
    SEINSHEIMER PAPER CO. v. THE UNITED STATES
    [No. D-835.
    Decided February 14, 1927;
    motion for new trial overruled May 2, 1927]
    
      On the Proofs
    
    
      Income tax; determination of salary dedMctions. — It appearing that the evidence upon which the Commissioner of Internal Revenue acted was sufficient to justify a conclusion that the salaries allowed by him as deductions in plaintiff’s corporate income tax return for ihe year 1917 were not less than the ordinary and necessary expense therefor, and in the returns for 1918 and 1919 were reasonable allowances, plaintiff is not entitled to a refund of taxes based on larger salary deductions.
    
      The ReportePs statement of the case:
    
      Mr. J. Robert Sherrod for the plaintiff. Mr. John D. Watkins, Miller efi Chevalier, and Harmon, Colson, Goldsmith & Hoadly. were on the brief.
    
      Mr. Alexander H. McC ormieh, with whom was Mr. Assistant Attorney General Herman J. Galloway, for the defendant.
    The court made special findings of fact, as follows:
    I. Plaintiff, the Seinsheimer Paper Company, is and was during the years 1917,1918, and 1919, a citizen of the United States, being a corporation duly organized and existing under and by virtue of the laws of the State of Ohio, and having its principal place of business at Cincinnati, in said State.
    II. Plaintiff, on or about March 29, 1918, in accordance with the provisions of the revenue act of 1916, as amended by the revenue act of 1917, and the regulations of the Treasury Department thereunder, and on forms furnished to it by the collector of internal revenue at Cincinnati, Ohio, prepared and filed with said collector returns purporting to show its income and invested capital for the calendar year 1917, computed in the manner provided in said statutes and regulations, and paid to said collector at the time said returns were filed income and excess-profits taxes on its income for said year amounting to $20,651.18.
    On or about December 15, 1919, as the result of an assessment, plaintiff paid to said collector, under protest, additional income and excess-profits taxes on said income for the year 1917 amounting to $26,404.64. The total income and excess-profits taxes which plaintiff paid to said collector on said income for the year 1917, as aforesaid, amounted to $47,055.82.
    III. Plaintiff, in accordance with the provisions of the revenue act of 1918 and the regulations of the Treasury Depaiiment thereunder, within the time prescribed by said act and regulations, and on forms furnished to it by said collector, prepared and filed with said collector returns purporting to show its income and invested capital for the calendar years 1918 and 1919, computed in the manner provided in said statutes and regulations, and paid to said collector within the time prescribed by said statutes and regulations, income and excess-profits taxes on said income for the year 1918 amounting to $33,948 and on said income for the year 1919 amounting to $2,317.65.
    In or about January, 1921, the Commissioner of Internal Revenue assessed against plaintiff additional income and excess-profits taxes for the year 1918 in the sum of $24,720. Plaintiff thereupon filed a claim in abatement of said additional assessment, and thereafter $8,013.73 of the additional assessment was abated by said commissioner, and plaintiff paid to said collector, under protest, the balance of said .additional assessment, to wit, the sum of $16,706.27, on or •about November 16,1923, making the total income and excess-profits taxes which plaintiff paid to said collector on said income for the year 1918 amount to $50,654.27.
    On or about July 27, 1923, the Commissioner of Internal '.Revenue assessed against plaintiff additional income and excess-profits taxes on said income for the year 1919, in the sum of $5,931.38, which plaintiff paid to said collector, under protest, on or about November 16, 1923, making the total income and excess-profits taxes which plaintiff paid to said collector on said income for the year 1919 amount to $8,249.03.
    IV. The plaintiff in making its income-tax return for the years 1911, 1918, and 1919, deducted $15,000 for each of said years as total salaries paid to its three officers in each year, $25,000 having been paid to its president, A. H. Seinsheimer; $25,000 to its vice president, L. A. Seinsheimer; and $25,000 to its secretary and treasurer, Walter Seinsheimer, during each of the years in question,
    V. The three officers to whom the above salaries were paid were during the years 1911, 1918, and 1919, the owners of all the outstanding capital stock of the plaintiff company. A. H. Seinsheimer, president of the company, is the father of the other two officers.
    VI. In the year 1916 the same officers served the company as in the years 1911, 1918, and 1919. The total salaries paid to these three officers for 1916 amounted to $16,000, $6,000 having been paid to the president and $5,000 to each of the other two officers. It was customary for the company at all annual meetings to agree upon the officers’ salaries to be paid during the current or ensuing year. The minutes of such a meeting held in January, 1917, show that it was agreed that the same salaries should be paid for the year 1917 as were paid in 1916. The minutes of the special meeting of stockholders held September 24, 1917, show that it was agreed that the salary of each of the three officers named should be increased for the year 1917 to $25,000. In carrying out that agreement a credit of $15,000 was set up in favor of each officer upon the closing of the books at the end of the year.
    VII. The following table shows the net income reported by the plaintiff for the years 1916, 1917, 1918, and 1919, the salaries paid to each of the three officers in each year, and the amount of capital stock owned by each officer during each year:
    
      
    
    VIII. During the year 1917 and the period from January 1, 1918, to June 5, 1918, plaintiff corporation was affiliated, as provided by the regulations and rulings of the Treasury Department, and section 240 of the 1918 act, with the Seins-heimer Eealty Company, an Ohio corporation, and during said time the three officers of plaintiff corporation were als'o officers of the Seinsheimer Eealty Company, but did not receive any compensation for their services as officers of the latter company during said time.
    The . Seiinsheimer Eealty Company was organized and served only as a holding company. It held title during 1917, 1918, and 1919 to the real estate occupied by the plaintiff company.
    IX. On or about November, 1920, the commissioner notified the plaintiff that there had been allowed as a deduction from the plaintiff’s gross income for the year 1917, as salary paid to officers only $45,000 of the $75,000 deducted by the plaintiff. The additional assessment of $24,720 referred to in Finding III, was based on said disallowance.
    On or about December 15, 1922, said commissioner notified plaintiff by letter that its income and excess-profits tax liability for the years 1917, 1918, and 1919 had been determined, and that pursuant to a conference had with plaintiff’s representative a total deduction from gross income for each of said years in the sum of $50,000 had been allowed on account of salaries paid its officers. A copy of said letter is attached to the petition herein as Exhibit 1, and is by reference made a part of this finding. Plaintiff thereupon appealed to said commissioner and the committee on appeals and review, his appellate body, as provided by section 250 of the revenue act of 1921, but was notified by letter on or about July 27, 1923, that said appeal, in so far as it related to salaries paid to officers, had been disallowed. A copy of said letter is attached to the petition filed herein, as Exhibit 2, and is by reference made a part of this finding.
    X. The additional income and excess-profits taxes which plaintiff was required to pay as aforesaid as the result- of the disallowance each year of $25,000 of the total amount of $75,000 which plaintiff paid to its officers during each of the years' 1917, 1918, and 1919, amounted to $12,038.17 for the year 1917, $21,061.03 for the year 1918, and $6,094.15 for the year 1919, or a total amount of $39,193.35.
    XI. On January 11, 1923, plaintiff executed and thereafter filed with said commissioner, at his request and as provided by subdivision (d) of section 250 of the revenue act of 1921, an income and excess-profits tax waiver for the year 1917 of the statute of limitations as to additional assessments for the year 1917.'
    XII. Claims for refund were duly filed within the time required by law for all amounts claimed in this action and all of said claims were rejected by the commissioner prior to and within two years' of the commencement of this action.
    XIII. The said sum of $39,193.35, which was paid by plaintiff as and for a tax as aforesaid, was received and is still retained by the United States.
    XIV. The Commissioner of Internal Revenue disallowed the said deductions in plaintiff’s income and excess-profits tax returns for the calendar years 1917, 1918, and 1919 on the ground that a total salary allowance of $75,000 per year for the said officers was unreasonable, and that a reasonable allowance for said salaries was a total of $50,000 per year. In arriving at his decision the commissioner gave full consideration to all facts bearing upon the question of a reasonable allowance.
    The court decided that plaintiff was not entitled to recover.
   Moss, Judge,

delivered the opinion of the court:

In its income-tax returns for the years 1911, 1918, and 1919 the plaintiff, the Seinsheimer Paper Company, deducted $15,000 for each of said years as total salaries paid to its three officers, $25,000 a year to each of them. The officers of plaintiff company consisted of the father and his two sons, Avho were the sole owners of the outstanding capital stock of the company and whose total salaries for the year 1916 and years prior thereto was $16,000.

The Commissioner of Internal Revenue in computing the net income of plaintiff disallowed as a deduction the sum of $75,000 per year as total salary, and allowed a total salary of $50,000 for each of the three years. As a result of the disallowance the commissioner assessed additional income and profits taxes for the three years involved, amounting in the aggregate to $39,193.15, and this, action is for the recovery of that sum.

Section 12 (a), act of 1916, 39 Stat. 756, provides as follows:

“ In the case of a corporation * * * such net income shall be ascertained by deducting from the gross amount of its income received within the year from all sources, first, all the ordinary and. necessary expenses paid within the year in the maintenance and operation of its business and properties * *

Under this statute, which is applicable to the 1917 taxes, salaries of officers were allowed as deductible items under proper Treasury regulations.

The revenue act of 1918 applicable to the taxes for 1918 and 1919 provides that in computing net income “ all the ordinary and necessary expenses * * *, including a reasonable allowance for salaries, are deductible.”

The ground upon which the commissioner disallowed the deduction of $75,000 per year for salaries was that same was an unreasonable amount; and be allowed a deduction of $50,000 as being a reasonable sum for such salaries.

The sole question, therefore, is whether or not the $50,000 allowed as a deduction by the commissioner constituted a reasonable salary.

The Commissioner of Internal Revenue under the law is charged with the duty of assessing the tax on net income, and in order to arrive at net income it is likewise his duty to consider and determine the question of proper allowable deductions.

It clearly appears from the record that, in reaching his conclusion as to the reasonableness of the allowance made by him, the commissioner gave full consideration to all facts bearing upon the question; and in addition to the facts appearing in the record he considered also certain information contained in the files of his office concerning salaries allowed as deductions to officers of companies doing a similar business, comparable in amount of invested capital and in volume of business.

The court is of the opinion that the evidence upon which the commissioner determined that a total salary of $50,000 was reasonable was sufficient to justify such conclusion.

It is therefore the judgment of the court that plaintiff’s petition should be and the same is hereby dismissed.

Gteaham, Judge; Hat, Judge; Booth, Judge; and Campbell, QMef Justice, concur.

On motion for new tided

Moss, Judge,

delivered the opinion of the court:

The Commissioner of Internal Revenue in computing the net income of plaintiff disallowed as a deduction the amount claimed by plaintiff, $75,000 per year as total salary, and allowed the sum of $50,000 for each of the years involved, 1917, 1918, and 1919.

Section 12 (a), act of 1916, 39 Stat. 756, applicable to the tax for the year 1917, provides that in computing net income “ all the ordinary and necessary expenses * * * ” are deductible.

Section 234 (a), of the act of 1918, 40 Stat. 1057, 1077. applicable to the tax for the years 1918 and 1919, provides that in computing net income “ all the ordinary and necessary expenses * * * including a reasonable allowance for salaries * * * ” are deductible.

The entire stock of plaintiff company was owned by A. H. Seinsheimer, the father, and by his sons, Louis A. and Walter Seinsheimer, and these three constituted the officers and active managers of the business of the company.

From the year 1900 to 1916, inclusive, A. H. Seinsheimer, the president of the company, received a salary of $6,000 per year, except for two years, 1910 and 1913, when he was paid $7,000 and $8,000, respectively. For the same period the two sons each received an average of $5,000 per year as salaries. Approximately, therefore, from 1900 to 1916, inclusive, the aggregate annual salaries paid amounted to $16,000, in the proportions above set forth. In and for the year 1917 these officers increased their salaries to $25,000 each per year. It was an increase of more than 386 per cent.

Salaries of officers to be deductible under the 1916 act must come within the classification of “ ordinary and necessary ” expenses incident to the maintenance and operation of the business, and like all other items of expense such salaries must be “ ordinary and necessary ” salaries. The term “ ordinary ” as used in the statute means customary or usual. No extrinsic evidence is needed in this case to establish what might properly be regarded as the ordinary, customary, or usual salary pertaining to the business of plaintiff company. The officers themselves by their own course, extending over a period of sixteen years, leave no room for question on that point. The record, however, discloses an abundance of evidence on the question.

Plaintiff’s motion is based on a recent decision of this court in the case of Botany Worsted Mills v. United States, ante, p. 405.

In that case it appeared that on January 11, 1890, the plaintiff company incorporated in its by-laws a certain provision for the compensation of its directors by which they were to receive, in addition to a nominal salary, a designated percentage of the net income. The percentage was changed from time to time, but from the year 1908 until after the close of the taxable year 1917 the directors had received annual payments under the express provision of the by-laws a sum equal to 32 per centum of the net income. Each director held a position as an executive officer or manager of a certain department of the business. This method of compensation was consistently followed for nearly thirty years, during which time the gross assets of plaintiff company had increased from $1,114,149.63 in 1890 to $28,893,777.12 in 1917; and its net assets, including reserves, had increased from $37,136.35 in 1890 to $10,999,862.48 in 1917. It was also shown that such method of compensating directors and officers had been the practice in many corporations engaged in the woolen manufacturing business. The court was of the opinion that the payment of such compensation for the year 1917 constituted one of the “ordinary and necessary expenses ” of the operation of the business, and that the Commissioner of Internal Revenue was without authority under the act of 1917 to determine the question of the reasonableness of a claim for deduction for salary. However, in the Botawy case the Government interposed as one of its defenses an alleged settlement in the Internal Revenue Bureau of all tax matters between the taxpayer and the Government, which the court sustained, and the petition was dismissed on that ground.

In this case the tax for three years was involved. For two of the years, 1918 and 1919, the commissioner was expressly authorized to deduct a reasonable allowance for salaries. For one of the years, 1917, his authority was limited to the inquiry as to.whether or not the salary came properly within the term “ ordinary and necessary ” expenses. The fact that the Commissioner of Internal Revenue in disallowing a portion of plaintiff’s claim employed the use of the term “ reasonable ” as applying to the whole case; or that the court used the word “ reasonable ” in stating the question to be “whether or not the $50,000 allowed as a deduction by the commissioner constituted a reasonable salary ” is beside the question. The facts, rather than the technical use of terms, must control. The salary claimed by plaintiff is neither an ordinary and necessary expenditure under the meaning of the act of 1916, nor is it a reasonable salary as contemplated by the terms of the act of 1918.

Plaintiff’s contention concerning the years 1918 and 1919 is not seriously urged.

It is the opinion of the court that plaintiff’s motion for new trial should be overruled, and it is so ordered.

Graham, Judge; Hay, Judge; Booth, Judge; and Campbell. Chief Justice, concur.  