1931 BTA LEXIS 1609">*1609 Under a resolution of a corporation dated March 13, 1917, 40 shares of the capital stock of the corporation were issued annually to a trustee as additional compensation to each of the petitioners. The trustee was to hold the shares for a period of five years. The trustee paid the dividends on the stock as received by him to the petitioners and, at the end of the five-year period in 1922, caused to be issued to each of the petitioners a certificate for 200 shares of the stock. Held, that each of the petitioners was liable to income tax in 1922 upon the fair market value of the 200 shares of stock received in such year.
24 B.T.A. 702">*702 These proceedings, which have been duly consolidated, are for the redetermination of deficiencies in income taxes for the calendar year 1922 as follows:
| Petitioner | Docket No. | Deficiency |
| Lyle H. Olson | 33061 | $29,803.43 |
| Fred S. Olson | 33199 | 26,179.87 |
| A. F. Bailey | 33274 | 27,569.94 |
24 B.T.A. 702">*703 The petitions contain the following allegations of error:
(a) The finding1931 BTA LEXIS 1609">*1610 that petitioner, in 1922, received beneficially as compensation for services, 200 shares of the capital stock of The American Appraisal Company, when in truth and in fact petitioner received, in 1922, compensation for such services in money or credits in the amount of $4,000, which amount was invested by him in stock of The American Appraisal Company pursuant to the agreement between the petitioner and said company.
(b) The finding that petitioner received beneficially 200 shares of the capital stock of The American Appraisal Company, for services, in 1922. Even though it be assumed that petitioner received shares of such stock for services, it is nevertheless true that (upon that assumption) he received beneficially, in 1922, only 40 shares of the stock of said company, for services.
(c) The finding that said stock had a fair market value in 1922 of $400 per share when, in truth and in fact, the said stock had no readily realizable market value in that year. If this contention be denied, then such finding was erroneous because the fair market value of said stock in 1922 did not exceed $100 per share. The finding is further erroneous insofar as it determines that said stock1931 BTA LEXIS 1609">*1611 is to be valued as of 1922. The agreement to purchase said stock was made in 1917.
(d) The finding that petitioner received taxable dividends from The American Appraisal Company in 1922 of $14,505.68, which amount is in excess of the taxable dividends received from said company by petitioner in that year.
The issue raised by allegation (d) has been disposed of by a stipulation that the correct amount of such dividends received by each petitioner is $1,860.
FINDINGS OF FACT.
For many years prior and subsequent to 1922 the petitioners have been employees and/or officers of the American Appraisal Company, hereinafter referred to as the Company, which was organized as a partnership in or about the year 1896 and incorporated two years later under the laws of Wisconsin, with its principal office at Milwaukee. The business of the Company is that of making appraisals and valuations of property. It has no other kind of business, owns no real estate, and deals in no commodity. It has been held by the Commissioner to be a personal service corporation. It is a close corporation with a capital stock on December 31, 1922, of $300,000, divided into 3,000 shares of the par value of1931 BTA LEXIS 1609">*1612 $100 each.
At various times the Company has issued its treasury stock to its officers and/or employees as extra compensation for services rendered. In March, 1916, there were issued to the petitioners certain shares of stock as extra compensation for meritorious services rendered. The minutes of a meeting of the board of directors of the Company on March 31, 1917, read in part as follows:
The distribution of six hundred shares of the capital stock of the Company, now in the treasury and partly unissued, to Messrs. L. H. Olson, F. S. Olson and A. F. Bailey, in equal amounts of two hundred shares each, additional to 24 B.T.A. 702">*704 their respective cash salaries, in consideration of their continuously remaining in the employ of the Company for a period of five years from March 1, 1917 came up for consideration.
Upon motion duly made and seconded, the following resolution was unanimously adopted:
Resolved, that in consideration of Messrs. L. H. Olson, F. S. Olson and A. F. Bailey agreeing to remain continuously in the employ of the Company, for a period of five years from March 1, 1917, their respective ledger accounts be each credited monthly with $333.33 1/3 commencing with1931 BTA LEXIS 1609">*1613 the present month,
That, on March 1st of each year, in consideration of the total credit balance thus credited, there be issued three certificates for forty shares each, par value $100.00 per share of the capital stock of the Company, to a Trustee to be designated by Messrs. L. H. Olson, F. S. Olson and A. F. Bailey; said certificate to be held for and on behalf of these three gentlemen.
That all dividends which may be paid on shares as issued to the Trustee shall, immediately as such dividends are received be assigned to Messrs. L. H. Olson, F. S. Olson and A. F. Bailey respectively, and when they respectively shall have been continuously in the employ of the Company for a period of five years, namely on March 1, 1922, said Trustee shall immediately assign all of the six hundred shares then issued, to Messrs. L. H. Olson, F. S. Olson and A. F. Bailey respectively, in equal amounts of two hundred shares each.
In the event of the death while in the employ of the Company, of Mr. L. H. Olson, Mr. F. S. Olson or Mr. A. F. Bailey or either of them prior to March 1, 1922, said Trustee shall assign and deliver to the legal representative of the decedent, all of the shares issued in1931 BTA LEXIS 1609">*1614 his behalf at the time of his death, subject only to provision that the shares so issued shall first be offered to the Company by the heir or heirs of the decedent before they may be sold in the open market.
Mr. O. F. Kiemke accepted the nomination to act as the Trustee and personally affixes his signature with the signature of Messrs. L. H. Olson, F. S. Olson and A. F. Bailey, to this record in mutual acceptance of the terms and conditions of the foregoing resolution.
O. F. KIEMKE L. H. OLSON F. S. OLSON A. F. BAILEYIn accordance with the above resolution the petitioners' accounts on the Company's books were each credited with $333.33 1/3 each month for a period of two years, or up to April, 1919. Thereafter, an account, designated as "O. F. Kiemke, Trustee for F. S. Olson, L. H. Olson and A. F. Bailey," was opened on the books of the Company and $1,000, the sum of the three credits theretofore entered on the petitioners' accounts, was credited to the trustee account each month. This method of accounting was continued until the several transactions were completed on February 28, 1922.
The Company charged its operating expenses with $1,000 each month (a total of1931 BTA LEXIS 1609">*1615 $12,000 each year), for the period March 1, 1917, to February 28, 1922, on account of the monthly credits to the petitioners 24 B.T.A. 702">*705 and/or the trustee for them, to take care of the liability created by the above resolution. The amounts so charged ($12,000 for each year) were taken and allowed as deductions in the Company's income-tax returns.
On February 28, 1918, a journal entry was made on the books of the Company crediting treasury stock with $12,000 and charging the account of each petitioner with $4,000. On April 30, 1919, the account of each petitioner was charged with $4,000 and the account of the trustee was credited with the sum of the three debits, $12,000. On the same day the account of the trustee was charged with $12,000 and the capital stock account credited with $12,000. On February 28th of each of the years 1920, 1921, and 1922 the account of the trustee was charged with $12,000 and the capital stock account was credited with $12,000. On February 28th of each of the years 1918 to 1922, inclusive, three certificates for 40 shares each were issued and delivered by the Company to the trustee for the three petitioners.
Dividends on the stock held by the1931 BTA LEXIS 1609">*1616 trustee were either paid to the petitioners or were credited to the stockholders' accounts and drawn by them at their pleasure.
On March 1, 1922, all of the Company's capital stock was held by its officers and/or employees and the estates or heirs of deceased officers or employees. No stock had ever been issued to anyone not connected with the Company and there have been no transfers of stock since March 1, 1922. This stock is not listed upon any stock exchange and is not dealt in upon any market. The only sale of this stock near the basic date was the sale on November 19, 1921, by Charlotte Lucas Moon, the widow of a former officer of the Company, to Joe L. Moon and the petitioners of 800 shares for a consideration of $400 per share, with interest at 6 per cent per annum on the unpaid balance of the purchase price, which was to be paid from the earnings distributed upon that stock. Under the provisions of the agreement, the stock certificates were transferred and delivered to the vendees, who had new certificates issued which they endorsed in blank and deposited in escrow until the terms of the agreement were fulfilled. In case of the default in payment by any or all of the1931 BTA LEXIS 1609">*1617 vendees, and the continuance of such default for a period of 60 days, the agreement between the vendor and the defaulting vendees ceased and terminated and the stock reverted to the vendor, unless the vendees not in default assumed the obligation of the defaulting party. By a supplemental agreement dated June 1, 1922, each petitioner herein agreed to pay Mrs. Moon $1,666.67 annually on account of the principal amount of the purchase price in addition to the payments agreed upon at the time of the sale. The vendees were given the right to dispose of the stock purchased at any 24 B.T.A. 702">*706 time, subject to the lien of Mrs. Moon for the unpaid purchase price.
The earnings of and dividends by the Company for the period March 1, 1913, to December 31, 1922, were as follows:
| Period | Book profits | Dividends |
| 3/1/13-2/28/14 | $82,321.43 | $159,150.00 |
| 3/1/14-2/28/15 | 1 59,053.17 | 21,220.00 |
| 3/1/15-2/28/16 | 23,979.00 | |
| 3/1/16-2/28/17 | 173,553.46 | |
| 3/1/17-2/28/18 | 234,895.07 | 90,380.00 |
| 3/1/18-2/28/19 | 433,878.14 | 279,262.50 |
| 3/1/19-12/31/19 (10 months) | 358,382.51 | 410,028.28 |
| 1/1/20-12/31/20 | 690,057.03 | 414,000.00 |
| 1/1/21-12/31/21 | 17,855.07 | 288,000.00 |
| 1/1/22-12/31/22 | 153,835.90 |
The Company's balance sheet as of December 31, 1921, is as follows:
| Assets | ||
| Cash on hand and in banks | $21,027.24 | |
| Accounts receivable | $383,019.71 | |
| Advance payments on contracts | 22,144.92 | |
| 360,874.79 | ||
| Cash invested on contracts under way | 217,790.92 | |
| Office furniture and fixtures | $189,246.96 | |
| Less depreciation | 54,446.05 | |
| 134,800.91 | ||
| Supplies inventory | 17,680.72 | |
| Duplicate invoices and plans | 155,718.78 | |
| Departmental libraries and records | 35,000.00 | |
| Total | 942,893.36 | |
| Liabilities | ||
| Capital stock outstanding | $288,000.00 | |
| Accounts payable | 20,487.03 | |
| Accrued salaries | 80,490.78 | |
| Unearned continuous service premiums | 97,917.60 | |
| Contingency reserve | 839.75 | |
| Undivided profits | 455,158.20 | |
| Total | 942,893.36 |
The liquidating value of the furniture and fixtures was about $50,000. The item of duplicate invoices and plans represents copies of appraisals that have a problematical future value in making appraisals of the same property, but had little, if any, liquidating value. The departmental libraries and records consisted of price lists and material and labor cost records accumulated in the course of the company's1931 BTA LEXIS 1609">*1619 business. These records were valuable in making appraisals, but had very little liquidating value. On March 1, 1922, the Company was threatened with a large deficiency tax for prior years.
The book value of petitioners' stock at December 31, 1921, was $258 per share. For the 14-month period ended February 28, 1919, the Company paid a cash dividend of approximately 100 per cent; for the 10-month period ended December 31, 1919, a cash dividend of approximately 150 per cent; for 1920 a cash dividend of 150 per cent; and for 1921 a cash dividend of 100 per cent. The fair market 24 B.T.A. 702">*707 value of the shares of capital stock on March 1, 1922, was $250 per share.
On or about March 1, 1922, the original stock certificates which had been issued to the trustee were surrendered and a new stock certificate for 200 shares was issued to each of the petitioners. Each petitioner than owned 387 1/2 of the total 3,000 shares outstanding. Each petitioner included the 200 shares issued to him in 1922 in his income-tax return for that year at their par value of $20,000. The respondent increased this amount tt $80,000 and asserted the deficiencies in controversy.
OPINION.
SMITH: In1931 BTA LEXIS 1609">*1620 so far as material hereto, section 213 of the Revenue Act of 1921 provides:
That * * * the term "gross income" -
(a) Includes gains, profits, and income derived from salaries, wages, or compensation for personal service * * * of whatever kind and in whatever form paid * * * and income derived from any source whatever. The amount of all such items * * * shall be included in the gross income for the taxable year in which received by the taxpayer * * *.
The petitioners' first allegation of error is to the effect that they received additional compensation in the form of money or credits in the amount of $4,000 each in 1922. On brief, the petitioners argue that:
The proper construction of the contract set forth in the resolution of March, 1917, is that it fixes as a measure of the additional compensation for service (the generating cause of the income) a definite amount in dollars and cents, which with the consent of petitioners was to be invested annually in stock of the employed company.
This argument seeks to apply literally the method or form employed and not the substance of the transaction. The intent of the parties was the issuance of certain treasury stock as additional1931 BTA LEXIS 1609">*1621 compensation for services rendered by the petitioners; that was the substance of the transaction. The plain language of the minutes and resolution, and the fact of the issuance of stock to the petitioners and other employees as additional compensation for services rendered in other years, support no other interpretation. The fact that those credits were the measure of the company's deduction from gross income as an expense for compensation paid for services rendered is not controlling here. . The income of these petitioners must be measured by the fair market value of the stock when received and not the amount of the credits entered upon their or the trustee's accounts upon the corporate books. ; , .
24 B.T.A. 702">*708 The second allegation of error raises the question of the number of shares of stock that each petitioner received in the taxable year 1922. The facts regarding the agreement and issuance of the stock to the trustee for the benefit of the petitioners are not in dispute. The petitioners1931 BTA LEXIS 1609">*1622 contend that each received only 40 shares of stock, whereas the respondent insists that each petitioner received 200 shares of stock in 1922. On brief, the petitioners argue that:
Under the resolution, no one had any beneficial interest in the stock after its issuance and delivery to the trustee other than petitioners themselves. So far as the issued stock was concerned, the contract embodied in the resolution was no longer an executory one. The issued stock could never revert to the company. Any such reversion would be inconsistent with the clause that the stock was to be "held for and on behalf of these three gentlemen".
We are not unmindful of the fact that petitioners agreed to remain in the service of the company for five years after March, 1917; but a careful study of the resolution - what it says and what it omits to say - leads to the conclusion that it was not intended that any breach of this agreement should operate to divest petitioners of their beneficial interest in the stock previously issued. In the first place there is no provision for such devestiture and forfeitures are not favored in the construction of contracts.
The petitioners further contend1931 BTA LEXIS 1609">*1623 that the issuance of these shares each year and their receipt by the trustee of the petitioners on their behalf was equivalent to and constituted receipt by the petitioners: that the trustee was the representative of the petitioners and that the receipt of the stock by him was equivalent to its receipt by them.
Section 213 of the Revenue Act of 1921 requires a return of "income derived from salaries * * * or compensation for personal services," and section 212(b) provides:
The net income shall be computed upon the basis of the taxpayer's annual accounting period * * * in accordance with the method of accounting regularly employed in keeping the books of such taxpayer; but if no such method of accounting has been so employed, or if the method employed does not clearly reflect the income, the computation shall be made upon such basis and in such manner as in the opinion of the Commissioner does clearly reflect the income. * * *
Although the income-tax returns of the petitioners for 1922 were not offered in evidence, no contention is made that petitioners' books of account were kept or their income-tax returns made upon other than a receipts and disbursements basis. In the absence1931 BTA LEXIS 1609">*1624 of such evidence it must be held that the additional compensation paid to petitioners was income to them in the year in which they "received" the shares of stock. No evidence has been offered that the petitioners reported in their income-tax returns for the years prior to 1922 any amount in respect of the shares of stock which were turned over to them in 1922. In fact the evidence shows conclusively that each petitioner returned in his income-tax return for 1922 the par 24 B.T.A. 702">*709 value of the shares of stock, a certificate for which was issued to him in 1922. All that the respondent has done in the determination of the deficiency is simply to increase the value of the stock from $20,000, the amount returned, to $80,000, the amount which the respondent contends to be its fair market value.
In , the Supreme Court defined income as that gain which is "received or drawn by the recipient [the taxpayer] for his separate use, benefit, and disposal." The petitioners content that they were the beneficial owners of the shares of stock from the time that certificates for the shares of stock were turned over to the trustee. 1931 BTA LEXIS 1609">*1625 But the incidence of the tax is not upon the value of property beneficially owned by an individual. A receipt by the trustee can not be regarded as a receipt by the petitioners. The shares of stock were received by the petitioners at the time they were turned over to them and made subject to their disposal. A fair reading of the agreement between the petitioners and the American Appraisal Company is that they were not to have the disposal of the stock until the stock was placed in their name. We have heretofore held, in construing similar arrangements, that a taxpayer employee realized income in the year in which he received the certificates of stock in the corporate employer, regardless of the prior delivery of such stock to a bonus custodian or trustee, or its deposit in escrow. ; ; ; ; ; 1931 BTA LEXIS 1609">*1626 ; ; .
The facts in these proceedings are more nearly those in . There it was held that where a receiver, by order of the court, was paid a sum monthly for his services, with liberty to apply for additional compensation at the end of receivership, such final allowance, made at the end of five years, was income of the year received and that it was not distributable for income-tax purposes through preceding years, even though an order had been entered by the District Court that the additional compensation was earned and had accrued in equal monthly installments throughout the receivership. The respondent did not err in holding each of the petitioners liable to income tax in respect of the fair market value of the 200 shares of stock issued to him in 1922.
The remaining issue is the determination of the fair market value of the 200 shares of stock received by each petitioner within the taxable year. In the statement attached to the deficiency notice the respondent stated that:
* * * inasmuch1931 BTA LEXIS 1609">*1627 as the only sales at this time of stock of the American Appraisal Company to willing purchasers by willing sellers were for $400.00 a share, also, in view of the large dividends paid by the corporation during the 24 B.T.A. 702">*710 years 1918 to 1922 inclusive as well as the computation of the value of the stock in accordance with A.R.M. 34, Cumulative Bulletin Number 2, Page 31, indicates a value in excess of $400.00 per share, this office holds the value of $400.00 per share as placed on the stock to be fair and equitable.
The respondent's valuation is based upon a sale of 800 shares of this stock by the widow of a deceased officer of the Company to the petitioners and another officer of the Company. The sale was made in 1921 at a price to be paid not in cash, but in installments largely out of the dividends upon the stock sold.
The petitioners included the 200 shares of stock received in 1922 in their income-tax returns for 1922 at its par value of $100 per share, but now contend that the stock either had no readily realizable market value in 1922 or that such value did not exceed the par value. Certain witnesses testified that the stock had no market value, such opinions being1931 BTA LEXIS 1609">*1628 predicated largely upon the fact that the stock was not listed or dealt in on any exchange and that the stock was closely held.
In , affd., ; certiorari denied by United States Supreme Court, October 26, 1931, we said:
* * * The absence of active trading in a stock does not necessarily show lack of fair market value, and under the circumstances other evidence, including evidence as to the intrinsic value of the assets back of the stock, should be considered in determining whether the stock had a fair market value. ; ; ; ; . * * *
We are not convinced that the stock had no fair market value merely because there were no sales of the stock in 1922. . There was a sale of the stock in 1921 at a price of $400 per share and the earnings of the company in 1920 were in excess $200of per share. 1931 BTA LEXIS 1609">*1629 The company paid cash dividends of at least 500 per cent over the four-year period from 1918 to 1921, inclusive, and had profits in excess of the dividends paid. It paid a 100 per cent cash dividend in 1921. The evidence supports the contention of the respondent that the market value of the stock at the time received by the petitioners in 1922 was at least $400 per share.
Since under the statute taxpayers receiving compensation for services in whatever form paid are required to include the same in their income-tax returns, we are of the opinion that each of the petitioners is liable to income tax in 1922 upon the 200 shares received in that year at the rate of $400 per share. Cf. ; ; .
Reviewed by the Board.
Judgments will be entered under Rule 50.
Footnotes
1. Loss. ↩