Docket No. 33691.
George H. Klein, Esq., for the petitioner. S. Jarvin Levison, Esq., for the respondent.
George H. Klein, Esq., for the petitioner. S. Jarvin Levison, Esq., for the respondent.
1. Employer contributions to an exempt pension and profit-sharing trust in excess of the agreement's terms held voluntary and not deductible under section 23(p)(1)(C) or (D), Internal Revenue Code. Wooster Rubber Co., 14 T.C. 1192, followed.
2. Dues paid to associations whose activities are devoted in substantial part to lobbying and propaganda purposes held not deductible as ordinary and necessary expenses. Section 23(q)(2), Internal Revenue Code.
3. Additions to petitioner's reserve for bad debts held, on facts, properly disallowed by respondent.
Respondent determined deficiencies in petitioner's income tax liability for fiscal years ending January 31, 1947, and January 31, 1948, in amounts of $8,537.76 and $7,876.90, respectively. The following issues are raised for each year:
1. Whether petitioner's deduction of contributions to its employee profit-sharing and benefit trust in excess of the terms of the Plan were properly disallowed under section 165(a) and 23(p)(1) of the Internal Revenue Code and regulations thereunder.
2. Whether payments of dues to certain organizations are deductible as ordinary and necessary business expenses under section 23 of the Code and regulations thereunder.
3. Whether part of petitioner's additions to its reserve for bad debts was properly disallowed as a deduction under section 23(k)(1) of the Code.
Some of the facts have been stipulated and are found accordingly.
FINDINGS OF FACT.
Petitioner is a corporation organized under the laws of the State of Washington. It is engaged in the wholesale grocery business, and maintains its principal offices in Spokane, Washington. For the fiscal years ending January 31, 1947, and January 31, 1948, it filed its Federal income tax returns on the accrual basis with the collector for the District of Washington.
On December 21, 1943, petitioner, by action of its board of directors, adopted and instituted an Employee-Profit-Sharing and Benefit Plan (hereinafter called the plan), effective as of January 31, 1944. After certain amendments, this Plan was approved by the Seattle, Washington, field office of the Bureau of Internal Revenue on October 4, 1944. Petitioner adopted this Plan in order to give its employees an opportunity to receive pensions at retirement and thereby to decrease the rate of turnover among its employees. Section 2.1 of the Plan provided, in part, that petitioner could contribute an amount from its net profits of not less than 5 percent thereof,
or in any amount in excess thereof at the discretion of the Board of Directors of the Company, which amount shall not be in excess of fifteen percent (15%) of the total compensation of the Participants hereunder.
Section 2.2 specified that
The Company does not make any representations as to the amount of the contributions, if any, which it will make in any year. * * *
The internal revenue agent in charge in Seattle corresponded with petitioner and its attorney in November 1946, concerning the Plan's tax consequences. The agent indicated that the formula for contributions by the Company was too indefinite and left too much discretion in the directors, including the determination of the extent of any contributions in excess of 5 per cent of net profits up to 15 per cent of total compensation of participants, to qualify for tax exemption benefits. He also suggested certain other amendments. As a result of this correspondence, petitioner's board of directors adopted and ratified certain amendments effective as of February 1, 1946. The Commissioner of Internal Revenue approved the amendments on January 8, 1947. Section 2.1 was amended to read as follows:
Section 2.1 Contributions
The Company proposes in each year to make contributions to the Trust Fund from its net profits, as computed for Federal Income Tax purposes before such contributions and before such taxes of five (5%) percent of such net profits, but not more than fifteen (15%) percent of total compensation of the Participants hereunder. The amount of such Company contributions shall be paid over by the Company to the Trustee within sixty (60) days from the last day of the year with respect to which such contribution is made. Payments on account of a contribution with respect to any year may be made by the Company from time to time at the direction of its Board of Directors. The aggregate contributions allocated to officers or employees each owning ten (10%) percent or more of the stock of the Company, shall not exceed thirty (30%) percent of the total of any contributions hereunder. For the purpose of this Plan, a stockholder shall be deemed to be an owner of stock of the Company if such stock is owned by himself, his spouse, or a minor lineal descendant.
Nothing herein contained shall prevent the Company from (1) amending the above formula for contributions (and no such amendments shall be deemed to be prejudicial to the interests of the Participants hereunder and/or their Beneficiaries) or (2) terminating the Plan and discontinuing the making of further contributions thereto, provided that such discontinuance shall not have the effect of vesting any interest in the Company and distributions to Participants and/or their Beneficiaries shall be made as if the Plan continued in full force and effect.
Section 4.2 was amended to read as follows:
Section 4.2 Vesting of Interest of Participants in Trust Fund
When a participant shall have completed a period of two (2) years continuous service under the Plan with the Company, his proportionate interest in the Trust Fund shall become vested and non-forfeitable, and thereafter upon the completion by him of each additional year of service with the Company in excess of two (2) years his proportionate interest in the Company's contribution for such year to the Trust Fund shall immediately become vested and non-forfeitable. Provided, however, that if any Participant (a) shall attain the age of sixty-five (65) years, or (b) shall die, or (c) shall be declared (sic) by the Company, or (d) shall have his service with the Company terminated by the Company because of curtailment in the business of the Company and without fault of the employee, the entire one hundred (100%) percent of his proportionate interest in the Trust Fund shall become non-forfeitable without regard for his period of service. What shall constitute termination of service by the Company because of curtailment in the business of the Company and without fault of the employee shall be determined by the Company in its sole and uncontrolled discretion. Any such non-forfeitable interest in the Trust Fund, however, shall be and become payable to the respective Participant or his Beneficiary or Beneficiaries only as hereinafter provided.
Petitioner, by its board of directors, made a contribution to the trust fund for the fiscal year ended January 31, 1947, in the sum of $18,507.48, which was 10 per cent of the compensation otherwise paid to all employees covered under the Plan. Of this sum, $2,730 was allocated to shareholder employees and the rest to nonshareholder employees. $16,259.93 of the total sum vested immediately in accordance with the Plan. Respondent computed the allowable deduction for the fiscal year ended January 31, 1947, under the Plan as amended, as follows:
+-----------------------------------------------------------------------+ ¦(a)¦Petitioner's net income before contributions and tax as¦ ¦ +---+-------------------------------------------------------+-----------¦ ¦ ¦corrected ¦$165,420.34¦ +---+-------------------------------------------------------+-----------¦ ¦(b)¦Allowable deduction under the Plan is 5% of (a) ¦8,271.02 ¦ +---+-------------------------------------------------------+-----------¦ ¦(c)¦Amount disallowed as excessive, year ended 1/31/47 ¦10,236.46 ¦ +-----------------------------------------------------------------------+
Petitioner's contribution to the trust fund for the fiscal year ended January 31, 1948, was $16,907.86, which was 7 1/2 per cent of the compensation otherwise paid to participants in the Plan. Of this sum, $2,083.85 was allocated to shareholder employees and the rest to non-shareholder employees. $13,881.58 of the total sum vested immediately, in accordance with the Plan. Respondent computed the allowable deduction for the fiscal year ended January 31, 1948, as follows:
+--------------------------------------------------------------------+ ¦(a) Petitioner's net income before contributions and tax¦$129,059.59¦ +--------------------------------------------------------+-----------¦ ¦(b) Allowable deduction under the Plan is 5% of (a) ¦6,452.98 ¦ +--------------------------------------------------------+-----------¦ ¦(c) Amount disallowed as excessive, year ended 1/31/48 ¦10,454.88 ¦ +--------------------------------------------------------------------+
The amounts contributed to the Plan for each of the fiscal years involved did not exceed 15 per cent of the compensation otherwise paid to all employees under the Plan during each of those years. These amounts exceeded 5 per cent of petitioner's net profits for each year, and such excess was disallowed by respondent. These amounts were actually paid, pursuant to resolutions by petitioner's board of directors, received by the trustee, and applied by the latter to the benefit of participants in the Plan in accordance with its provisions within 60 days after the close of the respective fiscal years. For each of the years in question, statements were filed with the Bureau setting forth the determinations of the board of directors as to the amounts contributed, the method of computation, the manner in which the monies were applied for the benefit of the employees under the Plan, and data with respect to the 25 highest paid participants.
During the fiscal year ending January 31, 1947, petitioner paid dues in the aggregate sum of $150 to the Good Roads Association and the Taxpayers' League. During the fiscal year ending January 31, 1948, petitioner paid dues aggregating $190 to those organizations and the Washington Wholesalers' Beer Association.
Petitioner operates 25 trucks in connection with its business in the State of Washington. The Good Roads Association fosters the improvement of farm-to-market roads. Petitioner obtained information as to the condition of roads and routes from that association. Conditions requiring correction were pointed out to the association, which took them up with local authorities. An officer or officers of the association had testified before legislative committees of the State of Washington when the subject of concern was the appropriations for roads. The association has also submitted formative plans concerning road construction to legislative groups of the State of Washington.
The Taxpayers' League is an association interested in what it calls equitable taxation. Petitioner obtained tax information relating to its business from this association. Such information has included advice of contemplated tax changes and the operation and interpretation of the consumers' sales tax law in effect in the State of Washington. The League frequently fosters taxes of certain types and objects to others that it claims to be either not equitable or not just. An employee of the Taxpayers' League has been called upon many times to help write tax laws. The League submits its position on taxation to the Washington State Legislature at its regular sessions every two years.
The Washington Wholesalers' Beer Association is an association of employers. It entered into labor negotiations on behalf of its members and also informed its members of possible legislative limitations on the sale of beer. During the years in issue it informed its members of the merits and progress of a proposed initiative in the State of Washington relative to the sale of alcoholic beverages. The proposed initiative was a ‘dry‘ measure. It was of the utmost importance to petitioner that any dry steps be suppressed. The Washington Wholesalers' Beer Association was a strong opponent and took all steps within its resources, including newspaper advertising, to obtain the disapproval of such legislation. Petitioner's gross sales of beer in the fiscal year ending January 31, 1947, amounted to approximately $500,000 out of total gross sales of $6,300,000, and in the fiscal year ending January 31, 1948, its gross sales of beer amounted to approximately $650,000 out of total gross sales of $7,500,000.
A substantial part of the activities of the Good Roads Association, the Taxpayers' League and the Washington Wholesalers' Beer Association was devoted to lobbying purposes, the promotion or defeat of legislation, and the exploitation of propaganda.
Prior to 1945, petitioner deducted bad debts on the specific ascertainment basis. It was given permission by the Bureau of Internal Revenue to adopt the reserve basis on January 19, 1945.
To arrive at the amount allocated to the reserve for bad debts for both of the fiscal years involved, petitioner took the total sales of the business, subtracted therefrom the amount of its beer sales, which are cash sales, and then applied a rate of one-fourth of 1 per cent to the remainder. The sum thus ascertained was added to the reserve. Cash sales of merchandise other than beer, totaling about $100,000 for each of the fiscal years, could not be precisely separated from credit sales under petitioner's method of accounting, and were included in the base figure to which the reserve percentage was applied. Pursuant to these calculations, petitioner added $14,500.31 to the reserve for the fiscal year ending January 31, 1947, and $17,121.66 for the fiscal year ending January 31, 1948.
Petitioner had a balance of $9,626.02 in its reserve on February 1, 1946. The balance was $23,643.40 on January 31, 1947. Outstanding accounts receivable as of January 31, 1947, were $353,760. Credit sales for the year then ended totaled about $5,700,000. On January 31, 1948, the reserve had a credit balance of $40,090.43, and outstanding accounts receivable totaled $194,083.72. Credit sales for the year then ended totaled about $6,750,000.
Petitioner wrote off as bad debts $482.93 for the fiscal year ended January 31, 1947, and $674.63 for the fiscal year ended January 31, 1948.
Petitioner recovered $2,150.56 during the fiscal year ended January 31, 1947, and $593.36 during the fiscal year ended January 31, 1948, which amounts had been charged off as bad debts during the period before petitioner obtained permission to adopt the reserve basis. These amounts so recovered were credited to the bad debt account and to that extent were taken into petitioner's gross income.
Petitioner's contributions to its employees' profit-sharing trust in excess of the amounts called for by the previously approved plan are a clearly forbidden deduction under section 23(p)(1)(C), Internal Revenue Code. Wooster Rubber Co., 14 T.C. 1192, reversed on other grounds, Commissioner v. Wooster Rubber Co. (C.A. 6), 189 F.2d 878; Irwin B. Schwabe Co., 17 T.C. 1215. The trust agreement expressly provides for contributions of 5 per cent of petitioner's net profits and no payment in excess of that amount would be made in accordance with the plan so as to meet the statutory description of payments ‘to or under a * * * pension * * * plan * * * .‘
SEC. 23. DEDUCTIONS FROM GROSS INCOME.(p) CONTRIBUTIONS OF AN EMPLOYER TO AN EMPLOYEES' TRUST OR ANNUITY PLAN AND COMPENSATION *under A DEFERRED-PAYMENT PLAN.—(1) GENERAL RULE.— If contributions are paid by an employer to or under a stock bonus, pension, profit-sharing or annuity plan, * * * such contributions or compensation shall not be deductible under subsection (a) but shall be deductible, if deductible under subsection (a) without regard to this subsection, under this subsection but only to the following extent:(C) In the taxable year when paid, if the contributions are paid into a stock bonus or profit-sharing trust, and if such taxable year ends within or with a taxable year of the trust with respect to which the trust is exempt under section 165(a) * * * .
* * * The profit sharing plan to which petitioner made payments was exempt under section 165(a) but we have held that only part of the payments made by petitioner were to or under a plan as envisaged by sections 165(a) and 23(p)(1)(C) and approved by the Commissioner. Only such payments as were actually called for by the predetermined formula contained in the agreement and declaration of trust are deductible under section 23(p)(1)(C) * * * .
Respondent * * * correctly disallows the excess payments made, which cannot be said to be a part of the plan as it was approved with its accompanying tax benefits by the Commissioner. * * * (Wooster Rubber Co., supra.)
It is true that the Wooster Rubber case was reversed on appeal, Commissioner v. Wooster Rubber Co., supra, but that was on the ground that the Court of Appeals differed with out conclusion that the terms of that plan were unambiguous. Here, we see no escape from the view that the trust agreement is clear and without any ambiguity. It leaves no room for construction by resort to extrinsic evidence.
In Produce Reporter Co., 18 T.C. 69, we held that it was unnecessary under the statute for a trust to include a ‘definite, predetermined formula‘ for the measurement of the contributions, in order for the trust to be exempt under section 165(a). That, of course, is not the present question. Whether or not the trust here involved was required to have a definite formula, it had one; and that is the formula which was exceeded by the payments in controversy. As in Produce Reporter Co., ‘We deem it unnecessary to pass upon the validity of the respondent's regulations‘ requiring that a trust secure respondent's approval before it can qualify for exemption under section 165(a). The fact is that the present petitioner desired that approval and obtained it by inserting the provisions in question in the trust agreement. We do not see how it can now be heard to say that express language appearing in a written document is not there, even if it be a fact that it did not need to be there otherwise.
Nor is any amount deductible under section 23(p)(1)(D) as being paid under a ‘plan * * * not * * * included in paragraphs (A), (B), or (C).‘ There was no plan unless the trust agreement in question can be so designated and, to the extent that the contributions were made in accordance with such a plan, they are deductible under (C) and not (D). Since not required by the trust agreement, the payments cannot be considered as ‘ordinary and necessary business expenses.‘ Gross-Given Manufacturing Co. v. Kelm (D. Minn.), 99 F.Supp. 144. And we cannot construe the stipulation of the parties that the expenses in question were ordinary and necessary as going beyond the amounts conceded by respondent to be deductible and called for by the agreement itself. Anything further would be a conclusion of law as to which a stipulation of the parties could not be binding upon us. First Mechanics National Bank of Trenton v. Commissioner (C.A. 3), 117 F.2d 127.
On the second issue, we have found as a fact that a substantial part of the activities of the organizations to which petitioner's contributions were made and for which it claims deductions was devoted to ‘lobbying purposes, the promotion or defeat of legislation, (and) the exploitation of propaganda ‘ within the meaning of section 29.23(q)-1 of Regulations 111. This regulation is to be given the force of law, Textile Mills Securities Corporation v. Commissioner, 314 U.S. 326, and no expenditure coming within its terms may be permitted as a deduction even under section 23(a). Mary E. Bellingrath, 46 B.T.A. 89; Roberts Dairy Co. v. Commissioner (C.A. 8), 195 F.2d 948, certiorari denied 344 U.S. 865. On the first two issues, the deficiency is accordingly sustained.
The relevant language of this regulation is identical with the corresponding sections of Regulations 74, involved in the Textile Mills Securities Corporation case, and Regulations 94, involved in the Mary E. Bellingrath case.
On the final issue we conclude that petitioner has not sustained its burden of showing that respondent's partial disallowance of additions to a reserve for bad debts was improper. Although petitioner had been in business for a number of years the record is inadequate as to its bad debt experience, and no information is furnished us from which we may conclude that the amount of the reserve as it existed at the end of each of the contested years was not sufficient to cover any future bad debt charge-offs for which it was established. We cannot say that the formula adopted by petitioner was proper in the light of its failure to produce evidence either as to its past experience or what might reasonably be expected in the future. But in any event, ‘A method or formula that produces a reasonable addition to a bad debt reserve in one year, or a series of years, may be entirely out of tune with the circumstances of the year involved.‘ Black Motor Co., 41 B.T.A. 300, affd. (C.A. 6) 125 F.2d 977. And those circumstances are not shown. On this issue also the deficiency is approved.
Reviewed by the Court.
Decision will be entered for the respondent.