This proceeding involves a deficiency in income tax for the calendar year 1941 in the amount of $76,296.49. The deficiency is the result of
In accordance with the terms of a contract dated January 2, 1939, it is determined that you received taxable income in 1941 in the amount of $142,076.40 as additional compensation for services rendered in 1939 and 1940 while you were domiciled in and a resident of the State of New York. Pursuant to the provisions of section 22 of the Internal Revenue Code your taxable income is accordingly increased by the amount of $114,576.40 representing the difference between $142,076.40 and the amount of $27,500.00 which you reported on your return for 1941.
To this determination by the Commissioner the petitioner assigns errors as follows:
(a) In determining the taxable net income of petitioner for the year 1941, the Commissioner erroneously held that all sums received by petitioner in 1941 from M. Lowenstein & Sons, Inc., except the sum of $40,000 received as salary and bonus for services rendered in 1941, were the separate property of petitioner, Howard Veit. Petitioner contends that all amounts received from M. Lowenstein & Sons, Inc. in the year 1941 were received as community property of petitioner and Laurette G. Veit, his wife.
(b) In determining the taxable net income of petitioner for the year 1941, the Commissioner erroneously held that petitioner received taxable income in 1941 in the amount of $142,076.40 as additional compensation for services rendered in 1939 and 1940. Petitioner contends that only the sum of $55,000 was received by petitioner in 1941 as additional compensation for services rendered in 1939 and 1940 and that the amount so received was received as community property of petitioner and Laurette G. Veit, his wife.
FINDINGS OF FACT.
Petitioner is an individual and has been domiciled in and a resident of California since November 30, 1940. Prior to that date he was domiciled in and a resident of the State of New York. He filed his income tax return for the year 1941 with the collector for the first district of California. The return was prepared on the cash basis.
Petitioner was at all times herein mentioned employed by M. Lowenstein & Sons, Inc., a New York corporation engaged in the business of converting, printing, and styling of cotton goods. M. Lowenstein & Sons, Inc., will be referred to hereinafter as the corporation. During 1939 and 1940 petitioner was executive vice president of the corporation in charge of sales, production, and styling. He was an outstanding man in the cotton goods industry and a valued employee of the corporation. He was not a stockholder of the corporation or any of its subsidiary corporations.
Petitioner's employment for the years 1939 and 1940 was pursuant to a written contract dated January 2, 1939. This contract provided for the rendition of services by the petitioner during the years 1939 and 1940 at an agreed compensation of $25,000 per year. In addition
FIFTH: A. As additional compensation, LOWENSTEIN shall pay to VEIT ten (10%) percent of the net profits of the Company after taxes but before any deduction for the additional compensation to VEIT as determined by the company auditors in accordance with good accounting practice and the provisions of this contract, for the entire term of employment taken as one accounting period. VEIT shall pay to LOWENSTEIN ten (10%) percent of the net loss of the company from operations and after taxes as determined by the company auditors in accordance with good accounting practice and the provisions of this contract for the entire term of employment taken as one accounting period, provided, however, that VEIT shall not be obligated to pay to LOWENSTEIN any amount in excess of Fifty thousand $50,000) dollars, that amount being the limit of his liability hereunder.
B. Tentative annual statement of VEIT's participation computed on the basis of the Company's fiscal year, 1939, shall be furnished VEIT not later than May 1, 1940, but said statement shall be submitted without prejudice to the final accounting which shall cover both years as a unit.
C. No later than May 1, 1941, VEIT shall be furnished a statement showing the amount to which he may be entitled as additional compensation, or the amount which he shall be obligated to pay, for both years covered by this contract.
D. The amount that VEIT shall be entitled to as additional compensation from LOWENSTEIN, or the amount that VEIT shall pay to LOWENSTEIN, as the case may be, shall be payable to LOWENSTEIN or VEIT, as the case may be, one-half (½) by July 1, 1941, and one-half (½) by October 1, 1941.
In order for petitioner to be entitled to this extra compensation he was required to remain in the corporation's employ for the entire two-year period covered by the contract, except in case of his death or illness or his discharge without reasonable cause by the corporation.
On May 16, 1940, petitioner and the corporation entered into a written agreement wherein the corporation agreed to pay petitioner a bonus of $15,000 for meritorious service to the corporation and its subsidiaries and it was acknowledged that the additional compensation, exclusive of the bonus of $15,000 to which petitioner was entitled for 1939 under the contract of January 2, 1939, was $81,999.93. Petitioner acknowledged payment of $10,000 on March 7, 1940, on account of the additional compensation, leaving a balance on account of the additional compensation and bonus of $86,999.93 as of May 16, 1940. Upon the payment of $1,999.93 on May 16, 1940, it was agreed that for 1939 a balance of $85,000 was due and payable to the petitioner under the terms of the contract of January 2, 1939, which amount was subject to reduction if there were any losses by the corporation for 1940, as provided in said contract.
On November 1, 1940, the corporation and petitioner entered into a further contract for the employment of petitioner during the year 1941 by the corporation at a salary of $15,000 per year, plus a percentage of certain west coast sales. At the request of the corporation it was provided that as additional consideration for the execution of the contract the balance of the amount tentatively determined to be petitioner's profit participation for 1939 should be paid to him in installments in 1940 and 1941. It was also provided that any amount to which petitioner might be entitled in the event there were net profits for the year 1940 should be paid in quarterly installments during 1942 rather than in 1941, as originally provided in the contract of January 2, 1939. It was further provided that petitioner would be paid interest on such latter amount at the rate of 1½ per cent per annum from October 1, 1941. These agreements were embodied in paragraph 8 of the contract and provided as follows:
EIGHT: As additional consideration for the execution of this contract, LOWENSTEIN and VEIT agree that—
a. The balance of monies to which VEIT is entitled by virtue of his participation in profits of LOWENSTEIN for the year 1939 shall be paid to VEIT as follows:
Twenty thousand and no/100 ($20,000.00) dollars on the signing of this agreement;
Thirteen thousand seven hundred fifty and no/100 ($13,750.) dollars, on March 1, 1941;
Thirteen thousand seven hundred fifty and no/100 ($13,750.) dollars, on June 1, 1941;
Thirteen thousand seven hundred fifty and no/100 ($13,750.) dollars, on September 1, 1941;
Thirteen thousand seven hundred fifty and no/100 ($13,750.) dollars, on December 1, 1941;
b. Such monies as VEIT may be entitled to, representing his share of the profits of LOWENSTEIN for the year 1940, shall be paid with interest from October 1, 1941, at the rate of One and one-half (1½%) percent per annum, as follows:
Petitioner arrived in California on or about November 30, 1940, established his domicile, and took up his duties under this new contract.
Under date of June 18, 1941, the petitioner and the corporation entered into a further written agreement which recited the former agreements and payments and that the corporation had by then furnished the petitioner with a statement of his participation in the profits of
Nov. 1, 1940 --------------------------------- $20,000 Mar. 1, 1941 --------------------------------- 13,750 June 1, 1941 --------------------------------- 13,750
It was also acknowledged that the balance of the additional compensation and bonus to which petitioner was entitled under the contract of January 2, 1939, for the period January 2, 1939, through and inclusive of December 31, 1939, was as of June 18, 1941, $27,500. This balance of $27,500 was paid to petitioner in the year 1941 and has been returned for taxation, together with the other $27,500 paid prior to June 18, 1941, by petitioner and his wife on a community property basis. In this agreement of June 18, 1941, it was acknowledged that the additional compensation to which petitioner was entitled under the contract of January 2, 1939, for the period January 2, 1940, through and inclusive of December 31, 1940, was $87,076.40, which amount was payable to petitioner with interest at the rate of 1½ per cent per annum from October 1, 1941. The contract provided with respect thereto as follows:
4. LOWENSTEIN and VEIT acknowledge that the additional compensation to which VEIT is entitled under the contract of January 2, 1939, for the period January 2, 1940, through and inclusive of December 31, 1940, is Eighty-seven thousand seventy-six and 40/100 ($87,076.40) dollars, which sum is payable to VEIT with interest at the rate of One and one-half (1½%) percent per annum from October 1, 1941, as follows:
Under date of December 26, 1941, the petitioner and the corporation entered into a further written agreement providing for employment of petitioner during 1942 and 1943 and that the balance of $87,076.40 which would otherwise become due in four equal installments of $21,769.10 each in 1942 should be paid in five equal installments of $17,415.28 each during 1942, 1943, 1944, 1945, and 1946, all of such deferred payments to bear interest at the rate of 1½ per cent interest per annum from October 1, 1941.
It was the practice of the corporation to defer profit participation payments to its executives. Payments arising under profit participation agreements with petitioner for years prior to 1939 had been deferred in a manner similar to those above. An interest account was
The cotton goods industry is one in which conditions fluctuate. It was not unusual for a large potential profit to disappear in a brief period. These extreme fluctuations had occurred both in the industry and with the corporation and it was impossible to predict with any certainty within any one year whether at the end of the year the corporation would have a net profit.
During 1941 petitioner received payment from the company of $95,000, of which $30 was withheld for social security taxes. This was the only amount actually received by petitioner from the corporation during 1941, with the exception of an expense reimbursement of a few hundred dollars. Of the amount of $95,000, $15,000 was for salary, $25,000 was a special bonus, and $55,000 was additional compensation on account of profit participation for the year 1939. Petitioner in his return for 1941 reported the above amount of $95,000 as community income, one-half of which, after deducting certain expenses, was reported as his net income. No part of the amount of $87,076.40 as petitioner's profit participation for 1940 was included in the above amount of $95,000 reported by petitioner in his return for 1941 because he was on the cash basis and did not receive any of this $87,076.40 in the year 1941. The $87,076.40 which was due by the corporation to petitioner as his share of 1940 profits was not credited to his account in 1941, nor was it in that year set apart for him in a way that he could have drawn upon it at any time he chose. On the contrary, the payment of the $87,076.40 was, by agreement of the parties and for a valid consideration on November 1, 1940, at a time when it had not yet been ascertained, deferred to later years and petitioner had no right in 1941 to demand and receive such $87,076.40 or any part thereof. Petitioner did not constructively receive the $87,076.40 in 1941 or any part thereof.
1. Petitioner in his brief states the first issue to be decided as follows: "Can the doctrine of constructive receipt be used to attribute the receipt of income to a taxpayer on a cash receipts and disbursements basis in a year in which he did not have the right to receive the income and did not in fact receive the income?" It will be noted that this issue was raised by petitioner's assignment of error (b), hereinbefore set out.
Our findings of fact show that in the year 1940 the amount which petitioner was entitled to receive as his share of 1939 profits under the contract of January 2, 1939, had been ascertained. The amount of petitioner's share in the 1940 profits had not yet been ascertained. It was not to be ascertained until in May of 1941.
Now, as to petitioner's share of the corporation's profits for the year 1940, this had not yet been determined when the new contract of November 1, 1940, was entered into. However, in the contract and as a part of the consideration for it, it was agreed between the parties that whatever petitioner's share of the profits for 1940 should prove to be, they should not be payable in 1941, as the original contract provided, but should be payable in 1942 in four equal quarterly installments on March 1, June 1, September 1, and December 1, 1942. Petitioner's share of the profits for 1940 was on June 18, 1941, ascertained by agreement of the parties to be $87,076.40, which it was agreed in carrying out the contract of November 1, 1940, should be paid petitioner, with interest at the rate of 1½ per cent per annum from October 1, 1941, in four equal installments of $21,769.10 on March 1, June 1, September 1, and December 1, 1942.
However, we think that the facts present in the instant case show clearly there was no constructive receipt by the petitioner in 1941 of the $87,076.40 in question, as defined by the regulation referred to. Petitioner, prior to November 1, 1940, had decided that he would move to California and take things easier. He talked things over with Leon Lowenstein, president of the corporation, and it was finally agreed that petitioner would continue in the employment of the corporation, but on a restricted basis. The terms of this new employment were embodied in a contract dated November 1, 1940, which is in evidence. As a part of this new employment contract and as one of the considerations for it, petitioner agreed to defer the receipt of his share of the 1940 profits, at that time undetermined, until 1942, when it was to be paid to him in four equal installments. The whole agreement of November 1, 1940, was an arm's length business transaction entered into by petitioner and the corporation which was regarded as mutually profitable to both. The only way we should be justified in holding that petitioner constructively received the $87,076.40 in 1941 would be to hold that the agreement to defer the payment of such $87,076.40 until 1942 was a mere subterfuge and sham for the purpose of enabling petitioner to postpone his income tax on the amounts involved to another year. The evidence does not justify such a holding, but, on the contrary, seems to establish that the agreement to defer the payments until 1942 was an arm's length contract, arrived at in the ordinary course of business.
As we have already pointed out, in this same agreement it was provided that petitioner should receive the balance of profits for
It was the habit of Lowenstein to defer payments to me, other employees as well, when they extended employment terms. Accruables that ran from 1931 to 1935 were not paid me until 1937. A profit accruable of 1936 was not paid me until 1939. There was always a discussion on these payments on my part, that due to the fact that the company charged me interest on capital and surplus before a determination of the profits, that when they deferred payment which I always recorded on a cash basis, in accordance with the law, they should pay me interest. While I was never successful in having them do that—so in this last contract referred to, when Mr. Lowenstein was, as I testified yesterday, anxious to keep me under his thumb, he voluntarily stated that he would make a small token payment in order to make me happy, because I had been contending with him about it for years. It was his proposition.
Petitioner's testimony as above given was corroborated by two other witnesses, Erich Kath, comptroller of the corporation, and Leon Lowenstein, president of the corporation. They testified by deposition, and part of our findings of fact is based on their testimony. Petitioner is an interested witness, and that fact should, of course, be taken into consideration in weighing his testimony, and we have done so. However, there is nothing to show that Kath and Lowenstein have any interest whatever in the outcome of this tax controversy.
The corporation, being on the accrual basis, deducted in its 1941 return the full amount of the $87,076.40 as an accrued liability due Veit, and it was allowed the deduction. Its right to such deduction is not in any way affected by the outcome of this proceeding. Therefore, taking into consideration all the evidence, we fail to see where there is any justification for applying the doctrine of constructive receipt to the $87,076.40 in question.
Petitioner cites and relies on Kay Kimbell, 41 B. T. A. 940, as a case which strongly supports his contention. We think it does. In the Kimbell case the taxpayer had transferred certain oil leases to a corporation upon an oral agreement on its part to pay Kimbell $15,512.70 upon transfer, and, commencing on January 1, 1934, to pay him a proportion of the oil production until oil to the value of $114,250 had been received. Shortly prior to January 1, 1934, another oral agreement postponed this oil payment, so that payment was to begin September 16, 1936, and continue until oil of the specified value
* * * It is only by giving recognition to the first oral agreement entered into at the time the leases were assigned to the corporation that respondent has any semblance of reason for his determination that the individuals constructively received the income in question. If the parties had a right to make the first oral agreement, they had a right to make the second, and our only concern is whether these agreements actually existed and were intended as real, genuine, bona fide agreements between the parties. * * *
The facts of the instant case appear to correspond closely to those in the Kimbell case. In both cases there was an agreement to pay at a particular time indefinite amounts, and, prior to the date on which those amounts were due or could be determined, payment was deferred. The Board of Tax Appeals found that the agreements in the Kimbell case were bona fide.
As we have already stated, we find that the agreement of November 1, 1940, entered into between petitioner and the corporation, by which, among other things, it was provided that payment of petitioner's share of the 1940 profits should be deferred from 1941 to 1942, was bona fide and entered into in a business transaction at arm's length. This being true, it naturally follows that the Kimbell case is applicable and controlling. The cases cited and urged by respondent are all distinguishable on their facts, and it would not serve any useful purpose to discuss them in detail here. On this issue we hold for petitioner.
We think we should point out that the evidence shows that in a subsequent contract entered into December 26, 1941, the petitioner and the corporation changed the dates of the payment of the $87,076.40 here in question from four equal payments of $21,769.10 each in 1942 to five equal installments of $17,415.38 each during 1942, 1943, 1944, 1945, and 1946. We do not have the year 1942 before us, and we express no opinion as to whether this contract of December 26, 1941, operates to make inapplicable the doctrine of constructive receipt for the year 1942. In other words, we express no opinion as to the effect of the contract of December 26, 1941.
2. Petitioner states the second issue in his brief as follows: "Is income received by a taxpayer while residing in a community property jurisdiction community property or separate property where the source of the income was a contract executed while the taxpayer was a resident of a non-community property state but the taxpayer's right to any income was completely inchoate prior to the establishing of residence
For purposes of clarification we point out that, having held under issue 1 that petitioner did not constructively receive the $87,076.40 in question in 1941, that amount is not involved in the issue we are now discussing.
The income which is here subject to our decision as to whether it was community property or separate property is the $55,000 which petitioner did actually receive in 1941 as his share of the profits of the corporation for 1939 and which he and his wife returned for taxation. We fail to see where there was anything "incohate" about this $55,000. When petitioner and his wife took up their domicile in California on November 30, 1940, petitioner had definitely received $20,000 in cash on 1939 profits when the new agreement was signed on November 1, 1940, and the corporation agreed to pay him the remainder in 1941 in four equal installments of $13,750 each. There were also some payments of petitioner's share of 1939 profits other than those just mentioned, but they were made in 1940 and are not here involved.
The testimony of Erich Kath, petitioner's comptroller, was to the effect that the corporation took as a deduction on its income tax return for 1939, as an accrued liability for "salary expense," the amount of petitioner's share of 1939 profits under the contract, which was $81,999.93. If this liability to petitioner was sufficiently fixed and certain to entitle the corporation to a deduction on its income tax return as a salary expense, it certainly was sufficiently fixed and definite to establish petitioner's property interest therein as his separate property under the laws of the State of New York, though, of course, he, being on the cash basis, would not be taxable on the amount until it was actually received. The years of actual receipt by petitioner of his share in 1939 profits were the years 1940 and 1941. Therefore, it seems clear that petitioner's right to the additional compensation for 1939 became vested while he was domiciled in and a resident of New York. This right to the additional compensation was subject to being defeated by his not remaining in the corporation's employ for the entire two-year period and by remote possibility that the corporation might have no net profits for the 1939-1940 period. Petitioner, however, did remain in the corporation's employ for the entire period, and the corporation did have substantial net profits for both years.
Since the right to the additional compensation for 1939 was earned while petitioner was domiciled in and a resident of New York, a noncommunity property state, it was his separate property in that state. The question is whether or not this right to the additional compensation remained the petitioner's separate property although it was
Questions relating to the ownership of income acquired after petitioner and his wife established their legal domicile in California must be determined under the laws of that state. Poe v. Seaborn, 282 U.S. 101. In In re Arms' Estate, 186 Cal. 554; 199 Pac. 1053, 1056, the California Supreme Court said:
* * * It has long been the established law of this state that where a husband brings into this state money or property acquired by him during coverture in another state, by whose laws it was his separate property, it remains his separate property after it reaches this state, and that any property acquired therewith in this state, either by purchase or exchange, is also the separate property of the husband. * * *
Cf. In re Bruggemeyer's Estate, 115 Cal.App. 525; 2 Pac. (2d) 534; Asher v. Welch (Dist. Ct. Calif., 1938).
We, therefore, hold that the respondent was correct in determining that the $55,000 received by petitioner as additional compensation in 1941 for profit participation for services performed during 1939 under the contract of January 2, 1939, was petitioner's separate income. Cf. C. J. Wrightsman, 40 B. T. A. 502; affd., 111 Fed. (2d) 227; Robert H. Lord, 30 B. T. A. 425; John M. King, 26 B. T. A. 1158; affd., 69 Fed. (2d) 639.
Petitioner, in contending that the $55,000 in question received by him in 1941 was community property of himself and his wife, cites and strongly relies on Fooshe v. Commissioner, 132 Fed. (2d) 686, reversing 46 B. T. A. 205. We think that case is clearly distinguishable on its facts. In that case the taxpayer entered the employ of an insurance company in 1919 as manager of its agency in St. Louis, Missouri. That employment contract provided that he would receive as part of his compensation 2½ per cent on renewal premiums when collected and paid to the company on policies written by him or through him under this contract. In the event the contract was terminated, the petitioner was to receive the 2½ per cent commission upon the renewal premiums, less a collection fee of 2 per cent, that is, petitioner upon leaving the agency would receive only ½ per cent on renewal premiums and the 2 per cent would be lost to him. The insurance company decided to transfer petitioner to Los Angeles, California, as manager of that agency. The taxpayer was agreeable to this, except for the matter of compensation under the new California contract. This contract did not contain the provision for 2½ per cent on collection of renewal premiums, as did petitioner's old Missouri contract. In order to induce petitioner to take charge of the company's Los Angeles office and in order that he would be more fully compensated
In the instant proceeding, petitioner had performed all of the services giving rise to the additional compensation while he was domiciled in and a resident of New York, and the $55,000 in question paid petitioner in 1941, while he was domiciled in and a resident of California, was for services completed in New York, a noncommunity property state. None of it was payment of compensation for any services which he rendered in California. These facts, it seems to us, clearly distinguish the instant case from Fooshe v. Commissioner, supra.
Decision will be entered under Rule 50.