*267 Decisions will be entered under Rule 50.
1. Deductions -- Depreciation -- Amortization of Leasehold. -- The transaction in which the taxpayer purchased a leasehold from its principal stockholder was bona fide so that thereafter the taxpayer was entitled to deductions for depreciation of the leasehold.
2. Income -- Capital Gain -- Sale of Leasehold. -- The taxpayer made a bona fide sale of a leasehold to a corporation of which he was the principal stockholder and the purchase price as received by him represented long term capital gains rather than dividends from the corporation.
3. Income -- Family Owned Corporation. -- The sublease of a theater by a corporation to a minority stockholder, where the remainder of the stock was owned by her husband and children, is not recognized for income tax purposes. The sublease served no business purpose of the corporation but merely effected a redistribution of income within an intimate family group at the expense of the corporation and was intended to result in a large reduction in the excess profits taxes of the corporation.
4. Income -- Dividend -- Family Owned Corporation. -- Income received by the wife in the above transaction held*268 taxable to her as a dividend from the corporation.
5. Deductions -- Losses -- Transaction Entered Into for Profit. -- A security trading arrangement between the taxpayer and his sister-in-law was a transaction entered into for profit and payments made by the taxpayer to his sister-in-law in settlement of litigation arising out of the termination of the arrangement were deductible under section 23 (e) (2).
*470 The Commissioner determined deficiencies as follows:
| Declared value | ||||
| Taxpayer | Year | Income tax | Excess profits | excess-profits |
| tax | tax | |||
| 58th Street Plaza Theatre, Inc | 1942 | $ 124.74 | $ 7,951.91 | |
| 1943 | 1,674.88 | 40,197.57 | $ 6,095.50 | |
| Jeannette Brecher | 1943 | 714.00 | ||
| Leo Brecher | 1943 | 19,713.47 |
The issues for decision are whether:
1. Plaza is entitled to deductions of $ 9,523.80 and $ 11,428.56 for the years 1942 and 1943 for the amortization of a leasehold which it acquired from Brecher on February 28, 1942, for $ 200,000;
2. Payments received by Brecher from Plaza of $ 12,000 in 1942 and $ 14,400 in 1943 on account of the $ 200,000 selling price of the lease constituted dividends to Brecher rather than long term capital gains;
3. The income from the operation*270 of the Plaza Theatre in 1943, in the amount of $ 40,396.64, is taxable to Plaza as income, and to Jeannette as a dividend from Plaza;
4. The Commissioner erred in reducing Jeannette's earned income credit for 1943 from $ 1,400 to $ 300;
5. The Commissioner erred in disallowing to the extent of $ 5,000, a $ 6,500 deduction claimed by Plaza as salary paid to Brecher in 1943;
6. Brecher is entitled to a deduction of $ 15,833.33 and one of $ 1,750 for 1943, representing payments made in settlement of litigation instituted by his sister-in-law, Anna Brecher;
7. Brecher, in computing his 1943 tax, is entitled to a deduction of $ 500 for 1942 representing legal fees in defense of a suit instituted by his sister-in-law;
8. The Commissioner erred in failing to adjust Plaza's excess profits credit for the years 1942 and 1943; and
9. Jeannette is entitled to credits in the amount of $ 700 for 1943 for two dependents.
*471 FINDINGS OF FACT.
The petitioner, 58th Street Plaza Theatre, Inc., hereafter called Plaza, is a corporation organized and existing under the laws of the State of New York. It used an accrual method of accounting and filed its returns for 1942 and 1943 with the collector*271 of internal revenue for the third district of New York. The petitioners, Leo Brecher and his wife, Jeannette, hereafter called Brecher and Jeannette, are individuals who, during the period here in question, filed their returns on a cash basis with the collector of internal revenue for the third district of New York. They filed a joint return for 1942 and individual returns for 1943.
Brecher has been engaged successfully for a long time in the motion picture industry as an exhibitor operating, owning, or leasing motion picture theaters in New York and vicinity. He leased property on 58th Street near Madison Avenue in New York in 1929 and converted the existing stables on the property into a motion picture theater, expending approximately $ 125,000 of his own funds for that purpose. He called it the Plaza Theatre. The lease was to terminate on September 1, 1939. He managed the theater at all times material hereto, devoting only a part of his time to it. He was engaged in other business activities during the taxable years.
He organized Plaza in 1930 and sublet the theater property to it for a term ending August 31, 1939. The rent paid by Plaza under the sublease was the equivalent*272 of the rent which Brecher had to pay to the landlord plus amounts sufficient to return to Brecher, over the period of the lease, the $ 125,000 which he had expended in the renovation of the building. The outstanding stock of Plaza consisted of 1,975 shares of which, in the early part of 1939, Brecher owned 1,550 and Jeannette owned 425, which he had given to her.
The land and building, subject to the lease, were sold to Walter Reade in the latter part of 1938. Reade was an operator of motion picture theaters in the New York area. The sale came as a complete surprise to Brecher who immediately attempted unsuccessfully to negotiate a new lease with Reade. Brecher then appealed to influential friends in a motion picture business who interceded in his behalf with Reade and, as a result, Reade leased the premises on June 21, 1939, to Brecher for a term of 20 years commencing September 1, 1939. The rental was $ 30,000 per year, 15 per cent of annual box office receipts in excess of $ 225,000, plus all taxes on the property in excess of $ 7,500 per annum. Brecher was required to make a security deposit of $ 50,000, most of which he paid out of his own funds and for the balance of which*273 he gave his personal notes. He was to remain personally liable for the payment of the notes notwithstanding any assignment of the lease, and was subject to certain restrictions should *472 he acquire another theater or any interest in another theater near the Plaza Theatre.
Brecher negotiated the lease for his own account and not on behalf of Plaza. Plaza could not have obtained the lease from Reade.
Plaza occupied and operated the theater commencing September 1, 1939, under an oral agreement with Brecher for tenancy from month to month terminable at will. Plaza, pursuant to that agreement, paid to Reade the rent required under his lease to Brecher and also paid to Reade such notes of Brecher's for the security payment as became due after September 1, 1939. That arrangement continued until February 28, 1942, on which date Brecher sold the lease to Plaza for $ 200,000, payable $ 1,200 per month without interest. The fair market value of the lease at that time was at least $ 200,000.
Plaza paid Brecher $ 12,000 in 1942 and $ 14,400 in 1943 as a part of the purchase price of the leasehold. Brecher reported those amounts as long term capital gains on the sale of the lease. *274 The Commissioner, in determining the deficiencies, held that they constituted dividends from Plaza. The sale of the lease by Brecher to Plaza was bona fide and the above amounts received on the purchase price were long term capital gains.
Plaza claimed deductions for 1942 and 1943 of $ 9,523.80 and $ 11,428.56, representing amortization of the cost of the leasehold. The Commissioner disallowed those deductions in determining the deficiencies on the grounds that Plaza was always the beneficial owner of the lease and the lease had no value on February 28, 1942. The Commissioner erred in disallowing the deductions claimed by Plaza for amortization of the cost of the lease.
Brecher owned 1,050 shares, Jeannette owned 425 shares, their son owned 250 shares and their daughter owned 250 shares of the stock of Plaza on December 29, 1942. The children received their shares as gifts from Brecher. Plaza on that day subleased the theater to Jeannette for a term of 5 years commencing January 1, 1943, with provision for renewals. Jeannette was required to pay all taxes on the property in excess of $ 7,500 per annum, a fixed rental of $ 40,000, 15 per cent of the amount by which the box office*275 receipts exceeded $ 225,000 in each year and $ 15,000 per annum out of the profits from the operation of the theater. The lessor could cancel the lease if less than $ 20,000 was paid out of the profits in any two consecutive years.
Reade was not informed of the sublease.
1942 and 1943. The proof on this issue is so inadequate that the Court is not justified in making findings of fact which would either bring the issue into focus or enable a proper decision to be made. The petitioner says that it deducted for New York State franchise taxes in 1936, 1937, and 1939 on the basis of payments, whereas it should have theater and the license previously issued to Plaza was cancelled. The *473 insurance policies of the theater were transferred to Jeannette with adjustments to Plaza on the premiums. Contracts for films were entered into in Jeannette's trade name after January 1, 1943. Jeannette in other ways held herself out as operator of the theater.
Jeannette employed Brecher to manage the theater for her during 1943 at a salary of $ 6,000 per year. Jeannette was present at the theater on three or four days each week for periods varying from one to three hours. Jeannette paid*276 the rent to Plaza for 1943 as required by the sublease.
Jeannette reported a net profit from the operation of the theater of $ 40,096.64 in her return for 1943. No part of that income was ever received by Brecher, directly or indirectly, and no part of it was used to discharge any of his obligations. Jeannette was not limited in any way in the use of the income which she derived from the operation of the theater. She used a large part to pay Federal and state income taxes and used other parts for personal purposes. The Commissioner, in determining the deficiencies, held that $ 40,396.64 1 was additional income of Plaza on the ground that the sublease from Plaza to Jeannette did not constitute a bona fide transaction and he held further that $ 40,096.64 was taxable to Jeannette as a dividend from Plaza.
Jeannette gave 400 of her 425 shares of Plaza stock to her children on January 4, 1943.
The box office receipts for the theater*277 ranged from a high of about $ 274,000 in 1931 to a low of about $ 146,000 in 1939. They amounted to about $ 180,000 in 1942 and to about $ 239,000 in 1943. The operating profit from the theater ranged from a high of about $ 92,000 in 1931 to a low of about $ 2,800 in 1939. Plaza reported net income of $ 16,284 for 1942 from the operation of two theaters, of which Plaza was the more profitable.
The sublease from Plaza to Jeannette served no business purpose of Plaza but was a family arrangement to give Jeannette increased income at the expense of Plaza and without payment of taxes thereon by Plaza.
Anna Brecher was Brecher's sister-in-law. He had an oral agreement with her in 1935 whereby she was to supply capital for some transactions in securities, he was to direct the sales and purchases, he was to guarantee Anna against loss and he was to receive one-half of the gains from trading if any existed at the termination of the arrangement. The arrangement was terminable at the will of either party.
Anna asked Brecher for some money from the account in 1940 and he told her that the account was in no position to give her any money. She insisted that she needed money and he gave her*278 $ 1,750 of his own *474 funds in 1940 with the understanding that it would be taken into account upon the final settlement of their arrangement. Shortly thereafter Anna notified Brecher that the arrangement was terminated. The transactions had resulted in a loss. The parties were unable to agree upon a settlement. Anna brought a suit for damages against Brecher in the amount of $ 101,484.04. A settlement agreement was finally reached on April 21, 1943, whereby Brecher agreed to pay Anna $ 42,500 in settlement of their entire differences.
Brecher paid $ 15,833.33 to Anna in 1943, pursuant to the settlement agreement. There were also outstanding at the end of 1943 thirty-two non-interest bearing promissory notes, each in the amount of $ 833.33, one of which was to mature each month, which Brecher had given to Anna for the balance of the settlement amount.
Brecher claimed a deduction for loss on his return for 1943 in the amount of $ 15,833.33. The Commissioner, in determining the deficiency, disallowed the deduction. The arrangement between Anna and Brecher entered into in 1935 was a transaction entered into for profit by Brecher and he sustained a loss of $ 15,833.33 from*279 that transaction in 1943.
Brecher paid an attorney $ 500 in 1942 for representing him in the suit brought by Anna. He claimed the amount as a deduction on his 1942 return and the Commissioner, in determining the deficiency for 1943 under the Current Tax Payment provisions, erroneously disallowed the deduction.
Plaza paid Brecher a salary of $ 6,500 in 1943, $ 5,000 of which related to the operation of the Plaza Theatre. He managed the Plaza Theatre during 1943. Plaza claimed a deduction for 1943 of $ 6,500 as salary paid to Brecher. The Commissioner, in determining the deficiency against Plaza, added to the $ 6,500 paid to Brecher by Plaza the $ 6,000 paid to Brecher by Jeannette and disallowed $ 5,000 of the total, with the explanation that reasonable compensation for his part time services in 1943 did not exceed $ 7,500.
Jeannette, on her return for 1943, claimed a dependent credit of $ 350 for each of two sisters, Yetta Koslan and Malvine Denelandau. The Commissioner, in the notice of deficiency, did not allow any credit for a dependent but made no reference therein to his omission of the two credits claimed on the return. The two sisters were dependent upon and received *280 their chief support from Jeannette and were incapable of self-support because physically defective during 1943.
The stipulation of facts is incorporated herein by this reference.
OPINION.
The first two issues can be considered together. The Commissioner argues that the lease from Reade to Brecher had no value on February 28, 1942, but the evidence shows that it was *475 worth at least $ 200,000 at that time. The other contention of the Commissioner is that Plaza was already the beneficial owner of the lease, and, as Brecher controlled Plaza, the transaction whereby Brecher sold the lease to Plaza was lacking in substance and bona fides. It is appropriate to scrutinize the various transactions closely since the stock of Plaza at the time was held by Brecher and Jeannette. However, it is clear from the evidence that Brecher negotiated the Reade lease for his own benefit and not on behalf of Plaza. Furthermore, the evidence shows that Plaza could not have obtained the lease from Reade. Plaza was operating the theater until February 28, 1942, on a month to month basis and benefited by the acquisition of a permanent lease. It did not pay more than the lease was worth. Careful*281 scrutiny fails to disclose any sufficient reason for failing to recognize the reality and genuineness of these transactions for tax purposes. Brecher sold the lease, a capital asset, which had no basis for gain in his hands. The payments which he received were long term capital gains as received. Plaza then had an asset which was exhausting. It was entitled to take annual deductions to recover its cost over the remaining life of the lease.
The third and fourth issues can also be considered together. The Commissioner has refused to recognize Jeannette as the operator of the theater during 1943 and has added to the reported income of Plaza for that year the additional income from the operation of the theater which was reported by Jeannette. Jeannette received that income so the Commissioner held that it is taxable to her as a dividend from Plaza. Jeannette actually entered into a sublease of the theater with Plaza and went through the formalities of replacing Plaza as the operator of the theater. The Commissioner argues that those formal acts were lacking in substance, Plaza had no business purpose in entering into the lease, it was not an arm's length transaction, it was lacking*282 in bona fides, and the whole arrangement should be disregarded for income tax purposes. The intimate relationship of the parties again requires close scrutiny of their various acts to determine whether or not they should be recognized for income tax purposes.
Plaza was operating two theaters of which the one here involved was by far the more important. Plaza had purchased the lease from Brecher for $ 200,000 just 10 months before the execution of the sublease to Jeannette. Qualified witnesses testified that the lease was worth more than $ 200,000 at that time. The operation of the theater during 1942 had been successful. It was benefiting from the stimulus of the war. The prospects on December 29, 1942, for increased earnings were good. The lease was for 5 years with provisions for renewals. Plaza reported net income of about $ 16,000 for 1942, most of which must have come from the operation of this theater. The directors of Plaza were Brecher, Jeannette and Schiffman, a non-stockholder *476 employed by Brecher. Brecher was the manager of the theater and the parties fully intended that he should continue as manager of the theater. The maximum gross income above the*283 rental to Reade which Plaza could receive from the sublease was $ 25,000. It would have to offset against that its annual deduction for depreciation on the lease in the amount of $ 11,428.56, perhaps other depreciation deductions on equipment of the theater, and $ 5,000 of the salary of Brecher which it intended to pay him in addition to the salary paid him for the management of the other theater. Those deductions would reduce the gross income of $ 25,000 to net income of about $ 8,500.
Plaza, at the time of the execution of the sublease, could anticipate the loss of a large part of the profits reasonably in prospect from its own operation of the theater. It actually reported net income of only $ 7,965.33 for 1943. It is unreasonable to believe that Plaza, having just acquired such a valuable lease, would have entered into a sublease of this kind with any stranger or in an arm's length transaction. Benefits to Brecher, Jeannette, or the children personally do not help the case for Plaza. The sublease was obviously bad business for Plaza, and Brecher and Jeannette knew it better than anyone. They knew that the income of Plaza was subject to excess profits tax whereas any income*284 of Jeannette would not be. They also knew that Jeannette had very little income of her own, whereas Brecher had substantial income. The prospective tax saving in the arrangement is too obvious to be overlooked as is the rearrangement of income in an intimate family group. Motives other than the best interest of Plaza motivated the sublease to Jeannette. The sublease was terminated at some time in 1944 not shown by the record, under circumstances not shown by the record, which Brecher said he was not prepared to go into when he was questioned about them on cross-examination.
The Commissioner was justified in refusing to recognize the sublease for income tax purposes and in taxing all of the income from the operation of the theater for 1943 to Plaza. Cf. Gregory v. Helvering, 293 U.S. 465; Higgins v. Smith, 308 U.S. 473; Moline Properties, Inc. v. Commissioner, 319 U.S. 436; Stanwicks, Inc., 15 T. C. 556. None of the circumstances shown by the record which are favorable to the petitioner's contention have been overlooked in reaching this conclusion. *285 These include the facts that the lease was actually entered into; the operation in form was in the name of Jeannette; she took an interest in the operation of the theater and gave it some of her time; in form at least, she assumed some of the risks and responsibilities; and, perhaps most significant of all, she actually received the net income as her own and used it without restriction for her own purposes. The latter fact need not be controlling where, as here, Brecher, the principal stockholder, and his two children were content *477 to allow Jeannette to have this particular money under their close family relationship, which money otherwise would have been used largely in the payment of corporate taxes. Jeannette argues against taxing the amount to her as a dividend if it is to be regarded as income of Plaza. No such dividend was declared, of course, and it was not distributed pro rata. Nevertheless, she received and used the money and it can be a dividend for tax purposes. Lincoln National Bank v. Burnet, 63 Fed. (2d) 131, affirming 23 B. T. A. 1304; Cleveland Shopping News Co. v. Routzahn, 89 Fed. (2d) 902;*286 Peoples Gin Co. v. Commissioner, 118 Fed. (2d) 72, affirming 41 B. T. A. 343; Speier v. United States, 9 Fed. Supp. 1020. Jeannette makes no separate argument in regard to the earned income credit which certainly falls to $ 300 if she is not regarded as the operator of the theater.
The fifth issue brings up a rather odd situation. Plaza claimed a deduction on its return for 1943 of $ 6,500 as salary for Brecher. The Commissioner considered that the $ 6,000 paid him by Jeannette should be added to the $ 6,500 paid him by Plaza and recognized as a claim for a deduction of $ 12,500. He allowed a deduction of $ 7,500 which is more than the petitioner claimed on its return or in its petition. Since the petitioner is not claiming a deduction in excess of that allowed, there is no issue for decision.
The sixth issue is whether Brecher is entitled to a deduction of $ 15,833.33 for 1943 representing payments made by him in that year in settlement of litigation instituted by his sister-in-law. The Commissioner gave no explanation in the notice of deficiency justifying his action in disallowing*287 this deduction. The evidence clearly shows that it was a loss and it resulted from the termination at an unfavorable time of a transaction entered into by Brecher for profit. He was on a cash basis and the loss was sustained for tax purposes as he made actual payments of the amount which he agreed to pay in settlement of the litigation. The petitioner also claims an additional $ 1,750 paid in 1940 as a loss in 1943, but has failed to show that that amount was not lost when the arrangement was terminated in 1940. It was not mentioned in the 1943 settlement.
The $ 500 involved in the next issue, representing legal fees paid in 1942 in resisting a suit, was deductible in that year either as a nonbusiness expense under section 23 (a) (2) or as a loss under section 23 (e) (2).
The eighth issue has to do with Plaza's excess profits tax credit for 1942 and 1943. The proof on this issue is so inadequate that the Court is not justified in making findings of fact which would either bring the issue into focus or enable a proper decision to be made. The petitioner says that it deducted for New York State franchise taxes in 1936, 1937, and 1939 on the basis of payments, whereas it should*288 have made the deductions on the basis of accruals. The Court has not been *478 informed of the facts in regard to the taxes so that it could determine when they accrued or in what amounts they accrued. The petitioner further claims that it had abnormal deductions for interest in 1937 and in computing the abnormality under section 711 (b) (1) (J) interest on tax deficiencies should be classified separately from interest on loans. Here again the facts have not been proven adequately. The evidence relied upon is some schedules prepared by an accountant and introduced in evidence without objection. The schedules might be regarded as proper proof of some of the figures but figures alone are insufficient. The schedules are somewhat inconsistent with the claims made. The Court would have to know more of the facts which led to the figures. No change in the determination of the Commissioner as to the excess profits tax credit can be made on the basis of the record.
The final issue is whether Jeannette is entitled to credits for two dependents under section 25 (b) (2) (A). Counsel for the Commissioner ignored this point on cross-examination and in his brief, from which we may *289 infer that he has nothing to suggest in opposition to the claim. A finding has been made showing that the petitioner is entitled to the two credits.
Decisions will be entered under Rule 50.
Footnotes
1. Why he included the extra $ 300 overt he amount reported by Jeannette is not shown.↩