes of Fedaral income taxation, the proprietor will be considered as no longer owning them after he elects under section 1361. Estate of David Wein, 40 T.C. 454">40 T.C. 454,*176 affd. 330 F. 2d 957. The facts here show that the "pseudo corporation" Columbia, which was the operating arm of Associates No. 2, earned the income itself on the FPC contract. Thus, although petitioner owned the assets of Columbia, the "pseudo corporation" Columbia and not petitioner, for purposes of Federal income taxation, is deemed to own the assets, specifically the contractual rights of petitioner under his contract with Sullivan and to have earned the income from reporting on the FPC contract. See Estate of David Wein, supra.The facts that Sullivan did not join in the election filed by petitioner and that petitioner and Sullivan filed no election that Associates No. 2 be taxed as a corporation do not preclude the earnings of Columbia resulting from its partnership or joint venture with Sullivan from being taxed thereon as a domestic corporation. Sullivan was not a partner owning an interest in Columbia, but Columbia, which is to be treated as a corporation with respect to its operation, became a partner or joint venturer in Associates No. 2 and received its earnings therefrom in its role as a "pseudo corporation." *177 There is nothing novel about a corporation being treated as a partner or joint venturer in an unincorporated business enterprise for purposes of Federal income taxation. See, e.g., Bentex Oil Corporation, 20 T.C. 565">20 T.C. 565; Maggio Bros. Co., 6 T.C. 999">6 T.C. 999; Charles H. Steffey, Inc., 23 B.T.A. 913">23 B.T.A. 913.
One-half of the earnings of Associates No. 2 was properly included in Columbia's income which it reported on its corporation income tax returns. No part of such income for the taxable years 1957 and 1958 was includable in petitioner's individual income for these years as determined by respondent. 6
*178 *337 In view of our decision it is not necessary for us to decide whether petitioner's tax liabilities for the years in issue may be reduced by the amount of taxes paid by or on behalf of Columbia for such years. Because of certain uncontested determinations made by respondent,
Decision will be entered under Rule 50.
Train, J., dissenting. I respectfully dissent.
Section 7805 gives the Secretary general authority to prescribe "all needful rules and regulations" for the Code's enforcement. However, in section 1361Congress saw fit to add with particularity that the election under that section is to be made under regulations prescribed by the Secretary, most probably in recognition of the fact that such an election might involve administrative problems whose resolution could best be left to administrative regulation.
The decision of the majority turns upon whether the regulatory requirements of T.D. 6124 are "mandatory" or "directory." So phrased, I believe this approach simply obscures the issue. The regulation here in question is neither unreasonable nor otherwise invalid. I do not understand the majority to suggest to the contrary. *179 Under these circumstances, I see no basis whatsoever for sanctioning noncompliance, no matter what characterization or semantic label one attaches to the regulation.
Essentially, I believe the majority has concluded that the regulatory requirements are not really important to the administration of the section, effectively substituting, in this respect, the judgment of the Court for that of the Secretary.
Footnotes
1. All section references herein are to the Internal Revenue Code of 1954, as amended, unless otherwise noted.↩
2. SEC. 1361. UNINCORPORATED BUSINESS ENTERPRISES ELECTING TO BE TAXED AS DOMESTIC CORPORATIONS.
(a) General Rule. -- Subject to the qualifications in subsection (b), an election may be made, in accordance with regulations prescribed by the Secretary or his delegate, not later than 60 days after the close of any taxable year of a proprietorship or partnership owning an unincorporated business enterprise, by the proprietor or all the partners, owning an interest in such enterprise at any time on or after the first day of the first taxable year to which the election applies or of the year described in subsection (f), to be subject to the taxes described in subsection (h) as a domestic corporation for such year and subsequent years.
(b) Qualifications. -- The election described in subsection (a) may not be made with respect to an unincorporated business enterprise unless at all times during the period on or after the first day of the first taxable year to which the election applies or of the year described in subsection (f), as the case may be, and on or before the date of election --
(1) such enterprise is owned by an individual, or by a partnership consisting of not more than 50 individual members;
(2) no proprietor or partner having more than a 10 percent interest in profits or capital of such enterprise is a proprietor or a partner having more than a 10 percent interest in profits or capital of any other unincorporated business enterprise taxable as a domestic corporation;
(3) no proprietor or partner of such enterprise is a nonresident alien or a foreign partnership; and
(4) such enterprise is one in which capital is a material income producing factor, or 50 percent or more of the gross income of such enterprise consists of gains, profits, or income derived from trading as a principal or from buying and selling real property, stock, securities, or commodities for the account of others.
(c) Corporate Provisions Applicable. -- Under regulations prescribed by the Secretary or his delegate, an unincorporated business enterprise as to which an election has been made under subsection (a), shall, except as provided in subsection (m), be considered a corporation for purposes of this subtitle, except chapter 2 thereof, with respect to operation, distributions, sale of an interest, and any other purpose; and each owner of an interest in such enterprise shall be considered a shareholder thereof in proportion to his interest.
* * * *
(h) Imposition of Taxes. -- The unincorporated business enterprise as to which an election has been made under subsection (a) shall be subject to --
(1) the normal tax and surtax imposed by section 11,
(2) the accumulated earnings tax imposed by section 531, and
(3) the alternative tax for capital gains imposed by section 1201.
* * * *
(j) Computation of Taxable Income. -- In computing the taxable income of an unincorporated business enterprise as to which an election has been made under subsection (a) --
(1) a reasonable deduction shall be allowed for salary or compensation to a proprietor or partner for services actually rendered; and
(2) there shall be allowed as deductions only such items properly allocable to the operation of the business of such enterprise, except deductions allocable to the proprietor or partners under subsection (i)(2).↩
3. The regulations provide in pertinent part as follows:
In order to prescribe temporary rules with respect to unincorporated business enterprises electing to be taxed as domestic corporations, Treasury Decision 6118 [1 C.B. 698">1955-1 C.B. 698], approved Dec. 30, 1954, is hereby amended by adding at the end thereof the following paragraph:
Par. 23. Unincorporated Business Enterprises Electing to be Taxed as Domestic Corporations. -- (a) In general. -- Section 1361 permits certain unincorporated business enterprises to elect to be taxed as domestic corporations. If the qualifications stated in section 1361 (b) are met, and if a proper election is filed in accordance with the provisions of this paragraph, then an unincorporated business enterprise with respect to which such an election is filed shall be treated for income tax purposes as a domestic corporation under the provisions of section 1361. The election may be made only with respect to taxable years of the partnership, or the proprietor, beginning after December 31, 1953, and ending after August 16, 1954.
(b) Manner of making election. -- (1) The election shall be made by filing a statement that the partners or the proprietor, as the case may be, elects under section 1361(a) to have the enterprise treated as a corporation, and by filing the return or amended return required by subparagraph (3) within the time prescribed by that subparagraph. The election is void unless perfected by the filing of such return or amended return.
(2) The statement shall be filed during the first 60 days after the close of the first taxable year of the partnership or proprietor to which the election is applicable. The statement shall give sufficient information to establish that the enterprise meets the qualifications set forth in section 1361(b). It shall also contain an agreement to notify the district director with whom the statement is filed if the interest of the electing proprietor or partners in the capital and profits of the enterprise becomes 80 percent or less, or if the enterprise becomes a corporation. The statement shall be signed by the proprietor or all of the partners owning an interest in the enterprise at any time during the period beginning with the first day of the first taxable year to which the election applies and ending on the day the election is filed. For example, a partner or proprietor having an interest at any time during the first taxable year with respect to which the election applies is required to sign the statement even though he holds no interest at the end of such year or at the time of the election. A partner or proprietor who acquires his interest after the end of the first taxable year to which the election applies but prior to the date of the election is also required to consent to the election by signing the statement even though he holds no interest at any time during the first year to which the election is applicable.
(3) If a statement of election is timely filed, the election must be perfected by filing for such enterprise an income tax return on Form 1120 containing a statement that such return has been prepared in compliance with the regulations under section 1361. If the last day prescribed for filing the return for such enterprise (including any extension of time for such filing) falls before the last day of the third month following the month in which the regulations under section 1361 are published in the Federal Register, the election shall be perfected by filing an amended return containing a similar statement, rather than a return, on or before the last day of such third month.
(4) The required statement and the income tax return (and any amended return) shall be filed with the district director of internal revenue with whom the enterprise would be required to file its return if it were a domestic corporation. See section 6091(b)(2).
(5) An election made in compliance with this paragraph shall be irrevocable as provided in section 1361(e)↩ and shall apply to the taxable year for which made and to all subsequent taxable years.
4. The provisions of T.D. 6124 which relate to the perfection of an election were revoked by T.D. 6332, approved Oct. 30, 1958, and filed Nov. 11, 1958, 2 C.B. 1108">1958-2 C.B. 1108, 1112. The change was made in order to reflect provisions of the Technical Amendments Act of 1958 which allowed a taxpayer to revoke his election under sec. 1361 within a certain prescribed period following the promulgation of final regulations under sec. 1361↩.
5. See also S. Rept. No. 1622, 83d Cong., 2d Sess., pp. 119, 456, which is substantially to the same effect.↩
6. Petitioner also argues that in analogous cases where a corporation performs all the work in a business enterprise but attempts to have the income from the enterprise taxed to its stockholders, the respondent has successfully argued that such income is taxable to the corporate entity which earned it pursuant to sec. 482, I.R.C. 1954, and its predecessor sec. 45, I.R.C. 1939. See Forcum-James Co., 7 T.C. 1195">7 T.C. 1195, remanded pursuant to stipulation 176 F. 2d 311; Advance Machinery Exch. v. Commissioner, 196 F. 2d 1006, affirming a Memorandum Opinion of this Court, certiorari denied 344 U.S. 835">344 U.S. 835. Respondent relies on other cases reaching the opposite result. See Miles-Conley Co., 10 T.C. 754">10 T.C. 754, affd. 173 F. 2d 958; Briggs-Killian Co., 40 B.T.A. 895">40 B.T.A. 895. We do not deem it necessary to resolve this argument between the parties in order to dispose of the issue before us. Sec. 482 provides that where two or more business organizations are owned or controlled directly or indirectly by the same interests, the Secretary or his delegate may allocate gross income, deductions, credits, or allowances between or among these business organizations if he determines that it is necessary to prevent evasion of taxes or clearly to reflect the income of the business organizations. Sec. 482 is inapplicable to the instant case because Associates No. 2 and Columbia are not owned nor controlled directly or indirectly by the same interests. See Hamburgers York Road, Inc., 41 T.C. 821">41 T.C. 821↩ (1964).