Comm'r of Internal Revenue

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Tax Court of the United States.Feb 25, 1953
19 T.C. 887 (U.S.T.C. 1953)

Docket Nos. 32659 32660 32662.



L. F. Loux, Esq., for the petitioners. Charles R. Hembree, Esq., for the respondent.

L. F. Loux, Esq., for the petitioners. Charles R. Hembree, Esq., for the respondent.

Respondent sustained in his determination that a portion of the amounts respectively received by petitioners upon the sale of their interests in Mainline Construction Company constituted payment to them of salaries accrued on the books of that corporation as due them and Edward H. Green.

The respondent determined deficiencies in income tax of the petitioners for the year 1947 as follows:

+--------------------------------------+ ¦Irving R. and Lotta R. Lewis¦$1,505.16¦ +----------------------------+---------¦ ¦Ernest M. and Pearle Green ¦1,736.40 ¦ +----------------------------+---------¦ ¦Howard H. and Anna Green ¦1,912.70 ¦ +--------------------------------------+

In their petition filed with this Court, petitioners Irving R. and Lotta R. Lewis assigned as error respondent's determination that part of the above deficiency in their tax is attributable to the omission from their original return of salary received in the amount of $2,300. No Evidence has been introduced nor argument advanced pertaining to the issue thus raised, and it will be considered as having been abandoned by the petitioners concerned. The sole remaining issue, which is common to all petitioners, is whether a portion of the amount received by petitioners upon the sale of their stock interests in Mainline Construction Company, an Ohio Corporation, constituted payment of certain salaries accrued on the books of the corporation as due them and forgiven by them on the books as a part of the stock transactions.


Stipulation of part of the facts filed by the parties is adopted and made a part hereof.

Petitioners herein are Irving R. Lewis and Lotta R. Lewis, Ernest M. Green and Pearle Green, and Howard M. Green and Anna Green, husbands and wives respectively, who in each case filed joint income tax returns for the year 1947, the year here involved, with the collector of internal revenue for the eighteenth collection district of Ohio.

The husband petitioners, Howard H. Green, Ernest M. Green, and Irving R. Lewis (hereinafter referred to as the petitioners), along with certain others, organized and incorporated Mainline Construction Company (hereinafter called Mainline) under the laws of the State of Ohio on January 24, 1944.

At the time of the incorporation the stock therein was issued on the basis of a $100 investment per share to petitioners and the others in amounts as follows:

+----------------------------------------+ ¦Edward H. Green ¦10¦shares¦) ¦ +------------------+--+------+-----------¦ ¦Howard H. Green ¦10¦“ ¦) ¦ +------------------+--+------+-----------¦ ¦Ernest M. Green ¦10¦“ ¦) 40 shares¦ +------------------+--+------+-----------¦ ¦Irving R. Lewis ¦10¦“ ¦) ¦ +------------------+--+------+-----------¦ ¦ ¦ ¦ ¦ ¦ +------------------+--+------+-----------¦ ¦Morris A. Davidson¦20¦shares¦) ¦ +------------------+--+------+-----------¦ ¦Francis M. Warren ¦20¦“ ¦) 40 shares¦ +----------------------------------------+

During the fiscal years ended March 31, 1944, and March 31, 1945, Mainline Construction Company accrued salaries on its books in favor of all of its officers. Prior to January 1, 1946, these salary accruals were reduced by cash payments so that after January 1, 1946, and at all times pertinent to this proceeding the unpaid salary accruals appearing on the books of Mainline Construction Company were as follows:

+-----------------------------+ ¦Edward H. Green ¦$4,800.00¦ +-------------------+---------¦ ¦Howard H. Green ¦3,600.00 ¦ +-------------------+---------¦ ¦Ernest H. Green ¦3,900.00 ¦ +-------------------+---------¦ ¦Irving R. Lewis ¦3,000.00 ¦ +-------------------+---------¦ ¦Morris A. Davidson ¦8,255.00 ¦ +-------------------+---------¦ ¦Francis M. Warren ¦8,374.34 ¦ +-----------------------------+

Edward H. Green died on November 17, 1945. Shortly thereafter the stock in Mainline theretofore held by him was transferred by his executrix to his two sons and a son-in-law, the petitioners herein, for a nominal consideration of $1 per share. The stockholdings of Mainline thereupon became as follows:

+----------------------------------------+ ¦Howard H. Green ¦14¦shares¦) ¦ +------------------+--+------+-----------¦ ¦Ernest M. Green ¦13¦“ ¦) 40 shares¦ +------------------+--+------+-----------¦ ¦Irving R. Lewis ¦13¦“ ¦) ¦ +------------------+--+------+-----------¦ ¦Morris A. Davidson¦20¦shares¦) ¦ +------------------+--+------+-----------¦ ¦Francis M. Warren ¦20¦“ ¦) 40 shares¦ +----------------------------------------+

The foregoing stockholdings continued through January 2, 1947, up until about June 11, 1947.

In the fall of 1945 stockholders Morris A. Davidson and Francis M. Warren (hereinafter called ‘Davidson-Warren group‘) became dissatisfied and friction grew up between them and the group of stockholders which included petitioners. Thereupon petitioners and the Davidson-Warren group began discussions concerning the purchase and sale of their respective interests in Mainline so that one or the other of the two groups would purchase the 50 per cent stock interest held by the other and thereby become owners of all of the outstanding stock in the corporation. One of the topics in these discussions was the way in which disposition of the above-mentioned unpaid accrued salaries would be made. After considerable discussion it was finally agreed by the parties that no consideration would be given to the payment of the accrued salaries because the financial position of Mainline did not warrant any payment thereof, and that such would be forgiven by all officers to whom the salaries had accrued.

On January 2, 1947, the petitioners and the Davidson-Warren group reached an agreement whereby the former would sell their interests in Mainline to the latter at an agreed selling price of $628.83 per share. This price was based upon the book value of the stock, after disregarding the liability for accrued salaries, plus the value of supplies and good will of the corporation. By so disregarding the liability for accrued salaries in determining the book value of the stock, the sale price thereof was increased about $400 per share.

Pursuant to the agreement petitioners on January 2, 1947, executed contracts of sale of their stock in Mainline and agreements covering all accrued salaries respectively due them from that corporation. The agreements covering the accrued salaries were made in consideration of $1 and other valuable considerations and were delivered to one M. F. McQuilkin, the accountant and arbitrator, to be held by him until the completion of the transactions relating to the sale of the stock. To carry out the sale agreements the parties later designated the Cleveland Trust Company as escrow agent, and an escrow agreement was entered into on February 4, 1947. During the period between January 2, 1947, when the contracts of sale and the agreements relative to forgiving their accrued salaries were executed by petitioners, and February 4, 1947, when the escrow agreement was entered into, McQuilkin acted as arbitrator or trustee for the parties.

Upon the execution of the escrow agreement the petitioners placed in the hands of the escrow agent certificates representing their shares of stock in Mainline Construction Company, the contracts of sale of such shares, assignments by each of them of all of their respective interests whatsoever in the corporation, and their written resignations as officers and directors.

All of the accrued salaries on the books of the corporation were canceled on the corporate books on June 13, 1947, after the final payment of the purchase price had been made to the petitioners in accordance with the terms of the escrow agreement.

Petitioners reported a capital gains profit on their sale of stock to the Davidson-Warren group as follows:

+------------------------------------------+ ¦ ¦Selling ¦ ¦ ¦ +---------------+---------+------+---------¦ ¦ ¦price ¦Cost ¦Profit ¦ +---------------+---------+------+---------¦ ¦Ernest M. Green¦$8,166.99¦$1,003¦$7,163.99¦ +---------------+---------+------+---------¦ ¦Howard H. Green¦8,795.22 ¦1,004 ¦7,791.22 ¦ +---------------+---------+------+---------¦ ¦Irving R. Lewis¦8,166.99 ¦1,003 ¦7,163.99 ¦ +------------------------------------------+

The respondent determined that of the foregoing amounts so reported as capital gain, the following sums represented the receipt of the balance of salaries due petitioners by the corporation taxable as ordinary income:

+-----------------------+ ¦Ernest M. Green ¦$5,340¦ +----------------+------¦ ¦Howard H. Green ¦5,520 ¦ +----------------+------¦ ¦Irving R. Lewis ¦4,440 ¦ +-----------------------+



The sole issue involves the propriety of respondent's determination that a portion of the amounts respectively received by petitioners upon the sale of their individual interests in Mainline represented payment to them of the salaries accrued on the books of that corporation in their names and that of Edward H. Green, and taxable as ordinary income.

In defense of his determination respondent maintains that the forgiveness of the salary so accrued and the sale of petitioners' stock in Mainline were parts of a single transaction; that the method employed in arriving at the sale price of the stock resulted in an increased price therefor; that in their receipt of the sale price thus inflated, petitioners actually received the salaries in question; and that so much thereof as is attributable to such salaries is properly taxable as ordinary income pursuant to the provisions of section 22(a), Internal Revenue Code.

SEC. 22. GROSS INCOME.(a) GENERAL DEFINITION.— ‘Gross income‘ includes gains, profits, and income derived from salaries, wages, or compensation for personal service (including personal service as an officer or employee of a State, or any political subdivision thereof, or any agency or instrumentality of any one or more of the foregoing), of whatever kind and in whatever form paid, or from professions, vocations, trades, businesses, commerce, or sales, or dealings in property, whether real or personal, growing out of the ownership or use of or interest in such property; also from interest, rent, dividends, securities, or the transaction of any business carried on for gain or profit, or gains or profits and income derived from any source whatever. * * *

Petitioners, however, contend that the accrued salaries were forgiven by them prior to the sales by them of their stock in Mainline, and that no part of the price per share for which they sold their stock is attributable to the salaries so forgiven. They argue that under no rule of law can they be charged with receipt of the accrued salary standing in favor of Edward H. Green. Thus, it is their position that the entire amount of the gains derived from such sales was properly reported by them as long term capital gains.

The question presented is essentially one of fact and petitioners' contentions find little support in the record made. The negotiations relative to the forgiveness of the salaries in question were carried on contemporaneously with those regarding the sales of stock. The agreements covering both transactions were executed on the same date. The forgiveness of the salaries increased the book value of the stock by approximately $400 per share. The book value so increased was used as a basis for determining the sale price that was paid petitioners for the stock. Furthermore the evidence clearly shows that the Davidson-Warren group would not have agreed to pay as much per share as they actually did pay had not the liability for payment of the salaries been thus canceled. At this point it is significant to note that actual cancelation of the salaries on the books of the corporation was made only after complete compliance had been had with respect to the agreements pertaining to the sales of the stock and after the agreed sale price so inflated had been received by petitioners.

Petitioners argue that respondent's determination results in certain incongruities and they devote much of their brief to pointing up such argument. However, petitioners' demonstration does not of itself prove error in respondent's determination. Petitioners received more for their stock than they otherwise would have received because the liability for their accrued and unpaid salaries was disregarded in computing the sale price of the stock. Hence petitioners in substance received their accrued salaries in the guise of an inflated sale price.

Nor do we agree with the petitioners' contention that they cannot be legally charged with receipt of the accrued salary in favor of Edward H. Green. We see no reason why they should not be so charged if they, in fact, were the legal or equitable owners of the chose in action represented by such accruals. While the evidence of record is sketchy as to this question it is appropriate to assume that petitioners were thus chargeable inasmuch as they were the ones who apparently agreed to the forgiveness and cancelation thereof. In any event the respondent so determined and petitioners, upon whom lay the burden, have failed to prove otherwise.

On the whole the facts we have found, based upon the evidence of record, fully sustain respondent's determination. Accordingly we answer the question posed in the affirmative and hold that a portion of the sums respectively received by petitioners upon the sale of their stock interests in Mainline in fact constituted payment of salaries accrued as due them and Edward H. Green on the books of that corporation, in the amounts determined by respondent, and that such amounts are taxable to them as ordinary income.

Decisions will be entered for the respondent.

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