*178 Decisions will be entered for the respondent.
Petitioners, key employees of the Chichester Chemical Company owned by D. D. Chidester, agreed after Chidester's death in 1927 to remain with the Company in consideration of the salaries which they were then receiving plus a ratable share of 6 per cent of gross sales of the Company. Chidester owed large amounts of debts at the time of his death and his wife, who was executrix of his estate, agreed with the creditors that the Company should be operated under an agreement with the creditors providing for their eventual payment. The key employees of the Company, including petitioners, agreed to continue with the Company at the salaries and percentage of gross sales above named and, in addition, were to receive an interest in the business if they remained with the Company until the creditors were paid and the administration ended. The creditors had all been paid by 1946 and the administration was ended in that year. The Company was then incorporated and a certain number of the shares were issued to petitioners in accordance with the prior agreement. Held, the fair market value of the shares of stock was not "back pay" within the*179 definition provided in section 107 (d), I. R. C.Held, further, since petitioner Bell failed to prove he was an employee of petitioner Giangiulio, administrator of the estate of D. D. Chidester, the $ 2,671.17 received by him from Giangiulio was not "back pay" under such section.
*418 These proceedings were consolidated at the hearing and involve deficiencies in income taxes for the year 1946 as follows:
| Frank R. Bavis | $ 3,156.46 |
| Thomas F. Bell | 2,049.03 |
| Donato A. Giangiulio | 2,344.66 |
*419 The deficiencies in controversy result from the refusal of the respondent (1) to treat the fair market value of certain shares of stock of the Chichester*180 Chemical Company, received in the taxable year by the petitioners, as back pay under section 107 (d) of the Internal Revenue Code, and (2) to treat the sum of $ 3,425 received in the taxable year by each of the petitioners Bavis and Bell from Donato A. Giangiulio, administrator of the estate of D. D. Chidester, as back pay under such section 107(d). This latter issue is now conceded by the petitioners except to the extent of an alternative issue which was raised by amendment to the petition in the case of petitioner Bell, that that portion of the compensation of $ 3,425 received by him from Giangiulio relating to commissions on principal of the estate in the amount of $ 2,671.17 was back pay under such section 107 (d).
FINDINGS OF FACT.
The facts were stipulated and are so found.
Petitioner Frank R. Bavis is an individual residing in Aldan, Pennsylvania. Petitioner Thomas F. Bell is an individual residing in Springfield, Pennsylvania. Petitioner Donato A. Giangiulio is an individual residing in Lansdowne, Pennsylvania. Their returns for the taxable year 1946 were filed with the collector of internal revenue for the first district of Pennsylvania.
Issue 1.
For some years prior*181 to October 21, 1927, the petitioners and others were in the employ of Davitt D. Chidester, sole proprietor of an unincorporated business known as Chichester Chemical Company (hereinafter called the "Company"). The Company, which manufactured a proprietary medicine, had been successful but it did not require the employment of substantial tangible assets. The book value of its net assets, other than good will, on October 21, 1927, was only $ 7,886.72. The following is a copy of the balance sheet of the Company as of such date: *420
| BALANCE SHEET -- 1927 | |||
| CHICHESTER CHEMICAL COMPANY | |||
| As of October 21, 1927. | |||
| * * * * * * * * * * * * | |||
| ASSETS | |||
| Cash in Bank | $ 3,560.92 | ||
| Cash on Hand | 500.00 | ||
| Accounts Receivable | $ 15,338.28 | ||
| Deduct Consignment Account | 6,091.30 | 9,246.98 | |
| Inventories: | |||
| Merchandise | 4,189.36 | ||
| Crude Drugs | 748.00 | 4,937.36 | |
| Total Current Assets | $ 18,245.26 | ||
| Furniture & Fixtures | $ 5,099.25 | ||
| Deduct Reserve for Depreciation | 2,384.44 | $ 2,714.81 | |
| Auto Truck | 1,137.50 | ||
| Less Depreciation | 94.80 | 1,042.70 | |
| Machinery | 1,025.53 | ||
| Total Fixed Assets | 4,783.04 | ||
| Total Assets | $ 23,028.30 | ||
| LIABILITIES | |||
| Accounts Payable | $ 14,141.58 | ||
| Notes Payable | 1,000.00 | ||
| Total Current Liabilities | $ 15,141.58 | ||
| Previous Capital | $ 10,478.50 | ||
| Net Profit as Per P. & L. State | 125,679.25 | ||
| 136,157.75 | |||
| Deduct Drawings | 128,271.03 | ||
| Present Capital | 7,886.72 | ||
| Total Liabilities and Capital | $ 23,028.30 |
*182 Davitt D. Chidester died October 21, 1927, leaving an estate that consisted of the Company, real estate, stocks and bonds, mortgages, notes, cash, and insurance. The value of the decedent's gross estate was determined to be $ 974,399.70, which included a value of $ 600,000 for the Company, and the value of the net estate was $ 101,224.99. Settlement of the estate tax liability was made upon that basis. The *421 claims of small creditors against the estate amounted to $ 23,395.15, and the claims of large creditors amounted to $ 553,175.03. The net book value of tangible assets of the Company amounted to only $ 7,886.72 and the difference between that figure and the $ 600,000 value, namely, $ 592,113.28, represented good will.
Under such circumstances, Elizabeth M. Chidester, wife of the decedent, who was executrix of his estate and his sole heir, legatee, and devisee under his will, entered into identical written agreements dated February 15, 1928, with the larger creditors of D. D. Chidester at the time of his death for the conservation of the decedent's assets and the payment of debts gradually out of the profits from the continued operation of the Company and liquidation*183 of other assets. While the agreement left the executrix wide discretion in handling the business, it fixed a minimum amount of $ 7,500 a month to be paid on account of claims and $ 1,000 per week to be applied to the taxes and carrying charges on real estate. Failure to meet the $ 7,500 monthly payments would be fatal to the plan at the option of the majority (in amount of claims) of the creditors involved if default in such payments lasted 60 days. The pertinent parts of such agreement are as follows:
THIS AGREEMENT made at Philadelphia, Pennsylvania, this fifteenth day of February, 1928, by and among E. M. CHIDESTER, Executrix of Davitt D. Chidester, deceased, hereinafter called the "Executrix" of the first part; the persons whose names are hereto affixed as creditors of Davitt D. Chidester, of the second part; and E. M. CHIDESTER, individually, as sole heir, legatee and devisee of Davitt D. Chidester, of the third part, WITNESSETH AS FOLLOW [sic]:
The parties of the second part were large creditors of Davitt D. Chidester at the time of his death, which occurred on October 21st, 1927. The party of the first part is his widow and has qualified as his Executrix, and desires*184 to preserve his good name and to pay all his debts and obligations in the same manner in which he met them during his life. The assets of the estate of the said Davitt D. Chidester consist of the business conducted by him prior to his death, known as the Chichester Chemical Company, and real estate in various parts of the United States, most of which is encumbered, but which is believed to have a value much in excess of all encumbrances. It is the desire of all the parties hereto to co-operate for their mutual interest and advantage toward the preservation of the estate and prevent the sacrifice of its assets.
NOW THEREFORE THIS AGREEMENT WITNESSETH: That the parties hereto, for and in consideration of the sum of one dollar by each to the other in hand paid, the receipt whereof is hereby acknowledged, and of the mutual covenants and undertakings herein contained, do hereby agree as follows:
1. Each of the parties of the second part covenants for himself, herself, and/or itself and all parties claiming by, through or under him, her or it, and agrees to furnish all signatures and take all necessary steps to carry out and fully perform this agreement by all of the said parties, the*185 covenants of which are made in consideration of the covenants of each of the others, and for their mutual advantage and protection.
*422 2. The Executrix is hereby authorized and instructed to carry on the business of the Chichester Chemical Company, manufacture and market the merchandise, collect the accounts and pay all bills and operating expenses, enter into contracts and agreements and generally conduct the business as it was run by Davitt D. Chidester during his lifetime, and shall receive for her personal services in connection with the management and operating thereof the sum of two hundred dollars ($ 200) per week in lieu of the salaries previously drawn by Davitt D. Chidester, two hundred dollars ($ 200) and E. M. Chidester, fifty dollars ($ 50).
* * * *
5. The Executrix is authorized to pay from the operating account of the business of the Chichester Chemical Company such sums as may be necessary to take care of interest and taxes on the real estate and keep encumbrances thereon in a condition satisfactory to the holders thereof, so that the assets may be preserved and foreclosures prevented. The Executrix estimates that a fund of one thousand dollars ($ 1000) per*186 week can be spared from the operating account of the business in order to protect the real estate from foreclosure sales and also to pay taxes and interest upon all the obligations of the estate, and she is hereby authorized by the parties of the second and third parts to so apply the said receipts.
6. After the payment of the checks and the small accounts listed on Schedules A and B above referred to, and the setting aside of the fund of $ 1000 per week for the purposes set forth in paragraph 5, the Executrix agrees to distribute from the receipts of the business of the Chichester Chemical Company among the parties of the second part proportionately at the end of each month at least seven thousand five hundred dollars ($ 7500) per month, and to add thereto such additional amount as she may determine to be safe to pay without adversely affecting the integrity and business standing of the Chichester Chemical Company, and should there be a default in any monthly minimum payment for the period of sixty days after its due date, the parties of the second part holding a majority in amount of the claims owned by and held by the parties of the second part may notify the Executrix that they*187 desire to cancel this agreement, and it shall then cease to be operative, except as to payments theretofore made and acts done by the Executrix prior to such cancellation under the terms hereof, and all parties shall then participate in the remaining assets of the estate in proportion to the then remaining unpaid balances of their accounts, provided, however, that nothing herein contained shall prejudice or affect the rights of any creditors holding securities, endorsements or obligations of other parties in addition to their claims against the said Davitt D. Chidester.
In the absence of such action by the holders of a majority in interest of the amount of claims, all the parties agree to accept payment in the manner herein provided so long as the executrix distributes among them monthly in proportionate amounts, the whole amount which can be spared from the operating account of the Chichester Chemical Company without jeopardizing its business standing and integrity.
* * * *
8. The parties of the second part for themselves and for all persons claiming by, through or under them respectively, agree that they will pool their interests in the manner herein provided and will co-operate*188 together and with the Executrix to the best interest of the estate and the conservation of its assets, and to this end will refrain from bringing suit or issuing any legal process or taking any steps which will result in the obtaining of a preference by any one over the other, or changing in any way the status quo which existed among them respectively at the time of the death of the decedent, and they further agree, *423 in consideration of the promise and agreement of the parties of the first and third part to convey the real estate as promptly as possible (and without fail, prior to the expiration of the lien of decedent's debts) to a Trustee for the protection and benefit of all the parties in interest, that they will and they do hereby waive their rights to perfect and perpetuate the lien of their respective debts on the real estate of the decedent, and further agree that the Executrix shall be relieved of all claims of surcharge by reason of her entering into and carrying out the terms of this agreement, and agree to accept the payment of their respective accounts in the manner herein provided for, and to extend sufficient time for the working out of the plan.
* * * *
16. *189 Each of the parties of the second part, in consideration of the agreements of the other parties of the second part and of the parties of the first part and third part, agrees to accept payment in accordance with the terms hereof, and will not bring suit or take any other legal proceedings to force or compel any payments to them of the amounts herein referred to. It is understood and agreed by all parties that the creditors by joining herein are not entering into a joint undertaking, but are merely waiving their respective rights to an immediate liquidation of the assets of the estate, and any of them who so desire may retain the original obligations of Davitt D. Chidester, noting upon them the payments made in accordance with the terms hereof, without in any way surrendering their rights to claims as creditors of his estate, and any note holder may, should he so desire, keep the obligation executed by the said Davitt D. Chidester and waive the execution of new notes to him by the Executrix payable out of the funds of the estate, without affecting his rights or the rights of any other party to this agreement.
On February 15, 1928, the same day the creditors' agreement was executed, *190 Mrs. Chidester, as executrix and sole legatee and devisee, entered into a written agreement with the key employees of the Company, which included the petitioners, providing in substance (1) that it was essential for the successful operation of the creditors' agreement that the key employees should continue to operate the business; (2) that they would continue in the business at certain salaries and each would receive an equitable interest in the business in varying proportions; (3) that the transfer of actual ownership be postponed until completion of the payment of the debts and the administration of the estate of D. D. Chidester; and (4) that the transfer be effected in the discretion of the widow, by incorporation, by the formation of a partnership, or otherwise as deemed expedient. These key employees were L. Willard Harris, advertising and general manager; Frank R. Bavis, assistant to Harris; Donato A. Giangiulio, secretary and accountant; J. Fred Hooper, in charge of purchasing and shipping; and Thomas F. Bell, in charge of general correspondence. The said employees had been with the Company since 1895, 1905, 1900, 1895, and 1915, respectively. The only other employees, numbering*191 approximately five at the date of Chidester's death, were minor office and shipping help. The pertinent parts of such employment agreement are as follows:
*424 THIS AGREEMENT made at Philadelphia, Pennsylvania, this Fifteenth day of February, 1928, by and among ELIZABETH M. CHIDESTER, Executrix of the last Will and Testament of Davitt D. Chidester, deceased, of the first part, ELIZABETH M. CHIDESTER, individually as widow and sole legatee and devisee of Davitt D. Chidester, deceased, of the second part, and L. WILLARD HARRIS, J. FREDERICK HOOPER, DONATO A. GIANGIULIO, FRANK R. BAVIS and THOMAS F. BELL, of the third part, WITNESSETH AS FOLLOWS:
WHEREAS, Davitt D. Chidester during his lifetime was the sole owner of the business of the Chichester Chemical Company, unincorporated, and the parties of the third part have been in charge of the operation of the business for many years and are thoroughly familiar with all the details of the business.
AND WHEREAS, subsequent to the death of the said Davitt D. Chidester on October 21, 1927, his Will dated August 16th, 1927, and codicil dated October 12th, 1927, were duly probated at Philadelphia, and Letters Testamentary thereon were issued*192 to Elizabeth M. Chidester as his Executrix, who under the terms of the said Will and Codicil is in her individual capacity the sole legatee and devisee of the whole estate of the said Davitt D. Chidester after the payment of his just debts and funeral expenses.
AND WHEREAS, under agreement of even date herewith entered into by the parties of the first and second parts with the larger creditors of the Estate of the said Davitt D. Chidester, the said creditors have agreed to grant to the parties of the first and second parts sufficient time to pay their accounts over a period of years from the income of the business, and it is essential for the successful operation of the said plan that the executives who are parties of the third part should continue to operate the business, and it is their desire to remain in the employ of the business and carry it on as heretofore under the terms hereinafter set forth.
AND WHEREAS, the parties of the third part received fixed salaries from the business up to the year 1923, and in that year received additional compensation equally divided among them of one per cent. upon the gross sales, and in 1924 received an increase in fixed salaries and additional*193 compensation of two per cent. upon the gross sales, and during the said year an agreement was entered into by which the fixed salaries were to remain at the 1924 basis with additional compensation increasing at the rate of one per cent. per annum until five per cent. was reached in 1927, at which time further increases were to be the subject of conference and adjustment, and after due consideration of the services rendered, the party of the first part agreed that for the year 1928 the compensation to be received by the parties of the third part shall be their fixed salaries as heretofore and additional compensation on the basis of six per cent. of the gross sales.
NOW THEREFORE IT IS HEREBY AGREED by and among the parties hereto as follows: --
1. The parties of the third part shall retain their respective positions and perform the duties heretofore performed by them in connection with the business of the Chichester Chemical Company at the same fixed salaries as those received during the year 1927. The additional compensation for 1928 shall be paid to them in equal shares on the basis of six per cent. of the gross sales of the Company. The additional compensation shall be subject*194 to future adjustments by the party of the first part, but shall not be reduced below the basis of five per cent. on the gross sales which was in force during the life of Mr. Childester, without the consent of three-fifths of the parties of the third part. It is understood and agreed that the party of the second part does not assume any personal liability for these payments and that the agreement to pay the additional *425 compensation is subject to the approval of the Orphans' Court of Philadelphia County in the event that there should be any contest with creditors of the Estate.
2. The parties of the third part agree to devote to the business of the Chichester Chemical Company and the affairs of the Estate of Davitt D. Chidester, their entire business time and attention and not to engage in any other business pursuit during the time that this agreement remains in force and they remain in the employ of the party of the first and second part.
3. The party of the first part and the party of the second part respectively agree to retain the parties of the third part in the employ of the business, they having the general management and supervision of it, subject, however, to the *195 direction of the party the first part during the continuance of the administration of the Estate, and of party of the second part during her remaining lifetime, and to continue the parties of the third part in their respective positions as long as they render satisfactory and faithful service to the Company and so long as the said Agreement with the larger creditors of the Estate remains in force.
4. The parties of the first and second parts further agree with the parties of the third part that upon completion of the payment of the debts of the Estate of Davitt D. Chidester and the consequent termination of the said Creditors' Agreement that she will convey to the parties of the third part then living and in the employ of the Company, their proportionate shares as shown on Schedule A, hereto annexed as a part hereof, of a full one-half undivided interest in the business, and to the personal representatives of any of them who may be deceased at that time a similar proportionate share, but these rights shall not be assignable or transferable without the consent of all the parties hereto, she retaining the other fifty per cent. interest during her lifetime, and further agrees that upon*196 her death her Executors shall convey to the parties of the third part, in equal shares, an additional five per cent. in the ownership and proprietary interest in the business. The party of the second part further agrees to make provisions in her Will authorizing and directing her Executors to carry out the terms of this agreement, and giving them full authority to authorize the administrator d. b. n. c. t. a. of the Estate of Davitt D. Chidester, should her death occur before the termination of the administration of his estate, to carry out the Creditors' Agreement and the terms of this Agreement to the end that in the event of the death of the party of the second part, the management and control of the business may be in the persons having experience in running it.
5. Upon the completion of the performance of the Creditors' Agreement and the administration of the Estate of Davitt D. Chidester, the party of the second part, or her Executors, if she or they so desire, may incorporate the business and the adjustments above provided for shall be made through common stock distribution, except that should the party of the second part or her Executor so desire, she or they may receive *197 preferred stock, six per cent. cumulative and participating with the common stock for the fifty or forty-five per cent. interest in the business and assets of the Company. The participating value of this stock shall be estimated upon the net profits of the Company averaged over the period of five years prior to the incorporation of the business and capitalized on a twenty per cent. basis. It shall have full voting rights and be preferred in distribution as to both capital and income.
6. Nothing herein contained shall be construed as giving to the parties of the third part any proprietary interest or ownership in the Company or its assets, nor shall they be in any way entitled to or liable for the profits or losses of the business until the final completion of the administration of the Estate of Davitt D. Chidester, at which time the question shall be determined as to whether the *426 business shall be incorporated or shall be operated as a partnership, or otherwise. Until the completion of such arrangements, the final decision of which shall rest with the party of the second part and/or her Executors, the party of the first part as Executrix, and of the second part as an individual, *198 shall remain the sole proprietors of the business.
* * * *
Schedule "A"
The proportionate shares of the parties of the third part in a certain Agreement entitled "Agreement for Operation of Business of Chichester Chemical Company", dated February 15th, 1928 and to which Agreement this Schedule "A" is annexed, of a full one half undivided interest in the business to be conveyed to them upon the completion of the payment of the debts of the Estate of Davitt D. Chidester and the termination of the Creditors' Agreement with the Estate of Elizabeth M. Chidester, party of the first and second part of said Agreement for operation of business of Chichester Chemical Company, are to be as follows:
| L. Willard Harris | Seven twenty-fifths (7/25ths) |
| J. Frederick Hooper | Five twenty-fifths (5/25ths) |
| Donato A. Giangiulio | Five twenty-fifths (5/25ths) |
| Frank R. Bavis | Five twenty-fifths (5/25ths) |
| Thomas F. Bell | Three twenty-fifths (3/25ths) |
The additional interest of five per cent. (5%) in the business to be conveyed by Elizabeth M. Chidester, party of the first and second part in the Agreement to which this Schedule is annexed, at the time of her death to the above mentioned third parties, is*199 to be divided equally among them, share and share alike.
The total compensation received by each of the petitioners from the Chichester Chemical Company for the years 1928 to June 30, 1946, inclusive, was as follows:
| Year | Bavis | Bell | Giangiulio |
| 1928 | $ 5,692.15 | $ 4,912.15 | $ 5,692.15 |
| 1929 | 5,558.05 | 4,778.05 | 5,558.05 |
| 1930 | 5,223.23 | 4,443.23 | 5,223.23 |
| 1931 | 4,872.19 | 4,077.09 | 4,872.19 |
| 1932 | 4,241.27 | 3,461.27 | 4,241.27 |
| 1933 | 4,308.65 | 3,528.65 | 4,308.65 |
| 1934 | 4,526.27 | 3,731.27 | 4,526.27 |
| 1935 | 4,350.07 | 3,555.07 | 4,350.07 |
| 1936 | 4,377.98 | 3,567.98 | 4,377.98 |
| 1937 | 4,257.68 | 3,462.68 | 4,257.68 |
| 1938 | 4,056.45 | 3,261.45 | 4,056.45 |
| 1939 | 3,946.58 | 3,151.58 | 3,946.58 |
| 1940 | 3,832.91 | 3,037.91 | 3,832.91 |
| 1941 | 3,763.66 | 2,958.66 | 3,758.66 |
| 1942 | 4,232.09 | 3,422.09 | 4,232.09 |
| 1943 | 5,639.71 | 5,049.71 | 5,639.71 |
| 1944 | 5,936.36 | 5,406.36 | 5,936.36 |
| 1945 | 6,228.94 | 5,698.94 | 6,221.44 |
| June 30, 1946 | 3,240.64 | 2,980.64 | 3,240.64 |
The above amounts consisted of fixed compensation of $ 2,600 per year for Bavis and Giangiulio and $ 1,820 per year for Bell to 1942, and $ 3,120 per year for Bavis and Giangiulio and $ 2,600 per year for Bell thereafter. The balance consisted of percentage compensation*200 based on sales as provided in the contract, vacation and Saturday overtime.
The executrix, Elizabeth M. Chidester, died on February 21, 1931, and D. A. Giangiulio was the surviving administrator, d. b. n. c. t. a., of the estate of D. D. Chidester. Pursuant to her agreement with *427 the key employees of the Company, Elizabeth M. Chidester made the following provision in her last Will and Testament:
I specifically give them (Trustees) full power and authority to carry out in all respects two agreements which I have entered into, one with the creditors of my late husband, Davitt D. Chidester, and the other with the employees of the Chichester Chemical Company, and I direct that my interest in the said business and estate shall be handled and managed in every way to facilitate the carrying out of the said agreements. I further direct that any person or corporation appointed as administrator, d. b. n. c. t. a. of the estate of Davitt D. Chidester, deceased, to carry out the administration of the said estate (in the event of my death before completing my administration thereof as his Executrix), to the fullest possible extent to which I or my Executors have the power to select *201 and direct such administrator, d. b. n. c. t. a., shall also be fully authorized and empowered to carry out the terms of the said agreements which I have entered into both individually and as Executrix of my late husband, and that my Executors and/or my Trustees shall in every way indemnify and protect any such administrator, d. b. n. c. t. a., against any loss, claim or damage by reason of the carrying out of the said agreements, or either of them.
After February 15, 1928, the entire net profits of the business were applied in liquidation of the debts of the estate of Davitt D. Chidester, deceased, until all were paid in full and the creditors' agreement was terminated shortly prior to July 1, 1946.
The net income of the Chichester Chemical Company for the years 1928 to June 30, 1946, inclusive, was as follows:
| Year | Amount |
| 1928 | $ 126,227.20 |
| 1929 | 102,524.34 |
| 1930 | 67,489.35 |
| 1931 | 63,019.13 |
| 1932 | 35,172.51 |
| 1933 | 31,144.76 |
| 1934 | 36,050.79 |
| 1935 | 25,985.89 |
| 1936 | 25,230.62 |
| 1937 | 25,464.50 |
| 1938 | 20,907.20 |
| 1939 | 13,059.36 |
| 1940 | (loss) 8,310.56 |
| 1941 | 89.53 |
| 1942 | 6,446.45 |
| 1943 | 24,432.78 |
| 1944 | 23,850.40 |
| 1945 | 27,492.13 |
| June 30, 1946 | 14,586.33 |
The administration of the estate was *202 carried on continuously from decedent's death until the final accounting in 1946 under the jurisdiction of the Orphans' Court of Philadelphia County, and in accordance with the terms of the creditors' agreement, first by Elizabeth M. Chidester as executrix until her death on February 21, 1931, then by the administrators appointed by the Court of whom Donato A. Giangiulio is the surviving administrator. Elizabeth M. Chidester's personal obligations under both agreements devolved upon and were carried out by her executors.
Upon final accounting to the Orphans' Court of Philadelphia County in 1946, the administrator of the estate of D. D. Chidester proceeded, by order of such court, to incorporate the previously unincorporated *428 Company, transferring to the new corporation the assets of the Company, and receiving stock of the corporation which was immediately distributed under the terms of a court adjudication to the petitioners and the others in proportion to their interests as defined in the agreement of February 15, 1928.
Pursuant to said distribution Bavis received 754 shares, Bell 452 4/10 shares, and Giangiulio 754 shares of common voting stock of the corporation, which*203 had a fair market value as of the date of receipt of $ 10 a share. The fair market value of the shares of stock received by each petitioner is in excess of 15 per cent of the gross income of each, respectively, for 1946, but less than 80 per cent of the total compensation of each for personal services covering the period from March 1, 1928, to July 1, 1946.
In their 1946 income tax returns the petitioners treated the fair market value of the shares of stock as back pay under section 107 (d) of the Internal Revenue Code and as being attributable ratably to the period from March 1, 1928, to July 1, 1946, and computed the tax thereon accordingly. The respondent treated the fair market value of said stock as income in the taxable year 1946 and computed the tax without applying the provisions of section 107 (d) of the Code.
Issue 2.
D. A. Giangiulio, upon his appointment February 28, 1931, as administrator of the estate of D. D. Chidester, entered into an oral agreement with Frank R. Bavis and Thomas F. Bell under which he agreed to share his commissions equally with them for services performed by them for the administrator in connection with the administration of the estate of D. *204 D. Chidester, from the date of his appointment to the final liquidation of the estate.
Between the years 1931 and 1945, inclusive, Bavis and Bell each received $ 4,067.16 from the administrator Giangiulio, representing one-half of the commissions received by Giangiulio on income of the estate pursuant to the oral agreement with him as set forth in the preceding paragraph.
When the debts of the estate of D. D. Chidester were paid and the creditors' agreement was terminated in 1946, Giangiulio received, upon the final adjudication of the estate in that year, commissions of $ 10,275, of which $ 8,013.52 represented commissions on principal to which the administrator was entitled upon the final accounting of the estate and the balance of $ 2,261.48 commissions on income. He divided this amount equally with Bavis and Bell according to their agreement, each receiving $ 3,425, of which $ 2,671.17 represented one-third of the commissions on principal paid to Giangiulio.
*429 The sum of $ 2,671.17 is in excess of 15 per cent of the gross income of petitioner Bell for 1946 and is less than 15 per cent in the case of petitioner Bavis. The sum of $ 3,425 is in excess of 15 per cent in *205 the case of Bavis and Bell. The sum of $ 3,425 is less than 80 per cent of the total compensation received by each from this source for personal services covering the period March 1, 1931, to July 1, 1946.
In their 1946 Federal income tax returns petitioners Bavis and Bell treated the $ 3,425 received by each as back pay under section 107 (d) of the Internal Revenue Code and as being attributable ratably to the period from March 1, 1931, to July 1, 1946, and computed the tax thereon accordingly. The respondent treated the $ 3,425 as income in the taxable year 1946 and computed the tax without applying the provisions of section 107 (d) of the Code.
OPINION.
Issue 1.
This issue raises the following question: Are the petitioners entitled to apply the provisions of section 107 (d) of the Code to the fair market value of certain shares of stock received from their employer in 1946 pursuant to the terms of a previous contract with said employer, or is such amount all taxable as income in the year when received? The applicable section of the statute and Treasury regulations are printed in the margin. 1
*206 *430 There can be no doubt from the facts which have been stipulated that the shares of stock in the newly organized corporation which were distributed to Bavis, Bell, and Giangiulio in 1946 were distributed to them as additional compensation for remaining in the employ of the Company from the date of the agreement in 1928 to the final accounting which was had in 1946. Whether petitioners are entitled to treat for income tax purposes the fair market value of the shares of stock which they received in 1946 as back pay depends upon whether the distribution of stock in 1946 falls within the statutory definition of "back pay." The applicable statute carries its own definition of "back pay" and we have printed that definition in the margin. It says:
* * * For the purposes of this subsection, "back pay" means (A) remuneration, including wages, salaries, retirement pay, and other similar compensation, which is received or accrued during the taxable year by an employee for services performed prior to the taxable year for his employer and which would have been paid prior to the taxable year except for the intervention of one of the following events: * * * [emphasis added].
We do*207 not think the payments here involved meet the conditions prescribed in the language which we have emphasized above. Regulations 111, section 29.107-3 provides, in part, as follows:
An event will be considered similar in nature to those events specified in section 107 (d) (2) (A) (i), (ii), and (iii) only if the circumstances are unusual, if they are of the type specified therein, if they operate to defer payment of the remuneration for the services performed, and if payment, except for such circumstances, would have been made prior to the taxable year in which received or accrued. * * *
It seems clear to us that the operation of the Chichester Chemical Company under the arrangement with the creditors' committee did not operate to defer payment to petitioners of the shares of stock which were issued to them in 1946. In fact, the very condition which entitled them to the shares of stock in 1946 was that they remain with the Company until all creditors were paid. That was what entitled them to receive the extra compensation. The facts show that under the agreement of February 15, 1928, the petitioners were to receive certain definite salaries plus additional compensation fixed on*208 a percentage of gross sales. That is shown in paragraph 1 of the agreement wherein it says:
*431 1. The parties of the third part shall retain their respective positions and perform the duties heretofore performed by them in connection with the business of the Chichester Chemical Company at the same fixed salaries as those received during the year 1927. The additional compensation for 1928 shall be paid to them in equal shares on the basis of six per cent. of the gross sales of the Company. * * *
So far as the records show these regular salaries plus the additional compensation agreed upon out of gross sales were paid to Bavis, Bell, and Giangiulio over the intervening years from 1928 to 1945, inclusive, and these amounts are not here in controversy. So far as we can see that was all they were entitled to receive in those prior years irrespective of whether the operation of the business under the creditors' agreement was similar in nature to bankruptcy or a receivership. Under the provisions of paragraphs 3, 4, and 5 of the agreement these key employees, including Bavis, Bell, and Giangiulio were to receive an interest in the business provided that they remained with the*209 Company until all the creditors were paid and the administration ended. If any key employee died in the meantime his estate was to receive the part to which he would have been entitled had he lived out the term. We fail to see where any of the petitioners herein could have demanded in any year prior to 1946 that any of the stock should be issued to them regardless of how solvent and able to pay the Company might have been. Thus, we do not think that one of the vital requirements prescribed in the definition of "back pay" has been met and petitioners cannot be sustained in their contention that the amounts represented by the fair market value of these shares of stock should be taxed as "back pay" under the provisions of section 107 (d), I. R. C.
Petitioners in their brief strongly rely on Langer's Estate v. Commissioner, 183 F.2d 758">183 F. 2d 758. We think that case is distinguishable on its facts. In the Langer case, supra, R. L. Langer and his associate, C. A. Lindsey, were officers and employees of Commodore Hotel Co., Ltd., and although claiming to be entitled by corporate action to compensation of $ 600 per month each, neither received any salary*210 during the years 1938 through 1942. In each of those years through 1941, Commodore suffered operating losses, its balance sheets showing continuing deficits, and it was unable to pay Langer and Lindsey their accrued salaries because it had to use its available funds to prevent foreclosure of a mortgage on its hotel building, furnishings, and fixtures. However, in January 1943, for the first time Commodore had become financially able to resume payment of salaries to Langer and Lindsey, and in January 1944, the board of directors ordered payment of the accrued back salaries as rapidly as the corporation's financial condition would warrant. Pursuant to this action, Langer and Lindsey each received in addition to current salaries, *432 $ 10,000 in 1944 and $ 11,500 in 1945. In their income tax returns for those years Langer and Lindsey treated the $ 10,000 and $ 11,500 as "back pay" under the provisions of section 107 (d) of the Code. The Commissioner determined the amounts were not back pay within the meaning of the applicable statute because Commodore had not been prevented from paying these salaries in the years when due because of an event similar in nature to bankruptcy*211 or receivership, and treated the amounts as income taxable in the years when received. We affirmed the Commissioner, see 13 T.C. 419">13 T. C. 419. The Ninth Circuit reversed us in Langer's Estate v. Commissioner, supra.The court in reversing us, among other things, said:
Under these findings, it is quite clear to us that the event which operated to defer the payment of the salaries of Langer and Lindsey was an event similar in nature to bankruptcy or receivership, for Commodore, during the years in question, was admittedly insolvent and was operating only at the sufferance of Pacific, which was, at all times, in a position to foreclose its deed of trust and mortgage on the hotel and its furnishings and, in fact, refrained from doing so inasmuch as it appeared that all available revenues were being applied by Commodore toward the payment of its indebtedness to Pacific rather than toward the payment of salaries to the corporate officers. If the situation in which Commodore found itself was not one similar to "bankruptcy or receivership" within the meaning of the Code, Section 107 (d) (2), and the Regulations, * * * then those statutory*212 words have no meaning, for the only element of legal bankruptcy lacking was a formal judicial declaration, -- a determination which the corporation or its creditors could have procured at any time, -- and it is obvious that to require such an official determination would be equivalent to saying that the only event similar to bankruptcy is bankruptcy itself.
Even if we assume in the instant case that the operation of the Company under the creditors' agreement was an event similar to bankruptcy or receivership and that Langer's Estate v. Commissioner, supra, would be good authority for so holding, petitioners would not win in the instant case because such operation of the business under the creditors' committee plan did not "operate to defer payment of the remuneration" to petitioners for services performed for the business and payment would not have been made prior to the taxable year 1946. (See Regs. 111, sec. 29.107-3.) As we have pointed out, it was not until 1946 that petitioners were entitled to be paid this additional compensation in the form of shares of stock in the newly organized corporation. Under these circumstances we fail to see*213 how such amounts can be adjudged "back pay" within the meaning of section 107 (d). The only salaries and other compensation which became due and payable to petitioners by the Company during the years 1928 to 1945, inclusive, were the regular salaries which the Company agreed to pay them, plus their percentage of gross sales. These amounts were paid in the years when due and are not involved here.
*433 For reasons we have already explained, nothing accrued in petitioners' favor as to the shares of stock which were issued and paid to them in 1946, until 1946. It was in that year that such extra compensation was both accrued and paid. Therefore, we regard the Langer case, supra, as inapplicable and not controlling here.
Issue 2.
With respect to the $ 2,671.17 received by petitioner Bell from Giangiulio, we are of the opinion that the record here does not show an employer-employee relationship between Bell and Giangiulio which is a prerequisite for the application of section 107 (d). The only fact of record is that Giangiulio, upon his appointment as administrator of the estate of D. D. Chidester, entered into an oral agreement with Bavis and Bell under which he *214 agreed to share his commissions equally with them for services performed for him in connection with the administration of such estate. Certainly Bavis and Bell were not employees of the estate under this oral agreement. There is no showing as to the amount of direction and control Giangiulio exercised over Bavis and Bell under such agreement which is one of the basic elements of an employer-employee relationship. On the contrary, the facts tend to indicate that the relationship between the petitioners under the oral agreement was more closely analogous to that of joint adventurers rather than that of employer and employees. The relation of joint adventurers is created, generally speaking, when two or more persons combine their property, money, efforts, skill, or time in some common undertaking. Here we have three men all actively engaged in the management of what was the most important asset of the estate, the Company. The executrix died and Giangiulio was appointed administrator of the estate. After his appointment, he agreed to divide his commissions with Bavis and Bell if they would perform certain services for him in connection with the administration of the estate. The*215 record is silent as to what services Bavis and Bell performed but it must be assumed that Giangiulio was satisfied since he made payment in accordance with the agreement. They all had an equal stake and an equal reward in its proper administration. However, in any event, it is not necessary to decide whether petitioners were joint adventurers since petitioner Bell has failed to prove that he was an employee of Giangiulio. On this issue we hold for the respondent.
Decisions will be entered for the respondent.
Rice, J., dissenting: I dissent on the first issue and would hold that the shares of stock distributed to petitioners in 1946 constituted back pay under section 107 (d) of the Code.
*434 As set out in the majority opinion, back pay includes compensation received or accrued during the taxable year by an employee for services performed prior to the taxable year and which would have been paid prior thereto except for the intervention of certain events. One such event is bankruptcy or receivership of the employer, and another is any other event determined to be similar in nature under regulations prescribed by the Commissioner. Regulations 111, section 29.107-3, *216 provides:
An event will be considered similar in nature to those events specified in section 107 (d) (2) (A) (i), (ii), and (iii) only if the circumstances are unusual, if they are of the type specified therein, if they operate to defer payment of the remuneration for the services performed, and if payment, except for such circumstances, would have been made prior to the taxable year in which received or accrued. For the purposes of this section the term "back pay" does not include * * * additional compensation for past services where there was no prior agreement or legal obligation to pay such additional compensation, or any amount which is not includible in gross income under chapter 1.
The majority opinion agrees that the shares of stock were distributed to petitioners as additional compensation for remaining in the employ of the Company, which means it was for services which they had performed for the Company from 1928 to 1946; but holds that the fair market value thereof was not back pay within the meaning of the statute because "nothing accrued in petitioners' favor as to the shares of stock which were issued and paid to them in 1946, until 1946." The majority say this is true*217 even assuming that the operation of the Company under the creditors' agreement was an event similar to bankruptcy or receivership.
As shown by the findings of fact, the executrix, in order to preserve the estate and prevent the sacrifice of its assets, entered into an agreement with the major creditors which provided for the continued operation of the Company and the gradual payment of the debts of the estate out of the profits therefrom. The agreement left the executrix wide discretion in handling the business and fixed minimum and relatively large amounts to be paid on account of claims each month and on taxes and carrying charges on real estate. It also provided that failure to meet these requirements would be fatal to the plan at the option of a majority of the larger creditors.
The success of the plan depended upon retaining the services of several key employees, including petitioners. These key employees, who were receiving relatively small salaries, were recognized in the employment contract of February 15, 1928, as being essential for the successful operation of the creditors' agreement of the same date and to continue to operate the business. They agreed to devote their*218 entire time and attention to the business and to remain in the employ of the business at approximately the same low rate of compensation; provided *435 that, when the creditors were paid off, the key employees would be entitled to a 50 per cent share of the business, and upon the death of Elizabeth Chidester, her executors would convey an additional 5 per cent interest in equal shares to them, as set out in the employment agreement. The financial condition of the estate, which necessitated the creditors' agreement and the concomitant obligations imposed thereby, made it impossible to pay said employees, currently, sufficient salary to induce them to remain in and operate the business. The agreement, therefore, provided for the transfer to the key employees of an equitable interest in the business in varying proportions. Under the two agreements, the transfer of ownership had to be postponed until completion of the administration of the estate and the payment of its debts. The creditors' agreement specifically required the executrix to "conduct the business as it was run by Davitt D. Chidester during his lifetime," and this meant as a sole proprietorship. Thus, it is evident*219 that the creditors' agreement and the employment agreement were each a part of one over-all transaction, one being dependent on the other. Had the Company made sufficient profits in years prior to 1946 and paid off the creditors, thereby meeting the requirements of the creditors' agreement, the right of petitioners to their proportionate share of the business would have become absolute and would have been distributed to them in a prior taxable year. It seems clear, therefore, that the receipt of the shares of stock of the Company in 1946 by the petitioners constituted compensation for services performed prior to the taxable year for which payment would have been made except for the circumstances discussed above. See James Newton Dean, 10 T. C. 672 (1948).
The facts in Langer's Estate v. Commissioner (C. A. 9, 1950) 183 F. 2d 758, 1 are somewhat similar to the facts of this case. In that case Langer and one Lindsey, during the period in question, were officers and employees of Commodore Hotel Co., Ltd., a California corporation. Although claiming to be entitled by corporate action to compensation of $ 600 per month*220 each, neither received any salary during the years from 1938 through 1942. In each of the years, from 1938 through 1941, Commodore suffered operating losses, its balance sheets showing continuing deficits. Throughout the period, the corporation's hotel building, fixtures, and furnishings were subject to a deed of trust and chattel mortgage, securing a promissory note payable to Pacific Mutual Life Insurance Co., on which Commodore was chronically in default. However, in January 1943, Commodore (having, in 1942, for the first time for a number of years realized operating profits), after making the required installment payments on its indebtedness to Pacific, became financially able to resume payment of *436 salaries to Langer and Lindsey. In January 1944, the board of directors ordered payment of the accrued back salaries as rapidly as the corporation's financial condition would warrant. Pursuant to this action, Langer and Lindsey received, in addition to current salaries, $ 10,000 in 1944 and $ 11,500 in 1945. The Court in its opinion said at page 760:
Under these findings, it is quite clear to us that the event which operated to defer the payment of the salaries of Langer*221 and Lindsey was an event similar in nature to bankruptcy or receivership, for Commodore, during the years in question, was admittedly insolvent and was operating only at the sufference of Pacific, which was, at all times, in a position to foreclose its deed of trust and mortgage on the hotel and its furnishings and, in fact, refrained from doing so inasmuch as it appeared that all available revenues were being applied by Commodore toward the payment of its indebtedness to Pacific rather than toward the payment of salaries to the corporate officers. If the situation in which Commodore found itself was not one similar to "bankruptcy or receivership" within the meaning of the Code, Section 107 (d) (2), and the Regulations (Treasury Reg. 111, Section 29.107-3), then those statutory words have no meaning, for the only element of legal bankruptcy lacking was a formal judicial declaration, -- a determination which the corporation or its creditors could have procured at any time, -- and it is obvious that to require such an official determination would be equivalent to saying that the only event similar to bankruptcy is bankruptcy itself.
*222 In Norbert J. Kenny, 4 T. C. 750 (1945), the taxpayer was an officer of a corporation serving under a contract calling for a specified salary. The corporation wished to obtain a loan from the Reconstruction Finance Corporation, which imposed a condition that a portion of the taxpayer's salary be retained and not paid to him until the loan was repaid to the R. F. C. In that case, although the restriction on the payment was voluntarily accepted by the corporation and by the taxpayer, this Court held that, inasmuch as it was a restriction imposed by the Government agency, it was analogous to a restriction imposed by a receiver, and relief was granted under section 107 (d) (2) (A) (iv).
The majority opinion distinguishes the Langer case on the ground that the back salaries there had accrued prior to the taxable year in which received, but states that even assuming that in the instant case that operation of the Company under the creditors' agreement was an event similar to bankruptcy or receivership and that the Langer case would be good authority for so holding, petitioners would not win here "because such operation of the business under the*223 creditors' committee plan did not 'operate to defer payment of the remuneration' to petitioners for services performed for the business and payment would not have been made prior to the taxable year 1946." This statement is obviously in error. It is clear from the findings of fact that the transfer of an interest in the business to the key employees had to be postponed until completion of the administration of the *437 estate and the payment of its debts. The two agreements were part of one over-all transaction; and, if sufficient profits had been made in a year prior to 1946 and the creditors had been paid off, the petitioners' right to the interest in the business as set out in the employment agreement would have become absolute in that prior year. To say that the creditors' agreement did not operate to defer payment of the remuneration prior to the taxable year 1946, ignores the facts of record. The executrix could not, under the creditors' agreement, transfer an interest in the business because it required her to operate it as a sole proprietorship until the creditors had been paid off. The record shows clearly that payment would have been made prior to the taxable year*224 except for such circumstances, and this case, therefore, falls squarely within the language of the statute and the regulations.
The majority opinion also states that "The only salaries and other compensation which accrued in petitioners' favor by the Company during the years 1928 to 1945, inclusive, were the regular salaries which the Company agreed to pay them, plus their percentage of gross sales" and that "nothing accrued in petitioners' favor as to the shares of stock which were issued and paid to them in 1946, until 1946." The majority misconstrue the clear and unambiguous language of the statute. It relates to compensation "accrued during the taxable year" not accrued prior thereto. The interpretation placed on the statute by the majority adds a restriction unwarranted by its express language and is, in effect, judicial legislation. It is true that the regulations provide that "the term 'back pay' does not include * * * additional compensation for past services where there was no prior agreement or legal obligation to pay such additional compensation," but that is not applicable under these facts where there was a definite agreement and legal obligation to pay an undivided*225 interest in the business to petitioners if they performed the services contracted for. They performed the services, were paid in stock, and all obligations under the 1928 agreement were therefore executed.
The rationale of this dissent does not conflict with our holding in the recent case of Elsie L. Sedlack, 17 T. C. 791 (1951), (now on appeal, C. A. 7, Feb. 19, 1952), where we held that the statutory definition of back pay is not satisfied where there was no legal liability or agreement on the part of the employer to pay any compensation other than the amounts actually received by the taxpayers in years prior to the taxable year.
The facts clearly indicate that the entire estate, including the Company, was insolvent. The liabilities exceeded the assets by approximately $ 200,000, and the only hope which the creditors had of realizing fully on the amount owing to them was to keep the business operating and have the debts of the estate liquidated over a period of time. This seems to have been the sole purpose of the creditors' agreement; *438 and, in order to carry out its terms, it was essential that the key employees be induced to remain with*226 the business. If the creditors could have realized 100 per cent on their claims on the date of decedent's death, there would have been no reason for them to agree to postpone payment over an indefinite period.
This case is also similar to the Langer case, supra, in that the creditors here (holding a majority in amount of the claims), like the creditors in the Langer case who were in a position to foreclose at all times, could cancel the creditors' agreement and then participate in the remaining assets of the estate in proportion to the unpaid balances of their accounts, if there was default in any monthly payment for a period of 60 days. As shown in the findings of fact, the income of the business was never sufficient to meet the required payments, and consequently a majority of the creditors could have cancelled the agreement at any time. This was the situation in the Langer case which was held to be similar to a receivership.
No specific salary restrictions were imposed by the creditors' agreement, but restrictions may be imposed just as effectively by the creditors demanding periodic minimum payments equal to or in excess of the net income of the business as *227 by requiring a ceiling on compensation, and that is, in effect, what happened in this case. The additional compensation agreed upon was reasonable under all the circumstances, but its payment had to be postponed until the debts were liquidated, as the creditors naturally did not want a reduction in the assets or security to which they had to look for payment. It was the financial condition of the estate that necessitated the employment agreement and continued postponement of the payment of the compensation in question.
Only the financial condition of the estate prevented earlier payment. The circumstances were unusual. They were similar to restrictions imposed in a bankruptcy or receivership proceeding, and, except for such circumstances, payment would have been made prior to the taxable year. I would, therefore, hold for petitioners on this issue.
Footnotes
1. SEC. 107. COMPENSATION FOR SERVICES RENDERED FOR A PERIOD OF THIRTY-SIX MONTHS OR MORE AND BACK PAY.
(d) Back Pay. --
(1) In general. -- If the amount of the back pay received or accrued by an individual during the taxable year exceeds 15 per centum of the gross income of the individual for such year, the part of the tax attributable to the inclusion of such back pay in gross income for the taxable year shall not be greater than the aggregate of the increases in the taxes which would have resulted from the inclusion of the respective portions of such back pay in gross income for the taxable years to which such portions are respectively attributable, as determined under the regulations prescribed by the Commissioner with the approval of the Secretary.
(2) Definition of back pay. -- For the purposes of this subsection, "back pay" means (A) remuneration, including wages, salaries, retirement pay, and other similar compensation, which is received or accrued during the taxable year by an employee for services performed prior to the taxable year for his employer and which would have been paid prior to the taxable year except for the intervention of one of the following events: (i) bankruptcy or receivership of the employer; (ii) dispute as to the liability of the employer to pay such remuneration, which is determined after the commencement of court proceedings; (iii) if the employer is the United States, a State, a Territory, or any political subdivision thereof, or the District of Columbia, or any agency or instrumentality of any of the foregoing, lack of funds appropriated to pay such remuneration; or (iv) any other event determined to be similar in nature under regulations prescribed by the Commissioner with the approval of the Secretary; * * *
Regulations 111, section 29.107-3 (added to the Regulations by T. D. 5855) provides, in part as follows:
An event will be considered similar in nature to those events specified in section 107 (d) (2) (A) (i), (ii), and (iii)↩ only if the circumstances are unusual, if they are of the type specified therein, if they operate to defer payment of the remuneration for the services performed, and if payment, except for such circumstances, would have been made prior to the taxable year in which received or accrued. For the purposes of this section the term "back pay" does not include * * * additional compensation for past services where there was no prior agreement or legal obligation to pay such additional compensation, or any amount which is not includible in gross income under chapter 1.
1. See also Estate of R. L. Langer, 16 T. C. 41 (1951), affd. (C. A. 9) 194 F. 2d 288↩.