Coughlin v. Commissioner

*516 Petitioner appeals from a deficiency in income tax for the calendar year 1922 in the sum of $4,432.73, asserted and advised of by respondent on March 25, 1926. By the errors assigned only one issue is raised, this being the correctness of respondent's action in holding that a payment of $38,000 received by petitioner in the year 1922 was not a dividend and represented income subject to both normal and surtax.

FINDINGS OF FACT.

Petitioner is a resident of Milwaukee County, Wis., and in 1918, at the instance of one H. W. Ladish, then president of the Ladish Drop Forge Co., of Cudahy, Wis., purchased from the latter 750 shares of common stock of that company. At the time of this transaction the said Ladish was the owner of 2,293.7 shares of the 3,000 authorized and issued shares of common stock of that corporation, of a par value of $100 per share and being the only voting stock of the corporation, and it was agreed between these two parties that petitioner would become the general manager and secretary of the corporation and would always draw the same salary for*2843 services as that paid by the corporation to its president. The price paid by petitioner for the 750 shares of stock was $140 per share, or a total of $105,000. Approximately one-half of the purchase price petitioner paid to Ladish in cash and gave his note to the latter for the balance. Petitioner borrowed from his bank the money to make this cash payment.

In October, 1918, petitioner was elected general manager and secretary of the Ladish Drop Forge Co. at a salary of $10,000 per year. For 1919 salaries of $13,000 were paid Ladish and petitioner. For the year 1920 salaries of $15,000 per year were agreed upon, each receiving $1,250 per month until April of that year when Ladish, as president, by direction to the office manager of the corporation, increased his own salary to $25,000 per year, effective as of the beginning of that year. Petitioner thereupon insisted that a similar increase be made in his salary, which was objected to by Ladish and relations between these two became strained. Sinally, at the close of that year Ladish agreed to the demand made by petitioner and the latter was, in January, 1921, paid $10,000 additional by the corporation for his services during*2844 1920. For the years 1921 and 1922 the salaries of both petitioner and Ladish were reduced to $1,000 per month.

Following the disputes between petitioner and Ladish in 1920 as to salary, the relations between the two were not pleasant, and in 1922 petitioner approached Ladish with the request that a dividend *517 be declared and paid by the corporation, as the latter had an accumulated surplus and in his opinion could pay one. No dividends had been paid on the common stock of the corporation since petitioner had made his purchase of same and he was having difficulty in paying interest on his two notes held by the bank and by Ladish and representing his purchase of the stock. At this time there was due on the note at the bank, $56,000 and the note in the hands of Ladish, $49,000. Ladish, who had at all times after petitioner became an officer of the corporation owned the majority of the voting stock and controlled its affairs, refused the request that a dividend be declared and thereupon petitioner announced his desire to dispose of his stock and retire from the corporation. Ladish then personally offered to repurchase petitioner's stock at the price paid for it, but this*2845 offer was refused on the ground that he had received no dividends but had carried the stock at a considerable cost. Thereupon, Ladish offered to buy the stock at the price paid, $105,000, plus the interest paid and accrued on the notes, amounting to $25,593.75. This offer was refused by petitioner, who submitted a counter offer of sale at the price paid, or $105,000, plus a sum equal to 25 per cent of the surplus accumulated by the corporation during the period petitioner had been an officer and owner of 25 per cent of the common stock. This latter amount was then computed by the office manager at direction of Ladish as $38,311.14, and thereupon Ladish offered to pay petitioner $38,000 in cash; cancel the note he held of $49,000 and pay the note of $56,000 due from petitioner to the bank, for a transfer to him of petitioner's 750 shares of stock, and to this petitioner agreed. Thereafter, on August 18, 1922, the transaction was carried out at the bank; Ladish delivering to petitioner two checks of the Ladish Drop Forge Co. for $56,000 and $38,000, respectively, and petitioner's note for $49,000 held by him. Petitioner delivered the check for $56,000 to the bank and received back*2846 his note held by it and the 750 shares of stock deposited as collateral and endorsed and delivered this stock to Ladish, and filed his resignation as an officer of the corporation.

The 750 shares of stock transferred by petitioner to Ladish were reissued by the corporation to the latter. The check for $56,000 of the corporation was charged by the latter on its books to the personal account of Ladish, and later Ladish gave his note to the corporation for this amount and the sum was transferred on the books to "notes receivable." The check for $38,000 was charged on the corporation books, by direction of Ladish, to a new account set up for that purpose and designated "Reserve for Bonuses" and charged off later from time to time to profit and loss.

Subsequent to March, 1923, the corporation had some tax controversy with the State of Wisconsin over the credit taken for this $38,000 payment as an expense, and a minute entry was drawn by *518 its legal counsel, at the instance of Ladish, reciting a meeting of the directors of the corporation on August 24, 1922, and reading in part as follows:

Resolved that the purchase of the stock formerly owner and held by C. L. Coughlin, *2847 by the officers of this company, pursuant to informal authorization heretofore conferred by the directors, and the payment of $38,000 to C. L. Coughlin in full for all claims for salaries, bonuses, and all other claims or accounts, be and the same hereby are in all respects ratified and confirmed.

Upon this minute entry being prepared it was signed "F. A. Ladish, Secretary pro tem" and inserted in the minute book at a point following the series of minutes of meetings held during petitioner's connection with the corporation, and the minutes already entered of meetings following that time were thereupon again written up and signed by the secretary who succeeded petitioner, to conform to the entry inserted. At this same time a letter was prepared and dated August 18, 1922, reading as follows:

Mr. CHARLES L. COUGHLIN,

Milwaukee, Wisconsin.

DEAR SIR: The following is a statement of the close of the transaction had between us to-day. The Ladish Drop Forge Company and I have purchased from you 750 shares of common stock of the Ladish Drop Forge Company at $140 per share, making a total of $105,000. The 750 shares have been transferred as follows: 400 shares to Ladish Drop*2848 Forge Company, and 350 shares to me. You have received for same check of the Ladish Drop Forge Company for $56,000 and note to me for $49,000 cancelled. Further the Ladish Drop Forge Company has paid today $38,000 which is in full of all claims you have against it for salary, bonus, or any other claim or account. Your note for $71,000 to Ladish Drop Forge Company was cancelled and delivered to you, and preferred stock Ladish Drop Forge Company held with it transferred to Ladish Drop Forge Company and H. W. Ladish. Liability on this note and preferred stock held with it transferred to the corporation and H. W. Ladish in proportion to the transfer of the 750 shares above.

Yours very truly,

This letter had a line at the bottom reading "The foregoing correctly states the transaction," and was presented to petitioner during the course of the controversy between the corporation and the State of Wisconsin in 1923 by the then secretary of the corporation, with request that he sign the quoted certificate as to correctness or give an affidavit reciting the same facts. This request was refused by petitioner.

In making his return of income for the calendar year 1922 on Form 1040, *2849 petitioner reported under income item No. 1 the sum of $7,580.65 as salaries, wages or commissioner, all received from the Ladish Drop Forge Co. Under item No. 6 he reported a net profit on sale of stock of $15,833.90, this being computed on Schedule "C" attached, as follows:

*519 Respondent in determining the deficiency appealed from treated the $38,000 included as a profit on sale of stock as a salary*2850 bonus received from the Ladish Drop Forge Co. and increased the amount reported under item No. 1 by this sum and eliminated the item of $15,833.90 reported as a profit on sale of stock under item No. 6.

OPINION.

TRUSSELL: The question presented by this appeal is the character or nature of the payment of $38,000 received by petitioner in 1922 in connection with his transfer of stock to H. W. Ladish and his resignation as an officer of the Ladish Drop Forge Co. Petitioner on his return for that year included this as a profit on sale of stock. Respondent in determining the deficiency held it to be a salary bonus. Petitioner in his appeal now insists that it represented the payment of a dividend by the corporation on the stock held by him and being then transferred to H. W. Ladish, and consequently subject to surtax only.

Upon the hearing petitioner, through his attorney, insisted that the only question for consideration by the Board is the correctness of respondent's theory that the payment in question represented a bonus - that the pleadings only put in issue the correctness of the two theories and should it be concluded that the payment was not a salary bonus and that respondent's*2851 theory consequently was erroneous, *520 it must under the pleadings be considered as a dividend distribution. With this we do not agree. The correctness of the deficiency determined is the general issue for our consideration. The Board is not limited, in deciding that issue, by either the theory under which the deficiency was determined or the theory under which it is sought to be redetermined. The question before us is the actual character of the payment in question as revealed by the evidence adduced.

Upon this question the record, we think, is clear. No basis whatsoever, in fact, is shown for the payment of a salary bonus to petitioner by the corporation. There is no indication whatsoever that the salary paid him was anything less than full compensation for his services. The only indication that the payment might be of that character is the fact that after petitioner's resignation as an officer of the corporation this payment was charged to a new account of "Reserve for Bonuses" and attempted to be charged off over an undetermined period to profit and loss. This action in itself indicates that the payment was not one of a bonus, but merely a method attempted to*2852 be used to obtain credit for the payment as a deduction for tax purposes. Among all the facts indicating the nature of the payment the only one suggesting a bonus character is this book entry itself. No fact sustains the correctness of this entry and all of the facts and circumstances in respect to the payment itself indicate the contrary. It is not shown that petitioner ever requested or was entitled to a bonus at the time this payment was made or that such a payment was ever considered in the transaction in connection with which he received this sum.

On the other hand, we can not agree with petitioner's contention that the payment made was a dividend distribution on the 750 shares of stock being sold by petitioner to H. W. Ladish. It is clearly shown to be a payment of an amount demanded and agreed upon as a consideration of the transfer of the stock to Ladish by petitioner in a personal transaction between the two. The corporation is not shown to have authorized or paid a dividend. In fact the sale of the stock itself, the transaction in which the payment was made, is shown to have been agreed upon because of the absolute refusal of Ladish, as president and owner of the*2853 majority of the voting stock of the corporation, to allow any dividend to be paid.

The mere fact that the price demanded by petitioner from Ladish for a transfer to the latter of his one-fourth of the common stock of the corporation was the sum paid for it plus an amount equal to one-fourth of the suprplus accumulated by the corporation during his ownership of such stock, does not result in that price when paid being, to the extent that it exceeds the former purchase price, a dividend on such stock in the hands of petitioner, nor can such theory *521 be sustained because of the added fact that Ladish in making payment for the stock used funds of the corporation. His use of such funds is a matter between him and the corporation and other stockholders. We are not concerned with the tax liability of the corporation or the manner in which the payment should have been or was later treated on its books.

Petitioner had paid $105,000 for the stock and his notes in this amount were outstanding and unpaid, one for $56,000 at the bank, and the other for $49,000 held by Ladish. The latter in consideration of the transfer to him of petitioner's stock paid the $56,000 note and had*2854 it returned to petitioner, delivered to him the $49,000 note for cancellation and gave him a check for $38,000, both of the payments being with funds of the corporation. Petitioner when asked at the hearing what the payment of $38,000 represented, frankly admitted "that was the difference between what I paid for the stock and what I got for it."

The payments in question are shown to our satisfaction to have been made solely in consideration of the sale and transfer to Ladish of petitioner's stock, and the payment of $38,000 to represent profit on that sale. This item was properly reported by petitioner in his return filed for that year.

The deficiency should be redetermined in accord with the foregoing findings of fact and opinion.

Judgment will be entered pursuant to Rule 50.