*1681 Petitioner, an advertising agency, held to be entitled to classification as a personal service corporation.
*187 The Commissioner determined deficiency in income and profits tax for 1920 in the amount of $8,350.49 and for 1921 in the amount of $1,275.25.
The petitioner asserts that the Commissioner committed error in computing its taxable net income for the calendar year 1920 in failing and refusing to allow as a deduction from gross income the sum of $3,519.25, representing a debt due from Frank Miller Company which was ascertained to be worthless and charged off within the taxable year 1920, and that the Commissioner likewise erred in failing and refusing to allow as a deduction from gross income the sum of $571.16, representing alleged debts due from American Railway Express ($333.76) and Mince Meat Manufacturers Association ($237.40) which were ascertained to be worthless and charged off within the taxable year 1921.
The petitioner also alleges that the Commissioner erred in*1682 holding that it is not entitled to classification as a personal service corporation in the calendar years 1920 and 1921.
At the hearing, counsel for the Commissioner conceded error on the part of the Commissioner in failing and refusing to allow as deductions the respective amounts for the respective years above mentioned and also conceded that capital was not an income-producing factor, leaving for our determination only the question of whether or not the petitioner is entitled to classification as a personal service corporation in the calendar years 1920 and 1921, the petitioner claiming that its income for those years is to be ascribed primarily to the activities of the principal owners or stockholders who are themselves regularly engaged in the active conduct of the affairs of the corporation.
The case is submitted on the pleadings, stipulations, testimony of witnesses and numerous exhibits.
FINDINGS OF FACT.
The petitioner is a corporation, organized and incorporated in 1903 under the laws of the State of New York, and after its incorporation and during the years 1920 and 1921 was engaged in the advertising business in New York, N.Y.
*188 Prior to incorporation, *1683 such business was conducted individually by Frank Finney. In 1903, Julian Street became associated with Finney and the business was incorporated under the name of Street and Finney, Inc. In 1903 Julian Street withdrew from the business, but the name, Street and Finney, Inc., was retained by the petitioner.
The original authorized and issued stock was 100 shares of common of a par value of $100 per share. The original stock was issued for the advertising business conducted by Frank Finney, furniture, fixtures, and good will. No cash was paid in for the stock. On July 1, 1921, the capitalization was changed to 2,000 shares of no par value common stock, the new shares being issued and exchanged for the old shares. No additional capital was at any time paid in.
The following were stockholders of the petitioner during the taxable years:
| Shares held in 1920 | |
| Frank Finney | 50 |
| F. N. Finney, his wife | 49 |
| Wyman M. Fitz | 1 |
Fitz resigned in July, 1920, and his share of stock was transferred to E. D. Beach.
| Shares held in 1921 | |
| Frank Finney, old shares until July 1 | 50 |
| Frank Finney, new shares after July 1 | 1,000 |
| F. N. Finney, old shares until July 1 | 48 |
| F. N. Finney, new shares after July 1 | 1,000 |
| E. D. Beach, old shares until July 1 | 2 |
*1684 E. D. Beach transferred his two shares to F. N. Finney on July 1, 1921.
The following were officers of the petitioner during the taxable years:
Year 1920 - Frank Finney, president.
F. N. Finney, treasurer.Wyman M. Fitz, secretary until July, 1920.
E. D. Beach, secretary after July, 1920.Year 1921 - Frank Finney, president.
F. N. Finney, treasurer. E. D. Beach, secretary.During the taxable years the following amounts were paid to officers and stockholders:
| Year 1920 | |
| Frank Finney, president, salary and bonus | $18,964.95 |
| F. N. Finney, treasurer, salary and bonus | 6,000.00 |
| W. Fitz, secretary, salary and bonus | 11,920.34 |
| Total | 36,885.29 |
| Year 1921 | |
| Frank Finney, president, salary and bonus | $17,799.18 |
| F. N. Finney, treasurer, salary and bonus | 8,750.00 |
| E. D. Beach, secretary, salary | 3,507.84 |
| Total | 30,057.02 |
*189 The number of employees of the petitioner and salaries and wages paid in the taxable years were as follows:
| Year 1920 | Year 1921 | |||
| Item | Number | Amount paid | Number | Amount paid |
| Art | 8 | $31,137.16 | 6 | $25,573.49 |
| Copywriting | 6 | 13,137.81 | 5 | 15,344.20 |
| Office management and research | 7 | 27,550.04 | 5 | 13,004.29 |
| Detail service | 7 | 43,587.33 | 6 | 28,132.95 |
| Mechanical preparation | 10 | 26,410.44 | 7 | 10,407.50 |
| Audit and accounting | 4 | 9,457.30 | 5 | 9,884.00 |
| Media | 2 | 5,140.00 | 1 | 4,680.00 |
| Contact assistant | 1 | 7,596.19 | ||
| Clerks, stenographers, typists, | 30 | 55,312.16 | 14 | 24,003.69 |
| errand boys, etc. (approximately) | 211,813.24 | 138,626.31 | ||
| Bonus, general | 5,175.02 | |||
| Total | 216,988.26 | 138,626.31 | ||
| Amounts which were charged to | 16,374.14 | 9,532.64 | ||
| clients for work performed in | ||||
| researches, art, etc., | ||||
| performed by employees | ||||
| Net amount paid | 200,614.12 | 129,093.67 |
*1685 In the above figures are included the amounts of salary and bonus paid to employees of the petitioner as follows:
| Employees | Item | 1920 | 1921 |
| ART | |||
| G. G. Clark | Salary | $5,300.00 | $8,849.86 |
| Bonus | 5,197.43 | 1,732.25 | |
| COPY WRITING | |||
| E. Fitz | Salary | n(1) | 2,600.00 |
| Bonus | (1) | 5,667.86 | |
| OFFICE MANAGEMENT AND RESEARCH | |||
| H. B. LeQuatte | Salary | 5,300.00 | 2,600.00 |
| Bonus | 5,197.42 | 1,732.25 | |
| DETAIL SERVICE | |||
| L. D. Hansen | Salary | 5,023.16 | 5,600.12 |
| B. Lee | do | 5,775.00 | (2) |
| F. G. Conway | do | 5,300.00 | 7,600.00 |
| Bonus | 6,212.70 | 2,042.77 | |
| A. Hanchett | Salary | 5,300.00 | 2,600.00 |
| Bonus | 5,197.42 | 1,732.55 | |
| E. D. Weeks | Salary | 2,625.00 | 5,850.00 |
| MECHANICAL PREPARATION OF | |||
| ADVERTISEMENTS | |||
| T. L. Wallace | Salary | 7,499.96 | n(2) |
| CONTACT ASSISTANT | |||
| C. S. Towerlin | n(2) | 7,596.19 |
*190 The various sources and amounts of petitioner's income for the year 1920 were as follows:
| Magazine | $232,565.85 |
| Newspaper | 46,279.50 |
| Poster | 660.00 |
| Preparatory work | 70,277.27 |
| Commissions on cost-plus contracts | 958.73 |
| Miscellaneous sales | 23.21 |
| Interest on Liberty bonds | 467.92 |
| Other interest | 887.50 |
| Special discount from printers and engravers | 4,185.09 |
| 356,307.07 |
*1686 The various expenses of the petitioner for the year 1920 were as follows:
| General expenses including office supplies and stationery | $30,384.62 |
| Legal expenses | 1,276.97 |
| Bank exchange and interest | 1,160.74 |
| Traveling and entertaining expense | 18,035.14 |
| Salaries to officers | 36,885.28 |
| Salaries, wages, and bonus to employees | 216,269.17 |
| Rent | 13,701.73 |
| Publicity | 7,263.51 |
| Telephone, telegraph, and postage | 5,505.46 |
| Bad debts claimed by the petitioner, disallowed by the | 4,653.86 |
| Commissioner and involved in this appeal | |
| 335,136.49 |
The various sources and amounts of petitioner's income for the year 1921 were as follows:
| Magazine | $114,933.91 |
| Newspaper | 55,056.25 |
| Poster | 1,104.66 |
| Preparatory work | 44,991.90 |
| Service fee in lieu of commission | 6,477.35 |
| Miscellaneous | 1,458.08 |
| Special discount from printers and engravers | 5,181.62 |
| Interest | 1,107.67 |
| Rent, part of office sublet | 2,733.36 |
| 233,044.80 |
The various expenses of the petitioner for the year 1921 were as follows:
| Salaries and bonus to officers | $30,057.02 |
| Salaries, wages, and bonus to employees | 133,159.19 |
| Preparatory work - sales expense | 7,791.45 |
| Publicity | 4,424.27 |
| Entertaining | 2,662.24 |
| Traveling | 8,782.83 |
| Postage and shipping | $1,853.70 |
| Office supplies | 3,317.03 |
| Telephone | 2,226.44 |
| Telegraph | 753.72 |
| Rent | 15,146.56 |
| Insurance | 1,278.37 |
| Legal expense | 1,534.62 |
| Dues in associations | 1,894.50 |
| Rate and credit service | 198.52 |
| Bank exchange | 69.63 |
| Office repairs and maintenance | 208.54 |
| Miscellaneous operating expenses | 3,736.52 |
| Interest | 2,126.52 |
| Taxes | 1,176.06 |
| Bad debts claimed by the petitioner, disallowed | 690.34 |
| by the Commissioner and involved in this appeal | |
| 223,087.71 |
*1687 *191 The gross sales of the petitioner for the year 1920 were $2,407,893.16 and for the year 1921 were $1,427,424.99.
The petitioner derived no income from Government contracts during the years 1920 and 1921.
The petitioner is an incorporated advertising agency. It had no machinery or printing presses and all mechanical work was done on the outside. Its principal stockholders during the taxable years 1920 and 1921 were Frank Finney and his wife, F. N. Finney. During said years, Frank Finney was regularly engaged in the active conduct of the affairs of the petitioner. He created the ideas around which the advertising campaigns were developed. He was not an artist, one P. G. Clark being employed as such. Finney, however, gave the artist the ideas and instructions as to what to prepare and the designs were submitted to him in rough forms and sketches and were gradually developed under his direction until finally approved by him. As to copywriting, Finney gave the ideas for the copy, roughed out the copy and turned it over to the copywriters for them to fill in the ideas. Copywriters did not completely execute any advertising and all their work, before acceptance, *1688 was approved by Finney.
As to media, the selection of magazines and newspapers and the space orders therein were all made by or under Finney's direction. All assistants and employees connected with petitioner's business worked under Finney's direction and supervision and such assistants and employees could not themselves have successfully carried on the business and retained the accounts. Finney conducted researches and closed all contracts with clients. Advertising space was not contracted for by the petitioner without an order from a client and space was not purchased by the petitioner and sold to *192 clients. Contracts between the clients and advertising agency could be terminated by the client at any time on 30 days' notice, the petitioner receiving no further commissions thereon. All advertising space ordered by the petitioner in publications belonged to the client. The petitioner's income came from commissions received from publications upon the insertion of advertising matter for its clients and service fees where the clients inserted no advertising matter in publications. The petitioner was not trading or merchandizing in anything. It had nothing to sell*1689 but services, the rendition of which to its clients was its sole and only business.
Mrs. F. N. Finney, the wife of the president of petitioner, was its treasurer. In order to discharge her duties as such she usually went to the office several times each week. Her time and attention, however, were devoted to the business of the company to such extent that she had little home life. She spent time at her home originating and experimenting with recipes of products of clients. She made frequent business trips with her husband and rendered much service in aiding him to secure accounts and in holding same; also in an advisory capacity in trying to develop new products. The advertising agency required the service and advice of a woman and Mrs. Finney, during the taxable years in issue, was the only woman rendering such service. Both she and her husband were engaged in the conduct of the affairs of the corporation, as heretofore stated.
The principal clients of the petitioner in 1920 numbered 24 and in 1921 numbered 23.
OPINION.
SEAWELL: The issues raised by the pleadings are whether or not the respondent erred in failing and refusing to allow as deductions from gross income*1690 for the years 1920 and 1921 alleged bad debt items in the amounts of $3,519.25 and $571.16, respectively, and whether the petitioner is entitled to classification as a personal service corporation in said years. At the hearing, the respondent conceded error in refusing to allow the aforesaid bad debt item.
In reference to the claim for personal service classification, the applicable law for the years 1920 and 1921 is found in section 200 of the Revenue Acts of 1918 and 1921, respectively. In order to qualify as a personal service corporation, the section requires such corporation to meet these tests: (1) The income of the corporation must be ascribed primarily to the activities of the principal owners or stockholders; (2) such principal owners or stockholders must themselves be regularly engaged in the active conduct of the affairs of the corporation; (3) capital, whether invested or borrowed, must not be a material income-producing factor; and (4) gains, profits or *193 income derived from trading as a principal, or gains, profits, commissions or other income, derived from a Government contract or contracts made between April 6, 1917, and November 11, 1918, inclusive, *1691 must not amount to or exceed 50 per centum of the gross income. A failure to comply with any one of these requirements is fatal to a claim for personal service corporation classification. , and .
The evidence is clear that the petitioner did not derive gains, profits or income from trading as a principal or derive such, or commissions or other income, from a Government contract or contracts made during the statutory period above mentioned.
The respondent at the hearing conceded that capital was not a material income-producing factor. It only remains, therefore, for this Board to consider and determine, in the circumstances of the instant case, whether the income of the petitioner is to be ascribed primarily to the activities of the principal owners or stockholders and whether such principal owners or stockholders were themselves, during the taxable years in question, regularly engaged in the active conduct of the affairs of the corporation.
The evidence shows that Finney and his wife were, during both years in quetion, the principal stockholders, *1692 Frank Finney being the president and his wife the treasurer of the petitioner. Both are shown to have been active in the conduct of the business of the corporation and, in view of what the evidence shows they did, were, in our opinion, and must nesessarily have been, in the sense of the statute, regularly engaged in the conduct of the affairs of the corporation. All that was done in the conduct and operation of the business was under the direction and supervision of Frank Finney, the president, who closed all contracts - a most important function.
The petitioner's manner of conducting its business was not materially different from numerous other advertising agencies which we have held entitled to personal service classification.
We are of the opinion, therefore, that petitioner is entitled to such classification, the evidence showing that petitioner's income during 1920 and 1921 is to be ascribed primarily to the activities of Finney and his wife, the principal stockholders, who were themselves during such years regularly engaged in the active conduct of the affairs of the corporation.
Our determination herein is in accordance with and controlled by our decisions in *1693 ;;; ; .
Judgment will be entered under Rule 50.