*1221 In 1928 petitioner, in order to retain the services of a valuable employee, agreed, in addition to the compensation he was then receiving for his services, to pay to his widow after his death $12,000 per year from the net earnings attributable to its St. Louis office. Held, payment made to the widow in 1934 under the terms of the agreement was an ordinary and necessary expense paid or incurred during the taxable year in connection with petitioner's business and is deductible from gross income.
*198 The respondent determined a deficiency against petitioner in income and profits taxes for the calendar year 1934 in the respective amounts of $1,608.76 and $585. The petitioner alleges that the respondent erred in including in gross income an amount of $12,000 representing payments made to Jennie Flarsheim during the taxable year and in failing to allow a deduction of this amount in computing net income. The case was submitted on the pleadings, exhibits, depositions, and oral testimony.
FINDINGS OF FACT.
The petitioner is a Missouri corporation, *1222 with its principal office at Kansas City, Missouri. It is engaged in the food brokerage business and acts as selling agent for numerous principals and clients, and also sells food and similar merchandise at wholesale on its own account. It has numerous branch offices located in important cities in the middle west portion of the United States, through which its business is transacted. These offices are under the control of managers responsible to the home office at Kansas City.
Milton Flarsheim (hereinafter referred to as Milton) entered the employ of petitioner's predecessor partnership about 1901. He was made manager of the branch office at St. Louis, Missouri, and continued to manage this office for petitioner up to and including 1915. About that time an oral agreement was entered into between petitioner and Milton, whereby, beginning in 1916, Milton operated the St. Louis office as his own and retained all the profits and stood the losses from the business conducted from that office. Under this agreement the St. Louis office was operated nominally under petitioner's corporate name but none of the profits accrued to petitioner. Milton had his own bank account in St. Louis*1223 from which the expenses of the office were paid by him. All employees were hired or discharged by him. He managed the business as his own. Billings *199 from the St. Louis office were made in petitioner's name and remittances were made to petitioner in Kansas City. These remittances were credited to Milton and paid over to him by petitioner. Petitioner maintained complete statistical and transportation departments which were used by Milton. He paid an overhead charge for these services. He also paid interest on any funds advanced to him by petitioner.
During the period when he operated the St. Louis office as his own, Milton also performed valuable services for petitioner. He enjoyed the confidence of the trade and was outstanding as a salesman and contact man. He was instrumental in obtaining for petitioner many valuable clients and was regularly consulted by petitioner in connection with its business and in planning sales campaigns. He made frequent trips to Kansas City on behalf of petitioner and was in daily contact with the Kansas City office by telephone. Petitioner regarded him as one of the most valuable men in the food industry. He was one of petitioner's*1224 principal contact men with food manufacturers. He was particularly expert in handling some commodities.
In 1928 Milton, who was then sixty years of age, became dissatisfied with the terms under which he was working and contemplated leaving the employ of petitioner and going into business for himself in order to build up an estate which he could leave to his wife. The officers of petitioner were advised of this situation and authorized negotiations with Milton, as a result of which the parties on September 13, 1928, entered into the following agreement:
THIS AGREEMENT, entered into this 13th day of September, 1928, by and between SEAVEY & FLARSHEIM BROKERAGE COMPANY, a Missouri corporation, hereinafter designated as first party, and MILTON J. FLARSHEIM, of the City of St. Louis, hereinafter designated as second party,
WITNESSETH:
WHEREAS, the second party has been in the employ of the first party for a period of many years, in charge and in control of their St. Louis office, and
WHEREAS, the first party is desirous of having the second party continue to manage and conduct the St. Louis office of the first party, and the second party is willing to so do if monetary provision*1225 is made for the care of second party's wife for her lifetime subsequent to the death of the second party and similar provision is made for second party in the event of his disability;
Now, THEREFORE, in consideration of the premises, it is covenanted and agreed by and between the parties hereto as follows, to-wit:
First: That the second party will continue to manage and conduct the office of the first party in the City of St. Louis under the terms and conditions under which he has heretofore operated and conducted said office.
Second: When the scond party shall, because of disability, be no longer able to operate said office, there shall be paid to the said second party all of the net earnings of the St. Louis office, computed in the same manner as heretofore.
Third: In the event of the death of the said second party, there shall be paid by the first party to the wife of the said second party, Jennie C. Flarsheim, out of the net earnings of the said St. Louis office, computed as heretofore, *200 the sum of Twelve Thousand Dollars ($12,000.00) per annum, payable in equal monthly instalments of One Thousand Dollars ($1,000.00) each, on the first day of each*1226 and every calendar month. In the event the net earnings of said St. Louis office do not total the sum of Twelve Thousand Dollars ($12,000.00) per annum, then the said Jennie C. Flarsheim shall receive all of said earnings, but nothing herein shall be construed as entitling the said Jennie C. Flarsheim to receive more than Twelve Thousand Dollars ($12,000.00) per annum, if the earnings of the said St. Louis office shall exceed said sum.
It is further understood and agreed that in the event the said Jennie C. Flarsheim shall receive less than the sum of Twelve Thousand Dollars ($12,000.00) in any one year because of the fact that the earnings of the St. Louis office for such year do not equal the sum of Twelve Thousand Dollars ($12,000.00), then and in that event, if in any subsequent year the earnings of said St. Louis office shall exceed Twelve Thousand Dollars ($12,000.00), she shall receive during such subsequent year if earned so much of the earnings in excess of Twelve Thousand Dollars ($12,000.00) as will equal the deficit between the sum of Twelve Thousand Dollars ($12,000.00) and the sum received by Jennie C. Flarsheim during any prior year, it being the intention hereby*1227 to give to the said Jennie C. Flarsheim the sum of Twelve Thousand Dollars ($12,000.00) per annum as long as she may live and as long as the total earnings during her lifetime and subsequent to the death of the said second party shall be equivalent to said sum, whether or not the earnings of the St. Louis office of first party for any particular calendar year or years shall fall below said sum.
* * *
Subsequently, Milton agreed orally that the services contemplated in the agreement of September 13, 1928, were for his lifetime. Thereafter, he was connected with petitioner's business until the time of his death and performed services similar to those previously performed by him.
Milton Flarsheim died April 27, 1931. Thereafter petitioner paid his widow, Jennie, the sum of $12,000 each and every year, including the taxable year before us, according to the terms of the agreement with Milton, executed September 13, 1928. Neither Milton nor his widow, Jennie, owned any stock or other interest in petitioner.
After Milton's death the petitioner operated the St. Louis office and all the gross income from that business, including the $12,000 paid to Jennie, was taken into its books*1228 of account.
OPINION.
KERN: The sole question before us is whether respondent erred in disallowing as a deduction from petitioner's gross income the $12,000 paid to Jennie Flarsheim in the taxable year.
Petitioner contends that the $12,000 in question should not be included in its gross income, but if so included it should be deducted in computing its net income, either as an expense or as exhaustion of the cost of the contract for Milton's services. The respondent contends that it is income to petitioner and is not deductible either as *201 an ordinary and necessary expense, or as exhaustion of a capital asset. The applicable statutes are set out in the margin. 1
*1229 It appears from the record that Milton Flarsheim had been employed by petitioner since 1901. He was manager of its St. Louis office and performed extremely valuable services of an executive nature in relation to the whole business of petitioner. He was a man of exceptional ability and wide acquaintance in the merchandising field and brought valuable business to petitioner. Prior to 1916 he had received a salary for his services, but beginning in 1916 he received the entire net earnings of the St. Louis office, which he conducted as his own. He did not, however, have any interest in petitioner which would survive his death. In 1928 he became dissatisfied with the arrangement under which he was working and considered going into business for himself in order to accumulate an estate which could be passed on to his wife after his death. Petitioner then became faced with the possibility of losing its most valuable employee, and at the same time acquiring a most formidable competitor who was thoroughly familiar with its business methods and enjoyed a close business relationship and the confidence of some of its most valuable clients.
In this situation petitioner sought to retain*1230 Milton's services if possible, and in order to meet his requirements agreed, in addition to the compensation which he was then receiving for his services, to pay to his wife, if she survived him, $12,000 a year during her lifetime. Obviously, this was additional compensation for his services. There is no contention that the $12,000 was a gift by petitioner or that it was in excess of what Milton's services were reasonably worth. The fact that petitioner might have had other reasons for wanting to keep Milton in its employ does not affect the value of his services. That it was contingent upon Jennie outliving Milton is not material, nor is the fact that it was to be paid to Milton's nominee. The provision in the contract that it was to be paid out of the net earnings of the St. Louis office was merely a limitation on petitioner's liability and the amount payable in a particular year. It in no way changed the character of the payment when made.
There is no question here of the assignment of income by the earner as in , and *1231 , *202 nor is there a question of assignment of income from a trust by the beneficiary thereof, . Here the petitioner in the taxable year was engaged in the operation of a business and received the profits therefrom. It was, however, obligated under its contract with Milton to pay from these profits $12,000 to Jennie Flarsheim. Obviously, it was intended by the parties to the contract of September 13, 1928, to increase the compensation for Milton's services, and the $12,000 paid to his nominee in the taxable year was additional compensation for the services rendered by him to petitioner in prior years. The obligation to pay was incurred from year to year after the death of Milton and when net income was earned by petitioner from the operation of the St. Louis office, and not previously. The expense, therefore, can not be attributed to earlier years for it was neither paid nor incurred in those years. The liability accrued in 1934. "The statute does not require that the services should be actually rendered during the taxable year, but that the payments therefor shall*1232 be proper expenses paid or incurred during the taxable year." ; ; .
We hold that the $12,000 here in question was an ordinary and necessary expense, paid or incurred by petitioner during the taxable year in connection with its business and is deductible from gross income. ;; . Cf. ; Mornhauser v.United states,. See article 23(a)(9) of Regulations 86. which provides:
Amounts paid by a taxpayer for pensions to retired employees or to their families or others dependent upon them, or on account of injuries received by employees, and lump-sum amounts paid or accrued as compensation for injuries, are proper deductions as ordinary and necessary expenses. Such deductions are limited to the amount not compensated for by insurance or otherwise. When*1233 the amount of the salary of an officer or employee is paid for a limited period after his death to his widow or heirs, in recognition of the services rendered by the individual, such payments may be deducted. * * *
Reviewed by the Board.
Decision will be entered under Rule 50.
MELLOTT dissents.
HARRON, concurring: The petitioner appears to have included in its gross income, on its return, the earnings of the St. Louis office, inclusive of the sum paid to Jennie Flarsheim. The sole question is whether petitioner is entitled to deduct in 1934 the $12,000 paid to Jennie, as a business expense.
*203 The pleadings and the briefs submitted in this proceeding represent greatly belabored straining at theories conceived in confusion. One misdirected argument after another from counsel for one party has brought forth equally misdirected reply arguments from counsel for the other party. Counsel for each party verily misses the forest for the trees. Determination of the question turns upon the proper classification, for tax purposes, of the payment made to Jennie Flarsheim. While I concur in the result reached, I reach that result on a different*1234 ground than does the majority opinion.
The answer to the question in this case is to be found by analysis of the agreement of September 13, 1928. It is clearly a contract entered into for the purpose of retaining the services of Milton Flarsheim in the employ of petitioner. Milton agreed to remain in petitioner's employ in consideration for petitioner's agreement to pay some sum annually to Milton's widow upon his death. The liability and the amount to be paid to the widow was made contingent upon the existence of net earnings in any year of the St. Louis office; and upon the amount thereof per year; and upon whether in any prior year less than $12,000 was paid to the widow. By its specific terms, the agreement does not state that petitioner agreed to pay to Milton any extra compensation for his services at any time. It is not accurate to conclude that the sums paid to Jennie Flarsheim represented additional compensation for the past services of Milton. However, from the terms of the agreement, it is close to reality to conclude that the payments to Milton's widow represented a pension to her for the duration of her life. Under the facts, such is a reasonable*1235 description of the nature of the payments to the widow of an employee of petitioner. It does not affect the nature of the payments, considered as pension payments, that the amount payable per annum to Jennie was made contingent upon the amount of the net earnings of the St. Louis office. The payment of a pension and the amount thereof can be the subject of a contract.
Once the nature of the payment to Milton's widow is established to be in the nature of a pension, the matter of petitioner's right to deduct the amount paid in the taxable year pursuant to the contract is not difficult. The liability to pay the sum in question accrued in the taxable year because petitioner's liability to make the payment was contingent in each year, and in 1934 the facts determinative of the liability occurred. The expenditure was proximately connected with petitioner's business, having been made in fulfillment of an obligation under a contract entered into in connection with petitioner's business. Further, the Commissioner, by his own regulations, has ruled that amounts paid by a taxpayer for pensions to retired employees or to their families or others dependent upon them, are *204 proper*1236 deductions as ordinary and necessary expenses. Regulations 86, article 23(a)-9, Act of 1934. It is reasonable to hold that the above regulation applies to amounts paid as a pension to the widow of an employee. The deduction is allowable as a business expense in the taxable year, upon the above stated grounds.
Footnotes
1. Revenue Act of 1934 -
Section 22(a) provides in part:
"'Gross income' includes gains, profits, and income derived from * * * trades, businesses, commerce * * *; or the transaction of any business carried on for gain or profit, or gains or profits and income derived from any source whatever."
Section 23(a) provides in part as follows:
"In computing net income there shall be allowed as deductions:
"(a) EXPENSES. - All the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business, including a reasonable allowance for salaries or other compensation for personal services actually rendered; * * *." ↩