*181 Decision will be entered under Rule 50.
Petitioner succeeded in 1940 to a partnership as "component corporation" under section 740 (b) (5), Internal Revenue Code. Computation of base period net income, involved in determining excess profits tax credit, included calculation of reasonable compensation to the former partners. Held, that the amounts determined by the Commissioner were reasonable, that amounts allowable for computation of "earned income credit" under section 25 (a), Internal Revenue Code, do not control, and that the validity of the deficiencies and the burden of proof are not affected by determination by the Commissioner of the computation as a lump sum rather than for each partner.
*1193 This case involves declared value excess profits tax and excess profits tax for the fiscal years ending April 30, 1943 and 1944. Deficiencies were determined as follows:
| Declared | ||
| Taxable year ended -- | value excess | Excess profits |
| profits tax | tax | |
| April 30, 1943 | $ 96.54 | $ 11,722.92 |
| April 30, 1944 | 14.97 | 4,548.98 |
The only question presented is as to the proper amount of certain salaries for officers in base period years, for the purpose of determining excess profits credit for the taxable years.
FINDINGS OF FACT.
The petitioner is a corporation, *183 organized May 1, 1940, under the laws of Mississippi, with its principal office at Greenwood, Mississippi. The returns for the fiscal years herein involved were filed with the collector for the district of Mississippi. (The petitioner's fiscal year ended on April 30. Hereinafter we refer to the year in which it ended as the fiscal year). Of petitioner's common stock of $ 100,000 par value, W. P. Manscoe and Louis Post each owned 49.5 per cent. Louis Post has at all times been president, and W. P. Manscoe was vice president until his decease about August 13, 1940. After his death his widow became the owner of his stock in the petitioner corporation. The corporation was the outgrowth of a partnership which had existed on an equal basis between Post and Manscoe since about 1917 and bore the same name as the petitioner corporation. Both partnership and corporation were engaged in the business of wholesale dealers in automotive parts and equipment. The principal reason for transferring the business from partnership to corporation was the incurable illness of Manscoe, from which he died soon afterward.
Manscoe, in the fiscal year ended April 30, 1938, was actively in complete charge*184 of the maintenance and service department of the business, including an equipment and sales department and installation of electric power plants and water pumps. In 1936 he fainted during an automotive show, and in May 1937 he had a heart attack. He was sick in 1938, but later for a while seemed better. He was a large man and hard working. His doctors found it hard to get cooperation from him. By the latter part of 1938 and early part of 1939 he was unable to put in full days at the place of business. His condition in 1939 was about the same as in 1938. Eventually, at some time undisclosed, his department, the service, shops, delco lights, had to close down. No one else could do his work except Post. He was incapacitated for a year before his death and was given blood *1194 transfusions two or three times during the latter part of 1939 and in 1940. About a year before his death he was diagnosed as having Hodgkin's disease, which is a wasting, malignant, incurable disease. It is not known how long it takes that disease to develop. After the corporation was formed May 1, 1940, he had no specific duties, for he was too ill for any specific position. He died at home.
*185 The gross sales of the partnership, by fiscal years each ended April 30, were approximately as follows: 1937, $ 328,000; 1938, $ 298,000; 1939, $ 268,000; 1940, $ 300,000. For the same years net income reported was: 1937, $ 36,993.12; 1938, $ 22,226.71; 1939, $ 19,591.85; 1940, $ 28,631.31. The two partners drew no salaries, but each had a drawing account from which he drew $ 5,200 per year. For the corporation's fiscal year beginning May 1, 1940, for the period ended with his death Manscoe received $ 1,500 salary. During the fiscal year 1939 the partnership added a new store at Clarksdale, Mississippi, to the three already operated at Greenwood, Tupelo, and Cleveland, Mississippi. After May 1, 1940, a fifth store was started at Grenada, Mississippi.
For the fiscal year 1937 each partner received $ 18,496.56, and Post claimed "earned income" credit upon 20 per cent, or $ 3,699.32. Each year thereafter each partner claimed "earned income" credit upon $ 3,000.
For the fiscal year 1941 the petitioner filed, on July 15, 1941, an income tax and corporation excess profits tax return. The income tax return deducted officers' salaries of $ 6,700 as $ 5,200 for Post, $ 1,500 for Manscoe. *186 In computing excess profits tax credit the partners' salaries of $ 10,400 were shown for each year in the base period of four fiscal years, 1937, 1938, 1939, and 1940. Excess profits net income reported was $ 10,618.76, with excess profits credit of $ 13,684.12. The return, therefore, showed no excess profits tax due. The petitioner also filed, on July 6, 1942, its corporation income and excess profits tax return for the fiscal year 1942. Executive salaries of $ 12,100 were deducted on the income tax return. In computing excess profits tax credit partners' salaries of $ 10,400 were shown for each of the base period years, 1937-1940. Excess profits net income was shown as $ 20,776.78; and specific exemption, excess profits credit, and excess profits credit carry-over totaled $ 23,642.53. Therefore, no excess profits tax was shown due.
On July 14, 1943, the petitioner filed its income and excess profits tax return for the fiscal year 1943. The income tax return deducted "administrative (L. Post)" $ 12,000. In computing excess profits credit partners' salaries in the base period were shown as $ 7,750.98 for the fiscal year 1937 and $ 6,000 for each of the remaining base period*187 years. An excess profits tax of $ 3,735.92 was reported, by *1195 using unused excess profits credit of $ 7,639.28 from the fiscal years ended 1941 (computed by using partners' salaries of $ 7,750.98 for first base period year and $ 6,000 thereafter) and $ 21,274.20 excess profits credit for the current year. Excess profits net income reported was $ 38,014.50.
On November 1, 1943, petitioner filed amended excess profits tax returns for the fiscal years 1941 and 1942, amending in each the computation of excess profits tax credit by using partners' salaries of $ 7,750.98 for the fiscal year 1937 and $ 6,000 per year for the remaining base period years, and arriving, for the fiscal year 1941, at an unused credit of $ 7,639.28 and no excess profits tax payable, and for the fiscal year 1942 arriving at a credit of $ 12,120.05 and no excess profits tax due.
On July 13, 1944, petitioner filed its income and excess profits tax return for the fiscal year 1944. The income tax return deducted "administration (L. Post)" $ 12,125. Computation of excess profits tax credit was on the basis of partners' salaries in the base period, being $ 7,750.98 in the fiscal year 1937 and $ 6,000 in *188 the remaining base period years, resulting in excess profits tax due of $ 13,761.45 (as corrected, $ 13,750.76); excess profits net income reported was $ 42,940.64.
The petitioner's tax returns for the taxable years and for a long time prior thereto were prepared by a certified public accountant upon whom it depended and in whom it had confidence.
Executive salaries allotted by the Commissioner for the base period years compare with net earnings (before salaries considered) as follows: 1937, 28.32; 1938, 45.57; 1939, 54.74; 1940, 38.32. Average for the four years was 39.36 per cent. For the taxable years 1943 and 1944 the percentage was 22.73 and 21.53.
The reasonable annual compensation for the partners in each base period year was $ 10,400.
OPINION.
The only question we have here is whether the Commissioner erred in computing excess profits tax for the taxable years by considering $ 10,400 per year the reasonable compensation of the partners during the base period years, in determining excess profits tax credit. The parties do not disagree as to the facts that the previous partnership was a component corporation within the meaning of section 740 (b) (1) (5), Internal Revenue Code, *189 and that computations are required under section 742 (g), Internal Revenue Code, as if the partnership were a corporation; and both rely upon Regulations 112, section 35.742-1 (b) (2), providing in pertinent part that among the adjustments necessary in computing excess profits net income or deficit are: "A reasonable deduction for salary or compensation to *1196 each partner or the sole proprietor for personal services actually rendered shall be allowed."
The partners actually received $ 5,200 each in the taxable years by way of a drawing account, before division of partnership profits. The Commissioner used $ 10,400 in computing the excess profits tax credit. The petitioner, in its original excess profits tax returns for the fiscal years 1941 and 1942, also used $ 10,400, but after filing its return for 1943, on November 1, 1943, it filed amended returns for 1941 and 1942, using $ 6,000 for each of the last three base period years and $ 7,550.98 for the first base period year. These figures it had used in its excess profits tax return for 1943. The Commissioner determined deficiencies according to the difference in the figures used by him and petitioner.
We first consider*190 the petitioner's contention that the figures used by it are proper because they are the proper figures for "earned income" upon which "earned income credit" was based under the provision of section 25, Revenue Act of 1936, 1 and as applied to partners by sections 184 and 185, Revenue Act of 1936. The contention is, in short, that, since under section 25 (a) (4) 20 per cent of net profits shall be considered earned income when the taxpayer is engaged in a business where, as here, both personal services and capital are material income producing factors, and since such 20 per cent was $ 7,550.98 for 1937 and $ 6,000 for the remaining base period years (total for the two partners) that figure must be used in computing excess profits tax. To this the respondent replies that "earned income credit" under section 25 is not the criterion; that the section is a relief section, in the nature of an additional exemption for normal tax computation, to be used solely for that purpose. In our opinion the respondent's view is correct. Section 25 (a) is headed "Credits for Normal Tax Only" and states specifically "There shall be allowed for the purpose of the normal tax, but not for the surtax, *191 the following credits against the net income: * * *" In subsection 4 it defines "Earned income" "For the purposes of this section." In the light of such provisions we think we may not, for the purpose of another portion of the statute, involving excess profits tax, limit the range of *1197 inquiry as to what is a reasonable deduction for salary or compensation merely to a computation of earned income under section 25, where clearly the matter is one of an exemption in the form of a credit. The fact that "earned net income" is arbitrarily set as not less than $ 3,000, or more than $ 14,000 indicates that the concept does not in general govern the question of fact as to what is reasonable compensation, which might be actually above or below that range. Obviously, under section 23 (a) (1) a salary under $ 3,000 or over $ 14,000 might be a reasonable deduction. The respondent's contention on the point is sustained.
*192 The petitioner contends also that the determination of deficiency is invalidated because it is based upon the allotment of executive salaries in the lump sum of $ 10,400 instead of separately to each partner, under the language of the regulation providing for adjustment by allowance of "a reasonable deduction for salary or compensation to each partner * * *." Petitioner cites Shield Co., 2 T. C. 763, and L. Schepp Co., 25 B. T. A. 419, as authority that salaries should be separately considered as to reasonableness. However, even assuming that in this matter of excess profits tax and computation of excess profits tax credit the same considerations apply as in the case of section 23 in regard to reasonable salaries thereunder, Miller Mfg. Co., v. Commissioner, 149 Fed. (2d) 421, is against petitioner's view; for there, though agreeing that proper procedure is for the Commissioner and Tax Court to find definitely what is reasonable compensation for each officer, rather than in an aggregate lump sum, the Circuit Court nevertheless holds that such lump sum determination does not rob the Commissioner's*193 finding of presumption of correctness or relieve petitioner of the burden of proof. The court refused to remand for specific findings as to each officer. We are therefore of the view that the burden of proof and validity of the determination of deficiency are not affected by the form of determination of reasonableness of compensation, in a lump sum.
We come then to the factual question as to whether the Commissioner erred, in computing excess profits tax credit, by allowing deduction in the base period years of $ 10,400 each year for partners' salaries or compensation. The petitioner thought those figures were reasonable when it filed its excess profits tax returns for the fiscal years 1941 and 1942, but it now says that it erred in so considering. It used the lower figures ($ 7,550.98 for the first base period year and $ 6,000 thereafter) when it came to file its excess profits tax return for the fiscal year 1943, the first to show a tax due. This is clearly a case of "blowing hot and cold" as affected by tax results. It was not until after the filing of the 1943 return that those for 1941 and 1942 were amended to use the lower figures. The attitude taken at an *1198 *194 earlier date, without monetary reason to do so, must logically be considered with the other evidence in deciding what is the reasonable figure for salaries, for the treatment and interpretation by parties are always pertinent in ascertaining intent. After the partners had for four years drawn $ 5,200 each per year on a drawing account, and after the petitioner corporation had for two years computed base period net income by using those figures as reasonable compensation, a lowering of those figures to secure better tax results must be scrutinized with care. That fact, however, does not alone control; the control lies in all of the pertinent facts. These we have carefully examined. The petitioner urges, in effect, that Manscoe was not reasonably worth $ 5,200 per year because of the condition of his health, especially after the fiscal year 1937. He died in August 1940.
The evidence is indefinite in some respects. It is apparent that he did work even contrary to his doctor's ideas, and evidence that he was incapacitated from carrying on his work does not appear earlier than the last year before his death. Yet his physician testified that his condition was about the same in 1939*195 as in 1938, so that it does not affirmatively appear that he could not substantially carry on, even as late as 1939. Only after the latter part of 1938, or early in 1939, was he unable to "put in full days," and whether that means all or only a part of the time is not clear. The partnership permitted him to draw $ 5,200, and the corporation even later considered it reasonable. We find ourselves unable to say that he was not reasonably worth that amount, even though he may not have put in very full time, or even not much time, toward the last. He apparently was a valuable man, and his contribution, even despite illness, may have been worthy of his hire. The argument that because of his condition earnings decreased does not seem to be borne out by the record, for, though earnings decreased from about $ 37,000 for the fiscal year 1937 to about $ 22,000 in 1938, there is very little to indicate any lessening of Manscoe's efforts or value so early as that time, and though profits then, for 1939, went down to about $ 19,600, they again rose to about $ 28,600 for the fiscal year ended April 1940 -- just at the time when Manscoe, under the evidence, was becoming incapacitated, and shortly*196 before his death. It seems rather clear from all this that Manscoe's physical condition did not greatly affect the profits of the partnership; from which it follows, we think, that his reasonable worth to the partnership was not greatly affected.
The petitioner points out however, that the salaries used by the Commissioner in computing the excess profits tax credit upon base period income represent a much greater percentage of net profits than did executive salaries in later fiscal years, 1943 and 1944, approximately 39 per cent as against 22 per cent; and the point is not devoid *1199 of force. But much of that force is dissipated by the fact that Post was the only executive whose salary is considered for 1943 and 1944, drawing $ 12,000 and $ 12,125, respectively (not greatly more than previously paid both Post and Manscoe in the partnership base years), whereas excess profits net income advanced for 1943 to $ 38,014.50 and for 1944 to $ 42,940.64. It seems obvious that Post carried on, for a comparatively small advance in salary, instead of the two former executives, so that of course the ratio of executive salary actually paid, to higher earnings, is lower. But we are *197 not convinced thereby that the $ 10,400 compensation paid in the base period years was excessive and not reasonable. The petitioner for about three years after the close of the partnership continued to regard the base period compensation as reasonable, and it changed that view only with prospective change in tax results. We think the Commissioner is not shown to have erred in his determination, and that the compensation paid the partners in the base period was reasonable.
Decision will be entered under Rule 50.
Footnotes
1. SEC. 25. CREDITS OF INDIVIDUAL AGAINST NET INCOME.
(a) Credits for Normal Tax Only. -- There shall be allowed for the purpose of the normal tax, but not for the surtax, the following credits against the net income:
* * * *
(3) Earned income credit. -- 10 per centum of the amount of the earned net income, but not in excess of 10 per centum of the amount of the net income.
(4) Earned income definitions. -- For the purposes of this section --
(A) "Earned income" means wages, salaries, professional fees, and other amounts received as compensation for personal services actually rendered * * *. In the case of a taxpayer engaged in a trade or business in which both personal services and capital are material income producing factors, a reasonable allowance as compensation for the personal services actually rendered by the taxpayer, not in excess of 20 per centum of his share of the net profits of such trade or business, shall be considered as earned income.↩