Kenny v. Commissioner

*750 Respondent has included in petitioner's income for 1941 a total sum received by him in 1941 for services rendered in prior years which did not become payable until 1941 under the terms of an agreement to *751 which petitioner was a party. The only question is whether the sum received*237 in 1941 is taxable in 1941, as respondent has determined. The deficiency in income tax which has been determined is $ 3,457.83.

Petitioner filed a joint return for 1941 with the collector for the first district of New York.

Some facts have been stipulated and certain documents have been introduced in evidence.

FINDINGS OF FACT.

Petitioner was president and treasurer of National Meter Co., a New York Corporation, in 1937 and thereafter. In 1935 National received a loan from the Reconstruction Finance Corporation, evidenced by its note, in the amount of $ 125,000. The note was secured by a mortgage on certain real estate, buildings, and equipment owned by National. In 1937 R. F. C. loaned National $ 75,000, evidenced by a second note. The second loan was made under an agreement that payments to R. F. C. would be applied first to the second note, and, when it was fully paid, to the first note. The total indebtedness was to be paid by July 31, 1947, at the latest. The second loan, as well as the first loan, was made by R. F. C. upon the understanding that National was solvent, it being stated in the respective resolutions of R. F. C. approving the loans "that Borrower is solvent." *238 When the second loan was approved by R. F. C., by its resolution, a condition was imposed upon National, which National accepted, that National would adjust the compensation of certain of its officers, namely, the chairman of the board, the president and treasurer (petitioner), the vice president and secretary, two sales managers, a director, and the Chicago office manager. The adjustments agreed upon were set forth in the R. F. C. resolution of November 22, 1937, which constituted the loan agreement. The adjustment with respect to the salary of petitioner which R. F. C. required was as follows:

N. J. Kenny, President and Treasurer, $ 12,000 per annum, $ 7,800 of which shall be payable and $ 4,200 of which shall be withheld by Borrower and credited on the books of Borrower and be paid to such officer only upon the prior written consent of this Corporation. [R. F. C.]

It was provided further in the loan agreement as follows:

* * * and that notwithstanding the aforesaid salary adjustments Borrower will at any time until payment in full of the indebtedness evidenced by the First Note and the Second Note, adjust salaries of its officers as required by this Corporation. [R. F. C.]

*239 In December of 1937 National sent a letter to petitioner setting forth the adjustment to be made in his salary in conformance with the requirements of R. F. C., and advised petitioner that the salary adjustment *752 would be effective January 1, 1938. Petitioner accepted the terms set forth in the letter. It was stated in the agreement with petitioner that $ 4,200 of his annual salary of $ 12,000 would be paid either upon the consent of R. F. C. or when the loan from R. F. C. was fully repaid. Thereafter, in 1938, 1939, and 1940 the annual salary paid to petitioner was $ 7,800. National credited to petitioner's account $ 4,200 in each of the above years, plus $ 1,957.63 additional in 1940, pursuant to a verbal agreement made between National and petitioner in 1940, without the consent of R. F. C., that petitioner should be credited with 6 percent of profits agreed upon. At the end of 1940, $ 14,557.63 had been credited to petitioner's account.

On March 17, 1941, the Pittsburgh Equitable Meter Co. acquired the assets and assumed the liabilities of National in exchange for stock of Pittsburgh. In connection with this transaction petitioner agreed to cancel claim to one-third*240 of the above credits. On March 17, 1941, Pittsburgh paid the balance of the indebtedness owing to R. F. C., and petitioner received $ 9,704.96 in full payment of the credits to him for salary and a share of profits.

Petitioner, during the years 1938 to 1941, inclusive, reported his income on a cash receipts basis. He did not report in his income on the returns for 1938, 1939, and 1940 any of the above sums which had been credited to his account. However, about March 15, 1942, he filed amended returns for those years in which he increased his income from salaries in the amounts of $ 2,800 for 1938 and 1939 and $ 4,104.96 for 1940, these amounts representing two-thirds of the total amounts credited to petitioner in those respective years. Petitioner paid additional tax for each year under the amended returns.

Respondent included the sum of $ 9,704.96 in the income of petitioner for 1941, and determined overassessments for the three earlier years. In the statement attached to the notice of deficiency respondent stated, in part, as follows:

Sums in excess of $ 7,800.00 credited to your account for each of the years 1938, 1939, 1940 are contingent, were not constructively received*241 nor were they the equivalent of cash for Federal income tax purposes, and therefore no part of such credits is taxable income until received by you.

OPINION.

Petitioner seeks to invoke the provisions of section 119 of the Revenue Act of 1943, amending section 107 of the Internal Revenue Code by adding a new provision, subsection (d), which defines "back pay" and prescribes how it shall be taxed.

Section 107 was added as a new section in the Internal Revenue Code by section 220 (a) of the Revenue Act of 1939, and was amended by section 139 (a) of the Revenue Act of 1942. With the further amendment *753 made by section 119 of the Revenue Act of 1943, section 107 is a special provision with four subsections (a) to (d), inclusive. Petitioner does not attempt to invoke the benefits of subsection (a). Subsection (d) is the only provision within the scope of which petitioner desires the question to be considered. The pertinent part of the statute is set forth in the margin. ¹ This statutory definition sets forth what shall constitute "back pay" for purposes of a special relief provision for taxing such income as set forth in subsection (1) of section 107 (d). But income which*242 does not fall within the definition shall not constitute "back pay." The question is whether the payment received by petitioner in 1941 for services performed in 1938 to 1940, inclusive, is "back pay" as defined by the statute.

*243 Obviously, the income in question is not "salaries" which would have been paid in the prior years except for the intervention of the events described in (i), (ii), and (iii), and petitioner does not contend otherwise. Our inquiry must be whether the "event" which prevented the payment of the income in question to petitioner in the earlier years was such event as is set forth in the statute. The event which prevented payment in the years services were performed was an agreement between National and petitioner, entered into because of a loan agreement between National and R. F. C. When R. F. C. made the loan to National it considered National solvent, but required National to reduce certain current expenses until such time as R. F. C. should approve the increase thereof. Petitioner agreed to receive $ 12,000 per year, $ 7,800 in cash payments, and a credit for the balance. Regarding the two agreements made in 1937 as a type of "event," it was not such "event" as is described in the statute in (i), (ii), and (iii).

*754 Petitioner places his entire reliance upon (iv), "any other event determined to be similar in nature under regulations prescribed by the Commissioner." The *244 Commissioner has issued his regulation under T. D. 5389, dated July 10, 1944, and reported in Internal Revenue Bulletin No. 14, July 25, 1944, p. 8, which amends Regulations 111 by inserting a new section, section 29, 107-3. The regulation now prescribed by the Commissioner is as follows (p. 9):

* * * *

An event will be considered similar in nature to those events specified in section 107(d)(2)(A)(i), (ii), and (iii) only if the circumstances are unusual, if they are of the type specified therein, if they operate to defer payment of the remuneration for the services performed, and if payment, except for such circumstances, would have been made prior to the taxable year in which received or accrued. For the purposes of this section the term "back pay" does not include remuneration which is deemed to be constructively received in the taxable year or years in which the services were performed, remuneration paid in the current year in accordance with the usual practice or custom of the employer even though received in respect of services performed in a prior year or years, additional compensation for past services where there was no prior agreement or legal*245 obligation to pay such additional compensation, or any amount which is not includible in gross income under Chapter 1.

* * * *

The reports of the Congressional committees show that the committees were concerned with the problem of how far the scope of the definition of "back pay" should extend. The definition first proposed was too limited and was rejected by the Finance Committee of the Senate. Thereafter, in conference, the definition of "back pay" was broadened to the definition enacted, with the explanation in the report of the Committee of Conference that "The term [back pay] refers only to remuneration, the payment of which has been deferred by reason of the unusual circumstances of the type specified in the definition." See Senate Report No. 627, 78th Cong., 1st sess., Finance Committee, p. 22; and House Report No. 1079, 78th Cong., 2d sess., Committee of Conference, p. 44. (Reported, also, in Internal Revenue Bulletin, No. 6, p. 81, March 25, 1944, and No. 7, p. 37, April 11, 1944.) The regulation of the Commissioner quoted above does not specify particular "events" which will be accepted as similar to those set forth in (i), (ii), and (iii) of the definition, but makes*246 the test any circumstance which is unusual and which is of the type specified therein, and provides, further, that there must be at least a prior agreement or legal obligation to pay additional compensation for past services.

Mindful of the rule that judicial and administrative interpretation must not invade the function of the legislature so as to extend the scope of a statute, the problem of applying the statutory definition of "back pay" must be regarded as a special problem in each case. The *755 regulation of the Commissioner provides a test which limits similar "events" to the "type" set forth in (i), (ii), and (iii), but it also sets forth a guide in the description of what shall not constitute "back pay." The remuneration in question is not excluded from "back pay" by that description of the negative.

Upon due consideration we think the situation which gave rise to the agreement made in December 1937 between National and petitioner constituted a similar event under the regulation which the Congress authorized the Commissioner to make. The situation was not usual, and National was restricted under its agreement with R. F. C. in making payments from earnings in ways which*247 resemble the restrictions placed upon business operations conducted under receivership. The salary of petitioner was fixed at $ 12,000 per year by R. F. C., with the condition that payment of $ 4,200 of annual salary was to be deferred. National, under its agreement with petitioner, was obligated to pay him the deferred payments of salary at such time as the loan from R. F. C. was fully paid.

Petitioner agreed to accept two-thirds of the sums credited to his account for salary in the prior years. Of the total sum of $ 9,704.96 paid him in 1941, $ 8,400 represents salary earned in the prior years. That amount exceeds 15 percent of the gross income of petitioner in 1941. It is held that the sum of $ 8,400 represents back pay under (iv) of section 107 (d) (2), and the income tax on that amount is limited as is prescribed in subsection 1 of section 107 (d). It is pointed out that such income could not be held to have been constructively received in the earlier years when credits to petitioner's salary account were made.

Petitioner, at some time in 1940, made another agreement with National relating to sharing in 6 percent of profits computed as agreed upon. The sum of $ 1,304.96*248 which petitioner received in 1941 was not back pay under section 107 (d) (2) (iv). It is so held, and such amount is includible in gross income for 1941 and is taxable in the regular way without benefit of section 107 (d) (1). Section 107 (d) (2) limits the definition of back pay to wages, salaries, retirement pay, and similar "compensation." Sharing in profits is not to be assumed to be compensation similar to salaries, and petitioner has not proved that it was. The holding made above is premised upon the conclusion that the restrictions on salary payments made by R. F. C. resemble the restrictions imposed by a receiver. The agreement made in 1940 with National was made without the consent of R. F. C.

Decision will be entered under Rule 50.