Appeal of Lister

3 B.T.A. 475

• Court: United States Board of Tax Appeals
• Decided: January 28, 1926
• Docket: Docket No. 3411
• Status: Published

Opinion

OPINION.

Smith

: In his original income-tax return for 1917, the taxpayer did not report the receipt of any income in respect of 166 shares of stock of Walworth Brothers, Inc., which were charged to him at par value as salary on the corporation’s books of account for the year 1917. He understood that these shares of stock were a gift to him and, accordingly, that he received no taxable income from this source.

An inspection of the original contract made between John P. Walworth and Charles W. Walworth, Lawrence, Mass., and the taxpayer, dated September 30, 1916, shows that the shares of stock were to be paid to the taxpayer “ if he faithfully performs his said duties to the corporation for a period of three years from this date.” It was provided that the shares of stock would be held in escrow by the Walworths until the taxpayer had completed his three years of service. If this had been done the taxpayer would not have received any income in respect of the shares of stock until they were actually received at the end of the three-year term. For the original contract of September 30, 1916, there was substituted a contract dated September 30, 1917, which provided in part that:

Whereas, James R. Lister lias been in the employ of said copartnership and intends to continue in the employ of said corporation at a cash salary of one hundred dollars per week, to be paid to him weekly,.and as additional compensation certain shares of stock as hereinafter provided, said stock, however, to be paid to him only in the event that he faithfully performs his duties to said corporation for a period of three years from September 30, 1916;

Now therefore: * ⅜ *

(10) It is further agreed that semi-annually during said period of three years there shall be credited to the party of the second part on the books of the corporation one-sixth of the par value of said five hundred shares of common stock of Walworth Bros., Incorporated and one-sixth of said one hundred shares of stock of Walworth Sales Corporation of no nominal or par value, which' shall be carried as an obligation of the party of the first part to the said James It. Lister for services rendered during the preceding six months, but which shall be cancelled on delivery of said stock at the end of said period of three years. ⅜ * ⅜

We can not doubt, in view of this language of the contract, that the shares of stock of Walworth Brothers, Inc., and of Walworth Sales Corporation were intended to be paid to the taxpayer and were paid to him as compensation for services to be rendered Walworth Brothers, Inc., over a three-year period ended September §0, 1919. To the extent that the shares of stock at the time they came into the possession and ownership of the taxpayer had a cash value, such cash value constitutes income of the taxpayer in the year of such receipt or ownership.

The evidence before us indicates an attempt on the part of Charles W. Walworth and John P. Walworth, on behalf of Walworth Brothers, Inc., to relieve the corporation from a large part of its income and excess-profits-tax liability for the years 1917, 1918, and 1919. An inspection of the original contract dated September 30, 1916, shows that the two Walworth brothers desired to compensate the taxpayer, who had been in their service for many years. The common stock of the corporation had been issued to them. They decided to give to the taxpayer 500 shares of the common stock but, before he could receive it, he must agree to work for Walworth Brothers, Inc., for a period of three years at a salary of $100 per week. This contract on its face never contemplated that the corporation should be subjected to any expense in respect of the gift of the shares.

When the terms of the income and profits-tax law of 1917 became known, Charles W. Walworth and his attorney apparently conceived a means of escaping a large part of the tax liability which was cast upon the corporation by the taxing act. There was first organized the Walworth Sales Corporation. The evidence before us and the testimony of one of the officers of the corporation indicate that the only excuse for the existence of this corporation was to reduce income-tax liability. It had the same office as Walworth Brothers, Inc., in New York City, and it was simply operated as the selling end of the business. Although the cost of selling was only about 1 ½ per cent of the selling price, the sales corporation was allowed a commission of 7½ per cent upon sales. The profits of the sales corporation were, under an agreement entered into by Walworth Brothers, Inc., and the sales corporation, to be used in acquiring the preferred stock of Walworth Brothers, Inc., owned by Charles W. Walworth and John P. Walworth, and the evidence is to the effect that approximately $200,000 of the preferred stock was acquired through the earnings of this corporation.

Although the 500 shares of stock which were to be given to the taxpayer did not belong to Walworth Brothers, Inc., the substituted contract of September SO, 1917, which the taxpayer was led to accept, provides that the shares of stock of both Walworth Brothers, Inc., and Walworth Sales Corporation are loaned to Walworth Brothers, Inc., “ to enable this agreement to be carried out.” The contract further provides that it is “understood and agreed that if at the end of three years the said party of the second part [the taxpayer] has earned said stock, or, on account of death, the said stock has been delivered in accordance with this agreement, the obligation of the corporation to return or pay for said stock to said parties of the third part will at the end of said period of three years be cancelled.” This language indicates that it was never the intention of the contracting parties that the corporation should be required to pay for the shares of stock.

We are convinced from a consideration of the entire evidence that the giving of the stock to the taxpayer never resulted in any expense to Walworth Brothers, Inc., and that, if it charged on its books of account any salary as having been paid to the taxpayer during the three-year period of the contract in excess of $100 per week, its books of account do not reflect actual facts.

Even though Walworth Brothers, Inc., did not pay the taxpayer during the tax years in question any amount in excess of $100 per week, this does not mean that the taxpayer did not derive any income from his employment by Walworth Brothers, Inc., in addition to the $100 per week cash paid him. The 500 shares of common stock of Walworth Brothers, Inc., and 100 shares of stock of Walworth Sales Corporation were paid to the taxpayer by Charles W. Walworth and John P. Walworth, in consideration of services to be performed for the corporation over a three-year period. The fair value of those shares at the time they became his absolute property constituted taxable income to him. But when did they become his absolute property, and what was their value at that date ?

An inspection of the substituted contract shows that the ownership of the shares of stock was to remain in Charles W. Walworth and John P. Walworth until the taxpayer had completed three years of service to Walworth Brothers, Inc. At the end of the period the .certificates for the shares were to be delivered to the taxpayer “ relieved of all trusts as his absolute property.” If the taxpayer ceased to be employed by the corporation prior to the end of the period, he forfeited all his rights to the shares of stock. During the period the taxpayer could not assign the shares to any one, except Charles W. Walworth and John P. Walworth, and any attempt to hypothecate or assign his rights in them to others would forfeit all his interests in them. Under these specific provisions of the agreement, we do not consider that the actual delivery of the certificates for a part of the shares to the taxpayer in 1918 and 1919, prior to the end of the three-year period, was such a modification of the contract as to make the value of the shares at the date of receipt income to the taxpayer. The stock certificates delivered to the taxpayer in 1918 and in the early part of 1919 were impressed with a trust, to hold the shares for the real owners, namely, Charles W. Walworth and John P. Wal-worth. The taxpayer came into the ownership of-the shares only upon the completion of the three years of service in the latter part of 1919.

During the year 1918 the taxpayer received from Charles W. Walworth $2,400, in consideration of which he relinquished all his right to and interest in 24 shares of Walworth Brothers, Inc., which he was to receive in absolute ownership at the termination of the three-year period. The receipt of this money was income to the taxpayer in the year 1918. During the year 1919 the taxpayer came into absolute possession and ownership of 476 shares of the common stock of Walworth Brothers, Inc., and, also, 100 shares of the stock of Walworth Sales Corporation. What was the fair market value of those shares at the date they came into the ownership of the taxpayer?

The evidence is to the effect that the shares of stock of both corporations were closely held and that there were no sales in the open market. In 1919, Henry Finegold was offered $8,000 or $9,000 by Charles W. Walworth for approximately 444 shares of the common stock of Walworth Brothers, Inc. Finegold refused the offer and then, in order to get Finegold out of the company, he was finally paid $20,000 for his shares. This is at the rate of approximately $45 a share but, in our opinion, this does not reflect the actual value of the shares of stock, even though at the time dividends at the rate of $6 a year were being paid upon them. The common stock of Walworth Brothers, Inc., received by the taxpayer, which was not taken back by Charles W. Walworth at a price which enabled him to pay his income taxes, was sold by the taxpayer in 1921 for $12 a share. From all the evidence we conclude that the stock received by the taxpayer was worth, at the date of its receipt in 1919, $28.50 a share. The shares of stock of Walworth Sales Corporation received by the taxpayer apparently never had any fair market value and the taxpayer never realized a dollar for his 100 shares of stock received. The taxpayer realized no income from the receipt of these 100 shares. In the early part of 1919, the taxpayer relinquished his right to 36 shares of common stock of Walworth Brothers, Inc., and received from Charles W. Walworth $3,600. For the purpose of computing the income of the taxpayer for the year 1919, this should be treated as a sale of 36 shares at $100 a share; the cost to the taxpayer of those shares was $28.50 a share. In 1920, the taxpayer sold 32 shares to Charles W. Walworth at $100 a share and derived a profit of $71.50 a share upon such sale.

At the hearing the taxpayer moved to amend his petition by having an alleged excess payment of income tax for the year 1917, in the amount of $2,516.64, credited against any deficiency which might be found to be due from the taxpayer for either of the years 1918 or 1919. ■ The taxpayer alleged that a claim for the refund of the overpayment of tax for the year 1917 had been filed with the Commissioner within five years from the date of the payment of the tax, and that under the decision of this Board in Appeal of Hickory Spinning Company, 1 B. T. A. 409, the taxpayer was entitled to the credit. Counsel for the Commissioner did not admit the filing of a claim for the refund within five years from the date of the payment of the tax, and the taxpayer adduced no proof of the filing within such period. In the absence of information upon this point, the request for the credit must be denied. The question whether the Board would have jurisdiction to allow such credit in computing the net deficiency provided the filing of the claim for refund within the five-year period had been proven, is not herein determined.