Pacific Flush Tank Co. v. Commissioner

*896 In this proceeding petitioner asks to be relieved of a deficiency of $282.03 in income taxes for the year 1922, alleging error of the respondent in disallowing a deduction of $2,100 claimed to represent either an annuity paid to the widow of its former president or a loss incurred in the operation of its business.

FINDINGS OF FACT.

The following facts were stipulated and are all of the facts in evidence:

(1) That the taxpayer corporation was duly organized December 30, 1905, under the laws of the State of Illinois and is engaged in the manufacture, selling and installing of sewage disposal apparatus.

(2) That the petitioner filed a return for 1922 and deducted from gross income as an ordinary and necessary business expense an item designated as follows: "Ida K. Miller (per minutes of 1905) $2,100.00." The above amount represents a payment to the widow of Sidney W. Miller, president of the corporation, who died in the year 1910, and was made in accordance with a contract made pursuant to a resolution adopted by the board of directors on December 30, 1905.

(3) That said resolution is contained*2218 in the minute book of the petitioner corporation on pages 101, 102 and 103, which are offered in evidence as petitioner's Exhibit 1, without objection.

(4) That the amount of $2,100 claimed as a deduction by the petitioner for the year 1922 was disallowed by the Commissioner of Internal Revenue, as shown in the deficiency letter and statement, a copy of which is attached to the petition and marked Exhibit A.

The resolution referred to in paragraph 3 above is as follows:

This agreement made this thirtieth day of December A.D. 1905 by and between Pacific Flush Tank Company, a corporation duly organized under the laws of the State of Illinois, and having its principal office in Chicago in said State, party of the first part, and Sidney W. Miller of said city and State, party of the second part, WITNESSETH:

Whereas: Said second party has been the manager of the business of Sidney W. Miller and Brother, copartners heretofore for upward of ten years trading as and under the name "Pacific Flush Tank Company" and conducted the same with such recognized skill and ability that from small beginnings the business of said firm grew steadily to so large and prosperous proportions, *897 *2219 that it was deemed wise to form a stock company to take over the business and assets of said firm and

Whereas: The said party of the first part has elected said second party as its president and expects to retain him as such indefinitely, and desires to own and control all patents, inventions and improvements of every kind which said second party may at any time acquire or make, that may be used or applied in the business of said first party, and

Whereas: The salary of the president of said company as fixed by its by-laws is recognized as inadequate compensation for the services of said second party as president of the company and for the products of his inventive and engineering ability,

Now Therefore, in consideration of the mutual covenants herein by the parties hereto, and in consideration of one dollar ($1.00) in hand paid, each to the other the receipt whereof is severally acknowledged by each to the other, the parties hereto have covenanted and have agreed and do hereby covenant and agree as follows:

First: Said party of the second part as long as he owns or he and his wife together own, a majority of the capital stock of said company, shall assign and transfer to said*2220 company all patents, inventions and improvements of every kind which he may hereafter acquire or make, that can be used or applied in the business of said company as determined by its objects set forth in its charter and future amendments thereto, for which said company shall be required to pay only the actual cost thereof to said second party and the expenses of the assignment thereof to said company.

Second: Said party of the first part in consideration of the benefit to it, growing out of the foregoing covenant, shall pay to said party of the second part Twenty (20%) per cent of the net earnings of said company, semiannually, during the first week of June and of December of each and every year for and during his natural life, so long as he owns or he and his wife together own, a majority of the capital stock of said company, and after the death of said second party, said party of the first part shall pay to the widow of said party of the second part, the sum of one hundred and seventy-five ($175.00) dollars a month, payable to her monthly, for and during the remainder of her natural life, so long as she is the owner of a majority of the capital stock of said company, or so long*2221 as what she owns and what is held in trust for her constitutes a majority of the capital stock of said company.

This contract is made pursuant to a resolution duly passed by the Board of Directors of said corporation on the Thirtieth day of December, A.D. 1905.

In Testimony whereof the said party of the second part has hereunto set his hand and seal and said party of the first part has caused these presents to be signed in its name by Walter H. Miller its vice president, and its corporate seal to be affixed hereto and attested by Lester E. Rein its secretary, the day and year first above written.

PACIFIC FLUSH TANK COMPANY,

BY WALTER H. MILLER, Vice President.

Attest:

LESTER E. REIN, Secretary.

OPINION.

VAN FOSSAN: Petitioner contends that the payments to Ida K. Miller under the terms of the above contract were either an ordinary and necessary expense or a loss. We find ourselves unable to catalog the item in either category.

*898 The payments to the widow were provided for in the contract made by the husband and the principles underlying payment to both are inextricably interwoven. As to the husband, the payment of 20 per cent of net earnings*2222 was either primarily in the nature of payment for capital assets (patents and improvements usable in petitioner's business) and so not allowable as expense () or a distribution of profits, equally unallowable (). The designation of the widow as the recipient of part of the payments to be made did not alter the character of the payments. Such payments would be, nevertheless, in consideration of the services and contributions of the husband. Nor is the difficulty removed by denominating the payments as annuities.

In the alternative, petitioner contends that the payments to the widow were a loss. Before this conclusion could be reached, however, it would be necessary for petitioner to establish the value of the patents acquired, their respective terms, and the proportionate part of the payments heretofore made properly to be allocated thereto, none of which facts are before us.

Decision will be entered for the respondent.