*4065 1. EXPENSES, COMPENSATION FOR SERVICES. - The petitioner authorized two bonuses of $25,000 each to be paid to its president, a 51 per cent stockholder, during 1920. Held, that the payments made in accordance with such authorization constitute compensation for the year 1920 and are deductible from gross income in that year.
2. INVESTED CAPITAL. - Earned surplus may be reduced by the amount of the preceding year's income and profits taxes prorated. Appeal of Russel Wheel & Foundry Co.,3 B.T.A. 1168">3 B.T.A. 1168.
3. INVESTED CAPITAL. - The respondent erred in reducing the amount of current earnings available for payment of dividends by a tentative tax. Appeal of L. S. Ayers & Co.,1 B.T.A. 1135">1 B.T.A. 1135.
4. INVESTED CAPITAL. - A stipulation was filed in which the respondent confessed error in reducing invested capital by the sum of $30,933.70 as representing accounts receivable charged off in 1919 by the petitioner but disallowed as a deduction for that year by the respondent.
*658 In this proceeding the petitioner seeks a redetermination*4066 of its income and profits taxes for the calendar year 1920, for which the Commissioner, as set forth in his deficiency letter dated November 5, 1925, determined a deficiency in the amount of $7,072.76.
Four issues are involved: (1) Whether the respondent erred in disallowing as a deduction from gross income two bonuses of $25,000 each authorized and paid to the petitioner's president during the taxable year; (2) whether the respondent erred in reducing invested capital for the taxable year on account of prior-year taxes prorated; (3) whether the respondent erred in reducing the amount of current earnings available for the payment of a dividend by a so-called "tentative tax"; and (4) whether the respondent erred in reducing invested capital for the taxable year by the amount of $30,933.70 as representing accounts receivable charged off in the prior year by the petitioner but disallowed as a deduction for that year by the respondent.
FINDINGS OF FACT.
The petitioner is a New York corporation with its principal office at 12 Water Street, New York City.
*659 The business of the petitioner was organized in 1904 as a partnership consisting of James C. Francesconi and W. *4067 A. Hensen, each owning a 50 per cent interest. The business was incorporated on October 5, 1909, with a capital stock of $10,000, represented by 100 shares of a par value of $100, each, James C. Francesconi holding 50 per cent of the shares and W. A. Hensen 50 per cent. Subsequently, the capital of the petitioner was increased to $100,000, and in 1917 or 1918, Francesconi acquired additional shares from Hensen so that during the year 1920 Francesconi owned 501 shares and Hensen 499. Francesconi has been president of the petitioner since its incorporation.
The petitioner is engaged in the business of trading in tallows and greases, paraffin, wax, vegetable oils and different kinds of soap stocks. As incidental to the main business of trading, it has also conducted a commission brokerage business in cottonseed oil but this represented a very small percentage of the total business done.
In 1909 the petitioner's gross business was approximately $100,000, and the office force consisted of Francesconi, a stenographer and a boy. There were no salesmen at this time and Mr. Francesconi was the moving factor in the business, soliciting orders and conducting the affairs of the company*4068 unaided. By 1913, due to the efforts of Francesconi, the business had increased to approximately $200,000 a year gross. In 1915 the office force consisted of 8 people. In 1919 there were 40 employees.
The status of the business from 1917 to 1921 is shown by the following table:
| 1917 | 1918 | 1919 | 1920 | |
| Gross sales | $6,068,681.83 | $5,730,339.25 | $4,773,157.08 | $2,821,023.63 |
| Other income | 21,331.06 | 17,276.04 | 83,727.94 | 56,312.27 |
| Cost of goods | 5,686,431.88 | 5,288,708.24 | 4,457,976.79 | 2,574,632.67 |
| Expenses | 211,667.43 | 294,525.20 | 276,494.73 | 309,402.41 |
| Net income | 191,933.58 | 164,381.85 | 122,414.00 | |
| Inventory, Jan. 1 | 217,899.30 | 323,717.81 | 321,442.13 | 323,617.52 |
| Inventory, Dec. 31 | 323,717.81 | 321,442.13 | 323,617.52 | 56,013.07 |
The "other income" listed above above represents commissions from brokerage business in cottonseed oil on the New York Produce Exchange.
On January 1, 1920, the surplus of the petitioner was $229,173.
The earnings for the year 1920 were as follows:
| From Jan. 1, 1920, to March 31, 1920 | $48,205.33 |
| Mar. 31, 1920, to June 30, 1920 | 2,703.99 |
| July 1, 1920, to Sept. 30, 1920 (loss) | 3,784.48 |
| Oct. 1, 1920, to Dec. 30, 1920 (loss) | 79,224.24 |
*4069 The surplus on December 31, 1920, was $86,939.85.
Francesconi received a regular salary of $39,200 per annum for the years 1919 and 1920. During these years Hensen was paid a *660 regular salary of $24,200. Francesconi devoted all of his time to the petitioner's business whereas Hensen devoted but a part of his time thereto. On January 28, 1920, the petitioner's board of directors passed the following resolution:
On motion duly made and seconded, it was unanimously -
Resolved, that, as agreed with the Vice President, Mr. Walter A. Henson in December 1919, in consideration of the special efforts exerted by the President, Mr. James C. Francesconi, and in acknowledgment and appreciation of the results attained by said James C. Francesconi in the conducting and upbuilding of the business, a special remuneration of Twenty five thousand ($25,000) Dollars in addition to his salary be paid to the President, Mr. James C. Francesconi, in such sums and at such times as in the judgment of the President, Mr. James C. Francesconi, shall seem advisable for the best interest of the Company.
(Signed) CHAS. FRANCESCONI,
Secretary.
On June 9, 1920, a meeting of the Board*4070 of Directors was held and a dividend of $80,000 was duly declared out of the surplus profits accrued to date and a bonus of $25,000 in addition to his salary was voted to the president. This resolution is as follows:
On motion duly made and seconded the following resolutions were adopted:
Resolved, that a dividend of eighty (80%) per cent, amounting to the sum of eighty thousand ($80,000) dollars be declared out of the surplus profits of the company accrued to date; such dividend to be paid to the stockholders of the company of record on this day pro rata.
Further Resolved, that a bonus of twenty-five thousand ($25,000) dollars be paid by the company to its President, Mr. James C. Francesconi, in recognition of the special efforts exerted and rendered to it by its said President, such payment to be in addition to all salary payments made and to be made to him.
There being no further business to transact the meeting on motion adjourned.
(Signed) CHAS. FRANCESCONI,
Secretary.
The accounts of the petitioner were kept and its income-tax returns for 1920 and prior years were filed on an accrual basis.
The special remuneration of $25,000 authorized by the*4071 resolution of the board of directors on January 28, 1920, was credited on the books of the petitioner to the account of Francesconi, as follows:
| January 31, 1920 | $6,000 |
| February 28, 1920 | 8,000 |
| March 31, 1920 | 9,250 |
| April 30, 1920 | 1,750 |
The bonus of $25,000 authorized by the resolution of the board of directors on June 9, 1920, was credited on the books of the petitioner to the account of Francesconi on June 9, 1920.
The credits totaling $50,000, representing additional compensation to Francesconi for the year 1920, were actually withdrawn by him *661 during the year 1920 and were included as income in his personal income-tax return.
The dividend of $80,000 pursuant to the resolution of the board of directors on June 9, 1920, was duly credited on the books of the petitioner on that date to stockholders of record.
At the beginning of 1920 Francesconi's account with the petitioner showed a debit balance of $60,000. At the end of the year it showed a credit balance of $303.93. His actual withdrawals during the year were $88,218.60 and the total credits to his account during 1920 were $148,522.53, itemized as follows:
| Regular salary | $39,200.00 |
| Bonus voted January 28, 1920 | 25,000.00 |
| Bonus voted June 9, 1920 | 25,000.00 |
| Dividend | 40,000.00 |
| Traveling expenses | 7,296.30 |
| Cash returned | 11,813.83 |
| Miscellaneous | 212.40 |
| Total credits | 148,522.53 |
*4072 During the year 1918 a bonus of $51,000 was paid to officers and employees, of which $41,000 was paid to Francesconi. No bonus or additional compensation was paid to officers or employees during the year 1919.
As president of the petitioner from the date of its organization, Francesconi performed all executive duties and procured new business for the company, making the necessary contracts of purchase and sale. During the years 1919 and 1920 he solicited orders and new contracts, secured the renewal of annual contracts which expired and obtained contracts with large nationally known companies. He was largely responsible for getting new business. He attended business conventions, traveled from five to seven days a month making new business contacts, soliciting orders, and obtaining new business. Francesconi secured the bulk of the orders. He was regularly at the office all day and at night when necessary, except when traveling on company business.
During the year 1919, business conditions were good, although not quite as good as in 1918. Sale prices for goods were high in 1919.
During the first half of 1920 business conditions continued good, and it was anticipated*4073 that it would be as good a year as 1919, when the company did a gross of over $4,700,000. New contracts were secured early in 1920 and contracts were on hand for later delivery. After the declaration of the bonus and dividend in June there was a general decline in business conditions starting after July 1, 1920.
During the last half of the year 1920 as an aftermath of the war, there was a decline in market conditions and losses resulted. Such *662 conditions were the result of overproduction, lack of demand, depreciation of inventory, and default on contracts and the drop in the sales price of goods frequently resulted in bad debts and accounts. Inventory and stock had to be moved at a loss and goods shipped under contract had to be sold to other purchasers below cost where the contract was breached.
The respondent disallowed the two bonuses totaling $50,000 as deductions from gross income and as an explanation for so doing he stated in his deficiency letter as follows:
On the date of September 18, 1925, you were advised that deduction for salaries of $50,000.00 would not be allowed unless copies of contracts and an extract from the minute books of the corporation*4074 showing authorization of this additional salary were submitted to this office.
No reply has been received to this letter and the deduction is, therefore, disallowed.
The respondent determined the petitioner's tax liability for the calendar year 1919 to be $25,898.59 and prorated this amount over the year 1920, thereby reducing the invested capital for the year 1920 by the amount of $10,913.67. This was in accordance with the respondent's regulations in force in respect of such taxable year.
In determining the proper deduction from invested capital due to dividends paid by the petitioner in excess of available earnings, the respondent reduced earnings by a tentative income and excess-profits tax held by him to have accrued to June 9, 1920, the date of the dividend.
The parties filed the following stipulation at the hearing:
Without waiving the other errors alleged to have been committed by the Commissioner of Internal Revenue in the determination of income and excessprofits taxes of the petitioner for the calendar year 1920, it is hereby stipulated by and between the petitioner and the Commissioner of Internal Revenue that the Commissioner erred in reducing the invested*4075 capital of the petitioner for the year 1920 by the sum of $30,933.70, and that said sum should be added to the invested capital of the petitioner in computing the income and excess-profits taxes for the year 1920.
OPINION.
GREEN: In disposing of the last three issues first, the second one is decided adversely to the petitioner, ; the third one adversely to the respondent, ; and the fourth one has been taken care of by stipulation of the parties.
The remaining issue is whether the respondent erred in disallowing as a deduction from gross income for the year 1920 the amount of $50,000 additional compensation, the payment of which to petitioner's *663 president, James C. Francosconi, was authorized at the meetings of the board of directors held on January 28, and June 9, 1920.
The respondent in his brief argues that by the very wording of the first resolution we should find that the first $25,000 was in fact an authorization of additional compensation as and for the year 1919, and that in any event the two bonuses of $25,000 each when added*4076 to the regular salary of $39,200 would exceed "a reasonable amount for salaries or other compensation for personal services actually rendered" allowable as a deduction under section 234(a)(1) of the Revenue Act of 1918. The reasonableness of the total compensation authorized and paid to the petitioner's president has not been put at issue in these proceedings. The pleading with respect to this issue consists of an allegation on behalf of the petitioner which was denied by the respondent in his answer. The petitioner alleges:
That the amount of $50,000.00 paid to the President for services rendered was authorized by the Board of Directors of the company as follows: At a meeting of such Board on January 28, 1920, the payment of $25,000.00 was authorized and at a meeting held on June 9, 1920 a further payment of $25,000.00 was authorized.
The answer set up no affirmative defense. The reasonableness of the salary was not questioned by the respondent prior to the time he filed his brief. Under such circumstances we fail to see where a discussion of the reasonableness of the compensation authorized and paid is at all proper.
*4077 We conclude that the additional compensation voted in January and June of 1920 was intended as compensation for the year 1920. That results of prior years may have had some influence on arriving at the amount to be paid in 1920 does not of itself preclude the allowance of the deduction. . . We are, therefore, of the opinion that the respondent erred in refusing to allow the deduction as claimed. In view of our determination that the respondent erred in disallowing as a deduction from gross income the two bonuses of $25,000 each, and in view of the fact that the net income of the petitioner for 1920 as disclosed by the deficiency letter was only $41,198.20, it is apparent that there is no deficiency for the year 1920. The petitioner has paid no Federal income or profits taxes for that year.
Reviewed by the Board.
Judgment will be entered on 15 days' notice, under Rule 50.