1952 U.S. Tax Ct. LEXIS 190">*190 Decision will be entered under Rule 50.
1. The petitioner became obligated in 1946 to pay additional compensation for the services of its former president, deceased, and in 1946 the estate of the former president became obligated to make restitution to Virginia Hansen Vincent of dividends improperly paid in prior years. These obligations were determined by order of a California court in 1946. The court's decree effected a compound novation whereby the petitioner discharged its obligation to pay $ 61,000 of compensation to the estate by assuming the obligation of the estate to make restitution of dividends to Virginia Hansen Vincent. Held, that a payment of $ 61,000 by the petitioner in 1946 was in discharge of its obligation to pay compensation which became fixed in 1946; that said payment was not a payment of dividends; and that said payment is deductible as a business expense in 1946 under section 23 (a) (1) (A).
2. Held, petitioner's obligation to pay Oscar Hansen salary for services rendered during 1929 became fixed in 1929, and it was not entitled to deduct in 1946 compensation in the amount of $ 2,250.
3. Under the facts, held, that petitioner has not established1952 U.S. Tax Ct. LEXIS 190">*191 by credible evidence that it sustained losses in 1946 totalling $ 6,500.
18 T.C. 354">*354 The respondent has determined a deficiency in the petitioner's income tax for 1945 in the amount of $ 25,376.20.
The petitioner sustained a net operating loss for the year 1946 and is entitled to a loss carry-back to the year 1945 under section 122. The respondent has reduced the amount of the net operating loss for 1946, which results in a corresponding reduction of the amount of the loss carry-back deduction in 1945. The petitioner concedes that some of the1952 U.S. Tax Ct. LEXIS 190">*192 adjustments made by the respondent to its taxable income for 1945 and 1946 are correct.
There are three issues presented for decision. The first two issues relate to the deductibility under section 23 (a) (1) (A) of two separate items, one in the amount of $ 61,000, and the other in the amount of $ 2,250. Payment of those amounts was made by the petitioner during 1946 pursuant to a decree of a state court, and the question is whether they constitute compensation for services rendered which is deductible in 1946. The third issue is whether payments totalling $ 6,500 made by the petitioner in 1946 under a decree of a state court are deductible as losses under section 23 (f).
The petitioner filed its returns with the collector for the first district of California.
18 T.C. 354">*355 FINDINGS OF FACT.
The facts which have been stipulated are found as facts and are incorporated herein by this reference.
Issue 1. The petitioner, a California corporation having its principal office in San Francisco, has been engaged in the business of finishing photographs since 1921. The petitioner keeps its books and files its returns on an accrual basis. Oscar Hansen was the president of the petitioner1952 U.S. Tax Ct. LEXIS 190">*193 from the time of its incorporation until his death in 1929, and he completely controlled the business and policies of the petitioner. The petitioner's stock has consisted of 2,500 shares of preferred and 2,500 shares of common. Before the petitioner was incorporated, Oscar Hansen and Warren Quinn carried on a photograph finishing business in partnership. At one time Warren Quinn owned all of petitioner's common stock. However, Hansen purchased Quinn's stock.
Oscar Hansen was married, and a daughter, Virginia, was born of the marriage. In 1920 Oscar and his wife separated, and they were divorced in 1922. Oscar's wife and daughter went to live in Michigan in 1920, and Virginia continued to reside there until 1940 when she moved to California. At some time prior to 1945 Virginia was married and became known as Virginia Hansen Vincent.
Oscar Hansen died intestate in 1929. His daughter, Virginia, then 13 years old, was his sole surviving heir. Other survivors were his mother, Josephine Hansen, and his brothers, Albert and Charles Hansen. Oscar Hansen was close to his mother and lived with her after he was separated from his wife.
During 1926 and 1927, Oscar conveyed all of the1952 U.S. Tax Ct. LEXIS 190">*194 preferred and common stock of the petitioner to his mother, Josephine, as trustee, in trust, for himself as beneficiary of the trust. He did not ever revoke or change the terms of the trust. In fact, and at law, he was the beneficial owner of all of the preferred and common stock of the petitioner, and Josephine had a bare legal title. However, upon his death, Josephine concealed the fact that she held the bare legal title as trustee, and the stock was not included in the assets of the estate of Oscar Hansen.
Josephine Hansen and Oscar Uhle were appointed coadministrators of the estate of Oscar Hansen.
After Oscar's death, Josephine Hansen persuaded Albert Hansen to resign from the faculty of Purdue University in Indiana and to manage petitioner's business. In 1929 Albert was elected president and a director of petitioner, and thereafter he managed the business of the petitioner until his death in 1940. Josephine assigned all of the preferred and common stock of the petitioner to Albert in 1930. Albert transferred some of the stock of the petitioner to a trust for the benefit 18 T.C. 354">*356 of his son Robert. Upon the death of Albert the rest of the stock was held in trust for the1952 U.S. Tax Ct. LEXIS 190">*195 benefit of his wife, Alice Hansen, and their children, Robert and Florence.
After the death of Oscar, dividends in the total amount of $ 95,000 were declared on all of petitioner's stock, but only $ 61,000 dividends and no more was paid. All of the dividends were paid to Albert and to his estate as follows:
| Dec. 31, 1937 | $ 25,000 |
| Oct. 31, 1938 | 10,000 |
| April 20, 1940 | 1,000 |
| Aug. 22, 1940 | 20,000 |
| Aug. 13, 1941 | 5,000 |
| Total | $ 61,000 |
The petitioner paid Albert a salary for his services which aggregated $ 81,210.09 during his lifetime, and petitioner paid the foregoing amount to him as compensation for his services during the years which he served as petitioner's president and manager.
On August 16, 1940, Virginia Hansen Vincent filed suit in the Superior Court for the County of San Francisco against the petitioner, the executrix of Albert Hansen's estate, and others, for the recovery of all of the stock of the petitioner, and for other relief. She instituted this proceeding upon the basis of information which led her to believe that she was the lawful owner of all of petitioner's stock. Her case came on for trial in February 1941, and on July 2, 1943, decision was1952 U.S. Tax Ct. LEXIS 190">*196 entered in the case in her favor. The defendants appealed up to the California Supreme Court. The Supreme Court, on May 7, 1946, affirmed the decision of the Superior Court and its judgment then became final. The decision of the Supreme Court is reported as . The findings of fact and conclusions of law of the Superior Court were not officially reported, but a copy has been received in evidence in this proceeding, together with the court's separate judgment and decree. The findings of fact, the conclusions of law, and the decree of the Superior Court are incorporated herein by this reference.
The Superior Court held that Oscar Hansen was the beneficial owner of all of the petitioner's stock at the time of his death, that the stock was impressed with a trust, and that Josephine Hansen was obligated to deliver the stock to the estate of Oscar Hansen upon his death, and that when she failed to so deliver the stock there was a resulting trust. The court held, also, that Virginia Hansen Vincent, as the sole heir of Oscar Hansen, was the rightful owner of the stock. The court found1952 U.S. Tax Ct. LEXIS 190">*197 that Albert Hansen could not have honestly believed that Josephine Hansen owned the stock and that he was possessed of knowledge which put him, as a prudent man, on inquiry as to the real ownership of the 18 T.C. 354">*357 stock, that he held the bare legal title to the stock subject to the claims of the true owner. The court held that Albert Hansen gave up his professional career to assume the management of petitioner, that he had devoted the remainder of his life to the business, that he had performed his duties with skill and ability, and that he had increased the business and more than doubled its value and worth. The court found that the reasonable value of Albert Hansen's services to the corporation for the entire period during which he rendered services was not less than $ 81,210.09, the compensation he had been paid, plus $ 61,000, or a total of $ 142,210.09.
In addition, the court directed the petitioner and the estate of Albert Hansen to transfer the legal title of all of the preferred and common stock of the petitioner to Virginia Hansen Vincent and to make delivery of the stock to her. The court also decreed that Virginia Hansen Vincent was entitled to receive all of the dividends1952 U.S. Tax Ct. LEXIS 190">*198 -- $ 61,000 -- which had been paid on the stock, plus interest.
The court also decreed that the petitioner should not attempt to collect or recover from the estate of Albert Hansen any of the sums previously paid to him or to his estate as dividends.
In 1946, pursuant to the final decree of the California Superior Court, the estate of Albert Hansen became obligated, inter alia, to convey and deliver petitioner's stock to Virginia Hansen Vincent and to make restitution to her of accumulated dividends in the amount of $ 61,000. In 1946, the petitioner became obligated to make payment of $ 61,000 to the estate of Albert Hansen as unpaid compensation for services which Albert Hansen had rendered to the petitioner during his lifetime. Under the decree of the Superior Court the petitioner satisfied its obligation to the estate of Albert Hansen by discharging the obligation of the estate to make restitution to Virginia Hansen Vincent of $ 61,000 of dividends which had been paid improperly to Albert Hansen and to the estate. The petitioner incurred and paid a business expense in the amount of $ 61,000 in 1946 by virtue of the orders and decree of the Superior Court, and is entitled1952 U.S. Tax Ct. LEXIS 190">*199 to a business expense deduction in 1946 under section 23 (a) (1) (A).
Issue 2. In 1927, Warren Quinn agreed to sell Oscar Hansen 2,500 shares of petitioner's common stock for $ 30,000, and Oscar agreed to pay for the stock in equal monthly installments of $ 750. Under this agreement Oscar became the owner of all of petitioner's common stock as well as its preferred stock. Prior to the execution of the agreement, the petitioner's board of directors increased Oscar's salary from $ 500 per month to $ 1,250 -- an increase of $ 750 per month -- to enable him to purchase Quinn's stock. Also, the directors voted him a bonus of $ 10,000 for past services to enable Oscar to meet the down payment on the stock. Also, the directors guaranteed performance of Oscar's obligations under the contract. The petitioner failed to pay Oscar, or to 18 T.C. 354">*358 credit his account on its books, with the $ 750 per month increase in his salary for the months of February, March, and April, 1929, in the total amount of $ 2,250. Those months were the last 3 months of Oscar's life. The petitioner was obligated to Oscar for unpaid salary in the amount of $ 2,250. This obligation accrued and became certain1952 U.S. Tax Ct. LEXIS 190">*200 in 1929. Under the decree of the Superior Court in the suit of Virginia Hansen Vincent, the petitioner was directed to pay, and did pay, to Virginia Hansen Vincent, the compensation owed to Oscar Hansen in the amount of $ 2,250. This amount is included in the larger sum of $ 18,950 which the court ordered the petitioner to pay under its decree.
Issue 3. The petitioner incorrectly recorded on its books the effect of a loan in the amount of $ 5,000 made to it by Oscar. Instead of crediting the sum of $ 5,000 to an account payable to Oscar, it charged it to his personal account on its books.
Subsequent to Oscar's death, the petitioner debited his account on its books and credited the account of his mother, Josephine, in the amount of $ 1,500. This entry had not been authorized by Oscar, nor had he been indebted in this or any other amount to Josephine Hansen at his death. Other improper bookkeeping entries resulted in a further understatement of the amount due Oscar at his death of $ 10,200, which amount is not material here. The foregoing errors and omissions in bookkeeping entries had the effect of reducing the amount shown as due and owing to Oscar by the petitioner. After1952 U.S. Tax Ct. LEXIS 190">*201 Oscar's death, there was due and owing from the petitioner to him the sum of $ 23,152.88 which included unpaid salary of $ 2,250, but the petitioner's books showed there was owing to him only the sum of $ 4,202.88, a difference of $ 18,950.
The petitioner paid the balance owing to the estate of Oscar Hansen, in 1946, in the amount of $ 18,950 (which included back salary of $ 2,250), pursuant to the decree of the Superior Court which became final in 1946; and said payment was made to Virginia Hansen Vincent.
The petitioner did not sustain a loss of $ 6,500 in 1946.
In its income tax return for 1946 the petitioner reported a net operating loss which it carried back to 1945. The petitioner's normal tax net income for 1945, without taking into account part of the operating loss carry-back which is in dispute in this proceeding, is $ 63,488.35.
OPINION.
Issue 1. The parties disagree as to the true nature of a payment of $ 61,000 which the petitioner made in 1946. The petitioner contends that the payment represented unpaid compensation for the services of its former president, Albert Hansen, and that as such it is a deductible business expense under section 23 (a) (1) (A). The respondent1952 U.S. Tax Ct. LEXIS 190">*202 has taken the view that the payment constituted dividends 18 T.C. 354">*359 which, of course, are not deductible. There is no dispute between the parties with respect to the facts, and the respondent does not deny that if the payment of $ 61,000 represented compensation for the services of Albert Hansen, deceased, the petitioner's obligation to make such payment did not arise and did not become fixed prior to 1946. The respondent cites no authority for his position which is in point. The problem is solely one of construing the facts under a decree of a California court in litigation instituted by Virginia Hansen Vincent.
We believe that a true interpretation of the entire order of the California Superior Court is as follows:
(a) Under its holding that Virginia Hansen Vincent was the true and lawful owner of all of petitioner's stock upon the death of her father, Oscar Hansen, and that she was entitled to all of the dividends which had been paid on the stock after his death, the estate of Albert Hansen became obligated not only to deliver the stock of petitioner to Virginia Hansen Vincent but also to make restitution to her of all of the dividends in the amount of $ 61,000.
(b) Also, that1952 U.S. Tax Ct. LEXIS 190">*203 the petitioner became obligated under the court's decree to pay to the personal representatives (his estate) of Albert Hansen, deceased, $ 61,000, in 1946, as additional compensation for services rendered to the corporation by Albert Hansen during his lifetime, over and above all of the compensation which the petitioner had paid to Albert Hansen.
(c) The court decreed that these obligations of the estate of Albert Hansen to Virginia Hansen Vincent, and of the petitioner to the estate of Albert Hansen, should be discharged in a way that is ordinarily described as a compound novation. The court directed that the petitioner should not sue the estate to make restitution of the dividends, but the court also decreed that the estate of Albert Hansen was entitled to have $ 61,000. The respective obligations were discharged by petitioner's assumption of the estate's obligation to pay $ 61,000 to Virginia Hansen Vincent in restitution of dividends which had been improperly paid to Albert Hansen and his estate, instead of to Virginia Hansen Vincent. It follows that the estate constructively received in 1946 $ 61,000 compensation for Albert Hansen's services and that it made restitution of1952 U.S. Tax Ct. LEXIS 190">*204 $ 61,000 dividends to Virginia Hansen Vincent through the petitioner under the novation which was effected by the Superior Court's order.
Under our construction of the facts we have found, therefore, that the petitioner in 1946 for the first time discharged its obligation to pay an additional $ 61,000 compensation for the services of Albert Hansen, deceased. We hold, therefore, that the petitioner is entitled to deduct in 1946 as a business expense, under section 23 (a) (1) (A), the sum of $ 61,000. ; 18 T.C. 354">*360 ; .
Issue 2. The Superior Court also found that the petitioner had not paid Oscar Hansen part of his salary in the amount of $ 2,250 for his services during the 3-month period preceding his death in 1929, and it ordered the petitioner to make payment to Virginia Hansen Vincent of that amount. The question is whether the payment of $ 2,250 is deductible in 1946 as a business expense under section 23 (a) (1) (A).
Unlike1952 U.S. Tax Ct. LEXIS 190">*205 the situation under the first issue, the petitioner was obligated by the resolution of its board of directors to pay Oscar additional salary of $ 750 during each of the 3 months preceding his death in 1929. It had knowledge of all the facts on which an accrual could be based in 1929. .
We recognize the "contested liability" rule, , and , as it pertains to the time for accrual. Although the petitioner might have denied liability to pay Oscar the sum of $ 2,250, the evidence does not show that the petitioner's failure to make such payment was anything more than capricious. We do not know why petitioner failed to pay Oscar Hansen $ 2,250, but the record here leaves no doubt that the petitioner was unequivocally obligated to pay the additional compensation of $ 2,250 in 1929.
Prior to Oscar's purchase of the petitioner's common stock from Quinn in 1927, the petitioner's board of directors had adopted a resolution increasing Oscar's salary by $ 750 per month. There is no evidence that this1952 U.S. Tax Ct. LEXIS 190">*206 action of the board was later invalidated or revoked. Instead, the inference is to the contrary because the reason for the increase in salary existed at Oscar's death. That is to say, he had not completed, at that time, payment of the monthly installments of $ 750 to Quinn for the purchase of the stock.
The petitioner stresses the fact that it did not record on its books any liability to Oscar Hansen for the amount in question. By not accruing the liability for the additional compensation on its books, the petitioner did not relieve itself of the obligation to make payment. The absence of book entries is not decisive of the question. Texas Co. ( .
The liability of the petitioner for the amount of $ 2,250 became fixed in 1929. The respondent's determination with respect to this item is sustained, and deduction of $ 2,250 in 1946 is disallowed.
Issue 3. The last two items in dispute are those which the petitioner paid to Virginia under the decree of the Superior Court. They are of similar nature and can be considered together. One item of $ 5,000 is the amount of a loan made by Oscar Hansen to the petitioner. 1952 U.S. Tax Ct. LEXIS 190">*207 The petitioner did not credit on its books the amount of $ 5,000 to 18 T.C. 354">*361 Oscar's account, nor did it discharge its obligation to pay such amount to Oscar or his estate prior to 1946. The other item, in the amount of $ 1,500, is the amount by which the petitioner arbitrarily debited Oscar's account and credited his mother's account on its books after his death.
The question is whether the payment in 1946 of these two items totaling $ 6,500, as directed by the court's order, is deductible as loss under section 23 (f). It is the contention of the petitioner that as a result of the court's decree, it was compelled to pay the same sums twice and that this duplication of payments resulted in loss.
Upon the evidence presented in this proceeding, we are unable to find that the petitioner sustained a loss aggregating $ 6,500 within the meaning of section 23 (f) by virtue of its payment of this amount under the court's order. There is nothing in the record which shows that the petitioner, in fact, paid the sum of $ 6,500 twice. The only payment of $ 6,500 which has been proved to our satisfaction is the one made to Virginia during 1946. This payment discharged the petitioner's indebtedness1952 U.S. Tax Ct. LEXIS 190">*208 to Oscar and is clearly not deductible as a loss. For failure of proof, the respondent's determination that the amount of $ 6,500 is not a deductible loss is sustained.
Decision will be entered under Rule 50.