Memorandum Opinion
BLACK, Judge: The Commissioner has determined deficiencies against petitioner as follows:
| 1939 | 1940 |
| Income Taxes | $2,718.23 | $3,650.43 |
| Declared Value Excess Profits |
| Taxes | 5.57 | 61.05 |
| Excess Profits Tax | None | 1,147.66 |
Petitioner assigns error attacking the determination of the Commissioner as follows:
(a) In computing petitioner's net income for the calendar year 1939, the respondent has erroneously disallowed as a deduction the sum of $8,000., representing ordinary and necessary expense incurred during the taxable year as a reasonable allowance for salary paid to its president for personal services actually rendered. Respondent has erroneously assigned as his reason therefor that such amount was not paid within the taxable year or within two and one-half months after the close thereof.
(b) In computing petitioner's net income for the calendar year 1939, the respondent has erroneously disallowed as a deduction the sum of $12,500.00 representing ordinary and necessary expense incurred during the taxable year as rent for premises occupied by petitioner as its principal place of business. Respondent has erroneously assigned as his reason therefor that such amount was not paid within the taxable year or within two and one-half months after the close thereof.
(c) In computing petitioner's net income for the calendar year 1940, the respondent has erroneously disallowed as a deduction the sum of $10,000.00, representing ordinary and necessary expense incurred during the taxable year as a reasonable allowance for salary paid to its president for personal services actually rendered. Respondent has erroneously assigned as his reason therefor that such amount was not paid within the taxable year or within two and one-half months after the close thereof.
(d) In computing petitioner's net income for the calendar year 1940, the respondent has erroneously disallowed as a deduction the sum of $12,500.00 representing ordinary and necessary expense incurred during the taxable year as rent for premises occupied by petitioner as its principal place of business. Respondent has erroneously assigned as his reason therefor that such amount was not paid within the taxable year or within two and one-half months after the close thereof.
[The Facts]
The facts have been stipulated as follows:
1. Petitioner (hereinafter sometimes referred to as the corporation), is a corporation organized on December 1, 1926, under the laws of Pennsylvania, with its office and principal place of business at 3201 North Broad Street, Philadelphia, Pennsylvania. At all times material to this proceeding, it was engaged in the retail sale of new and used automobiles.
2. Petitioner's Federal income and declared value excess profits tax returns for the calendar years 1939 and 1940, and its Federal excess profits tax return for the calendar year 1940 were filed with the Collector of Internal Revenue for the First Collection District of Pennsylvania, at Philadelphia, Pennsylvania. Photostatic copies of petitioner's Federal income and declared value excess profits tax and excess profits tax returns for the calendar years 1939 and 1940 are introduced in evidence.
3. Petitioner's books of account are kept on the accrual basis and its Federal income and declared value excess profits tax and excess profits tax returns for the years 1926 to 1940 were prepared in conformity therewith.
4. At all times material to this proceeding, all of petitioner's capital stock was owned by Thomas B. Martindale, its president.
5. At all times material to this proceeding, the management of the corporation's financial transactions was in the sole control of Thomas B. Martindale.
6. Accruals of salary and rent expenses claimed as deductions by petitioner and disallowed in part by the respondent are predicated upon credits upon the books of account of petitioner to the following accounts:
"Account Payable, Thomas B. Martindale"
"Account Payable, Thomas B. Martindale, Rent"
"Account Payable, Thomas B. Martindale, Salary"
"Reserve for Bonus"
7. In its Federal income and declared value excess profits tax return for the calendar year 1939, petitioner claimed as a deduction the sum of $15,020. and $30,000., being the amounts charged on the books of account of the corporation for salary earned and rent, respectively, accrued and owing to Thomas B. Martindale. Of such amounts the respondent has disallowed the sums of $8,000. and $12,500., respectively.
8. For the calendar year 1939, Thomas B. Martindale reported the amount of $15,020. as salary received and the amount of $30,000. as rent received as items of income in his individual Federal income tax return for that year, which was prepared and filed on the basis of cash receipts and disbursements. On February 1, 1943, Thomas B. Martindale filed a claim for refund with the Collector of Internal Revenue for the First District of Pennsylvania for refund of income taxes paid on the amounts which were reported by him as rent and salary, and which were disallowed as a deduction to the petitioner in respondent's notice of deficiency. The respondent has taken no action on this claim.
9. On January 1, 1939, there was a credit balance of $104,945.89 on petitioner's books of account in the account designated as "Account Payable, Thomas B. Martindale". There were no balances in the accounts designated as "Account Payable, Thomas B. Martindale, Salary", "Account Payable, Thomas B. Martindale, Rent", and "Reserve for Bonus".
10. During the calendar year 1939 the authorized salary of Thomas B. Martindale for that year was credited upon the books of account of the corporation in the sum of $15,020. This amount was composed of the tentative base salary of $7,020. per annum and additional compensation of $8,000. These amounts were credited upon the books of account of the corporation in the following manner:
The tentative base salary of $7,020. was credited in equal monthly amounts of $585.00 to the account designated as
"Account Payable, Thomas B. Martindale, Salary".
The additional compensation of $8,000. was credited on December 31, 1939, to the account designated as
"Account Payable, Thomas B. Martindale". The crediting of this latter amount to this account was ratified at a duly constituted meeting of the Board of Directors of petitioner held on January 15, 1940.
11. For the calendar year 1939 the corporation agreed to pay to Thomas B. Martindale a rental of $30,000. for its use and occupancy of the premises owned by him and located at 3201 North Broad Street, Philadelphia, Pennsylvania, and used by the corporation as a salesroom and warehouse. This rental was credited monthly upon the books of account of the corporation in amounts of $2,500. each or an aggregate for the year of $30,000. The account which was credited with this amount was designated as
"Account Payable, Thomas B. Martindale, "Rent".
12. During the calendar year 1939 the petitioner made monthly cash payments of $585.00 each to Thomas B. Martindale on account of accrued salary earned in the sum of $7,020., which were charged against the account designated as
13. During the calendar year 1939 the petitioner made cash payments to Thomas B. Martindale on account of accrued rental in the amounts and on the dates shown as follows:
| April 11 | $ 2,500.00 |
| May 22 | 2,500.00 |
| June 6 | 5,000.00 |
| June 28 | 5,000.00 |
| August 30 | 2,500.00 |
| Total | $17,500.00 |
These payments were charged on the books of account of the corporation to the account designated as "Account Payable, Thomas B. Martindale, Rent".
14. The balance of accrued rent $12,500., was transferred by journal entry on December 31, 1939, as a credit to the account designated as
"Account Payable, Thomas B. Martindale".
15. On July 10, 1939, a cash payment was made to Thomas B. Martindale in the sum of $10,000., which was charged to the account designated as
16. As a result of the above entries, the credit balance in the account designated "Account Payable, Thomas B. Martindale", on December 31, 1939, was $115,445.89. There were no balances in the accounts designated "Account Payable, Thomas B. Martindale, Rent", "Account Payable, Thomas B. Martindale, Salary", "Reserve for Bonus".
17. No cash payment was made by petitioner to Thomas B. Martindale during the period January 1, 1940, to March 15, 1940, inclusive, on account of the credit balance in the account captioned "Account Payable, Thomas B. Martindale", on December 31, 1939.
18. In its Federal income and declared value excess profits tax return and ind its excess profits tax return, for the calendar year 1940, petitioner claimed as a deduction the sums of $17,020. and $30,000., being the amounts charged on the books of account of the corporation for salary earned and rent, respectively, accrued and owing to Thomas B. Martindale. Of such amounts, the respondent has disallowed the sums of $10,000., and $12,500., respectively.
19. For the calendar year 1940, Thomas B. Martindale reported the amount of $17,020. as salary received, and the amount of $30,000. as rent received, as items of income in his individual Federal income tax return for that year which was prepared and filed on the basis of cash receipts and dibursements, and showed no taxable net income.
20. During the calendar year 1940 the authorized salary of Thomas B. Martindale for that year was credited upon the books of account of the corporation in the sum of $17,020. This amount was composed of the tentative base salary of $7,020. and an additional compensation of $10,000. authorized at a duly constituted meeting of the Board of Directors. These amounts were credited upon the books of account of the corporation in the following manner:
The tentative base salary of $7,020. was credited monthly in amounts of $585.00 each to the account designated as
The additional compensation of $10,000. was credited on December 31, 1940, to an account payable, designated as
"Reserve for Bonus".
21. For the calendar year 1940 the corporation agreed to pay to Thomas B. Martindale a rental of $30,000. for its use and occupancy of the premises 3201 North Broad Street, Philadelphia, Pennsylvania. This annual rental was credited monthly upon the books of account of the corporation to the individual account of Thomas B. Martindale in amounts of $2500. each, or an aggregate for the year of $30,000. The account which was credited with this amount was designated as
22. During the calendar year 1940 the petitioner made monthly cash payments of $585.00 each to Thomas B. Martindale on account of accrued salary earned in the sum of $7,020., which were charged against the account designated as
23. During the calendar year 1940 the petitioner made cash payments to Thomas B. Martindale on account of accrued rental in the amounts and on the dates shown:
| January 5 | $ 1,000.00 |
| January 29 | 1,000.00 |
| March 15 | 3,000.00 |
| May 20 | 2,500.00 |
| June 11 | 5,000.00 |
| October 28 | 2,500.00 |
| December 14 | 2,500.00 |
| Total | $17,500.00 |
These payments were charged on the books of account of the corporation to the account designated as
24. The balance of accrued rent, $12,500., was transferred by journal entry on December 31, 1940, as a credit to the account designated as
25. On July 9, 1940, cash payment was made to Thomas B. Martindale in the sum of $10,000., which was charged to the account designated as
26. On December 31, 1940, petitioner's books showed a credit balance in the amount of $117,945.89 to the account designated as
"Account Payable, Thomas B. Martindale" and a credit balance of $10,000., in the account designated as
There were no balances in the accounts captioned
27. No cash payment was made by petitioner to Thomas B. Martindale during the period January 1, 1941, to March 15, 1941, inclusive, on account of the credit balances in the accounts captioned "Account Payable, Thomas B. Martindale" and "Reserve for Bonus", on December 31, 1940.
28. On June 30, 1941, the balance in the account designated as "Reserve for Bonus" was transferred as a credit to the account captioned "Account Payable, Thomas B. Martindale".
29. The balancing of the account designated
"Account Payable, Thomas B. Martindale", was accomplished by the following transactions as recorded on the books of petitioner:
| Dr. | Cr. |
| Balance, December 31, 1940 | | $117,945.89 |
| June 30, 1941, transfer from "Reserve for Bonus," | | 10,000.00 |
| October 1, 1941, 247 Shares full-paid $100. par Capital |
| Stock Issued | $ 24,700.00 |
| October 1, 1941, Demand note issued | 100,000.00 |
| February 9, 1942, Cash paid | 3,245.89 |
| $127,945.89 | $127,945.89 |
30. On December 31, 1939, the corporation's balance sheet shows the following financial condition:
| ASSETS |
| Cash | | $ 16,508.21 |
| Notes and Accounts Receivable | | 122,597.54 |
| Merchandise Inventory | | 82,665.76 |
| Total Current Assets | | $221,771.51 |
| Other Assets | | 18,299.49 |
| Total Assets | | $240,071.00 |
| LIABILITIES |
| Notes Payable Banks | | $ 24,623.33 |
| Accounts Payable: |
| Thomas B. Martindale | | 115,445.89 |
| Trade Creditors | | 6,709.86 |
| Accrued Bonus | | 1,100.00 |
| Other Liabilities | | 3,389.48 |
| Total Liabilities | | $151,268.56 |
| Total Assets | | $240,071.00 |
| Total Liabilities | | 151,268.56 |
| Net Worth | | $ 88,802.44 |
| Composed of: |
| Capital Stock | $75,300.00 |
| Surplus | 13,502.44 |
| | $ 88,802.44 |
31. On December 31, 1940, the corporation's balance sheet shows the following financial condition:
| ASSETS |
| Cash | | $ 24,985.30 |
| Notes and Accounts Receivable | | 153,963.35 |
| Merchandise Inventory | | 121,634.31 |
| Total Current Assets | | $300,582.96 |
| Other Assets | | 16,298.63 |
| Total Assets | | $316,881.59 |
| LIABILITIES |
| Notes Payable Banks | | $ 78,978.87 |
| Accounts Payable: |
| Thomas B. Martindale | | 117,945.89 |
| Trade Creditors | | 14,695.72 |
| Accrued Bonus | | 1,930.27 |
| Accrued Bonus - |
| Thomas B. Martindale | | 10,000.00 |
| Other Liabilities | | 4,111.62 |
| | $227,662.37 |
| Total Assets | | $316,881.59 |
| Total Liabilities | | 227,662.37 |
| Net Worth | | $ 89,219.22 |
| Composed of: |
| Capital Stock | $75,300.00 |
| Surplus | 13,919.22 |
| | $ 89,219.22 |
32. For the calendar year 1939, the corporation derived gross income in the amount of $21,905.34 as a result of the corporation's financing the sales of new and used cars. This amount is reflected in Item 13 of Page 1 of the Income and Excess Profits Tax Return for the calendar year 1939 and appears as the second item in the Schedule attached to and made a part of said return.
33. For the calendar year 1940 the corporation derived income in the amount of $18,698.09 as a result of the corporation's financing the sales of new and used cars. This amount is reflected in Item 13 of Page 1 of the Income, Declared Value Excess Profits and Defense Tax Return for the calendar year 1940 and appears as the second item in the Schedule attached to and made a part of the said return.
34. At any time during the period January 1, 1939 to March 15, 1941, petitioner could have borrowed from banks on a secured basis sufficient cash to have paid Thomas B. Martindale in full the amounts standing to his credit on petitioner's books of account, but did not during this period borrow any money for this purpose.
From the foregoing facts it will be seen that the Commissioner in his determination of the deficiencies has allowed petitioner in each of the taxable years a deduction for the amounts of cash payments which it made to its president, Thomas B. Martindale, as salary and as rent. The Commissioner has disallowed certain amounts which petitioner accrued on its books in each of the taxable years as salary, bonus and rents but which it did not pay in cash either in the taxable year when accrued or up to March 15 of the year following. The Commissioner in making such disallowances acted under section 24 (c), Internal Revenue Code which is printed in the margin. 1
It is petitioner's contention that the amounts of salary, bonus and rent in each of the taxable years which were accrued on its books as liabilities to its president and not paid to him in cash were credited to his account in such an unconditional manner as to amount to constructive receipt of such amounts on the part of petitioner's president. Petitioner contends (1) that it was financially able to pay these amounts in the years in which they were accrued as liabilities and (2) petitioner's president to whom such amounts were credited had the unrestricted right to demand and receive payment of these amounts in the years in which they were credited. Petitioner points out that the stipulated facts show that in each of the taxable years Thomas B. Martindale returned these amounts for taxation on his income tax return. Therefore, says petitioner, facts which would make applicable section 24 (c)(2) are not present and not being present the Commissioner's determination cannot be sustained. Regulations 103, section 19.42-2 refers to constructive receipt in the following language:
Income which is credited to the account of or set apart for a taxpayer and which may be drawn upon by him at any time is subject to tax for the year during which so credited or set apart, although not actually reduced to possession. To constitute receipt in such a case, the income must be credited or set apart to the taxpayer without any substantial limitation or restriction upon which payment is to be made, and must be available to him so that it may be drawn at any time, and its receipt brought within his own control and disposition. A book entry, if made, should indicate an absolute transfer from one account to another. * * *
Respondent's contention as stated in his brief is as follows:
* * * where the relationship between debtor and creditor, here involved, admittedly does not satisfy the condition of section 24 (c) (3); and where there has been neither payment by the creditor nor receipt by the debtor in money or money's worth, the fiction of constructive payment and receipt cannot be resorted to in order to modify or change the plain language and intent of section 24, limiting deductions otherwise allowable under section 23(a) to deductions for debts, not only incurred but actually paid within the taxable year, or two and one half months thereafter, and requiring that debts incurred must be actually paid in money or money's worth during the taxable year, or two and one half months thereafter.
In other words, respondent's contention is that the doctrine of constructive receipt has no place whatever in applying the restrictions imposed on certain deductions by section 24 (c). Respondent says that the court's references to "constructive payment" and "constructive receipt" in Musselman Hub-Brake Co. v. Commissioner, 139 Fed. (2d) 65 were obiter dicta because in that case there had been actual payment by the creditor to the debtor the first two and one half months following the taxable year in the form of promissory notes executed by the debtor to the creditor which were worth their face value and which were accepted by the creditor as full payment of the amount due.
Regardless of whether what the court said in the Musselman Hub-Brake Co. case, supra, about "constructive receipt" and "constructive payment" was obiter dicta, this court in the recent case of Michael Flynn Manufacturing Company, 3 T.C. 932 promulgated June 1, 1944, held that section 24(c) of the Internal Revenue Code may not be interpreted to disallow to petitioner the deduction of the accrued expenses for salaries since the salaries were includable in the gross income of the officers in the taxable years when such salaries were unconditionally credited to their account under the doctrine of constructive receipt and the condition to disallowance set forth by section 24(c) (2) of the Internal Revenue Code accordingly did not exist.
Our decision in the Michael Flynn Manufacturing Company case, supra, is of course controlling here if the facts show that there was constructive receipt by Thomas B. Martindale in each of the taxable years of the salaries, bonus and rents in question which were accrued on petitioner's books but not paid to him in cash. The amounts paid to him in cash are not in controversy. As to the year 1939 we think there was constructive receipt of the entire amounts involved for that year. In that year Martindale's regular salary of $585 per month was drawn by him in cash. The additional salary of $8,000 was credited to him on December 31, 1939, to the account designated "Account Payable, Thomas B. Martindale." The balance in the rent account not paid in cash, amounting to $12,500 was credited in the same manner on December 31, 1939, to the account designated "Account Payable, Thomas B. Martindale." We think the amounts thus credited to Thomas B. Martindale, coupled with other facts which have been stipulated, fulfill the requirements prescribed by the Commissioner's regulations prescribing the conditions of constructive receipt. Thomas B. Martindale in his individual income tax return for 1939 returned these amounts for taxation as part of his gross income for that year and in so doing we think he acted properly. As to these amounts the facts show (1) that petitioner was financially able to pay the amounts thus credited and (2) that Thomas B. Martindale, petitioner's president and sole stockholder, had the unrestricted right to demand and receive the amounts thus credited to his account. Such facts fulfill the measure of constructive receipt. Cf. John A. Brander, 3 B.T.A. 231 and John I. Chipley, 25 B.T.A. 1103.
As to the year 1940, the situation is the same as to the rent payments as it was in the year 1939, but we do not think it is the same as to salary. In 1940 Thomas B. Martindale received his regular monthly salary of $585 in cash. The additional compensation of $10,000 which petitioner alleged Martindale constructively received in 1940 was credited on December 31, 1940, to an account payable designated as "Reserve for Bonus." On June 30, 1941, the balance in the account designated as "Reserve for Bonus" was transferred as a credit to the account captioned "Account Payable, Thomas B. Martindale." Thus the unconditional crediting to the account of Thomas B. Martindale of this $10,000 bonus for the year 1940 did not take place until June 30, 1941. It was not until then that this particular $10,000 was constructively paid to him and constructively received by him. Under these circumstances we think petitioner must be disallowed this deduction from its 1940 gross income because of the limitations imposed by section 24(c).
It may well be that the $10,000 additional salary to Martindale in 1940 under the facts stipulated represented an accrued liability of petitioner to him in 1940, although carried on petitioner's books as "Reserve for Bonus." See Paul and Mertens Law of Federal Income Taxation, section 12.67, Vol. 2. This section deals with the subject "Where Liability is Reflected by Use of Reserves" and, among other things, says: "For example, expenses accrued or incurred representing a fixed liability will be deductible by a taxpayer on the accrual basis, notwithstanding that they are designated as reserves on the taxpayer's books." But it should be remembered that the question with which we are dealing in the instant case is not the ordinary one of the right of a deduction by a taxpayer on the accrual basis. The question with which we are dealing is petitioner's right to deduct certain accrued items as limited by section 24(c) of I.R.C. And confining ourselves to that narrow question we hold as above stated that petitioner is not entitled to deduct in 1940 the $10,000 additional compensation voted to Thomas B. Martindale in that year.
Petitioner has an alternative contention to its main contention which it states in its brief as follows:
In the alternative, where petitioner unconditionally credited to the account of its president on its books of account authorized salary, bonus and rent due in the aggregate amounts of $45,020. for 1939 and $47,020. for 1940, and where petitioner actually paid him in cash amounts aggregating $34,520. during the year 1939 and $34,520. during the year 1940, respondent erred in disallowing under Section 24(c) $10,000. of the amount actually paid in cash during each year on the ground that such payments were on account of credit balances owing by petitioner at the beginning of each year.
It is unnecessary to pass upon this alternative contention in so far as 1939 is concerned, for we have sustained petitioner for that year. For 1940 we have not sustained petitioner as to the $10,000 bonus or additional salary for that year. It, therefore, becomes necessary to consider petitioner's alternative contention for 1940.
The stipulated facts show that on July 9, 1940, cash payment was made to Thomas B. Martindale in the sum of $10,000 which was charged to the account designated as "Account Payable, Thomas B. Martindale." This was several months prior to the crediting of $10,000 on petitioner's books, December 31, 1940, to a "Reserve for Bonus." It was nearly a year prior to the crediting of this $10,000 to "Account Payable, Thomas B. Martindale" which took place on June 30, 1941. Under such circumstances we cannot hold that this $10,000 cash paid to Thomas B. Martindale on July 9, 1940, was a payment to him of a bonus for 1940. There are no facts which would justify such a holding. The $10,000 paid to him on July 10, 1940, was simply a cash payment on an account payable to Thomas B. Martindale which exceeded $100,000. So far as we can see it has no other legal significance. As to the $10,000 additional compensation for 1940 to Thomas B. Martindale, petitioner is not sustained.
Decision will be entered under Rule 50.