Decision will be entered under Rule 50.
1. Petitioner, a corporation engaged in the purchase and sale of new and used automobiles and in the sale of parts and the rebuilding of motors, in January 1941 fixed maximum salaries of its officers for 1941 and in December 1941 provided by resolution that such part of the compensation as had not been paid in cash should be paid by the issuance of stock of the corporation and "this be done and paid during the month of December." Petitioner kept its books and filed its income tax returns on an accrual basis. Held, that the full amount of the salaries thus paid or incurred by petitioner is deductible in 1941 as ordinary and necessary business expense except to the extent that such compensation may be excessive.
2. The evidence examined and the amount of reasonable compensation of each officer determined for the year 1941.
*135 The Commissioner has determined a deficiency of $ 2,480.71 in petitioner's income tax for the year 1941 and of $ 3,131.95 in excess profits tax for the same year. The deficiencies are due to the addition to net *135 income as disclosed by petitioner's return of an unallowable deduction designated by the Commissioner as "(a) Compensation of officers $ 14,000.00." This adjustment is explained in the deficiency notice as follows:
| (a) Compensation of officers deducted in return | $ 32,727.48 |
| Allowed | 18,727.48 |
| Disallowed | $ 14,000.00 |
To the extent disallowed, it is held that the claimed deduction does not represent an ordinary and necessary business expense paid or incurred during the taxable *136 year within the meaning of Section 23 (a) and 24 (c) of the Internal Revenue Code.
The petitioner has assigned errors as follows:
(a) Respondent erred in determining that: The salaries allowed and paid to the officers of the corporation were excessive or unreasonable, or that the same was not an ordinary and necessary expense of the business.
(b) Respondent alleges that the salaries paid were (to the extent disallowed) not incurred or paid within the taxable year within the meaning of Sections 23 (a) and 24 (c) of the Internal Revenue Code.
FINDINGS OF FACT.
The petitioner is a corporation, organized under the laws of the State of New York in the year 1940. It is an authorized dealer in Ford automobiles, is engaged in the *136 business of buying and selling automobiles, the servicing of automobiles, and the buying and selling of automobile parts.
The corporation income and declared value excess profits tax return of petitioner for the year 1941 was filed with the collector of internal revenue for the first district of New York.
Prior to 1940 and since approximately 1916, the business of petitioner was conducted and owned by J. J. Hart. For many years Hart had in his employ Morris Katz, Fred Whitehead, Harry Abrams, and Thomas Opdyke. When petitioner was incorporated in 1940, J. J. Hart became president; Katz, secretary; Whitehead, treasurer; and Abrams, assistant secretary. Upon incorporation the aforementioned individuals subscribed to and paid for petitioner's capital stock at the rate of $ 1,000 per share. Fred Whitehead purchased one share for $ 1,000 and Morris Katz purchased three shares for $ 3,000. Respondent's Exhibit A shows the total outstanding capital stock of petitioner at the beginning of the year 1941 as $ 35,000. J. J. Hart testified that he believed he originally purchased 36 shares of the capital stock of petitioner at $ 1,000 per share, but he was not sure that 36 was the exact number. *137 Since there was only $ 35,000 worth of stock, or 35 shares, originally purchased and Katz and Whitehead purchased four of the 35 shares, the number purchased by Hart could not exceed 30, since the record shows that Harry Abrams purchased one share. The members of the board of directors of petitioner consisted of J. J. Hart, Morris Katz, Fred Whitehead, and Harry Abrams.
At a meeting of the board of directors held on January 2, 1941, the board passed the following resolution:
* * * *
*137 A motion was also duly made and seconded that the compensation of the Officers for the year 1941 be not in excess of the following amounts:
| Mr. John J. Hart | $ 18,000.00 |
| Thomas Opdyke | 1,825.00 |
| Morris Katz | 5,000.00 |
| Fred Whitehead | 5,000.00 |
| Harry Abrams | 5,000.00 |
It was further resolved that should there be insufficient cash during the year to pay the above salaries, that a weekly amount agreed upon by all officers be paid weekly and the balance of agreed salaries be paid by the issuance of stock in the Corporation.
At a meeting of the board held on December 15, 1941, the following resolution was passed:
The purpose of this meeting was to take up the matter of compensation due the officers as per resolution adopted at the *138 meeting held on January 2, 1941. At that time it was resolved that should the cash position of the corporation be insufficient to pay the full salaries of the officers, the balance would be paid by the issuance of stock.
A motion was made by Mr. Whitehead that this be done and paid during the month of December. Motion was seconded and so carried out.
Compensation paid in cash to the officers of petitioner during 1941 for services rendered was $ 18,727.48, the amount allowed by respondent in the deficiency notice.
On February 14, 1942, stock was issued to the officers of petitioner pursuant to the board's resolution dated December 15, 1941, as follows:
| Name | Shares | Alleged value |
| J. J. Hart | 30 | $ 12,000 |
| Morris Katz | 3 | 1,200 |
| Fred Whitehead | 1 | 400 |
| Harry Abrams | 1 | 400 |
| Thomas Opdyke | None | None |
| Total | 1 14,000 |
Petitioner paid no dividends in 1941. Petitioner's income tax return for 1941 shows gross sales in the amount of $ 1,252,015.02; cost of goods sold $ 1,067,435.56; and net income in the amount of $ 4,053.37. Its balance sheet shows cash in the amount of $ 462.36 at the beginning of the year 1941 and in the amount of $ 809.27 at the end of that year. This balance sheet *139 showed capital stock of $ 35,000 at the beginning of the year and of $ 49,000 at the end of the year, all denominated common stock. This balance sheet also showed earned surplus and undivided profits of $ 144.75 at the beginning of the taxable year and of $ 4,176.56 at the end of the year. In its income tax return for 1941 petitioner deducted $ 32,727.48 as salaries paid its officers, but the separate salaries paid each officer are not shown on the return.
*138 Reasonable compensation for the services of petitioner's officers actually rendered in 1941 was as follows:
| J. J. Hart | $ 12,000 |
| Morris Katz | 4,800 |
| Fred Whitehead | 4,800 |
| Harry Abrams | 4,800 |
The Commissioner, in his disallowance of $ 14,000 of the amount deducted by petitioner as salaries incurred and paid its four officers in 1941, did so upon the following basis: In the case of J. J. Hart, the amount that was held excessive was $ 12,000; in the case of Harry Abrams, the amount that was held excessive was $ 400; in the case of Morris Katz, the amount that was held excessive was $ 1,200, and in the case of Fred Whitehead, the amount that was held excessive was $ 400.
Petitioner kept its books and filed its income tax returns on an accrual basis.
The *140 fair market value of petitioner's stock in the latter part of December 1941 was at least $ 400 per share.
OPINION.
As has already been stated in our preliminary statement, the Commissioner, in his determination of the deficiencies, disallowed $ 14,000 of the deduction which petitioner took on its income tax return for 1941 as compensation paid or incurred to its four officers, stating that "To the extent disallowed, it is held that the claimed deduction does not represent an ordinary and necessary business expense paid or incurred during the taxable year within the meaning of Section 23 (a) and 24 (c) of the Internal Revenue Code."
It will be noted that the Commissioner in his determination of the deficiencies did not raise the point of the reasonableness of the salaries paid or incurred by the petitioner to its officers during the taxable year. However, both parties have treated the reasonableness of the salaries as one of the main issues in the case, and at the hearing much of the evidence which was received was devoted to that issue.
Neither at the hearing nor in his brief did respondent discuss section 24 (c) of the code. Therefore, we shall treat that section of the statute as not *141 being involved in the case.
Respondent, in his brief, states the issues involved as follows:
1. Where in addition to the salaries of officers of petitioner, who are the sole stockholders, which were paid in cash stock which was not shown to have any value, was issued to these officers in exact proportion to the stock already owned by them, is the amount deductible limited to the amount paid in cash?
2. In the alternative, if the Court should hold that the amount deductible is not limited to the amount paid in cash, should the amount of $ 14,000.00 be disallowed as a deduction on the ground that it represents excessive compensation?
*139 This, we think, is a fair statement of the issues as raised by the pleadings and as they now exist in this proceeding.
As stated above, the Commissioner in his determination of the deficiencies allowed petitioner a deduction for all the cash which it paid the four officers in 1941, amounting to $ 18,727.48. In arguing his contention No. 1, the substance of respondent's contention seems to be about this: That the resolution adopted by petitioner's board of directors January 2, 1941, did not fix a definite salary liability of $ 33,000 on the part of petitioner *142 to the four officers in question, but provided only that the salaries should not exceed the amounts fixed opposite the names of the respective officers; and that under such a resolution the only amount that petitioner could deduct as salaries for these officers was the amount of $ 18,727.48 actually paid them in cash. It is respondent's further contention that the resolution of December 15, 1941, still did not create a definite salary liability in the amounts mentioned in the original resolution of January 2, 1941, but only provided for a stock distribution to the four officers in question, and that, inasmuch as petitioner has not proved the fair market value of the stock at the time set apart for these officers, December 15, 1941, petitioner is not entitled to any deduction by reason of the stock distribution, even though it is on an accrual basis.
At this point we may remark that no stock was issued to Thomas Opdyke, one of the parties mentioned in the resolution of January 2, 1941, and we have no issue as to the deductibility of the salary paid to him, whatever it was.
We shall discuss the foregoing contentions made by respondent. We agree with respondent that the resolution of *143 January 2, 1941, did not create a liability of any definite amount on the part of petitioner to the officers named therein. If nothing more had been done, it seems reasonable to assume that all petitioner would have been entitled to deduct as salaries paid or incurred to these four officer-employees would have been the cash which was actually paid to them in 1941. But this resolution must be read in conjunction with the one which was adopted December 15, 1941, and, when this is done, we think that a reasonable construction to be given the two resolutions together is that John J. Hart was to be paid a salary of $ 18,000, and Morris Katz, Fred Whitehead, and Harry Abrams were to be paid salaries of $ 5,000 each, and that whatever part of the salaries had not been paid to each in cash should be paid to them in stock of the corporation during the month of December 1941.
Respondent cites Package Machinery Co., 28 B. T. A. 980, for the proposition that the basis for the deduction for stock issued as compensation for services is the fair market value of the stock as of the date of issue. That case so holds. Among other things, our opinion *140 in that case said: "This liability must, of course, *144 for the purposes of the tax, be translated into dollars and cents; and we have consistently held that the translation must be based upon the fair market value of the stock as of the date of issue." Respondent argues that we have no evidence of the fair market value of the stock of petitioner at the end of the year 1941 and, therefore, we should not allow petitioner, on the accrual basis, any deduction for the value of the stock which it was obligated to issue to these officers under the provisions of the resolution of December 15, 1941.
It is true that we have no direct testimony in the record of what the fair market value of this stock was at the time in question. The stock was closely held and there had been no sale of any of the shares subsequent to the organization of the corporation in 1940. However, we do have this much evidence in the record which it seems to us bears upon the value of the stock on the basic date: Petitioner was organized in September 1940, taking over a business then operated by John J. Hart as a sole proprietor; the incorporators paid $ 1,000 per share for the 35 shares which were issued, either in money or property; the business had been operated successfully *145 both before and after its incorporation; the balance sheet of petitioner as of December 31, 1941, showed the $ 14,000 stock here involved as outstanding and showed earned surplus and undivided profits of $ 4,176.56 after taking into account the $ 35,000 capital stock which was outstanding at the beginning of the year, plus the $ 14,000 capital stock here in question; and the 4 officers agreed to accept these shares, which were to be issued to them at $ 400 per share, in payment of the balance of their salaries tentatively fixed by the resolution of January 2, 1941, and they returned the full amount of these salaries, including the cash received and the shares of stock at $ 400 per share, for taxation on their income tax returns for the year 1941. The book value of the shares was in excess of $ 700 per share. Therefore, on the strength of this evidence, we have found in our findings of fact that these shares had a fair market value of at least $ 400 per share in the latter part of December 1941. We hold, therefore, that petitioner is entitled to a deduction of the $ 14,000 in question unless some part or all of it represented excessive compensation.
This brings us to respondent's alternative *146 contention, No. 2, which is that the full $ 14,000 should be disallowed because it represents excessive compensation. In his deficiency notice respondent did not break down this $ 14,000 as to the four officers, but at the hearing he did so, and we have given this breakdown in our findings of fact.
Mertens, in his Law of Federal Income Taxation, vol. 4, sec. 25.51, says:
*141 * * * In determining whether the particular salary or compensation payment is reasonable, the situation must be considered as a whole. Ordinarily no single factor is decisive. There are various tests which have been commonly applied in determining the reasonableness of the particular salary or compensation, such as the ratio of the particular salary and the aggregate salaries to gross income, the size of the particular business, the extent and scope of the employees' work, the employees' qualifications and contributions to the business venture, amount of salaries paid to the particular employee in prior years, general economic conditions, prevailing salaries paid to employees performing similar services in a comparable enterprise, the availability of others to fill the office held by the particular employee, and *147 salary policy of the corporation as to all employees. * * *
We have considered the foregoing factors, in so far as covered by the evidence in the record, in arriving at our conclusion of reasonable salaries, which conclusion has been embodied in our findings of fact. Not all of the factors mentioned in the above quotation from Mertens are represented in the evidence which is before us. Indeed, it is rare where we have all of such factors represented by the evidence in any case. But in the instant case we do have considerable evidence bearing upon the reasonableness of the salaries of these four officers and it is upon a careful consideration of this evidence that we have made our findings of fact.
It is true, as petitioner urges in its brief, that petitioner did a large volume of business in 1941; that these four officers devoted all of their time to the business and held responsible and important positions with petitioner; and that the salaries paid and incurred by petitioner to them seem reasonable in amount when compared to the total volume of business which petitioner did in 1941.
It is also true, as respondent points out in his brief, that, although petitioner did a large volume *148 of business in 1941, amounting to $ 1,250,000, it had a net profit of only $ 4,053.37 after the deduction of salaries and other expenses, that it paid no dividends in 1941, and that it failed to show the salaries paid to these particular employees in prior years either by petitioner as a corporation or by J. J. Hart as a sole proprietor.
After taking all factors into consideration we have concluded that compensation to J. J. Hart of $ 1,000 per month, or $ 12,000 for the year, and $ 400 per month to each of the other three officers, Katz, Whitehead, and Abrams, or $ 4,800 for the year to each, would be reasonable, and we have so found in our findings of fact. These amounts should be used in a recomputation under Rule 50.
Decision will be entered under Rule 50.
Footnotes
1. Amount disallowed in deficiency notice.↩