
    EDWARD T. KIRTZ AND ROSALYN S. KIRTZ v. THE UNITED STATES THE PARAMOUNT FINANCE COMPANY v. THE UNITED STATES
    No. 2-59
    No. 3-59
    [Decided June 6, 1962]
    
      
      Harían Pomeroy for plaintiffs. Norman A. Sugarman on the briefs.
    
      S. Lawrence Shaiman, with whom was Acting Assistant Attorney General John B. Jones, Jr., for defendant. Lyle M. Turner, Philif B. Miller, and Eugene Emerson on the brief.
   Laramore, Judge,

delivered the opinion of tbe court:

This suit arises from the determination of a deficiency in plaintiffs’ income taxes assessed and collected by the Internal Kevenue Service. The plaintiffs in this action are Edward T. Kirtz and Kosalyn S. Kirtz (hereinafter referred to as Kirtz), and the Paramount Finance Company (hereinafter referred to as Paramount).

At all times material Kirtz was an insurance agent duly licensed by the Ohio Superintendent of Insurance and engaged in the business of writing life insurance. Kirtz and his wife filed a timely joint Federal income tax return on the cash basis for the calendar year 1955, the year involved in their petition.

Max Feldman, Arthur L. Feldman, and Herbert I. Baker, are the principal officers of Paramount, and at all times pertinent herein they were in control of management and were the majority stockholders therein. For conciseness and ease of comprehension these officers will hereinafter be referred to simply as the Feldmans.

In 1951, the Feldmans first discussed the possibilities of making arrangements to refer insurance business to insurance companies. They contacted a representative of the Credit Life Insurance Company of Springfield, Ohio, and an oral agreement was accomplished along lines suggested by the insurance company, which required that such insurance be written through a licensed insurance agent in order to comply with Ohio law. The Feldmans were given the privilege of selecting the agent through whom insurance would be written. They selected Kirtz, a personal friend of Arthur L. Feldman, who agreed to become the licensed agent in this arrangement. The insurance company sent the necessary papers to the Feldmans for having Kirtz designated as an agent of the insurance company, the Feldmans had Kirtz sign them, then they sent the papers back to the insurance company.

After Kirtz became the insurance agent for their operations, the Feldmans proceeded to contact automobile dealers and other types of retail and installment-sale dealers and point ont the advantages of having available credit life, health, and accident insurance for their customers. These activities tied in with their operations conducted for Paramount since, during the years in question, Paramount did discount business with at least 150 automobile dealers.

The Feldmans actively engaged in handling the details of their arrangements with the Credit Life Insurance Company, seeking to persuade the dealers that it was to their advantage as well as that of their customers to have credit life insurance coverage. This activity on the part of the Feldmans was solely with the dealers and was not done directly with the customers, nor at the Paramount offices. It is impossible to determine precisely what amount of time the Feldmans spent on insurance business since such activities were correlated with their contacts with dealers for promotion of the finance business of Paramount.

Pursuant to the agreements between the Feldmans and the Credit Life Insurance Company, and between the Feld-mans and Kirtz, the amounts received in the years 1954 and 1955 by the Feldmans from Kirtz were for the promotion of insurance and the referral of insurance business.

In making payment for these policies to the Credit Life Insurance Company, a monthly check for the total of all premiums that month was drawn on the account of Paramount payable to Kirtz. These premiums were derived from the financial paper purchased by Paramount from dealers. This check, together with a summary of policies written during the month, was delivered personally to Kirtz by Arthur Feldman. Kirtz deposited the check in a special account entitled “Edward Kirtz, Special Account.” Kirtz then forwarded a check issued on such account to Credit Life Insurance Company for 60 percent of the premiums, retaining 40 percent. In accordance with his previous agreement with the Feldmans, he retained 5 percent of the premiums and returned 85 percent of the premiums to the Feldmans.

The amount received by Kirtz in 1955, representing 5 percent of the premiums, was reported by him as taxable income, but he did not report as taxable income the 35 percent of the premiums which were paid to the Feldmans.

The amounts paid to the Feldmans for the referral of insurance business were not received or controlled by Paramount, and were not treated by it as its income. The amounts received by the Feldmans were treated as income by them and reported on their tax returns for 1954 and 1955.

The arrangements between Paramount, the Feldmans, and Credit Life Insurance Company were made known to the Ohio Superintendent of Insurance in the course of an investigation requested by the Internal Revenue Service to the Insurance Department. The Department of Insurance did not advise any of the parties to stop or alter in any way the arrangements. In fact, payments such as those made herein to the Feldmans have been made by other insurance agents in connection with other finance companies. Such payments have been a practice in the Cleveland area for many years.

Simply stated, we have a situation where a customer pays a premium for insurance, let us say, in the amount of $100. He pays the full amount to Paramount, which in turn performs the necessary paperwork. Paramount then forwards the full $100 to Kirtz, who in turn sends $60 to the insurance company. There is no dispute at this point. Kirtz, however, sends $35 to the Feldmans. The Government contends that this payment to the Feldmans is in violation of Ohio law, thus no deduction should be permitted Kirtz. Further, the Government contends that this payment should be treated as it it were constructively received by Paramount, should be included in its gross income, and that no deduction be permitted Paramount because there is nothing to indicate that Paramount regarded the payment to the Feldmans as necessary expenses of the corporation. Thus, the Government has collected income tax on the same $35 from the Feldmans, Paramount, and Kirtz.

The plaintiffs first contend that receipt of this payment should not be included in their gross income. They allege that they were mere conduits through whom the money passed and that they held the money with no “claim of right.” Second, plaintiffs contend that if receipt of the payment is includable in gross income, it is a deductible trade or business expense.

As to Paramount, the facts reveal that it never received payment from Kirtz. We think it is quite unreasonable to attribute to the corporation receipt of income which it never realized, then deny a deduction for an amount equal to the sum of a payment made to several of its officers. Conceivably there may be instances where receipt of income by an officer of a corporation is tantamount to receipt of income by the corporation. In our view, if the income should be attributable to the corporation for reasons owing to the fact that corporate officers were actually performing services for the corporation, then this amount should be deductible under applicable Code provisions. Since the result is identical whether the amount involved is includable in gross income then deducted or not included in gross income, we conclude it is moot as to the method employed.

As to Kirtz, he actually received payment from Paramount and it should properly be included in his gross income. If Kirtz is to be entitled to a tax benefit with respect to the amounts paid the Feldmans, such benefit must be in the form of a deduction from gross income.

The Government does not contend that the payment to the Feldmans by Kirtz was not an ordinary and necessary expense. Indeed, it could not because the facts show that Kirtz would not have been involved at all had he not consented to make payments to the Feldmans. However, the Government alleges that these payments were in violation of Ohio law and to permit a deduction would thwart a well-defined public policy. In support of its position the defendant cites several cases which hold a finding of “necessity” cannot be made if the allowance of the deduction would frustrate sharply defined national or state policies proscribing particular types of conduct, evidenced by some governmental declaration thereof. Tank Truck Rentals, Inc. v. Commissioner, 356 U.S. 30; Hoover Motor Express Co., Inc. v. United States, 356 U.S. 38; Commissioner v. Heininger, 320 U.S. 467.

In Tank Truck Rentals v. Commissioner, supra, the court stated at page 35:

Certainly tlie frustration of state policy is most complete and direct when the expenditure for which deduction is sought is itself prohibited by statute. See Boyle, Flagg & Seaman, Inc. v. Commissioner, 25 T.C. 43.

The Boyle, Flagg & Seaman case, cited with approval by the Supreme Court above, bears a strong similarity to the facts in the instant case. There, the Tax Court held that payments made by an insurance agency to automobile dealers for insurance solicitation in violation of Illinois law were non-deductible expenses.

The Boyle case, and every case relied on by the defendant, contained an element lacking in the present action; i.e., a determination by the authority charged with the enforcement of the state or federal law or the carrying out of the public policy involved that the expense for the deduction sought was incurred in violation of that law or well-defined public policy. Lacking any such determination, we are of the opinion that an allegation by the Internal Revenue Service that the expense was incurred in violation of a state statute is insufficient to disallow an otherwise proper deduction unless the expense occasioned an act malmn in se. To permit the Internal Revenue Service to employ Federal tax law'in an effort to enforce its concept of state law as the Service views it would be an unnecessary extension of its delegated authority, at the very best, and creates a disruptive atmosphere of interference by the Federal Government in an area traditionally reserved to the states. Inasmuch as the Ohio Superintendent of Insurance was apprised of the activities herein discussed and did not determine that a well-defined public policy was being violated, we are of the opinion that neither the Internal Revenue Service nor this court should provide that determination. For these reasons, the plaintiff Kirtz should be granted the deduction he seeks.

There remains one other issue for our consideration which we have not previously mentioned. In reporting its income for the years 1954 and 1955, Paramount used the reserve method for determining its deductions for bad debts. In lieu of deducting bad debt losses in the year the debt became wholly or partially worthless, under section 166(a) of the Internal Revenue Code of 1954, the taxpayer, pursuant to section 166 (c) of the Code, used the reserve method for determining its deductions for bad debts.

In determining a reasonable addition to its reserve for bad debts for 1954, Paramount applied to its year-end balance of accounts receivable for 1954 the average ratio for the preceding 18 years of the amount of its annual net charge-off for bad debts to its annual year-end outstanding accounts receivable. Likewise, for the year 1955, it applied to its year-end balance of accounts receivable for 1955 the average ratio for the preceding 19 years. This was the method agreed upon in 1949 between Paramount and the Internal Revenue Service. The starting point used for bad debts was 1937 because, due to Paramount’s size prior to that time, the early loss figures were not considered representative. Under this method, when 20 years’ representative experience became available, the oldest year’s experience was to be dropped and the latest year’s experience added, so as to use a 20-year moving average based upon the latest 20 years’ experience. In examining Paramount’s tax returns for 1954 and 1955, the Internal Revenue agent redetermined the taxpayer’s reserve for bad debts by limiting the loss ratio applied to year-end receivables to that for the current year and the preceding five years. The taxpayer alleges that this redetermination was an arbitrary abuse of discretion. While we recognize that the Internal Revenue Service agreed to a method in 1949 for administrative convenience to both taxpayer and the Service, we do not believe that the Service is thereby forever bound by such agreement. It is not unreasonable for the Commissioner of Internal Revenue to reappraise former administrative determinations in the light of new circumstances and facts.

Section 166(c) of the Internal Revenue Code of 1954 provides:

In lieu of any deduction under subsection (a) there shall be allowed (in the discretion of the Secretary or his delegate) a deduction for a reasonable addition to a reserve for bad debts. 26 U.S.C. (I.R.C. 1954) § 166 (1958 Ed.).

Since Iby the terms of the statute the taxpayer is allowed to deduct its actual bad debts as a matter of right, but an addition to a reserve for estimated bad debts “in the discretion of the Secretary or his delegate” the issue is whether the exercise of discretion by the Commissioner of Internal Revenue was reasonable. Certainly the plaintiff has shown that the method it used in determining the amount to be added to its bad debt reserve was reasonable, but this is irrelevant. It does not follow that if the plaintiff was reasonable in its determination the defendant was unreasonable. The burden is on the plaintiff to show that the Commissioner was unreasonable, and absent this showing we will not assume that there has been an abuse of discretion. The taxpayer does not claim that the reserve for bad debts as determined by the Commissioner was insufficient to cover actual bad debt losses for the years involved. In fact, the opposite is true, the allowance determined by the Commissioner more than covered the actual losses. Although the method of computation employed by the Commissioner differed from that method formerly used and directed to be used by him, the determination of what constitutes a reasonable allowance shall be determined in the light of the facts existing at the close of the taxable year. From the standpoint of the plaintiff, it may be a sound management decision to accumulate surplus funds against future contingencies, but this does not mean that an adjustment of this accumulation by the Commissioner is unreasonable. We are convinced that the determination by the Commissioner was reasonable and not an abuse of discretionary powers.

For the reasons stated in this opinion, and pursuant to an agreement between the parties, judgment will be entered in favor of plaintiff Kirtz in the amount of $9,209.84, together with interest thereon as provided by law.

To the extent consistent with this opinion, judgment will be entered for plaintiff Paramount with the amount of recovery to be determined pursuant to Eule 38(c) of the Eules of this court.

It is so ordered.

Durfee, Judge; Whitaker, Judge; and JoNES, Chief Judge, concur.

Davis, Judge, took no part in the consideration or decision of this case.

FINDINGS OF FACT

The court, having considered the evidence, the report of Trial Commissioner Eoald A. Hogenson, and the briefs and argument of counsel, makes findings of fact as follows:

1. The Paramount Finance Company, hereinafter called Paramount, is an Ohio corporation with its principal office located at Cleveland, Ohio. At all times material it has been engaged in the business of making small loans and purchasing retail installment contracts at discount.

2. Edward T. Kirtz and Eosalyn S. Kirtz are husband and wife residing at Shaker Heights, Ohio. At all times material Edward T. Kirtz (hereinafter called Kirtz) was an insurance agent duly licensed by the Ohio Superintendent of Insurance and engaged in the business of writing life insurance.

3. Paramount filed timely Federal income tax returns for the calendar years 1954 and 1955, the years here involved, on the accrual basis.

4. Kirtz and his wife filed a timely joint Federal income tax return on the cash basis for the calendar year 1955, the year here involved.

5. During the years in issue, Max Feldman was Paramount’s president, Arthur Feldman was its executive vice president, and Herbert Baker was its treasurer. They were also shareholders of Paramount to the extent shown in the table in. this finding. None of them is or was a licensed insurance agent.

During the years 1944 and 1945, Paramount’s capital stock was held as follows:

6. Mas Feldman, Arthur Feldman, and Herbert Baker comprised a group, hereinafter referred to as the Feldman Group, in which each had an equal interest. Arthur Feld-man and Herbert Baker are respectively the son and son-in-law of Max Feldman, founder of Paramount. The Feldman Group was set up for the purpose of promoting the referral of insurance by automobile dealers, furniture dealers, and other retail merchants, to specified insurance companies, through the Paramount Finance Company. In payment for this work the Feldman Group received a percentage of the premiums from all such referrals and certain service charges. The Feldman Group was engaged hi this activity during 1954 and 1955, the years in issue. The term “Feldman Group” is a designation first used by the respective attorneys in proceedings hi these cases and not previously used by anyone to name collectively the three persons involved.

7. In 1951 the Feldman Group first discussed the possibilities of making arrangements to refer insurance business to insurance companies. Arthur Feldman, who was the executive vice president of Paramount, thereafter contacted a representative of the Credit Life Insurance Company of Springfield, Ohio, and an oral agreement was accomplished along lines suggested by the insurance company, which required that such insurance be written through a licensed insurance agent in order to comply with the Ohio law. Mr. Feldman was given the privilege by the insurance company of selecting the agent through whom insurance would be written.

8. Arthur Feldman selected his personal friend, Edward T. Kirtz, as the licensed insurance agent through whom Credit Life insurance would be written. Kirtz agreed to become the licensed agent in this arrangement.

Kirtz had nothing to do with accomplishing the arrangements made by Arthur Feldman and the insurance company, all of which were negotiated, including changes, directly between Mr. Feldman and the insurance company. Prior to his selection by Mr. Feldman, Kirtz had never been an agent for any credit life insurance company. The insurance company sent Arthur Feldman the necessary papers for having Kirtz designated as an agent of the insurance company, Feldman had Kirtz sign them, and Feldman then mailed the papers to the insurance company.

During the pertinent period in suit a rubber-stamp facsimile of Kurtz’s signature was stamped on the policies. In 1957, this practice of using a rubber stamp was discontinued pursuant to a directive issued by the Ohio Superintendent of Insurance requiring all policies to be signed by the insurance agents personally.

9. After Kirtz became the insurance agent in the manner above stated, the members of the Feldman Group proceeded to contact automobile dealers and other types of retail and installment-sale dealers and show them the advantages of introducing or having available credit life, health, and accident insurance for their customers. During the years in question, Paramount did discount business with at least 150 automobile dealers.

10. During these years, the members of the Feldman Group were actively engaged in handling the details of their arrangements with the Credit Life Insurance Company, distributing promotional material to the various dealers to promote the sale of insurance to the dealers’ customers whoso installment contracts were to be purchased by Paramount, seeking to persuade the dealers that it was to their best interest as well as that of the customers to have credit life insurance coverage, and following up with those dealers who were not generating such business.

This activity on the part of the Feldman Group was solely with the dealers, and was not done directly with the customers, nor at the Paramount offices.

11. While the amount of time devoted by the individual members of the Feldman Group to promotion of the referral of insurance business and related activities varied considerably from week to week, it ranged roughly from 6 to 30 hours a week by each member, and was estimated to average somewhere between 20 to 25 hours per week by each member. The evidence does not establish that the members of the Feldman Group spent time devoted exclusively to the promotion of sales of insurance, but rather that such activities were correlated with their contacts with dealers for promotion of the finance business of Paramount.

12. As a result of the referral by the Feldman Group during 1954 and 1955 of insurance business to the Credit Life Insurance Company of Springfield, Ohio, the Feldman Group was paid (1) specified percentages of the premium paid to the insurance company in those instances where the referral of insurance business by the Feldman Group resulted in the writing of insurance and (2) the full amount of certain service charges paid by the insurance company.

13. The amounts paid to the Feldman Group, in terms of a percentage of the premium paid plus a service charge, were determined by agreement between Arthur Feldman and Credit Life Insurance Company. Changes in the amounts were similarly determined.

14. Under this agreement, and in the manner hereinafter stated in finding 16, during the years in question Kirtz was paid 5 percent of the premiums and the Feldman Group received 35 percent of the premiums plus the entire service charge for the referral by the Feldman Group of insurance business to the Credit Life Insurance Company. The service charge was the difference between the experience rating (based on losses on policies issued) and the commission.

15. Pursuant to the 1951 agreement (i.e. between Arthur Feldman and the Credit Life Insurance Company, and Arthur Feldman and Edward T. Kirtz) the amounts received in the years 1954 and 1955 by the Feldman Group from Kirtz as set forth above, were for the promotion of insurance and the referral of insurance business to the Credit Life Insurance Company. Prior to the inception of the Feldman Group, no credit life insurance was sold to Paramount’s customers.

16. In making payment for these policies to the Credit Life Insurance Company, a monthly check for the total of all premiums that month was drawn on the account of Paramount Finance Company payable to Edward T. Kirtz. These premiums were derived from the financial paper purchased by Paramount from dealers. This check, together with a summary of policies written during the month, was delivered personally to Kirtz by Arthur Feldman. Kirtz deposited the check in a special account entitled “Edward Kirtz, Special Account.” Kirtz then forwarded a check issued on such account to the Credit Life Insurance Company for 60 percent of the premiums, retaining 40 percent in accordance with the agreement between Feldman and the insurance company. In accordance with his previous agreement with Feldman, Kirtz retained 5 percent of the premiums and returned 35 percent of the premiums to Arthur Feldman, acting in behalf of the Feldman Group. The service charge was mailed monthly by Credit Life Insurance Company to Kirtz, and under the agreement between Kirtz and the Feld-man Group, Kirtz deposited this service charge in the same special account. Kirtz retained no portion of this service charge, as he had agreed with Feldman that it was to be paid to the Feldman Group. Ordinarily Kirtz distributed the funds (both the 35 percent of premiums and the service charges) by checks from the special account to Arthur Feld-man as the representative of the Feldman Group, and on occasion Kirtz would draw a blank check on this account issued to Arthur Feldman, and Arthur Feldman would fill in the amount due. The foregoing procedures conformed to the instructions originally given by Credit Life Insurance Company to Arthur Feldman as to how such transactions should be handled.

17. Kirtz played no role in the determination of either the commission or the service charge. He simply acquiesced therein. His only direct dealings with the insurance company were once a year in renewing his license and once a month in remitting the prior month’s premiums. He never met or talked with representatives of the insurance company. He always acted upon the instructions of Arthur Feldman. His participation in the entire program was limited to his acts specifically stated in these findings.

18. The amount received by Kirtz in 1955, representing 5 percent of the premiums, was reported by him as taxable income in his 1955 income tax return, but he did not report as taxable income the 35 percent of the premiums or the service charges which were paid to the Feldman Group.

19. Paramount did not require credit life and accident and health insurance in connection with its purchase of discount paper from its various automobile, furniture, and other retail dealers. The members of the Feldman Group, however, encouraged and promoted, through these dealers, the sale of such insurance. No credit insurance was written in connection with Paramount’s small loan business.

20. The Feldman Group had essentially the same arrangement with the Progressive Mutual Life Insurance Company relating to payment of fees for referral of casulty insurance that it had with the Credit Life Insurance Company in regard to credit insurance. However, the mechanics for handling the transactions were somewhat different, as hereinafter related. With respect to such referrals, the Feldman Group received between 10 and 15 percent of the premiums paid.

21. The purchaser of the automobile which was the subject of discount paper purchased by Paramount was not limited in any way as to where he purchased his insurance. He could obtain his insurance through any agent or insurance carrier. In fact, a major portion of the automobiles financed by Paramount were insured by the purchasers’ agents with freedom of choice as to companies. In some instances the automobile dealers controlled or had their own insurance arrangements. There were instances where Paramount required the customer to obtain his own insurance.

22. In connection with credit life, accident, and health insurance, the information that the customer wanted such insurance through Paramount was usually set forth in the papers executed by the purchaser with the dealer. Paramount employees typed up the credit life policy, applied the stamped signature of Mr. Kirtz, sent the original to the customer, and retained a copy for use by Paramount. The policy was dated, and went into effect the day it was written. Neither the Paramount Finance Company nor the employees of Paramount received any additional compensation for the handling of the paper work for this credit life, accident, and health insurance. The activities of Paramount employees were carried on in the Paramount offices.

23. Unlike credit life, accident and health insurance, Paramount required that casualty insurance be obtained on all automobile loans, even though the purchaser could obtain his own coverage. Approximately 60 percent of Paramount’s total volume of business during 1954 and 1955 related to automobile loans. When neither the dealer nor the customer requested or secured insurance elsewhere, and Paramount was authorized to obtain such insurance, it purchased the same through the Progressive Mutual Insurance Company. Where Paramount was authorized to obtain the casualty insurance, whether through Progressive Mutual or upon instructions from the customer to obtain it elsewhere, Paramount’s employees handled the paper work involved, which was the same in both cases, and consisted of submitting the appropriate application for insurance directly to the insurance company. Where the dealer or customer obtained casualty insurance other than through Paramount, no paper work was required by Paramount, but it was then necessary for Paramount to follow up on this policy to assure proper coverage. No additional compensation was received by Paramount or its employees for handling the paper work on insurance referred to Progressive Mutual Insurance Company.

Upon receipt and processing of the application by Progressive Mutual, the original policy was sent by Progressive to the insured with a copy to Paramount reflecting the appropriate loss-payable clause. Paramount was billed monthly for these premiums on its discount business and submitted its check drawn on the account of the Paramount Finance Company to Progressive. On a direct small loan to a customer, where an automobile was the collateral, a Paramount check covering the insurance premium accompanied the application. The fees to the Feldman Group were forwarded by Progressive to its licensed agent, Burk-ons Insurance Company, which remitted the same to the Feldman Group.

24 From Paramount’s standpoint, it was much more efficient if casualty insurance was ordered through Paramount rather than through the automobile dealer or independently by the customer, because this eliminated the necessity for follow up by Paramount to assure itself that there was full coverage with a proper loss-payable clause and eliminated the problems which arose when insurance was canceled or was not written for the full term of the paper. There was a considerable amount of checking work for Paramount where the insurance was not written through Paramount.

25. The amounts paid to the Feldman Group for the referral of insurance business to the Progressive Mutual and Credit Life Insurance Companies were not received or controlled by Paramount Finance Company, and were not treated by it as its income. The Feldman Group were, at all times pertinent herein, in control of the management and finances of Paramount Finance Company and the majority stockholders therein.

26. The policies issued to Paramount’s customers by Credit Life Insurance Company and Progressive Mutual Insurance Company were issued through licensed agents, were payable to the borrower with the customary loss-payable clause and were sold at standard rates which had been approved by the Ohio Superintendent of Insurance.

27. The percentage of premiums and service charges paid to the Feldman Group was reasonable for the services performed by the group and by the Paramount Finance Company. It is not possible to determine from the evidence in these cases the extent to which the activities of the members of the Eeldman Group were separate and apart from their duties as officers and employees of Paramount.

28. If insurance written because of any referral, as above related, was for any reason canceled, the Feldman Group refunded a portion of the amount which had been paid to it on such insurance.

29. The arrangement between Paramount Finance Company, the Feldman Group, and Credit Life Insurance Company, together with pertinent details of the mechanics of the arrangement and the names of the agents and the insurance underwriters, were made known to the Ohio Superintendent of Insurance in the winter of 1957 by Arthur Feldman through a Mr. Morris, a special investigator of the Law Enforcement Section of the Division of Insurance, who was conducting an investigation for the Superintendent of Insurance. Mr. Arthur Feldman was advised by Mr. Morris that the investigation was being made as a result of a request by the Internal Kevenue Service to the Insurance Department for a finding that the method being used by Kirtz and the Feldman Group was against public policy. The plaintiffs’ witnesses testified that to the best of their knowledge the Superintendent of Insurance has never taken any action in connection with this arrangement or other similar arrangements. Neither the Feldman Group nor Kirtz were advised by the Department of Insurance to stop or alter in any way the arrangement with the Credit Life Insurance Company. In fact, the special investigator advised Kirtz to continue in the identical manner as he had done in the past. Neither the Feldman Group nor Kirtz considered their actions to be illegal or against Ohio public policy.

30. Payments such as those made herein to the Feldman Group have been made in Cleveland by other insurance agents in connection with other finance companies. Such payments have been a practice in the Cleveland area for many years and are made for the referral of insurance business. If these payments had not been made to the Feldman Group, Kirtz would not have received 5 percent of the premiums.

31. In prior examinations by the Internal Revenue Service for previous tax years, the facts relating to these payments to the Feldman Group had been fully disclosed and explained to the Service which verified the amounts, but never attempted to tax such payments as income of Paramount.

32. During the years 1954 and 1955, Paramount paid Max Feldman $12,000; Arthur Feldman, $16,000; and Herbert Baker, $10,800. The salaries of these individuals, the Feld-man Group, were substantially less than they would normally have received from Paramount for their services because of consideration given to the payments they received directly for the referral of insurance to Credit Life and Progressive Mutual Insurance Companies. When the Feld-man Group ceased to receive these payments for the referral of insurance in 1958, the salary of each was increased $12,000 per year.

33. The activities of the Feldman Group helped Paramount by promoting the volume of its business, lessening its risk of loss because of the increased insurance coverage, earning profits on the financing of the premiums, and simplifying the mechanics of assuring continued coverage.

34. The directors of Paramount knew of the arrangements between the Feldman Group and Credit Life Insurance Company and the Progressive Mutual Insurance Company and did not object to receipt of money by the members of the Feldman Group in payment for the referral of insurance to these companies. In fact, no increase was made by Paramount in the low salaries of Max Feldman, Arthur Feldman and Herbert Baker because of the monies which they were receiving from the referral of insurance. During the years 1954 and 1955, the directors of Paramount included the three members of the Feldman Group and Cecilia Plewacki and Albert Shephard.

35. The amounts received by the Feldman Group in 1954 and 1955, for the referral of insurance, amounting to $21,000 and $45,000, respectively, were divided equally among the three members of the group and included by each of them as taxable income in their individual Federal income tax returns for the years 1954 and 1955, in the respective amounts of $7,000 and $15,000. They paid income taxes on these amounts.

36. In reporting its income for the years 1954 and 1955, Paramount used the reserve method for determining its deduction for bad debts.

37. In determining a reasonable addition to its reserve for bad debts for 1954, Paramount applied to its year-end balance of accounts receivable for 1954 the average ratio for the preceding 18 years of the amount of its annual net Charge-off for bad debts to its annual year-end outstanding accounts receivable. Likewise, for the year 1955, it applied to its year-end balance of accounts receivable for 1955 the average ratio for the preceding 19 years.

38. This was the method agreed upon in 1949 between Paramount and the Internal Eevenue Service with the objective of avoiding the trouble and expense connected with periodic questioning of the reserve. The starting point used for bad debt experience was 1937 because, due to Paramount’s size prior to that time, the early loss figures were not representative. Under this method when 20 years’ representative experience became available, the oldest year’s experience was to be dropped and the latest year’s experience added, so as to use a 20-year moving average based upon the latest 20 years’ experience.

39. Working with its independent accountant, Paramount’s management determined (as set forth in findings 37 and 38) that bad debt reserves of $79,069.38 for 1954, and $87,696.75 for 1955, were reasonable. Management’s judgment was based upon its own experience and its knowledge of reserves maintained by other similar companies. These reserves were slightly in excess of 2 percent of outstanding year-end receivable balances.

40. In the judgment of Paramount’s management a reasonable reserve for bad debts for the years in issue is not less than 2 percent of receivables. This conforms with Paramount’s experience based on development of a 20-year moving average and expert opinion in the industry.

41. For each of the years in issue, Paramount’s reserve for bad debts at the begininng and at the end of the year and its additions (determined as set forth in finding 37) and charges to its reserve were as follows:

42. Paramount’s (1) year-end balance of accounts and notes receivable, (2) amount of bad debts charged off by it during that year, and (3) ratio for each year of the amount so charged off to the balance of receivables, all determined as set forth in finding 37, are as follows for the years 1937 through 1955:

43. During the years 1937 through 1955, Paramount effected recoveries on debts previously charged off, which it included in its taxable income, as follows:

44.In examining Paramount’s tax returns for 1954 and 1955, the internal revenue agent redetermined the taxpayer’s reserve for bad debts, in the amounts set forth in Column F, below, by applying the percentage set forth in Column E to the balance shown in Column A:

45. The reserve for bad debts used by Paramount for the years 1954 and 1955 and the additions which it made to such reserve for these years are reasonable.

46. The revenue agent redetermined Paramount’s reserve for bad debts by limiting the loss ratio applied to year-end receivables to that for the current year and the preceding 5 years. The 6 years selected by the revenue agent were years of abnormally low losses from bad debts, due in part to the fact that the value of automobiles being financed did not decline as rapidly as was normally expected during the postwar and Korean war era, and to a high degree of employment and prosperity during this period. The revenue agent’s determination of reserve for bads debts was less than 1 percent of Paramount’s year-end receivables.

47. Upon audit of Paramount’s Federal income tax returns for the years 1954 and 1955, the revenue agent (a) redetermined the deduction for bad debts as set forth in finding 46; and (b) concluded that Paramount was in receipt of income in the amount of $21,000 for 1954, and $45,000 for 1955, which had been paid to the Feldman Group as set forth above, but did not allow such amounts as deductible expenses of Paramount. As a result, deficiencies were determined in Paramount’s 1954 and 1955 income taxes in the respective amounts of $81,703.44 and $29,116.19.

48. Thereafter, on or about July 8,1958, Paramount paid such deficiencies of $81,703.44 and $29,116.19, together with statutory interest thereon of $6,275.98 and $4,016.84, respectively, to the date of payment, by remitting $71,112.45 to the District Director of Internal Eevenue.

49. On or about July 3,1958, Paramount duly filed timely claims for refund of 1954 and 1955 income taxes on the grounds set forth in the petition in the respective amounts of $37,979.42 and $33,133.03, plus interest, or such other amounts as are legally refundable.

50. On audit, the revenue agent concluded that the payments through Kirtz to the Feldman Group, amounting to $13,500, should have been included by Kirtz and his wife in their gross income for 1955, but allowed no deduction from their gross income for the amount of such payments. As a result, a deficiency was determined in their 1955 income taxes in the amount of $8,130.20.

51. Thereafter, on July 2, 1958, Kirtz and his wife paid such deficiency of $8,130.20, together with statutory interest of $1,079.64 thereon to the date of payment, by remitting $9,209.84 to the District Director of Internal Eevenue.

52. On July 3,1958, Kirtz and his wife duly filed a timely claim for refund of 1955 income taxes on the ground set forth in their petition in the amount of $9,209.84, plus interest, or such other amount as is legally refundable.

53. The income taxes and interest paid by Paramount and Kirtz and sought to be recovered in these cases have not been refunded or credited, other than to the asserted deficiencies above related.

54. These actions have been consolidated for trial and all further proceedings.

In the Paramount action, the trial has been limited to the issues of law and fact relating to the right of the plaintiff to recover, reserving the determination of the amount of recovery, if any, for further proceedings.

In the Kirtz action, the parties have agreed that judgment is to be entered for the defendant if the court finds that the payments to the Feldman Group are income to Kirtz and are not deductible by him; judgment in the amount of $9,209.84, together with interest thereon as provided by law, is to be entered for the plaintiffs, if the court finds either that the payments to the Feldman Group are not income to Kirtz or that they are deductible by him.

CONCLUSION OF LAW

Upon the foregoing findings of fact, which are made a part of the judgment herein, the court concludes as a matter of law that plaintiffs Edward T. Kirtz and Eosalyn S. Kirtz are entitled to recover, and it is therefore adjudged and ordered that they recover of and from the United States nine thousand, two hundred nine dollars and eighty-four cents ($9,209.84), with interest thereon as provided by law.

The court further concludes that plaintiff Paramount Finance Company is entitled to recover, to the extent consistent with this opinion, and judgment will be entered to that effect. The amount of recovery will be determined pursuant to rule 38 (c) of the Kules of this court.

In accordance with the opinion of the court and on a memorandum report of the commissioner as to the amount due thereunder, it was ordered on August 17, 1962, that judgment for plaintiff Paramount Finance Company be entered for $13,081.71, with interest thereon as provided by law, for the year 1954, and $26,628.24, with interest thereon as provided by law, for the year 1955. 
      
       SBC. 162. TRADE OR BUSINESS EXPENSES
      (a) In General — There shall be allowed as a deduction all the ordinary and necessary expenses paid or Incurred during the taxable year in carrying on any trade or business, including—
      (1) a reasonable allowance for salaries or other compensation for personal services actually rendered. 26 TXS,C> (I.R.C. 1954) § 162 (1958 Ed.).
     
      
       166. Bad debts.
      (a) General Buie.
      (1) Wholly 'worthless debts.
      There shall be allowed as a deduction any debt which becomes worthless within the taxable year.
      (2) Partially worthless debts.
      When satisfied that a debt is recoverable only in part, the Secretary or his delegate may allow such debt, in an amount not in excess of the part charged off within the taxable year, as a deduction.
     