*40 Decisions will be entered under Rule 50.
1. Petitioners Al and Ethel Goodman were officers and, in effect, the sole shareholders of Al Goodman, Inc., a corporation engaged in the sale of "high-style" ladies' shoes at retail. In November 1949, the corporation advanced $ 145,000 to Al to be used by him to pay certain personal Federal income tax liabilities. The loan was secured by collateral worth more than twice the amount of the loan. Al and Ethel also withdrew certain sums from the corporation on open account and made repayments thereof from their salaries as corporate officers. At the close of 1949, their open accounts showed total debit balances of $ 6,913.45. Held, the $ 145,000 advance and the $ 6,913.45 balance of withdrawals on open account were regarded by all the parties as loans and Al and Ethel intended to repay them and did repay them from time to time. They were, therefore, loans to those petitioners and not taxable dividends.
2. In its fiscal year 1949, petitioner Al Goodman, Inc., paid no dividends but added all of its earnings after taxes to its accumulated surplus. It had never paid any dividends since its organization, March 30, 1946, although its *41 earnings were large. Held, petitioner was availed of in its 1949 fiscal year for the purpose of preventing imposition of surtax on its shareholders through the medium of permitting its profits to accumulate beyond the reasonable needs of its business. Consequently, it is liable for the surtax imposed under section 102, Internal Revenue Code of 1939, for that year.
3. In its fiscal year 1950, the corporation had net earnings of $ 114,175.35, out of which it paid taxes to the Federal Government of $ 42,830.80, it declared and paid dividends of $ 52,680 to its stockholders and added the remainder of its earnings, which was less than $ 20,000, to its accumulated surplus. Held, petitioner was not availed of in its fiscal year 1950 for the purpose of preventing imposition of surtax on its shareholders through the medium of permitting its profits to accumulate beyond the reasonable needs of the business. Consequently, it is not liable for the surtax imposed under section 102 for the fiscal year 1950.
*288 The Commissioner*43 has determined the following deficiencies in the income taxes of the petitioners:
| Docket | Petitioners | Year | Deficiency |
| No. | |||
| 42714 | Al Goodman, Inc | Fiscal year ended Mar. 31, 1949 | $ 16,108.52 |
| 42714 | Al Goodman, Inc | Fiscal year ended Mar. 31, 1950 | 6,289.16 |
| 42715 | Al Goodman and Ethel Goodman | Calendar year 1949 | 102,261.26 |
*289 A number of relatively minor adjustments made by the Commissioner in the reported net incomes of petitioners for the years involved were either not contested by petitioners, contested but abandoned at the hearing of these causes, or settled by stipulation. Those adjustments will be reflected in the Rule 50 computation. The issues remaining for decision are indicated in the statements accompanying the Commissioner's deficiency notices, as follows:
1. Petitioner Al Goodman, Inc. (Docket No. 42714):
It is held that during the taxable years involved [fiscal years ended March 31, 1949 and 1950], you were availed of for the purpose of preventing the imposition of the surtax upon your shareholders through the medium of permitting your earnings and profits to accumulate beyond the reasonable needs of your business and you are, therefore, liable for the*44 surtax imposed by section 102 of the Internal Revenue Code [of 1939].
2. Petitioners Al Goodman and Ethel Goodman (Docket No. 42715):
During the taxable year involved [1949] Al Goodman, Inc., a corporation controlled by you, advanced funds to you in the aggregate amount of $ 151,913.45 It is held that the amount in question was, in fact, a distribution to you of the earnings of the corporation and taxable to you as dividends under the provisions of Section 22 of the Internal Revenue Code [of 1939]. * * *
Petitioners by appropriate assignments of error contest the correctness of the foregoing determinations of the Commissioner.
FINDINGS OF FACT.
Some of the facts were stipulated and are so found.
Petitioners Al Goodman and Ethel Goodman are husband and wife who, during all times here material, resided in Charlotte, North Carolina. They filed a joint income tax return for 1949 with the collector of internal revenue for the district of North Carolina. For convenience Al Goodman will sometimes hereinafter be referred to as Al, and Ethel Goodman will sometimes hereinafter be referred to as Ethel.
Petitioner Al Goodman, Inc. (hereinafter sometimes referred to as the corporation), was *45 a corporation organized under the laws of the State of North Carolina on March 30, 1946, with its principal office and place of business in Charlotte, North Carolina. It was dissolved as of March 31, 1952, subject to the provisions of section 55-132, North Carolina General Corporation Law, which continued its corporate existence for 3 years for, among other things, the purpose of prosecuting and defending actions by or against it. The corporation filed its income tax returns for the 1949 and 1950 fiscal years with the collector of internal revenue for the district of North Carolina.
*290 Organization of Corporation and Nature of Its Business.
Al Goodman has been in the ladies' retail shoe business in Charlotte for over 22 years, commencing with the operation of a leased shoe department (hereinafter sometimes referred to as the leased department) in the Lucille Shop, a ladies' ready-to-wear clothing store located at 132 North Tryon Street. The leased department sold slightly higher than "popular" priced shoes. On or about January 15, 1941, Al expanded his operations by opening, as a sole proprietorship, a ladies' retail shoe store at 204 North Tryon Street in Charlotte *46 (hereinafter sometimes referred to as the main store.) That store catered to the "carriage trade" and carried only expensive, so-called "high-style," shoes. Its interior decoration was extensive, consisting of fine furniture, carpeted floor, draped walls, expensive lighting fixtures, and other decorations which gave it the appearance of a luxurious salon. The store's inventory of shoes was kept in stockrooms and was not visible to customers sitting in the store. In 1948, about $ 4,300 was spent on store redecoration and smaller sums were spent for that purpose in 1949 and 1950.
On March 30, 1946, Al Goodman, Inc., was organized and began business on April 1, 1946, in the main store and leased department. It acquired from Al the following sole proprietorship assets and liabilities of the main store and leased department:
| Assets | Liabilities and net worth | ||
| Cash | $ 49,700.00 | Liabilities | -0- |
| Accounts receivable: | |||
| Main store | 13,913.75 | ||
| Leased department | 3,818.42 | ||
| Inventory | 20,167.83 | Net worth | $ 87,600.00 |
| Total assets | $ 87,600.00 | Net worth | $ 87,600.00 |
An additional $ 300 in cash was contributed to the corporation so that it began business with $ 50,000 in cash, *47 and total assets and net worth of $ 87,900.
The corporation issued 879 shares of stock as follows:
| Number | |
| of | |
| Shareholder | shares |
| Al Goodman | 877 |
| Ethel Goodman | 1 |
| Morris Goodman (Al's brother) | 1 |
On October 1, 1946, 172 of Al's shares were transferred to Ethel, increasing her holdings to 173 shares and leaving Al with 705 shares. On or about November 4, 1949, one of Al's shares was transferred to Paul Ervin, his attorney, thus reducing Al's shares to 704. Al was the beneficial owner of the shares held by Morris Goodman and Paul Ervin and, when the corporation was finally dissolved on March 31, *291 1952, its assets were distributed in the proportion of 706 shares to Al and 173 shares to Ethel. Except as hereinafter noted Al served as the corporation's president and general manager, Morris as its vice president and manager of the leased department, and Ethel as its secretary-treasurer. The corporation's board of directors was composed of Al, Ethel, and Morris and, from on or about November 4, 1949, Paul Ervin.
The corporation carried on the same type of business as was previously engaged in by Al individually. Al was the moving spirit of the corporation, was*48 in complete control of all phases of its operations, and, in the trade, the corporation and Al were looked upon as one and the same. Al was an outstanding shoe merchant. He partially or completely designed most of the shoes sold in the corporation's two outlets, specifying to the supplying factories how he wished the shoes made. He was an excellent forecaster of styles and, as a consequence, the corporation's business prospered. The major hazard of the high-style shoe business is that high-styles usually become obsolete at the end of the season in which they are introduced. Consequently, if a particular style does not sell well during the season, the remaining inventory thereof usually must be sold to jobbers at a loss price approximating 40 per cent of the retailer's cost. Because of Al's excellent style forecasting, however, the corporation had a minimum amount of such losses.
The corporation's biggest selling season was the Easter season and, as a consequence, it conducted its business on the basis of a fiscal year ending at about the termination of that season (March 31), when its inventories were lowest. April and May were also heavy sales months for summer season shoes. *49 As for purchases, the corporation placed its orders for a particular season's shoes 5 to 6 months in advance of that season so that timely delivery would be assured. Because most of its shoes were specially designed by Al the corporation was committed not to cancel an order once a factory actually began work thereon, although payment on the order was not due until delivery.
At a later point in these findings is a table which includes certain pertinent data, regarding the corporation's purchases and loss sales of obsolete shoes to jobbers, for each fiscal year of its life.
Investments and Expansion of the Corporation.
On or about October 31, 1946, the corporation and Arthur Schwartz, a department store merchandise manager experienced in the ladies' shoe line, organized G. & S., Inc., to establish and operate a chain of ladies' retail shoe stores. It was felt that such an expansion of the corporation's business was wise because (a) Al's name was well known in parts of the South and would be sure to attract business to G. & S., (b) although a shoe shortage still existed and the factories were *292 allotting shoes to retailers on the basis of past experience, they were willing*50 to ship merchandise to stores in towns where they were not adequately represented, and (c) by purchasing shoes for both G. & S. and itself the corporation's buying power would increase, making it easier to satisfy the minimum quantity purchase requirements factories often imposed as a condition of making Al's specially designed shoes.
The corporation invested $ 40,000 in G. & S. on October 31, 1946, and Schwartz invested $ 5,000. In return the corporation received 350 shares of G. & S. preferred stock, and it and Schwartz each received 50 shares of G. & S. common stock. On September 3, 1947, the corporation and Schwartz each invested an additional $ 8,333.33 in G. & S. and each received 83 1/3 additional shares of G. & S. common stock. The total capitalization of G. & S. never exceeded $ 61,666.66. Schwartz at all times managed the operations of G. & S.
G. & S. opened leased shoe departments in stores in Raleigh and Greensboro, North Carolina, and Savannah, Georgia. It has opened no new outlets since 1948, but was and is on the alert for favorable locations in which to so do. Its business has prospered and its annual sales have passed the half million-dollar mark but have not*51 quite reached a million dollars. There is no evidence that any expansion contemplated by G. & S. in 1949 and 1950 could not have been financed out of its earnings, rather than through additional capital invested by the corporation and Schwartz.
On August 14, 1946, the corporation invested $ 4,312.50 in the stock of Johansen Bros. Shoe Company, one of the corporation's principal suppliers. The investment was made during the period when factories were still allotting shoes to retailers. The corporation felt that, as a stockholder, it might find it easier to purchase the quantity of shoes it desired.
On March 23, 1950, the Lucille Shop, in which the corporation operated its leased department, filed a petition in bankruptcy which was adjudicated the following day. By March 31, 1950, the corporation had liquidated most of its inventory in the leased department. The Lucille Shop finally closed in April or May. The corporation wished to again operate a leased shoe department on those premises whenever a new store was opened there. In September 1950, such a new store was opened and the corporation thereupon formed Eddy's, Inc., to operate a leased shoe department therein. The corporation*52 invested $ 40,000 in Eddy's common stock, which $ 40,000 largely represented the proceeds derived from liquidating the inventory of its former leased department in the Lucille Shop.
Early in 1947, Al requested the owner of the main store to extend the building 22 feet, since the corporation needed more space. The *293 owner agreed to do so but wished to wait until building costs declined. The minutes of the January 21, 1947, meeting of the corporation's board of directors record the following resolution:
RESOLVED that the President [Al] continue to press [the building owner] * * * in the matter of enlarging the building and to explain to him that the Corporation stands to spend between $ 30,000 and $ 50,000 in the matter.
The building was finally extended 17 feet in 1952 at a cost to the corporation of $ 4,826.41. The delay in carrying out the enlargement plans was in part occasioned by the fact that (as hereinafter discussed) negotiations for a new lease to supersede the one then in effect for the main store were being conducted. The new lease was not signed until October 19, 1951.
Lease Situation and Dissolution of Corporation.
When Al first opened the main store, *53 as a sole proprietorship, he entered into a 5-year lease for the premises, commencing January 15, 1941, at a rental of $ 400 per month for the first 3 years and $ 425 per month thereafter. On September 30, 1944, Al leased the main store for 7 years, commencing on January 15, 1946, and terminating on January 14, 1953, at a rental of $ 600 per month. The lease permitted assignment or subletting only with the owner's written consent. When the corporation was formed on April 1, 1946, to take over Al's business the lease remained in Al's name but the rent was paid directly by the corporation. The owner at no time gave Al written consent to assign or sublet the store to the corporation and the corporation's tenancy thereof was by sufferance. However, the landlord at no time indicated any objection to the occupancy by the corporation.
The main store was located in a business area which was known as Charlotte's center of exclusive women's shops. Al became aware of the fact that a trend was developing in Charlotte toward leasing business property for rentals based on a percentage of the tenant's gross sales, with a minimum rental guaranteed, rather than for flat rentals. Therefore, *54 during the latter part of 1948 he began contacting the property owner with a view toward obtaining a new flat rental lease, either to supersede the lease then in effect or to commence when the current lease terminated on January 14, 1953. He thereby hoped to assure the corporation a longer period of occupancy of the main store at favorable rates. However, the owner's representative did not wish to discuss the matter until near the end of the term of the existing lease, although Al continued contacting him in hopes he might do so. There was never any indication that Al would not be able to obtain a renewal of the lease on the main store, the only uncertainty was as to the rental that would be demanded therefor.
*294 In April 1949, Al told his real estate agent to be on the alert for any favorable location that might be leased for the main store. Al also told the real estate agent that if no favorable location could be leased he would consider buying property.
The minutes of a special meeting of the corporation's board of directors, dated May 4, 1951, are in part as follows:
The Chairman [Al] then called the attention of the directors to the fact that the lease on the place *55 of business in which the corporation conducts its business affairs will expire in January 1953 and that if a new lease is negotiated with the owner of the premises it will be necessary for the corporation to make a substantial investment in redecorating and modernizing the interior of the place of business; that he had been carrying on negotiations with the owner of said property lasting over a period of more than a year in an effort to work out a new satisfactory lease arrangement in order that the directors of the corporation might know as early as possible what the probable expense of renovation and modernizing the quarters would amount to but that so far he had not been able to work out a satisfactory arrangement for a new lease but that these negotiations were still proceeding.
Mr. Al Goodman also called the attention of the directors to the fact that if negotiations for a renewal of the lease are not satisfactorily completed it might become necessary for the corporation to purchase a site for its own use and that in view of this possibility negotiations have been underway between him and certain real estate agents in Charlotte concerning the possible purchase of an appropriate*56 site; that such a purchase would require the expenditure of a very large sum of money, possibly aggregating as much as $ 250,000.00, and that it was his feeling that the corporation should, therefore, keep its financial affairs in as liquid a condition as possible so that the corporation would be prepared financially to meet the situation either by purchasing a site or by renovating its present site upon obtaining a renewal of the lease agreement.
On October 19, 1951, a new lease was entered into between Al and the owner of the main store property. The lease was for a period of 7 years, from January 15, 1952, through January 14, 1959, and superseded the last year of the then existing lease. The monthly rental was set at 5 per cent of gross sales, or $ 1,250, whichever sum was greater. Al, who had been advised by his attorney in March 1950 that it was unwise to have the lease in his name individually because it made him personally liable for the rent and because the corporation could be required to vacate the premises at any time, endeavored to get the lease in the corporation's name but was not successful. Moreover, the lease prohibited assignment or subletting without the owner's*57 written consent.
The minutes of a special meeting of the corporation's board of directors on March 14, 1952, include the following:
Mr. Goodman further explained that extensive efforts had been made to try to find a suitable location for the corporation's business in various sections of the City of Charlotte; that efforts had been made to purchase a building on S. Tyron Street and negotiations had been undertaken with W. T. Grant & Co. for the corporation either to purchase or to rent a suitable space on the property *295 just north of the present location, but that all of said efforts were fruitless and that the only lease which could be procured was a lease from J. P. Hackney, Sr., trustee, copy of which is attached to these minutes and which lease the said landlord would make only to Al Goodman, individually; that said lease agreement has been executed and became effective as of January 15, 1952 and that the landlord has simply permitted this corporation to continue to occupy said premises at sufferance and this corporation has been paying the rent thereon since January 15, 1952. Mr. Goodman pointed out that this situation has created an undesirable and untenable position*58 for the corporation because at any time the landlord could forbid further use of the premises by the corporation and Mr. Goodman suggested that serious consideration be given to a liquidation of the corporation, said liquidation to be effective as of the end of the fiscal year of the corporation on March 31, 1952. Mr. Goodman further stated that as the situation now stands insofar as the lease agreement with J. P. Hackney, Sr., trustee, is concerned, he personally is in position of being a guarantor or surety for the payment of the rental provided for in said agreement, and that he feels that this is unfair to him and places him under an unnecessarily heavy legal obligation for which the corporation pays him no compensation.
Thereafter, a resolution was passed to the effect that it would be to the best interests of the stockholders (who were the same people as the directors) to dissolve the corporation effective March 31, 1952. The stockholders, at a meeting held immediately after that of the board, voted to so dissolve the corporation. Upon dissolution the corporation's assets were split between Al and Ethel on the basis of 706 shares and 173 shares, respectively. Since dissolution*59 the business has been conducted as a limited partnership by Al and Ethel.
Loans to Al and Ethel, and Dividends Paid.
In 1948, Al was called in by the head of the Charlotte office of the Bureau of Internal Revenue's intelligence division and realized that he might be in tax difficulties. He became aware of the seriousness of the matter when, in March 1949, an indictment was returned against him for income tax evasion covering the taxable years 1942, 1943, and 1944. On October 7, 1949, Al, upon advice of his attorneys, entered a plea of nolo contendere in the United States District Court for the Western District of North Carolina, was adjudged guilty, and was sentenced to an 18-month sentence in a Federal penitentiary. The court allowed Al 30 days in which to set his business affairs in order. His sentence was to begin on November 7, 1949.
Al, who was very much disturbed by the sentence, engaged Paul Ervin, an attorney and neighbor, to seek reduction in the sentence, and to advise his wife and serve as attorney for, and a director of, the corporation in his absence. Ervin was also to endeavor to secure an additional 30-day stay in the execution of Al's sentence so that Al might*60 have added time to settle his affairs.
Al then went to Chicago to plan the corporation's purchases for the coming seasons. He returned to Charlotte on the morning of Friday, *296 November 4, at which time Ervin informed him that the court refused to grant the additional 30-day stay. However, it was Ervin's impression that the court would seriously consider reducing the 18-month sentence if Al paid his Federal tax liability for the 1942-44 period covered by the indictment. That tax liability was known to be about $ 185,000. It was also then apparent that Al was liable for additional State income taxes for 1942-44, and for additional Federal income taxes for 1945-47, which would increase his total tax liability to between $ 200,000 and $ 225,000. The State tax liability for 1942-44 was subsequently determined to be $ 20,299.89 and the Federal liability for 1945-47 to be $ 20,077.99 (and both were paid by personal checks in November 1950).
The approximate value of the assets Al and Ethel owned on November 4, 1949, was, in addition to their stock in the corporation, as follows:
| United States Treasury bonds (cash value) | $ 90,000 |
| Building and loan shares | 10,000 |
| Samuel Shoe Company stock | 10,000 |
| Pennsylvania Railroad Company stock | 2,800 |
| Packard Motor Company stock | 1,000 |
| Pan-American Airways stock | 6,000 |
| American Smelting Company stock | 6,000 |
| Al's savings bank account | 24,000 |
| Lot on Queens Road, Charlotte | 35,000 |
| Al's residence | 50,000 |
| Total | $ 234,800 |
*61 However, Al did not wish Ethel to be troubled, after he departed to serve his sentence, with liquidating any of those assets in order to raise the necessary funds with which to pay his taxes. Consequently, he had only until Monday, November 7 (the day his sentence began), to himself raise the funds with which to satisfy his Federal income tax liability for 1942-44.
On the evening of November 4, therefore, a meeting of the corporation's board of directors was called. At that meeting Ethel was elected president of the corporation in place of Al who resigned both as president and as a director but was then elected vice president. Morris Goodman was elected secretary-treasurer. 1 Paul Ervin's firm was selected as attorneys for the corporation and Ervin was subsequently elected a director to take Al's place. It was agreed that since Al was the moving spirit of the corporation it would be wise for the other officers to consult him on business matters during his imprisonment. The matter of a loan to Al was then discussed and the minutes of the *297 meeting indicate that a loan in the amount of $ 175,000 was first considered, but that $ 145,000 was felt to be all the corporation*62 could prudently lend if it were to avoid any possibility of risk of a cash shortage in conducting its operations. The directors felt that it would be to the best interests of the corporation to lend Al money to pay his Federal tax liabilities for 1942-44 since it would probably hasten Al's return to the active management of the corporation.
A loan of $ 145,000 was agreed upon by the board, which loan was to be evidenced by a note payable on demand, was to bear interest at 2 1/2 per cent per annum, and was to be secured by an assignment of all of Al's stock in the corporation. At a stockholders' meeting held immediately after the board meeting the board's action was approved. As of the date of these board and stockholders' meetings*63 the corporation's bank balance was $ 353,430.77.
On Monday morning, November 7, 1949, Al executed a negotiable demand note for the $ 145,000, bearing interest at 2 1/2 per cent per annum, and executed a trust instrument (in which Paul Ervin was named as trustee) pledging his stock in the corporation as security for the note. The note, trust instrument, and pledged stock were delivered to Ervin and were retained by him until the note was paid in full, as discussed below. The pledged stock was worth at least twice the amount of the loan. Immediately after this transaction Al turned himself over to the Federal authorities and began serving his sentence.
Al's Federal tax liability for 1942-44, the years covered by the indictment, was fixed at $ 183,216.43 and was paid on November 8, 1949, with funds obtained from the following sources:
| Loan from corporation | $ 145,000.00 |
| Al's savings bank account | 24,000.00 |
| Ethel | 14,216.43 |
| Total | $ 183,216.43 |
On December 2, 1949, the District Court reduced Al's sentence from 18 months to a year and a day. Al was paroled on March 7, 1950, after serving one-third of the reduced sentence. One of the inquiries made by the parole board was*64 whether Al had paid the $ 183,216.43 tax liability. The answer to that inquiry was that he had paid it.
Ervin had suggested in discussions just prior to the time Al departed to serve his sentence that the corporation, which had theretofore never paid a dividend, then do so in order to establish a dividend paying pattern. However, it was decided that the corporation should maintain itself in a strong cash position so as to be able to weather a possible business slump resulting from the adverse publicity of Al's imprisonment and so that it would have no trouble paying its suppliers promptly without need of credit extension. In this latter respect it was anticipated *298 that, since there was feeling in the industry that Al's imprisonment would injure the corporation's business, it would probably be difficult to obtain credit from suppliers were it necessary to do so. It was soon evident, however, that the adverse publicity had no noticeable ill effects on the business and that the corporation was able to meet its supplier obligations without difficulty. Consequently, on December 20, 1949, the board of directors voted a 60 per cent dividend, amounting to $ 52,740, but paid *65 out only $ 52,680. 2 On December 28, Al received $ 42,360 thereof, $ 120 of which represented dividends on the shares held by Paul Ervin and Morris Goodman but of which Al was the beneficial owner, and Ethel received $ 10,320. Al did not vote on the payment of the dividend, since he was then in prison and not a member of the board, but he was consulted about it prior to its declaration. This was the only dividend the corporation ever paid.
The loan to Al was carried continuously on the corporation's books as an asset. The loan was also shown as an asset in the corporation's annual audit reports, financial statements, and State and Federal tax returns. It was understood that Al was to pay the interest and was to make payments on the principal of the note from time to time until the *66 note was completely paid off. No definite time was established, however, for such payments.
Al repaid $ 45,000 of the note's principal on March 30, 1950, and paid $ 3,300 in interest on March 28, 1951. Part of the funds for the $ 45,000 repayment was derived from the $ 42,360 dividend received by Al from the corporation. At a board of directors' meeting on May 4, 1951, Al agreed that he was able to pay the balance of the note on 30 days' notice. At all times Al was financially able to repay the note in full by liquidating a portion of his personal assets, the greater portion of which was liquid.
On November 19, 1951, Al made a further interest payment of $ 2,193.01 on the note. On March 31, 1952, the date of the corporation's liquidation, $ 100,000 remained payable on the principal of the note and $ 990.35 was due in interest. These were discharged by an adjusting journal entry which resulted in Al's paying tax, at capital gains rates, on the $ 100,990.35 total as a corporate asset distributed to him in the liquidation.
Al and Ethel occasionally withdrew money from the corporation, on open account and without specific consideration by the board of directors, and made various *67 repayments thereof. Their personal accounts on the corporation's books, which accounts were reflected in all the corporation's financial reports and tax returns, reveal in part the following: *299
| Al | |||
| Date | Explanation | ||
| Debit | Credit | ||
| Apr. 1, 1947 | Balance | $ 2,913.45 | |
| Mar. 31, 1948 | Contributions, Apr. 30, 1947, to | ||
| Mar. 31, 1948 | 2,452.08 | ||
| Mar. 31, 1948 | Journal entry (Bonus) | $ 2,500.00 | |
| Mar. 31, 1948 | Transferred to Donations account | 2,452.08 | |
| Mar. 31, 1948 | Bonus paid | ||
| Mar. 31, 1948 | Transfer to Accrued Taxes and Expenses | ||
| Apr. 1, 1948 | Balance | 413.45 | |
| June 30, 1948 | H. C. Northrop | 250.00 | |
| Aug. 31, 1948 | H. C. Northrop | 250.00 | |
| Mar. 31, 1949 | Journal entry (Bonus) | 2,500.00 | |
| Mar. 31, 1949 | Bonus paid | ||
| Mar. 31, 1949 | Transfer from Accrued Taxes and | ||
| Expenses | |||
| Apr. 1, 1949 | Balance | 1,586.55 | |
| July 31, 1949 | Al and Ethel Goodman | 7,500.00 | |
| Oct. 31, 1949 | Reimbursement | 2,500.00 | |
| Apr. 1, 1950 | Balance | 3,413.45 |
| Ethel | |||
| Date | Explanation | ||
| Debit | Credit | ||
| Apr. 1, 1947 | Balance | $ 1,500.00 | |
| Mar. 31, 1948 | Contributions, Apr. 30, 1947, to | ||
| Mar. 31, 1948 | |||
| Mar. 31, 1948 | Journal entry (Bonus) | 1,500.00 | |
| Mar. 31, 1948 | Transferred to Donations account | ||
| Mar. 31, 1948 | Bonus paid | $ 1,500.00 | |
| Mar. 31, 1948 | Transfer to Accrued Taxes and Expenses | 1,500.00 | |
| Apr. 1, 1948 | Balance | ||
| June 30, 1948 | H. C. Northrop | ||
| Aug. 31, 1948 | H. C. Northrop | ||
| Mar. 31, 1949 | Journal entry (Bonus) | 1,500.00 | |
| Mar. 31, 1949 | Bonus paid | 1,500.00 | |
| Mar. 31, 1949 | Transfer from Accrued Taxes and | 1,500.00 | |
| Expenses | |||
| Apr. 1, 1949 | Balance | 1,500.00 | |
| July 31, 1949 | Al and Ethel Goodman | 7,500.00 | |
| Oct. 31, 1949 | Reimbursement | 2,500.00 | |
| Apr. 1, 1950 | Balance | 3,500.00 |
*68 The various "Bonus" entries in Al's and Ethel's accounts represent part of the predetermined salaries of those petitioners; they were not amounts which, at the end of the corporation's fiscal year, were decided to be paid as additional compensation. The July 31, 1949, debits totaling $ 15,000 were withdrawals made for the purpose of paying an attorney's fee in connection with Al's tax difficulties. Al received a $ 5,000 reimbursement on that fee which, on October 31, 1949, was credited to his and Ethel's personal accounts on the corporation's books.
Following is a table containing certain financial data taken from the corporation's books and returns, prior to any adjustments by respondent, which are here pertinent:
| Selected Financial Data -- Al Goodman, Inc. | ||||
| Apr. 1, | Fiscal year ended Mar. 31 | |||
| 1946 | ||||
| 1947 | 1948 | 1949 | ||
| Cash on hand | $ 50,000 | $ 168,757.28 | $ 209,203.01 | $ 263,648.86 |
| Current assets 1 | 87,900 | 231,864.88 | 307,816.73 | 336,644.77 |
| Current liabilities | 80,070.96 | 72,381.17 | 44,949.36 | |
| Working capital | 87,900 | 151,793.92 | 235,435.56 | 291,695.41 |
| Sales (Retail) | 953,335.92 | 939,786.65 | 776,195.27 | |
| Loss sales of obsolete shoes | ||||
| to jobbers | ||||
| Total purchases | 611,281.96 | 623,551.65 | 487,821.75 | |
| Purchases paid for in first | ||||
| quarter (April, May, and | ||||
| June) | 134,797.26 | 202,729.86 | 95,310.09 | |
| Al's salary | 23,300.00 | 23,300.00 | 22,100.00 | |
| Ethel's salary | 11,900.00 | 11,900.00 | 13,700.00 | |
| Net income before Federal | ||||
| income taxes | 175,426.17 | 158,718.66 | 89,803.78 | |
| Net income after Federal | ||||
| income taxes | 108,780.38 | 99,221.14 | 55,744.82 | |
| Dividends paid | ||||
| Surplus | 108,580.38 | 207,801.52 | 263,606.14 |
| Selected Financial Data -- Al Goodman, Inc. | |||
| Fiscal year ended Mar. 31 | |||
| 1950 | 1951 | 1952 | |
| Cash on hand | $ 183,568.55 | $ 175,540.30 | $ 162,022.66 |
| Current assets 1 | 365,930.92 | 362,975.41 | 368,123.08 |
| Current liabilities | 52,577.37 | 34,800.37 | 25,089.36 |
| Working capital | 313,353.55 | 328,175.04 | 343,033.72 |
| Sales (Retail) | 764,925.69 | 632,586.18 | 511,721.44 |
| Loss sales of obsolete shoes | |||
| to jobbers | 22,262.23 | 10,638.58 | 15,655.10 |
| Total purchases | 467,247.81 | 401,714.13 | 337,433.64 |
| Purchases paid for in first | |||
| quarter (April, May, and | |||
| June) | 87,070.21 | 110,152.97 | 39,760.13 |
| Al's salary | 28,500.00 | 33,700.00 | 33,700.00 |
| Ethel's salary | 14,300.00 | 11,900.00 | 11,900.00 |
| Net income before Federal | |||
| income taxes | 114,175.35 | 79,504.69 | 48,837.89 |
| Net income after Federal | |||
| income taxes | 71,344.55 | 50,054.24 | 29,660.44 |
| Dividends paid | 52,680.00 | ||
| Surplus | 282,768.97 | 335,181.99 | 364,842.43 |
*70 *300 Ultimate Findings.
The $ 145,000 advanced to Al by the corporation to pay his Federal income tax liability, and the debit balances totaling $ 6,913.45 in Al's and Ethel's personal accounts (representing withdrawals by them from the corporation) were intended by the corporation, Al, and Ethel to be loans, and Al and Ethel intended to repay them in full. They were, in fact, loans and not taxable dividends.
The earnings and profits of the corporation were permitted to accumulate beyond the reasonable needs of its business in its 1949 fiscal year. The corporation was availed of in that fiscal year for the purpose of preventing the imposition of the surtax upon its shareholders through the medium of permitting its earnings or profits to accumulate instead of being divided or distributed.
The earnings and profits of the corporation were not permitted to accumulate beyond the reasonable needs of its business in its 1950 fiscal year. The corporation was not availed of in that fiscal year for the purpose of preventing the imposition of the surtax upon its shareholders through the medium of permitting its earnings or profits to accumulate instead of being divided or distributed.
*71 OPINION.
We first consider the issue applicable to petitioners Al and Ethel Goodman, to wit: Whether the corporation's "loan" of $ 145,000 to Al in November 1949 and the debit balances totaling $ 6,913.45 in their personal accounts with the corporation at the end of 1949 represented dividends within the meaning of section 115 (a), Internal Revenue Code of 1939, and therefore were taxable to them in that year under section 22 (a) of the 1939 Code, or whether they were loans as they purported to be.
Al and Ethel were, in effect, the sole stockholders of the corporation and Al was in complete control of its operations. That this fact is not controlling, as well as the correct test to be applied in determining the instant question, was set forth by us in Carl L. White, 17 T.C. 1562">17 T. C. 1562, 1568:
The important fact is not petitioner's measure of control over the company, but whether the withdrawals were in fact loans at the time they were paid out. Wiese v. Commissioner (C. A. 8, 1938), 93 F. 2d 921, 923, certiorari denied 304 U.S. 562">304 U.S. 562, rehearing denied 304 U.S. 589">304 U.S. 589 (1938).*72 The character of the withdrawals depends upon petitioner's intent and whether he took the company's money for permanent use in lieu of dividends or whether he was then only borrowing. Id. * * *
The question, therefore, is one of fact and one which we must decide upon consideration of all the circumstances present in this particular *301 case. Victor Shaken, 21 T. C. 785. Citation of many cases would, consequently, be of little value.
As regards the $ 145,000 advance to Al in November 1949, we note the following:
The advance was not for personal living expenses or the like, but, rather, to aid Al in a distressing circumstance. It was, for Al, an unusual, nonrecurring, emergency situation. Moreover, since Al was the "brains" of the corporation it was to the latter's best interest to do everything within reason to hasten his return to active management of the corporation's affairs. The payment of Al's tax liability, which was the purpose for which the loan was made, was regarded as, and in fact was, an important factor in reducing the time Al served in prison.
The advance was formally discussed and approved at meetings of the corporation's*73 board of directors and stockholders. Al executed a negotiable demand note for the $ 145,000, bearing interest at 2 1/2 per cent per annum, and executed a trust instrument pledging his stock in the corporation as security for the payment of the note. Those documents and Al's stock were delivered to the trustee named in the trust instrument. The stock pledged as security had a value in excess of twice the amount of the advance. Moreover, at all times Al had personal assets of considerable value in addition to the pledged stock which could have been resorted to to repay the loan.
Shortly after Al returned from prison in March 1950, he in fact did repay $ 45,000 of the advance to the corporation. The major portion of the funds for that repayment was derived from a dividend which Al had received from the corporation, but such dividend was declared by the corporation on December 20, 1949, and paid to Al on December 28. Interest, although not accrued on the corporation's books, was actually paid by Al in the amounts of $ 3,300 and $ 2,193.01 on March 28, 1951, and November 19, 1951, respectively.
Al was ready and willing to pay the $ 100,000 principal balance of the note on 30 days' *74 notice. That balance, which was outstanding when the corporation was liquidated on March 31, 1952, and the $ 990.35 interest accrued and unpaid at that time, were settled by adjusting journal entries in the liquidation which resulted in Al's paying taxes, at capital gains rates, on those amounts as corporate assets distributed to him in the liquidation.
The corporation consistently treated the $ 145,000 as a loan. It was shown as an asset of the corporation in its books, audit reports, financial statements, and State and Federal tax returns. While it is true that such bookkeeping entries by themselves are evidential only and not determinative of tax liability, the other evidence we have *302 detailed above serves to bolster the weight that may be given those entries. Irving T. Bush, 45 B. T. A. 609, remanded on another issue (C. A. 2) 133 F.2d 1005">133 F. 2d 1005.
We are convinced after a careful review of all of the circumstances revealed in the record, Victor Shaken, supra, that both Al and the corporation regarded the $ 145,000 advance as a loan which was to be repaid. Consequently, that advance*75 was a loan to Al in 1949, and not a taxable dividend. See Carl L. White, supra;Irving T. Bush, supra;Herman M. Rhodes, 34 B. T. A. 212, reversed on another issue (C. A. 6) 100 F.2d 966">100 F. 2d 966.
We have reached the same conclusion as respects the $ 6,913.45 debit balances in Al's and Ethel's personal accounts at the close of the 1949 calendar year. A study of those accounts indicates that withdrawals were made by those petitioners from time to time but that repayments were consistently made by crediting part of their salary to those accounts. Victor Shaken, supra. The net effect of these series of transactions was a credit balance in each of their accounts as of the start of the corporation's 1950 fiscal year (April 1, 1949).
We think it clear that the consistent repayments by petitioners of their withdrawals from the corporation, the last of which was a $ 5,000 repayment applicable to the $ 15,000 withdrawal for the attorney's fee, coupled with the reflection of the balances of their personal accounts in the corporation's financial records and*76 tax returns, constitutes conduct indicating that the parties involved regarded the withdrawals as loans and that Al and Ethel intended to repay them. See Carl L. White, supra.A further fact supporting this interpretation of Al's and Ethel's intent is that they at all times had ample resources with which to satisfy any debit balances in their accounts. Comey & Johnson Co., 8 B. T. A. 52. On this state of the record we deem it of no significance that the withdrawals were not formally authorized by the directors or that no interest was charged thereon, Irving T. Bush, supra, and we hold that the debit balances totaling $ 6,913.45 in Al's and Ethel's personal accounts at the close of the 1949 calendar year represented loans to them and not withdrawals taxable as dividends.
Section 102 Surtax.
The final issue in this proceeding is whether the petitioner corporation is subject to tax under section 102 of the Internal Revenue Code of 19393 for its fiscal years ended March 31, 1949 and 1950.
*77 *303 Respondent determined and contends that the corporation was "availed of for the purpose of preventing the imposition of the surtax upon its shareholders," under section 102 (a), by permitting its earnings and profits "to accumulate beyond the reasonable needs of the business," as that phrase is used in section 102 (c). If petitioner's earnings and profits were permitted to accumulate beyond the reasonable needs of the business then, under section 102 (c), such fact is determinative of the purpose to avoid the imposition of the surtax upon the shareholders, unless petitioner proves the contrary by a clear preponderance of the evidence. See Whitney Chain & Mfg. Co., 3 T. C. 1109, affd. (C. A. 2) 149 F.2d 936">149 F. 2d 936.
Whether or not petitioner permitted its earnings and profits to accumulate beyond the reasonable needs of the business and was "availed of" for the prohibited purpose are questions of fact to be determined from all the evidence. Helvering v. National Grocery Co., 304 U.S. 282">304 U.S. 282; Helvering v. Chicago Stock Yards Co., 318 U.S. 693">318 U.S. 693. Consequently, *78 "decided cases are not decisive and have comparative value only." World Pub. Co. v. United States, 169 F.2d 186">169 F. 2d 186.
From its inception the corporation prospered. It began operations with a working capital of $ 87,900, of which $ 50,000 was cash. By the opening of the 1949 fiscal year its working capital had increased to $ 235,435.56, of which $ 209,203.01 was cash, and it had accumulated a surplus of $ 207,801.52. Its net income for that year was $ 89,803.78, before Federal income taxes, and $ 55,744.82 thereafter. Consequently, at year's end, its working capital was $ 291,695.41, cash on hand was $ 263,648.86, and accumulated surplus was $ 263,606.14. We are not convinced that the petitioner corporation had any need at the end of that fiscal year ended March 31, 1949, for the further accumulation of surplus. It seems to us that its failure to distribute any part of its net profits for that year in dividends and the addition of $ 55,744.82 to its already large earned surplus was accumulating its earnings and profits beyond the reasonable needs of the business. Therefore, under section 102 (c), this is determinative of the corporation's purpose*79 to avoid surtax upon its shareholders unless the corporation by the clear preponderance of the evidence shall prove to the contrary. We do not think that the corporation by a clear preponderance of the evidence has proved to the contrary.
*304 We have endeavored to give full findings of fact on this section 102 issue and we do not deem it necessary to repeat them here. Petitioner has advanced a variety of reasons in an effort to prove that such accumulations were not beyond the reasonable needs of its business. However, after a careful consideration of petitioner's contentions, in light of all the circumstances involved, we have found that petitioner has failed to prove that its accumulations for the year ended March 31, 1949, were reasonably needed in its business, Latchis Theatres of Keene, Inc., 19 T.C. 1054">19 T. C. 1054, and that the unreasonable accumulations were to no extent, World Pub. Co. v. United States, supra, for the prohibited purpose. Helvering v. National Grocery Co., supra.
We think that the situation is different for the fiscal year which ended March 31, 1950. The corporation's*80 net income for that fiscal year was $ 114,175.35. Of this amount, it paid taxes to the Federal Government of $ 42,830.80, it declared and paid dividends of $ 52,680 to its stockholders, and it retained the remainder of its earnings for that year, something less than $ 20,000, adding it to earned surplus.
It was in this fiscal year that petitioner's president, Al Goodman, found himself in serious income tax difficulties, had to pay some $ 183,000 in income tax deficiencies and penalties, and was sent to Federal prison for his offense. There was certainly a period of uncertainty for the future of the corporation and its business at that time and when it is considered that it paid $ 42,380.40 to the Federal Government for taxes in that year and $ 52,680 in dividends to stockholders, we do not think that its addition to its surplus of the remainder of its earnings for that year, something less than $ 20,000, was an accumulation of its earnings beyond the reasonable needs of its business. Of course, as things turned out later, there was no apparent need for the accumulation because the ill effects of Al's conviction for income tax evasion did not prove as serious to the business as *81 might well have been expected. However, in passing judgment upon this section 102 issue for the fiscal year ended March 31, 1950, we must take conditions as they were then and not as they proved to be later. This we have done, and we decide the section 102 issue for the fiscal year 1950 in petitioner's favor.
One of the arguments which the Commissioner strongly urges for the application of the section 102 surtax to the corporation's fiscal year 1950 was the $ 145,000 loan which the corporation made to Al in November 1949. As indicated in our discussion relative to the first issue, the $ 145,000 loan to Al furthered the corporation's best interests since Al's early return to the business was vital. In fact, petitioner derived interest income from the loan and Al at all times intended, and had the resources, to repay the loan. The same intent and ability to repay was present in regard to the loans to Al and Ethel on open account. *305 None of the loans, therefore, weakened petitioner's financial position and they were not disguised dividends. Corporate Investment Co., 40 B. T. A. 1156. We do not think that the Commissioner's imposition of the*82 section 102 surtax for the fiscal year ended March 31, 1950, should be sustained. We so hold.
Decisions will be entered under Rule 50.
Footnotes
1. Following Al's return from prison a board meeting was held on March 26, 1950, at which time Al, Morris, and Ethel were elected to the offices they held before Al's imprisonment, i. e., president, vice president, and secretary-treasurer, respectively. Al also again became a director.↩
2. An error in computation was here made. Although $ 52,740 ($ 60 per share) was the total dividend voted, Ethel was designated to, and did, receive only $ 10,320 on 172 shares, rather than the correct sum of $ 10,380 on 173 shares.↩
1. Debit balances in Al's and Ethel's personal accounts are included in current assets as well as, beginning with the 1950 fiscal year, the $ 100,000 balance owed by Al on the $ 145,000 loan. The corporation's investments in the stock of G. & S. Inc., Eddy's Inc., and Johansen Bros. Shoe Company are not included in current assets.↩
3. SEC. 102. SURTAX ON CORPORATIONS IMPROPERLY ACCUMULATING SURPLUS.
(a) Imposition of Tax. -- There shall be levied, collected, and paid for each taxable year (in addition to other taxes imposed by this chapter) upon the net income of every corporation (other than a personal holding company as defined in section 501 or a foreign personal holding company as defined in Supplement P) if such corporation, however created or organized, is formed or availed of for the purpose of preventing the imposition of the surtax upon its shareholders or the shareholders of any other corporation, through the medium of permitting earnings or profits to accumulate instead of being divided or distributed, a surtax equal to the sum of the following:
* * * *
(c) Evidence Determinative of Purpose. -- The fact that the earnings or profits of a corporation are permitted to accumulate beyond the reasonable needs of the business shall be determinative of the purpose to avoid surtax upon shareholders unless the corporation by the clear preponderance of the evidence shall prove to the contrary.↩