1953 U.S. Tax Ct. LEXIS 166">*166 Decisions will be entered under Rule 50.
1. Petitioner is a motion picture actress unskilled in financial matters. In 1939, she employed her stepfather, G. M. Fontaine, who is an experienced business man of San Jose, California, to look after her business affairs generally. His compensation was contingent and at first was fixed at 25 per cent of her earnings. Later, the Commissioner determined deficiencies against petitioner for 1940, 1941, and 1942, on the ground that the amounts paid Fontaine were excessive and that compensation at 15 per cent was reasonable. Acting on Fontaine's advice petitioner agreed to the deficiencies and paid them. Thereafter, petitioner and Fontaine by mutual agreement amended their contract so that he would receive 15 per cent instead of 25 per cent for his services. He was paid that percentage in 1945 and 1946. Held, the amounts paid Fontaine in 1945 and 1946 were reasonable considering that they were paid under a contract made prior to the rendition of the services and that the contract was made in an arm's length transaction and that Fontaine's compensation was fixed on a contingent basis. Regulations 111, section 29.23 (a)-6 (2) and 1953 U.S. Tax Ct. LEXIS 166">*167 (3).
2. On the facts, held, that certain business gratuities which petitioner paid in 1945 and 1947 were paid under such circumstances as to disclose that there was a direct relationship between the payments and petitioner's business as a professional motion picture actress. Held, further, the payments were reasonable in amount and are deductible as ordinary and necessary business expenses under section 23 (a) (1) (A) of the Code.
20 T.C. 323">*323 These cases have been consolidated.
In Docket No. 31720, Olivia de Havilland Goodrich, deficiencies have been determined as follows:
| Year | Deficiency |
| 1945 | $ 28,875.05 |
| 1946 | 18,335.37 |
| 1947 | 1,461.48 |
| Total | $ 48,671.90 |
1953 U.S. Tax Ct. LEXIS 166">*168 The deficiency for 1945 is due to adjustments explained in the deficiency notice as follows:
(a) The deductions claimed in your return for the items detailed below are disallowed to the extent of $ 29,830.58, as shown in the following: 20 T.C. 323">*324
| Claimed | Allowable | Disallowed | |
| (1) Manager | $ 33,334.50 | $ 6,694.33 | $ 26,640.17 |
| (2) Business gifts | 2,843.49 | 1,421.74 | 1,421.75 |
| (3) Miscellaneous business expenses | 1,666.00 | 594.11 | 1,071.89 |
| (4) Studio maid | 1,245.34 | 622.67 | 622.67 |
| (5) Trade papers | 88.40 | 28.80 | 59.60 |
| (6) Unemployment insurance | 44.50 | 30.00 | 14.50 |
| Totals | $ 39,222.23 | $ 9,391.65 | $ 29,830.58 |
Adjustment (1) shown above which was the major adjustment was explained in the deficiency notice as follows:
(1) It has been determined, under the provisions of section 23 (a) (1) (A) of the Internal Revenue Code, that the amount of $ 6,694.33 represents reasonable compensation for the managerial services rendered by your stepfather, G. M. Fontaine, in lieu of $ 33,334.50, the amount claimed in your return. The excessive amount claimed, or $ 26,640.17, is disallowed.
The adjustments for 1946 are similar to those for 1945, and are explained in a similar way. 1953 U.S. Tax Ct. LEXIS 166">*169 The principal one and the one which accounts for most of the deficiency is the same as adjustment (1) for 1945.
The deficiency for 1947 was due to the following adjustments made by the Commissioner to the net income reported by petitioner on her return:
(a) The deductions claimed in your return for the items detailed below are disallowed to the extent of $ 1,972.30, as shown in the following:
| Claimed | Allowable | Disallowed | |
| (1) Wardrobe expense | $ 4,620.95 | $ 3,080.63 | $ 1,540.32 |
| (2) Wardrobe maintenance | 490.78 | 245.39 | 245.39 |
| (3) Depreciation on furs | 905.00 | None | 905.00 |
| (4) Gratuities and gifts | 2,799.90 | 1,800.01 | 999.89 |
| (5) Legal and professional | 14,867.07 | 14,613.07 | 254.00 |
| Totals | $ 23,683.70 | $ 19,739.10 | $ 3,944.60 |
| Your community half of amount disallowed | $ 1,972.30 |
In Docket No. 31721, Marcus A. Goodrich petitioner, the deficiency is for the year 1947 and is for $ 1,461.48 and is due to the same adjustments as shown above made in the case of Olivia de Havilland Goodrich. They were husband and wife during the year 1947 and filed separate returns on the community property basis.
The assignments of error which still remain in controversy present the following1953 U.S. Tax Ct. LEXIS 166">*170 issues for our decision:
1. Is petitioner Olivia de Havilland Goodrich, Docket No. 31720, entitled to deductions in the amounts of $ 26,640.17 and $ 18,688.44 for the years 1945 and 1946, respectively, for amounts paid to her stepfather, G. M. Fontaine, in addition to the sums of $ 6,694.33 and $ 4,674.06 allowed by respondent as reasonable compensation for personal services rendered to her as her business manager under contract?
20 T.C. 323">*325 2. Were business gratuities in the amounts of $ 811 and $ 918.75 in the year 1945 and in the amount of $ 775 in the year 1947 personal or ordinary and necessary business expenses within the meaning of section 23 (a) (1) (A) of the Internal Revenue Code?
All of the other issues presented by the pleadings were settled by stipulation of the parties or were conceded by petitioner.
FINDINGS OF FACT.
Olivia de Havilland Goodrich, referred to hereinafter as the petitioner, is an actress. She won the Academy Award for her acting in "To Each His Own," which was filmed during 1945, one of the taxable years before us. She married Marcus A. Goodrich in the fall of 1946, and during the balance of the taxable years in controversy they resided together as husband1953 U.S. Tax Ct. LEXIS 166">*171 and wife in California. The returns for the taxable years were filed with the collector for the sixth district of California at Los Angeles.
Issue 1.
Petitioner was reared in San Jose, California, by her mother, Lilian Fontaine, and her stepfather, G. M. Fontaine, who were married in 1925. The relationship between petitioner and her stepfather was not a happy one, and because of seemingly irreconcilable differences between them, petitioner left home at the age of 16. Her mother and stepfather still reside together in San Jose as husband and wife.
Shortly after leaving home petitioner, in September 1934, obtained her first professional engagement in the theatre which led to a motion picture contract in Los Angeles. Inasmuch as she was a minor it was necessary that a guardian of her person and estate be appointed and her mother acted in that capacity. When petitioner became of age the guardianship of her mother was terminated -- this was in 1939. At the end of her mother's guardianship petitioner had the difficult problem of deciding how her financial affairs would be managed. She had no experience in financial affairs or business matters and knew nothing about such things. 1953 U.S. Tax Ct. LEXIS 166">*172 She did not know anyone in Southern California whose business it was to take care of people's affairs. The only person known to her to whom she could turn, who possessed what she regarded as the two requisites, business experience and a long-standing reputation for honorable conduct, was her stepfather, G. M. Fontaine. Accordingly, on December 30, 1939, petitioner entered into the following written contract with him:
OLIVIA de HAVILLAND, First Party, and G. M. FONTAINE, Second Party, have agreed and hereby do agree as follows:
First Party hereby employs Second Party as business and financial manager, assistant secretary, and accountant, and to act for First Party in all financial 20 T.C. 323">*326 matters pertaining to the employment of the First Party as an actress in moving pictures, and theatrical and radio productions of all kinds; and agrees to pay to Second Party, in consideration of the performance of said services, twenty-five (25) per cent of whatever salary or other compensation First Party shall receive from his said employment during the life of this Agreement, and to make such payments when First Party shall receive payments from her said employer.
Second Party agrees to use1953 U.S. Tax Ct. LEXIS 166">*173 his best efforts in and about the performance of the conditions of this Agreement on his part and to devote all time necessary thereto, no matter where party of first part may be located -- Los Angeles, San Francisco, New York or and [sic] other place inside or outside of the United States. All expenses, of whatever kind and nature, incurred by party of the second part in the execution and performance of this Agreement (such as, for example; traveling, hotel bills, motor car cost, gifts, entertainment, income tax payments, etc., etc.,) shall be paid for, settled and satisfied by party of the second part from his twenty-five (25) per cent takings.
This Agreement shall be in effect for a period of five (5) years from the date thereof, in substitution of and a continuation of a similar Agreement now in effect between party of the First Part, and LILIAN FONTAINE, party of the second part.
At the time petitioner's mother met Fontaine he was general manager and part owner of Hale Brothers in San Jose, one of a coastal chain of department stores. His income was considerable, he had a responsible position, and he enjoyed a good reputation in the community as a successful and reputable1953 U.S. Tax Ct. LEXIS 166">*174 businessman. He retired from this position about 1930, when he was about 60 years of age, to take up another line of work in which he was interested and which would be less exacting, namely, investment counseling. He opened an office in the First National Bank Building in San Jose as investment counselor and business analyst.
In 1936, upon the advice of a friend with whom she discussed religious matters, petitioner had become reconciled with Fontaine in the sense that when they met they spoke pleasantly, but their relationship was largely a business one confined to business matters. She saw him only occasionally. Communication with him for business purposes was conducted by correspondence and telephone. Inasmuch as Fontaine under the agreement dated December 30, 1939, undertook to perform and thereafter did perform the same services as had previously been rendered by Lilian Fontaine as her guardian, it appeared reasonable to petitioner to compensate him in the same manner as had been allowed by the court to Lilian Fontaine by payment of 25 per cent of her salary. The only experience she had had respecting the worth of such services was the prior contract with Lilian Fontaine1953 U.S. Tax Ct. LEXIS 166">*175 which had been approved as fair and reasonable by a court of competent jurisdiction acting in the protection of her interests as a minor. She believed that the amount to be paid Fontaine was a reasonable figure and that the contract was fair, being upon a contingent basis. She entered into the contract with Fontaine solely as a business transaction without any thought that she would be discharging an obligation 20 T.C. 323">*327 to support either him or her mother and without any discussions along such a line.
During the years 1940, 1941, and 1942, petitioner paid Fontaine 25 per cent of her salary as required by the contract. Her salary for those years amounted to $ 60,835.41, $ 77,083.33, and $ 47,083.32, respectively. In 1943, respondent in auditing petitioner's returns for said 3 years determined that 25 per cent was not a reasonable figure but that 15 per cent of her salary was reasonable compensation for services actually rendered by Fontaine. Upon the advice of Fontaine, petitioner accepted that determination and paid deficiencies in income tax for said years, and Fontaine voluntarily agreed that in the future petitioner's payments to him under the contract should be reduced to1953 U.S. Tax Ct. LEXIS 166">*176 15 per cent of her salary since that had been determined by the Commissioner to be a reasonable figure for his services. He continued, however, to render the same services after such modification of the agreement as he had rendered previously. Payment of 15 per cent of her salary to Fontaine was made during the years 1943 and 1944, and was allowed by respondent as reasonable compensation for his services.
When the agreement of December 30, 1939, was to expire at the end of 1944, petitioner regarded it as essential to continue it and it was renewed by mutual consent on January 5, 1945. It was necessary for someone to continue to act as her business manager for she still had no experience in business or financial matters, and it was necessary to have someone she trusted in complete charge of her affairs because of her many absences from Los Angeles during the war period. She was away from home on bond selling tours during 1943. At the end of 1943, she visited Army, Navy, and Marine Hospitals in and around Chicago, Oklahoma City, Fort Sam Houston, El Paso, and Santa Fe. In February 1944, she left for Alaska and visited patients all down the Aleutian Chain of Islands. In October1953 U.S. Tax Ct. LEXIS 166">*177 1944, she left for the South Pacific to visit hospitals in that area where she was hospitalized in a barracks hospital for 6 weeks with pneumonia. She returned to the United States with a fungus infection of the bronchial tubes and in 1945 she went to Boston to consult a specialist. Because of such absences from home and of her inexperience in business and financial matters, she renewed the agreement with Fontaine as a necessary measure to protect herself and property.
During the years 1945 and 1946, petitioner paid Fontaine 15 per cent of her salary as required by the contract, as modified and extended, amounting to the respective amounts of $ 33,334.50 and $ 23,362.50 and deducted such payments on her Federal income tax returns. Respondent allowed as a deduction only 3 per cent of her salary, or $ 6,694.33 for 1945 and $ 4,674.06 for 1946, and disallowed the balance of the amounts actually paid.
20 T.C. 323">*328 After petitioner married Marcus A. Goodrich in the fall of 1946, the latter was desirous of taking over the management of petitioner's business and financial affairs and had had experience in that regard. Petitioner, accordingly, at the end of 1946 or the beginning of 1947, 1953 U.S. Tax Ct. LEXIS 166">*178 wrote to Fontaine explaining the situation to him and the agreement between petitioner and Fontaine was canceled by mutual consent as of the end of 1946. Thereafter Goodrich handled petitioner's affairs, employing Business Administration Co. to do the routine clerical work. Since that time petitioner has not seen Fontaine and at no time, either theretofore or thereafter, did she furnish any money to support him or her mother, nor has either of them ever asked for any help or support.
The contract between petitioner and Fontaine was a bona fide arm's length agreement, reasonable in the light of the circumstances under which it was made, as well as reasonable under the circumstances existing during the taxable years and payment of 15 per cent of her salary thereunder during 1945 and 1946 was intended to represent and was, in fact, solely compensation for services actually rendered by Fontaine.
Issue 2.
In 1945, petitioner expended $ 811.68 for a gold necklace and gold clips which she gave during that year to Edith Head, who was the head designer of women's clothes at Paramount Studios. She designed petitioner's clothes for two films in 1945, and, in addition, at petitioner's 1953 U.S. Tax Ct. LEXIS 166">*179 request, designed some clothes for petitioner for a trip East where petitioner knew she would be photographed. The clothes were made by the Wardrobe Department at Paramount and petitioner paid Paramount the cost of making the clothes. She could not properly pay Edith Head for her services but she considered her a distinguished designer in the business and felt privileged to have her design the clothes. She also believed that the clothes designed for her use in "To Each His Own" made a definite contribution toward the effect of petitioner's characterization in that film for which she won the Academy Award. Petitioner felt she should recognize Edith Head's services in some way and she did this by making the gift referred to. The gift was made entirely for business reasons, and not for any personal reason.
In 1945, petitioner expended $ 918.75 for a silver tea set and coffee-pot which she gave during that year to Phyllis Laughton, who was a dialogue director. She had assisted petitioner in many films beginning in 1941 and petitioner asked for her services on several pictures and worked with her after hours when petitioner lacked confidence in the director of a particular film. 1953 U.S. Tax Ct. LEXIS 166">*180 She was dialogue director on both films petitioner made in 1945 and, in addition, assisted petitioner on 20 T.C. 323">*329 many occasions when she had to make speeches and broadcasts. The gift was made as a business gratuity in recognition of her services and assistance to petitioner in a business way.
In 1947, petitioner expended the sum of $ 775 for an oil painting which she gave during that year to her new agent, Kurt Frings. By his industry the agent had obtained for petitioner a contract for "The Snake Pit," calling for a salary of $ 208,000, but petitioner's former agent contested his discharge and claimed the agent's commission on the contract. The matter was submitted to arbitration. Petitioner was forbidden by the Screen Actors Guild from paying more than 10 per cent as agent's commission. Since the new agent could not receive anything for his services petitioner felt she should give some recognition to his services. Knowing that he liked paintings, the gift in question was made to him. It was a business gratuity. The agent was not a personal or close friend of petitioner.
The parties have stipulated that the following amounts are allowable as deductions in addition to those1953 U.S. Tax Ct. LEXIS 166">*181 allowed in the notices of deficiency:
| Year | Item | Amount |
| 1945 | Wardrobe | $ 1,071.89 |
| 1946 | Wardrobe | 656.94 |
| 1946 | Travel | 861.38 |
| 1947 | Wardrobe | 612.59 |
| 1947 | Legal and professional | 254.00 |
| 1947 | Business gifts | 124.44 |
| 1947 | Business gifts | 100.45 |
OPINION.
Issue 1.
There is no controversy between the parties that petitioner actually paid G. M. Fontaine $ 33,334.50 in 1945 and $ 23,362.50 in 1946, for services rendered to her under a written contract for business management services. Of these amounts the Commissioner has allowed $ 6,694.33 in 1945 and $ 4,674.06 in 1946, and has disallowed the balance on the ground of unreasonableness.
The applicable statute and regulations are printed in the margin. 1
1953 U.S. Tax Ct. LEXIS 166">*182 20 T.C. 323">*330 We think the payments which petitioner made to Fontaine in 1945 and 1946 for his services as her business manager in those years came within both the letter and the spirit of the Commissioner's regulations printed in the margin. The Commissioner has allowed petitioner only part of the amount which petitioner actually paid Fontaine as resonable compensation for his services and has disallowed the balance apparently on the ground that it represented some kind of support which petitioner was contributing to her stepfather, Fontaine, and, through him, to petitioner's mother, Lilian Fontaine. The evidence completely refutes any justification for such a theory. In the first place, the evidence shows that Fontaine was a businessman of some means of his own and was amply able to support his wife and was in no need of help from petitioner or anyone else. In second place, the evidence shows that while the relations between petitioner and Fontaine were friendly, they were by no means cordial and that the contract under which the payments were made was strictly a business contract and one which was made at arm's length.
The evidence shows that petitioner, upon realizing her dream1953 U.S. Tax Ct. LEXIS 166">*183 of becoming a well-known artist in her profession, had acquired little or no knowledge of business affairs and seemingly had no desire to learn of them, preferring to leave such matters to others in whom she had confidence. For this purpose, she turned to Fontaine, her stepfather, who, notwithstanding personal trouble between them which resulted in her leaving home at 16 years of age, was respected by petitioner as a man of integrity and good business judgment. For services which she considered valuable and essential to one in her position, she agreed to pay him in the first years of his services 25 per cent and in later years, including the two taxable years before us, 15 per cent of her earnings in any particular year. Fontaine's compensation was entirely contingent. Neither party knew at the time the contract was made how much Fontaine would receive in the years 1945 and 1946. They could not know, and although it is perhaps true that the payments which were actually made to Fontaine under the 20 T.C. 323">*331 contract exceeded the expectations of both parties when the contract was made, nevertheless it seems to us that the obligation of petitioner to pay was a legal obligation and1953 U.S. Tax Ct. LEXIS 166">*184 one which she was both morally and legally expected to perform. Generally speaking, if contingent compensation is paid pursuant to a free bargain between the employer and the individual made before the services are rendered, not influenced by any consideration on the part of the employer other than that of securing on fair and advantageous terms the services of the individual, it should be allowed as a deduction even though in the actual working out of the contract it may prove to be greater than the amount which would ordinarily be paid. Regs. 111, sec. 29.23 (a)-6 (2). See California Vegetable Concentrates, Inc., 10 T.C. 1158. On this issue we sustain the petitioner.
Issue 2.
Respondent states this issue in his brief as follows:
2. Were gifts in the amounts of $ 811.00 and $ 918.75 in the year 1945 and a gift in the amount of $ 775.00 in the year 1947 personal or ordinary and necessary business expenses within the meaning of Section 23 (a) (1) (A) of the Internal Revenue Code?
Petitioner contends that the amounts in question were paid by her as business gratuities and were reasonable and that the services rendered to her were commensurate1953 U.S. Tax Ct. LEXIS 166">*185 with the outlay.
The record discloses that Edith Head, recipient of one of the business gratuities, was a well-known clothes designer for women. She designed petitioner's clothes for use in the film "To Each His Own" for which petitioner won the Academy Award. Petitioner testified that Edith Head's clothes designing made a definite contribution toward the effect of her characterization in that film. In addition, at petitioner's request, Edith Head designed some clothes for petitioner for a trip East where she knew she would be photographed frequently.
Phyllis Laughton, a recipient of another of the business gratuities here involved, was a dialogue director. She had assisted petitioner in many films beginning in 1941, and petitioner had asked for her services on several pictures. Phyllis Laughton had worked with petitioner after hours when petitioner lacked confidence in the director of a particular film. She was dialogue director on both films petitioner made in 1945, "Well Groomed Bride" and "To Each His Own," and, in addition, assisted petitioner on many occasions when she had to make speeches and broadcasts.
Through his industry as an agent for petitioner, Kurt Frings, the1953 U.S. Tax Ct. LEXIS 166">*186 recipient of the third business gratuity, obtained for petitioner a contract for "The Snake Pit" from which petitioner derived a salary of 20 T.C. 323">*332 some $ 208,000. However, because of a contested discharge of petitioner's former agent, the usual 10 per cent commission could not be paid Frings under the existing rules of the Screen Actors Guild. Since petitioner could not compensate Frings in money, she felt she should give some recognition to him for his efforts and the success thereof. The recognition was evidenced by the business gratuity here involved.
We think the evidence discloses that there was a direct relationship between the three foregoing expenditures and petitioner's business as a professional actress and that the gratuities were business gratuities and not personal gifts. Cf. William Lee Tracy, 39 B. T. A. 578. In Reginald Denny, 33 B. T. A. 738, the amount of the gift was so large that the Board refused to consider it as an ordinary and necessary business expense without a showing that the services were in some way commensurate with the outlay, citing Welch v. Helvering, 290 U.S. 111">290 U.S. 111.1953 U.S. Tax Ct. LEXIS 166">*187 In the instant case we think petitioner has clearly made the required showing to support the deductions. On this issue we hold for petitioner. To the extent that these expenditures were not allowed in the determination of the deficiencies they should be allowed under Rule 50.
Decisions will be entered under Rule 50.
Footnotes
1. Internal Revenue Code.
SEC. 23. DEDUCTIONS FROM GROSS INCOME.
In computing net income there shall be allowed as deductions:
(a) Expenses. --
(1) Trade or business expenses. --
(A) In General. -- All the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business, including a reasonable allowance for salaries or other compensation for personal services actually rendered; * * *
Regulations 111. Sec. 29.23 (a)-6. Compensation for Personal Services. --
* * * *
(2) The form or method of fixing compensation is not decisive as to deductibility. While any form of contingent compensation invites scrutiny as a possible distribution of earnings of the enterprise, it does not follow that payments on a contingent basis are to be treated fundamentally on any basis different from that applying to compensation at a flat rate. Generally speaking, if contingent compensation is paid pursuant to a free bargain between the employer and the individual made before the services are rendered, not influenced by any consideration on the part of the employer other than that of securing on fair and advantageous terms the services of the individual, it should be allowed as a deduction even though in the actual working out of the contract it may prove to be greater than the amount which would ordinarily be paid.
(3) In any event the allowance for the compensation paid may not exceed what is reasonable under all the circumstances. It is in general just to assume that reasonable and true compensation is only such amount as would ordinarily be paid for like services by like enterprises under like circumstances. The circumstances to be taken into consideration are those existing at the date when the contract for services was made, not those existing at the date when the contract is questioned.↩