*78 Decisions will be entered under Rule 50.
1. The amounts paid by petitioner to its four officers in the taxable years 1942, 1943, 1944, and 1946, pursuant to its bona fide contingent compensation plan adopted in 1931, and consistently followed, constituted reasonable compensation for the services rendered to it by such officers in those respective taxable years.
2. The amount of $ 2,867.98, representing Illinois sales tax, which petitioner erroneously accrued and deducted in 1940, was not properly included in petitioner's 1943 income when the Illinois court held it was not liable for the payment of such tax.
*1 These consolidated proceedings involve deficiencies in income, *79 declared value excess-profits, and excess profits taxes for the years and in the amounts as follows:
| Declared | |||
| Year | Income tax | value excess | Excess profits |
| profits tax | tax | ||
| 1942 | $ 26,901.27 | $ 2,194.40 | |
| 1943 | 26,901.06 | $ 2,029.10 | |
| 1944 | 26,746.85 | 2,396.38 | |
| 1946 | 24,683.01 | ||
| 1947 | 400.98 |
The contested issues are (1) whether the respondent erred in disallowing in part compensation paid by petitioner to its four officers in the taxable years 1942, 1943, 1944 and 1946 as excessive, and (2) whether the respondent erred in including the amount of $ 2,867.98 in petitioner's income for 1943, representing Illinois sales tax accrued and deducted in 1940, but which petitioner never paid.
The case was submitted on a partial stipulation of facts and oral testimony. The stipulated facts are found accordingly. Other facts not stipulated are found from the evidence.
*2 FINDINGS OF FACT.
Petitioner is a Delaware corporation organized in 1926 and maintaining its principal office in the city of St. Louis, Missouri. It kept its books and filed its returns on an accrual method of accounting. Petitioner's tax returns for the periods involved were filed with the collector *80 of internal revenue for the first district of Missouri at St. Louis, Missouri.
Upon its incorporation petitioner exchanged its 50,000 shares of no par capital stock for the assets of the Streckfus Steamboat Line Company, an Illinois corporation, organized in 1910 and having a paid-in capital of $ 179,973. Petitioner, as did its predecessor, has principally engaged in the operation of excursion boats on the Mississippi River.
The founder of petitioner's predecessor was Captain John Streckfus, who had four sons, Joseph, John, Roy, and Verne, each of whom began working on the company's river boats as boys during their vacations. As each completed his education he became associated with the company on a full-time basis. All four sons learned the excursion boat business from the ground up. As they became eligible each passed the required examinations and were duly licensed as mates, engineers, pilots, and masters of river vessels.
After the death of the founder in 1926 the four sons took over the operation of the business. Joseph, the eldest son, became president and general manager; Roy was district manager in New Orleans; John was superintendent of construction, and Verne was assistant*81 superintendent of construction. The reasonableness of the compensation paid to these four officers is in controversy. The compensation paid by petitioner to each of such four officers for the years 1942 to 1947, inclusive, was as follows:
| Year | Joseph | John | Roy | Verne | |
| Streckfus | Streckfus | Streckfus | Streckfus | Total | |
| 1942 | $ 56,641.68 | $ 33,040.79 | $ 33,040.79 | $ 33,040.79 | $ 155,764.05 |
| 1943 | 61,874.76 | 36,093.57 | 36,093.57 | 36,093.57 | 170,155.47 |
| 1944 | 59,028.00 | 34,432.80 | 26,420.10 | 27,080.47 | 146,961.37 |
| 1945 | 17,708.76 | 10,330.05 | 10,330.05 | 10,330.05 | 48,698.91 |
| 1946 | 64,361.04 | 37,543.73 | 37,543.73 | 37,543.73 | 176,992.23 |
| 1947 | 36,734.88 | 21,428.56 | 21,428.56 | 21,428.56 | 101,020.56 |
In each of the years 1942 to 1947, inclusive, the petitioner paid a basic salary to Joseph Streckfus of $ 12,000; to John Streckfus, $ 6,999.96; to Roy Streckfus, $ 6,999.96, except in 1944 when he was paid $ 5,371.03; and to Verne Streckfus, $ 6,999.96, except in the year 1944 when he was paid $ 5,505.28.
The compensation paid to such officers in the years 1945 and 1947 was not adjusted by the respondent and is not in controversy.
*3 The amounts disallowed by the respondent as*82 excessive compensation for the taxable years 1942, 1943, 1944, and 1946 are as follows:
| Year | Joseph | John | Roy | Verne |
| Streckfus | Streckfus | Streckfus | Streckfus | |
| 1942 | $ 6,641.68 | $ 12,160.79 | $ 11,177.79 | $ 12,540.79 |
| 1943 | 11,874.76 | 15,213.57 | 14,230.57 | 15,593.57 |
| 1944 | 9,028.00 | 13,552.80 | 4,557.10 | 6,580.47 |
| 1946 | 14,361.04 | 16,663.73 | 15,680.73 | 17,043.73 |
During the taxable years involved the 50,000 shares of petitioner's capital stock outstanding were held in part by the petitioner's four officers, individuals related to the Streckfus family, the Mercantile Trust Company and Joseph Streckfus, as trustees, and certain individuals unrelated to the Streckfus family, in amounts as follows:
| Name | 1931 | 1942 | 1943 |
| Joseph Streckfus | 10,730 | 6,911 | 6,171 |
| Joseph Streckfus, Trustee | 27 | 27 | 27 |
| Joseph Streckfus family | 5,172 | 5,912 | |
| John Streckfus | 4,835 | 5,527 | 5,527 |
| Verne Streckfus | 4,807 | 5,432 | 5,432 |
| Roy Streckfus | 2,779 | 404 | 404 |
| Roy Streckfus family | 3,050 | 3,050 | |
| Lilly S. Manning family | 778 | 778 | 778 |
| Anna S. Manthey family | 501 | 701 | 701 |
| May Streckfus | 243 | 293 | 293 |
| Mercantile Trust Company and Joseph Streckfus, | |||
| Trustees | 15,203 | 15,203 | 15,203 |
| Unrelated | 10,097 | 6,502 | 6,502 |
| Total | 50,000 | 50,000 | 50,000 |
| Name | 1944 | 1945 | 1946 |
| Joseph Streckfus | 5,411 | 4,788 | 4,188 |
| Joseph Streckfus, Trustee | 27 | ||
| Joseph Streckfus family | 6,652 | 7,252 | 7,852 |
| John Streckfus | 5,527 | 5,527 | 5,527 |
| Verne Streckfus | 5,432 | 5,432 | 5,432 |
| Roy Streckfus | 404 | 404 | 404 |
| Roy Streckfus family | 3,050 | 3,050 | 3,050 |
| Lilly S. Manning family | 778 | 778 | 778 |
| Anna S. Manthey family | 701 | 701 | 701 |
| May Streckfus | 293 | 293 | 293 |
| Mercantile Trust Company and Joseph Streckfus, | |||
| Trustees | 15,203 | 15,203 | 15,203 |
| Unrelated | 6,522 | 6,572 | 6,572 |
| Total | 50,000 | 50,000 | 50,000 |
The trust which owned 15,203 shares was created by the will of Captain John Streckfus, Sr. The beneficiaries were his seven children, Joseph, Roy, John and Verne Streckfus, Lilly S. Manning, Anna S. Manthey, and May Streckfus. Each beneficiary had a one-seventh interest, or 2,172 shares each, except May whose interest was 2,171 shares. The unrelated stockholders consist of 13 or 14 individuals.
Petitioner's gross operating income, the amount of profit subject to its contingent compensation plan and the cash dividends paid in the taxable years in question are as follows:
| Profit subject | |||
| Year | Gross operating | to contingent | Dividends |
| income | compensation | ||
| plan | |||
| 1942 | $ 1,497,167.75 | $ 440,764.34 | $ 50,000 |
| 1943 | 1,539,168.20 | 484,373.46 | 100,000 |
| 1944 | 1,325,382.89 | 460,650.49 | 100,000 |
| 1946 | 1,597,784.73 | 505,092.29 | 100,000 |
*84 *4 In 1945 the dividend payment was $ 50,000.
At the annual meeting of the stockholders of petitioner held on January 12, 1931, a proposed contingent compensation plan based on profits for petitioner's main officers was unanimously adopted. At subsequent annual meetings of petitioner's stockholders for all years prior to 1942 similar plans with certain clarifying amendments were approved. At the annual stockholders' meeting held on January 12, 1942, the plan was amended by reducing the basic salary of the petitioner's three top officers and increasing the amount of profits required to be earned before the application of the graduated percentage rates for determining the amount of the contingent compensation. Under the 1942 plan, which remained throughout all the taxable years involved, the bonus payments were to be as follows:
Base Salary only when profits are below $ 50,000.
1/2 of 1% of base salary added to base for every thousand dollars of profit from $ 50,000 to $ 75,000.
3/4 of 1% of base salary added to base for every thousand dollars of profit from $ 75,000 to $ 100,000.
1% of base salary added to base for every thousand dollars of profit from $ 100,000 up.
In *85 determining the profits subject to the plan there were to be excluded gains or losses from the sale of securities in the current year, all income from securities, except so much thereof as is equal to the interest paid or accrued on the corporation's indebtedness for the current year, all unrealized increase or shrinkage in the book value of securities, and charges for Federal and state income and profit taxes paid or accrued in each year, including additional assessments of such taxes which the corporation may be required to pay.
During the 20 years the contingent plan of compensating petitioner's officers was in effect, the value of the petitioner's capital stock increased from approximately $ 4 to $ 27 per share.
In 1931 petitioner's officers inaugurated a plan to build steel boats to replace its wooden boats. In 1931 they acquired a steel hull steamer which they redesigned and completely rebuilt as a steel excursion vessel. This ship was placed in service in 1933 and was called the President. She was licensed to carry 3,146 passengers and had a crew of 180. The President operated between New Orleans and St. Paul during a 6-month period. In 1943 she was completely enclosed *86 and thereafter operated at New Orleans the entire year, making two trips daily except on Monday.
In 1936 petitioner purchased another steel hull for $ 25,000. The petitioner's officers and crew reconstructed this hull into one of the finest and most modern of steel excursion steamers at a cost of $ 730,029.48. She was christened the Admiral and placed in service in the spring of 1940. The Admiral is licensed to carry 4,400 passengers. *5 She carries a crew of about 250, including 80 waiters, 100 others engaged in operating the concessions and kitchen, and the remainder in operating the ship. The Admiral operated out of St. Louis, Missouri, during the season from May until the middle of September. She made two trips daily, except on Monday. The morning trip was from 10 a. m. to 4 p. m. and the evening trip from 9 p. m. to 12 p. m. The Admiral did not operate during 1945 because of the labor shortage. During this idleness Joseph and John Streckfus supervised the making of necessary repairs and the installation of elevators. They also installed elevators in the President at New Orleans. In 1946 the Admiral was operated two weeks over the normal season.
Petitioner owned*87 and operated a wooden hull steamer known as the Capitol. This ship was enclosed and heated and was operated in New Orleans during the winter season of 1942 and 1943.
Joseph Streckfus was president and general manager of the petitioner and had charge of its activities both at St. Louis and New Orleans. He attended to the finances, paid the bills, and supervised the advertising, and the selection and training of the crews, and other personnel, including the selection and training of the orchestras used on the Admiral. He also had charge of the purchasing of the food and liquid refreshments. Joseph Streckfus frequently accompanied the Admiral on trips and at times was in charge of the ship as master.
During the taxable years when the Admiral was in operation John Streckfus was the ship's master, and either Roy or Verne Streckfus was the alternate. They customarily arrived at the wharf at 7:30 or 8 in the morning, and supervised the preparation of the vessel for the morning trip. After the Admiral returned from the morning trip the vessel was cleaned and made ready for the evening trip. The officers usually left the ship about 12:30 a. m., having been on duty 16 or 17 hours. During*88 the period the Admiral was idle, John, under the direction of Joseph, supervised the repairs and improvements necessary for the next season.
Verne and Roy Streckfus had supervision and charge of the operation of the steamer President operating out of New Orleans. Roy acted as master and was in charge of navigation. Verne supervised the concessions, attended to purchasing the supplies, and the hiring and training of employees and had general supervision of the office, which the petitioner maintained in New Orleans. The President also ran a day and evening trip, so that working days of its officers were between 17 and 18 hours in length.
The hazardous nature of petitioner's business in carrying thousands of passengers made it subject to extensive regulation by Federal, state and local governments. Petitioner's officers had to be familiar with all such regulations and constantly alert to see that they were observed. *6 During the war years additional problems and responsibilities arose. Petitioner's officers had to meet additional harbor regulations, the rationing of food and materials, and the constant shortage and turnover of labor.
During the period between 1920 and 1935*89 there were about 28 competitors operating passenger steamers at various times, all of which were unsuccessful. Largely due to petitioner's modernized equipment, its safety record, the quality of its service and entertainment features, it had no competition from other excursion boats during the taxable years.
The petitioner's contingent compensation plan established in 1931 and continued in effect throughout the taxable years was bona fide. The compensation paid to each of petitioner's four principal officers, pursuant to such plan, in the respective taxable years in question was reasonable.
In its 1940 tax return petitioner claimed and was allowed a deduction of the amount of $ 2,867.98 accrued on its books as representing Illinois sales tax. Petitioner did not pay the tax, but contested its liability, and in 1943 the Illinois court, having jurisdiction, held that petitioner was not liable for the tax. In his deficiency notice the respondent included the amount of $ 2,867.98 in petitioner's gross income for the year 1943.
OPINION.
The primary question presented is whether the amounts paid to the four principal officers of petitioner constitute reasonable compensation for services*90 each rendered in the taxable years 1942, 1943, 1944, and 1946.
The compensation consisted of a fixed basic salary plus contingent compensation based on profits, the amount of which was determined upon the application of a graduated percentage ratio of certain profits arrived at under a specified formula. The four officers, whose compensation is in controversy, were shareholders of petitioner's capital stock in varying amounts, and the respective amounts paid to them bore no relation to their stockholdings.
The courts and the Treasury Regulations have long recognized the contingent method of fixing compensation, paid pursuant to a free bargain uninfluenced by any consideration other than securing on fair and advantageous terms the services of the individual. Draper & Co., 5 T.C. 822">5 T. C. 822; California Vegetable Concentrates, Inc., 10 T.C. 1158">10 T. C. 1158; Mayson Manufacturing Co. v. Commissioner, 178 F. 2d 115; Regulations 111, sec. 29.23 (a)-6 (2) and (3).
The plan of the petitioner under which the contingent compensation was paid was unanimously approved by its shareholders in 1931, more than 10 years*91 prior to the taxable years in question. Since 1931 the *7 stockholders of petitioner at their annual meetings have authorized the continuance of the plan. The plan adopted in 1942 and which was effective throughout the taxable years involved modified the plan in effect in prior years by reducing the basic salaries and by increasing the minimum profit required before the percentage rate was applicable.
When the contingent compensation plan was adopted in 1931, the four principal officers and their families held 49.4 per cent of the 50,000 outstanding shares of the petitioner's stock, individuals unrelated to the Streckfus family held 10,097 shares or approximately 20 per cent, and the remaining 15,203 shares were held in a trust of which the Mercantile Trust Company and John Streckfus were the trustees. The trust company by its duly authorized representative attended the meetings of petitioner's stockholders. While the contingent compensation paid in good years was liberal, in lean years it was less than adequate. It is to be noted that the respondent did not adjust the compensation paid to such four officers in the leaner years 1945 and 1947. The amounts paid in those years*92 were considerably less than the respondent allowed as reasonable in each of the taxable years, 1942, 1943, 1944, and 1946, in which the compensation paid is in controversy.
During the years the contingent compensation plan has been in effect the value of petitioner's capital stock increased from approximately $ 4 to $ 27 per share. In the years 1942 and 1945 dividends of $ 1 per share were paid. In 1943, 1944, and 1946, a dividend of $ 2 per share was paid, or a yield of 7.4 per cent.
The record, in our opinion, furnishes abundant evidence that the contingent compensation plan adopted in 1931 was a good faith transaction fairly entered into and beneficial to the petitioner. Accordingly, we have found as an ultimate fact that the plan was a bona fide arrangement and that the compensation paid to petitioner's four officers, pursuant to such plan in the taxable years 1942, 1943, 1944, and 1946, was reasonable. We hold that the amounts paid by petitioner to its four officers in the taxable years 1942, 1943, 1944, and 1946 as compensation for services rendered to it are properly deductible under section 23 (a) (1) (A) of the Internal Revenue Code.
The remaining issue presents the question*93 whether the respondent properly included the sum of $ 2,867.98 in the petitioner's income for 1943. In 1940 the petitioner accrued and deducted in its return for that year the amount of $ 2,867.98 representing Illinois sales tax. The respondent allowed the deduction. The petitioner did not pay the tax, but contested its liability therefor. In 1943 the Illinois court held that the petitioner was not liable for the payment of such tax, and the respondent included such amount in the petitioner's income for the taxable year 1943.
*8 In Dixie Pine Products Co. v. Commissioner, 320 U.S. 516">320 U.S. 516, and Security Flour Mills Co. v. Commissioner, 321 U.S. 281">321 U.S. 281, the Supreme Court held that a controverted obligation is not accruable until the dispute is settled even though the dispute is one of law.
The petitioner was on the accrual basis, and under the rationale of the above authorities the accrual of the amount of $ 2,867.98 as Illinois sales tax in 1940, the claimed deduction in the petitioner's return for that year, as well as the allowance of the deduction by the respondent, was improper.
All the facts pertaining to *94 this issue were stipulated, and there is nothing in the limited facts presented to indicate that the treatment of the controverted item by both parties was other than the result of a mutual mistake.
The respondent contends that his determination that the petitioner realized income in 1943 of the amount of $ 2,867.98 claimed and allowed as a deduction in 1940 should be sustained, since the petitioner has failed to establish the amount excludible under section 22 (b) (12) of the Internal Revenue Code.
The purpose of section 22 (b) (12), added by section 116 of the Revenue Act of 1942, and made retroactive to prior years, was to give relief to taxpayers who would otherwise have to pay a tax on recoveries, where the prior reduction resulted in no tax benefit. Central Hanover Bank & Trust Co. v. United States, 159 F. 2d 865. The section imposes no tax but grants an exemption. The petitioner concedes that it received a tax benefit in 1940, since the improper deduction reduced its taxable income for that year. It argues, however, that it realized no income in 1943 when the Illinois court sustained its contention that it was not liable for the payment *95 of the Illinois sales tax, and that an adjustment may be made only for the year 1940, which is barred by the statute. We think the position taken by the petitioner is correct. An erroneous deduction taken in a prior year may not be treated as income of a later year. Commissioner v. Schuyler, 196 F. 2d 85, and authorities therein referred to. Cf. El Dorado Oil Works, 46 B. T. A. 994; American Light & Traction Co., 42 B. T. A. 1121, affd. 125 F.2d 365">125 F. 2d 365; Greene Motor Co., 5 T.C. 314">5 T. C. 314.
The respondent contends for the application of the tax benefit rule, and cites cases wherein the rule has been applied to recoveries where deductions taken and allowed in a prior year resulted in a tax benefit. In all such cases the deductions appear to have been properly claimed and allowed. He refers us to no authority, nor has our independent search revealed any case where the tax benefit rule has been extended to cover deductions improperly claimed and allowed in a prior year where such year is barred by the statute, except where the plea of *96 estoppel has been sustained. Cf. Lloyd H. Faidley, 8 T.C. 1170">8 T. C. 1170. In the *9 instant case no estoppel has been pleaded, nor was any evidence presented showing any basis for an estoppel. We hold that the petitioner did not realize income in 1943, when the Illinois court determined the petitioner was not liable for the payment of the Illinois sales tax. The respondent erred in including in petitioner's gross income for 1943 the sum of $ 2,867.98 as a recovery of a prior deduction claimed and allowed.
Other issues covered by the stipulation will be given effect in the recomputation under the rule.
Decisions will be entered under Rule 50.