Comm'r of Internal Revenue

Tax Court of the United States.Sep 28, 1945
5 T.C. 870 (U.S.T.C. 1945)

Docket No. 4822.



Errett G. Smith, Esq., for the petitioner. David F. Long, Esq., for the respondent.

Petitioner, an industrial or consulting engineer, incorporated his business in 1922 after a number of years of individual operation, in the taxable years 1940 and 1941 he either owned or controlled nearly all the corporation's stock and received practically all its net earnings. Petitioner traveled extensively and did considerable entertaining. He withdrew sums of money from the corporation and expended them, both in and out of Chicago, his home and the business address of the corporation, for what he considered necessary to promote, develop, and maintain business. He personally kept no records of his expenditures and was unable to identify them with any particular business transaction. The sums withdrawn by petitioner were recorded in a certain account on the corporation's books, together with other items paid directly by the corporation for business expenses. Respondent allowed all the items payable to named payees other than petitioner, but included in petitioner's gross income items payable to him or to ‘cash.‘ Held, respondent did not err in treating said withdrawals as income to petitioner and requiring petitioner to substantiate their expenditure for purposes of deductions; held, further, it appearing that at least some part of the withdrawals was used for ordinary and necessary business and traveling expenses, petitioner is entitled to a deduction of 50 percent of the amounts required to be added to his income. Rule of Cohan v. Commissioner, 39 Fed.(2d) 540, applied. Errett G. Smith, Esq., for the petitioner. David F. Long, Esq., for the respondent.

Respondent has determined deficiencies in petitioner's income tax in the amounts of $655.77 and $3,316.89 for the respective calendar years 1940 and 1941. The asserted deficiencies are based primarily upon the inclusion in petitioner's gross income of certain amounts reported as deductions for business expenses by petitioner's corporation, Lucien I. Yeomans, Inc., and in part from the denial to petitioner of the status of ‘head of a family.‘ Respondent now concedes that status. The remaining issues, therefore, are whether said amounts are includible in petitioner's gross income and, if so, whether petitioner is entitled to deductions for all or any portion thereof.


Petitioner is an individual. During the calendar years 1940 and 1941 he resided at Chicago, Illinois, and his income tax returns for those years were filed with the collector for the first district of Illinois.

Petitioner is a member of numerous engineering societies. From 1913 to 1922, he was engaged in business individually as a consulting engineer or an industrial engineer. In 1922, for various reasons, the principal one being the conservation of interests he had in patent rights in the event of his death, he organized a corporation, Lucien I. Yeomans, Inc., which has since continued the business formerly conducted by him as an individual. During the years in controversy petitioner was president of the corporation and either owned or controlled nearly all of its stock and received practically all of its net earnings. The corporation's business address was at Chicago. Petitioner, his secretary, and a part time stenographer were the only regular employees of the corporation.

Petitioner traveled extensively on business. In 1940 he made 33 trips out of Chicago and was away a total of about 142 business days. In 1941 he made 36 trips and was away 122 business days.

It was petitioner's practice always to carry with him funds withdrawn from the corporation. Some of the purposes for which he expended such funds were for his traveling expenses and payment for laboratory work, for the making of models, for automobile rentals, for printing, for investigations having to do with the design of a new line of machinery, for the employment of help when needed, for the traveling expenses of persons who accompanied him on business trips, for the entertainment of persons, both in and out of Chicago, doing business with the corporation or with whom the corporation sought to do business, and for other things which in petitioner's judgment were reasonable expenditures for the company to develop, promote, secure, and maintain business.

Petitioner personally kept no records of the expenditures for such purposes. The corporation had a somewhat novel system of keeping records of its receipts and disbursements. This system consisted of the use of voucher checks and duplicate deposit slips. Checks and deposit slips were prepared on a typewriter. At the bottom of the original of the checks was a perforated voucher slip, on which was recorded a brief notation of the purpose for which the check was drawn. Simultaneously with the writing of each check, a carbon duplicate was made. Ordinarily the voucher was torn off from the original before the check was sent to a payee, but the duplicates were kept by the corporation. The corporation had some thirty-five or more accounts in its system, and the appropriate account number was recorded on each check and duplicate. The duplicate sheets were then assembled by petitioner's secretary and inserted in a looseleaf binder. A similar practice was followed in connection with deposit slips, so as to record all receipts by the corporation. The binders including the duplicate sheets thus constituted the corporation's ‘books of original entry‘ and afforded a record of all receipts and disbursements by the corporation.

Two of the corporation's accounts are designated ‘Account No. 15‘ and ‘Account No. 32.‘ The former is styled ‘Traveling expenses in connection with the development and carrying on of the business, Entertainment, Taxicabs, etc.‘ In this account were recorded all expenditures for the purposes above stated, and all the contested items passed through that account. Account No. 32 is styled ‘Advances made to L.I.Y. personally to be accounted later.‘ It is petitioner's drawing or salary account.

Many of the items recorded in account 15 during the taxable years show checks made out direct to railroad companies for tickets, to hotels in settlement of monthly statements, and to other named payees for designated purposes. Petitioner or the corporation had credit accounts at several of the Chicago hotels, and petitioner would often register at those hotels people who were in town on business of the corporation or with whom the corporation sought to do business, and instruct the hotels to charge their expenses to the company's account. Other items in account 15 show checks made to ‘Cash‘ and to ‘L.I.Y.,‘ the initials being those of petitioner. When the funds carried by petitioner became depleted, if he was in town, he would have his secretary make out a check to him or to cash, and either he or she would cash it to replenish them. If he was out of town, the usual practice was to write a check on the corporation's bank account and cash it at a hotel. In that case he would notify his secretary, who would make appropriate entries to record such checks.

Petitioner rented a two-room apartment in Chicago, in which he lived. He paid the rent with his personal funds. Sometimes he prepared his own breakfast there and sometimes he would buy it in town. Usually he ate no lunch. He ‘charged‘ himself a dollar and a half a day for elevated fare to and from the office and for newspapers. His grocery bills, laundry bills, etc., were paid with his personal funds. Sometimes such bills were paid through the office by company check, but in such cases the amounts were charged to account 32— his drawing account. He was separated from his family. His wife and daughter lived in Philadelphia, where the daughter was attending the University of Pennsylvania. All expenses of his wife and daughter were paid by petitioner with his personal funds.

The total of all the entries in account 15 for 1940 was $9,845.55, and the total for 1941 was $11,877.60. The corporation deducted those sums as business expenses in its returns for the respective years. Of the total deduction of $9,845.55 for 1940, a revenue agent investigating the corporation's returns questioned items amounting to $4,052, and of the total deduction of $11,877.60 for 1941 he questioned items amounting to $5,377. The items questioned consisted of checks to ‘Cash‘ and to ‘L.I.Y.‘ Not all such items in account 15, however, were questioned.

Petitioner drew a salary of $9,281.16 in 1940 and $31,510.31 in 1941, which sums he reported in his individual returns. He did not report any sums which passed through account 15 in those years. Respondent has increased petitioner's income for 1940 by the amount of the items questioned by the revenue agent, i.e., $4,052, and increased his income for 1941 by the amount of the disputed items for that year, i.e., $5,377. Respondent has further refused to allow any deductions from those amounts for expenses.



Respondent has treated as additional income to petitioner certain sums withdrawn by petitioner from the corporation, Lucien I. Yeomans, Inc., in 1940 and 1941, which sums were included in deductions taken by the corporation for business expenses in its returns for those years. In making his determination, respondent relied upon section 22(a) of the Internal Revenue Code, defining ‘gross income,‘ and section 19.23(a)-2(b) of Regulations 103.

SEC. 19.23(a)-2. Traveling expenses.— Traveling expenses, as ordinarily understood, include railroad fares and meals and lodging. If the trip is undertaken for other than business purposes, the railroad fares are personal expenses and the meals and lodging are living expenses. If the trip is solely on business, the reasonable and necessary traveling expenses, including railroad fares, meals, and lodging, are business expenses.(b) If an individual receives a salary and is also repaid his actual traveling expenses, he shall include in gross income the amount so repaid and may deduct such expenses.* * * Only such expenses as are reasonable and necessary in the conduct of the business and directly attributable to it may be deducted. A taxpayer claiming the benefit of the deductions referred to herein must attach to his return a statement showing (1) the nature of the business in which engaged; (2) the number of days away from home during the taxable year on account of business; (3) the total amount of expenses incident to meals and lodging while absent from home on business during the taxable year; and (4) the total amount of other expenses incident to travel and claimed as a deduction.Claim for the deductions referred to herein must be substantiated, when required by the Commissioner, by evidence showing in detail the amount and nature of the expenses incurred.

We think respondent has acted properly in including such sums in petitioner's income. Petitioner is an industrial or consulting engineer. He is engaged essentially in a personal service business. The corporation is but a continuation in corporate form of the same business conducted by him for many years as an individual. Petitioner and his secretary were the only full time employees of the corporation. The sums which he withdrew he spent as he pleased, with little, if any, accountability to anyone. In the end he received practically all the earnings of the corporation.

Petitioner himself kept no records of his expenditures and, so far as the sums in dispute are concerned, the company records afford only a very unsatisfactory showing of the purposes for which expenditures with particular business purposes. Petitioner testified in a general way that all the sums in dispute were expended for what he considered necessary to promote, develop, and maintain business. He was in Chicago, his home, considerably more than half the time in each of the taxable years. Substantial portions of the sums in dispute, it is claimed, were expended in Chicago, but petitioner was unable at the hearing to demonstrate the connection between any claimed item of ‘Chicago expenses‘ and a specific business transaction.

Petitioner complains that respondent has tried to confine his case to a very narrow channel by requiring him to include the controverted sums in his gross income in accordance with the regulation relating to traveling expenses, and by requiring him to substantiate such expenditures as provided by that regulation. He contends that not all of the amount disallowed was claimed as traveling expenses and need not be supported as such. It is further urged that the disallowed sums were expended by the corporation and that petitioner, personally, was but an instrumentality through which the wishes of the corporation were effectuated. Petitioner testified that in making expenditures he considered that he was an agent of the corporation, handling corporate funds and disbursing them for what he though to be corporate purposes; that he did not look upon the money as his; that he kept ‘company money‘ in one pocket and his personal funds in another pocket; and that none of the ‘company money‘ was spent for his personal benefit.

Such subtleties of reasoning are too tenuous to distinguish petitioner's position from either that of an employee who admittedly spends his own funds and is reimbursed therefor or that of one doing business as an individual who makes expenditures and claims deductions therefor as business expenses. Some of the money in dispute, it appears, was used for ‘development‘ and other purposes which might well be in the nature of capital expenditures. Petitioner can not, by the expedient of incorporating himself and carrying on his personal service business in corporate form, secure a deduction as a business expense for an item which is properly a capital expenditure. Nor can he, by such an expedient, spend money freely for whatever he considers a business purpose, keep no records of such expenditures, and, when income tax deductions are claimed in respect thereof, avoid the obligation to substantiate such expenditures.

Regardless of the applicability of the regulation to all or only a portion of the amounts in controversy, we think the respondent's action in including the sums in petitioner's gross income was warranted. In such circumstances as we have before us, where petitioner had complete freedom in spending the money as he chose, we find nothing unreasonable in treating the money as his— as income to him— and in requiring him to justify whatever deductions he claims for business expenses.

The total of the disbursements recorded in ‘Account No. 15‘ for 1940 was $9,845.55, and for 1941 it was $11,877.60. Of these sums the respondent has allowed $5,793.55 and $6,500.60, respectively. The sums allowed include, in the main, such items as checks payable to railroad companies for tickets and checks payable to hotels for hotel bills— items which on their face would seem to have been spent for business purposes. It was only the remainder of $4,052 for 1940 and $5,377 for 1941 that respondent included in petitioner's income, and those sums consist entirely of items payable to ‘Cash‘ or to ‘L.I.Y.‘ It was those sums whose expenditure petitioner was called upon by respondent to substantiate.

With respect to those sums no deductions were allowed. We can not, from the record before us, determine with precision the exact amounts which should be allowed as deductions, as we might if petitioner had kept any records by which he could with some reasonable degree of accuracy have identified his expenditures. Nevertheless, we are convinced that at least some part of the disputed sums (including even some expenditures in Chicago) was used for purposes which fall within the category of ordinary and necessary business expenses and some part for traveling expenses. We must, therefore, apply the rule of the Cohan case and make the best estimate we can. After a careful examination of all the testimony and the exhibits, and particularly the transcripts of ‘Account No. 15,‘ we conclude that petitioner should be allowed a deduction of 50 percent of the amounts required to be included in his gross income— in other words, $2,026 for 1940, and $2,688.50 for 1941.

Cohan v. Commissioner, 39 Fed.(2d) 540.

Decisions will be entered under Rule 50.