Decision will be entered under Rule 50.
Petitioner issued its check, for salary, to its principal stockholder (not an officer) who held more than 50 per cent of its stock. He endorsed it the same day and it was immediately deposited by petitioner in its bank account. The stockholder's account on petitioner's books was first charged, then credited, with the amount of the check. Petitioner is not shown to have had money to cover the check. Held, neither actual nor constructive payment was proven and no error is shown by the Commissioner in denying deduction under section 24 (c) of the Internal Revenue Code.
*962 This case involves deficiencies in income and excess profits tax for the fiscal year ended February 28, 1942, in the amounts of $ 3,866.84 and $ 8,805.20, respectively. The issue is whether petitioner is entitled to a deduction in the amount of $ 10,000 for salary accrued to its majority stockholder. Petitioner filed its return for the taxable year with the collector for the district of Oklahoma.
FINDINGS OF FACT.
The petitioner was organized on March 24, 1941, under the *10 laws of Oklahoma, to succeed a partnership of the same name and to engage in oil well drilling operations. It kept its books and filed its returns on an accrual basis of accounting. During the taxable year 61 shares of petitioner's 250 shares of authorized stock were held by S. C. Hill, president; a like number of shares by C. L. Hight, vice president; 2 shares by J. A. Bradshaw, secretary-treasurer; and the remaining 126 shares, or 50.4 per centum, by Fred Ptak.
The closing balance sheet of the partnership was as follows:
| Assets | |
| Cash | $ 70.90 |
| Receivables | 435.88 |
| Equipment | 13,000.00 |
| Total | $ 13,506.78 |
| Liabilities | |
| Payables | $ 411.74 |
| Notes payable | 13,000.00 |
| Accruals | 485.26 |
| Net worth (deficit) | 390.22 |
| Total | $ 13,506.78 |
Petitioner used the same figures for the opening entries in its books except that it appreciated equipment by the amount of $ 25,390.22 to offset the deficit and capital stock accounts.
Hill, Hight, and Bradshaw were the directors of petitioner. Hill and Hight devoted all of their time to the operations of petitioner in the field. Bradshaw was its part time bookkeeper and performed like services for Clarke & Co., a corporation two-thirds of the stock of which was owned by Ptak. Ptak solicited *11 and otherwise obtained all of the drilling contracts for, and attended to financial matters of, petitioner. He was active in the affairs of Clarke & Co., and received for services rendered to it, a monthly salary of $ 380 and a bonus of $ 100. A major part of the work done by petitioner was performed for Clarke & Co.
On December 30, 1941, the directors of petitioner adopted a resolution to pay each of its directors the amount of $ 200 per month for services rendered to petitioner since March 31, 1941, and that Ptak be paid $ 10,000 as compensation for service rendered by him. No other compensation was authorized for Ptak.
*963 The balance sheet of petitioner on December 31, 1941, was as follows:
| Assets | |
| Cash | $ 341.99 |
| Accounts receivable | 40,623.03 |
| Cost wells in progress | 882.19 |
| Fixed assets | 1 41,041.18 |
| Prepaid expenses | 1,239.87 |
| Total | $ 84,128.26 |
| Liabilities | |
| Notes payable | $ 14,127.77 |
| Accounts payable | 2 34,020.55 |
| Taxes | 4,062.82 |
| Accrued payroll | 2,417.26 |
| Accrued interest | 585.00 |
| Capital stock | 25,000.00 |
| Surplus | 3,914.86 |
| Total | $ 84,128.26 |
On May 13, 1942, petitioner issued its check in favor of Ptak in the *12 amount of $ 9,970 for salary for 1941, less social security tax. The check was endorsed by the payee on the same day and immediately deposited by petitioner for credit in its bank account. The account of Ptak in the books of petitioner was first charged and then credited with the amount of the check. On May 13, 1942, and at the close of that month petitioner did not have sufficient funds in its bank account to pay the check. Clarke & Co., owed petitioner $ 22,785.98 on May 11, 1942. It had considerable income and was able to borrow necessary money from a bank but owed considerable money. The indebtedness of Clarke & Co. to petitioner was eventually paid off, except $ 5,212.09 charged off as bad debt by petitioner in its fiscal year 1945. Petitioner did not pay a salary to Ptak for the fiscal year ended February 28, 1943. Ptak died about October 17, 1949.
In its return for the taxable year petitioner, in addition to the salary accrued in favor of Ptak, claimed as deductions compensation in the amounts of $ 4,232 and $ 4,614 for full time service of Hill and Hight, respectively, and $ 2,550 for part time service of Bradshaw. In his determination of the deficiencies the deduction *13 taken for salary accrued for Ptak was disallowed under section 24 (c) of the Internal Revenue Code upon the ground that the amount did not represent reasonable compensation for services rendered, and that the amount was not actually or constructively paid within the taxable year or within two and one-half months after the close thereof.
OPINION.
The petitioner had the burden of showing the inapplicability of the three conditions set out in section 24 (c) of the *964 Internal Revenue Code. 1*14 All three conditions of the statute must co-exist to the application of the provision. Michael Flynn Mfg. Co., 3 T. C. 932; Akron Welding & Spring Co., 10 T. C. 715.
Apparently because the record shows that Ptak owned more than 50 per cent of the petitioner's stock (within section 24 (b), I. R. C.), and because there is no showing as to whether he was on a cash or accrual basis of accounting, the petitioner makes no contention with reference to clauses 2 and 3 of section 24 (c), and is contesting no more than alleged lack of payment within two and one half months after the close of its taxable year within the meaning of clause 1. It does not contend that actual payment was made. The effect of the argument on the point is that, under the facts, Ptak constructively received the amount during or within two and one half months after the taxable year.
Part of petitioner's burden of proof under its contention was that the amount in controversy was unqualifiedly subject to the demand of Ptak. Ptak was not a director, or an officer of *15 petitioner and no proof was made that he had authority to disburse corporate funds. Petitioner did not have sufficient funds in its bank account on May 13, 1942, to pay the check issued to Ptak and Bradshaw testified that he doubted if it had that much in the account at any time between December 30, 1940, and the date the check was drawn. It was not established by evidence that Ptak ever demanded payment or that the amount accrued was actually paid at any time. Neither does it appear from the evidence that Ptak reported the amount in 1941 or 1942.
It is argued that the situation here is no different, in substance, from what it would be if petitioner had borrowed sufficient funds to pay the salary, and after cashing a check drawn against the borrowed money, Ptak had loaned the amount to petitioner. The issue must be decided on what was done and not on what might have been done. Moreover, there is no proof here that petitioner could have borrowed the necessary money to pay Ptak.
No effort appears to have been made by petitioner to pay the salary until a few days before the expiration of the statutory period allowed within which to make payment. At that time there was not, as already *16 *965 pointed out, sufficient funds to petitioner's credit to pay the check, and no proof was made that that condition had not prevailed since the adoption of the resolution authorizing the salary. Endorsement of the check by Ptak, and delivery thereof to petitioner for deposit to its credit, was not payment, actual or constructive. Petitioner was in the same financial condition, as respects Ptak, after the completion of the transaction as it was before the issuance of the check and Ptak received nothing. The formality was nothing more than a bookkeeping or paper transaction.
Cases are cited in support of contention that Ptak could have received payment on the check upon demand. There was no proof here of an intention or understanding that the check was to be presented to the bank by the payee for payment. To the contrary, the inference from the manner in which the check was handled is that the check would not be presented for payment. Moreover, the evidence does not show that Ptak could have received payment on demand for petitioner is not shown to have had the necessary money at any time.
Other cases cited by petitioner do not support its view. All of them are distinguishable on their *17 facts. In Fincher Motors, Inc., 43 B. T. A. 673, cash was available for payment of the obligation, but we held that there was no constructive payment. In Celina Mfg. Co. v. Commissioner, 142 Fed. (2d) 449, reversing 47 B. T. A. 967, notes were issued and accepted with an agreement that they constituted payment of the salary. In Musselman Hub-Brake Co. v. Commissioner, 139 Fed. (2d) 65, demand notes, having a cash value equal to their face amount, were issued for the obligations. A similar situation prevailed in Michael Flynn Mfg. Co., supra;Ohio Battery & Ignition Co., 5 T. C. 283; and Akron Welding & Spring Co., supra.
The evidence in the record does not establish that Ptak constructively received or that petitioner constructively paid the salary in question.
Aside from the conclusion just expressed, we have held that constructive receipt does not require a holding that there was constructive payment, and that constructive payment does not constitute payment under the statute. P. G. Lake, 4 T.C. 1">4 T. C. 1, affd., 148 Fed. (2d) 898; Granberg Equipment, Inc., 11 T.C. 704">11 T. C. 704.
No error was committed by respondent in denying the deduction under the provisions of section 24 (c). So holding, it *18 is not necessary to pass upon the reasonableness of the salary authorized by the directors.
To reflect net loss and unused excess profits carry-backs from 1944, the amounts of which are not in controversy,
Decision will be entered under Rule 50.
Footnotes
1. Includes appreciation set up March 24, 1941.↩
2. Includes $ 10,000 for compensation voted Ptak, plus $ 345 for an advance.↩
1. SEC. 24 (c) Unpaid Expenses and Interest. -- In computing net income no deduction shall be allowed under section 23 (a), relating to expenses incurred, or under section 23 (b), relating to interest accrued --
(1) If such expenses or interest are not paid within the taxable year or within two and one half months after the close thereof; and
(2) If, by reason of the method of accounting of the person to whom the payment is to be made, the amount thereof is not, unless paid, includible in the gross income of such person for the taxable year in which or with which the taxable year of the taxpayer ends; and
(3) If, at the close of the taxable year of the taxpayer or at any time within two and one half months thereafter, both the taxpayer and the person to whom the payment is to be made are persons between whom losses would be disallowed under section 24 (b)↩.