1950 U.S. Tax Ct. LEXIS 76">*76
1. Income -- Accrual Basis -- Reversing Entries. -- Taxpayer properly reported accrued rent as shown on corporate books after reversing entries had eliminated amounts which were collected but later refunded.
2. Deductions -- Accrual Basis -- State Tax on Income -- Increases Due to Deficiency Determination. -- Additional deduction for state excise tax proper where adjustments made by Commissioner increasing net income were proper and uncontested but not where they were contested.
15 T.C. 341">*341 The Commissioner determined deficiencies in the petitioner's tax as follows:
| Declared value | ||
| Year: | Income tax | excess-profits tax |
| 1945 | $ 635.56 | $ 166.34 |
| 1946 | 4,643.60 | |
| 1947 | 1,530.91 |
1950 U.S. Tax Ct. LEXIS 76">*77 The issues raised by the petitioner are, (1) whether the petitioner's income from rent for 1946 includes $ 20,000 which was originally accrued on its books but for which an adjusting entry was made before the close of the year, and (2) whether the Commissioner erred in disallowing a deduction for salary of the treasurer of the petitioner in excess of $ 100 a month for 1946 and 1947. The respondent, by an amended answer, alleges that he erred in allowing the petitioner deductions for 1946 and 1947 for additional Massachusetts tax based upon the increased income for those years determined in the notice of deficiency.
FINDINGS OF FACT.
The petitioner filed its returns for the taxable years with the collector of internal revenue for the district of Massachusetts. It used an 15 T.C. 341">*342 accrual method of accounting and reporting. Its income consisted solely of rents derived from real estate.
Liberty Liquors, Inc., at all times material hereto, was a corporation engaged in the wholesale liquor distributing business. Its stock was owned 90 per cent by Patrick J. Curran and 10 per cent by his wife, Beatrice. It bought land and buildings in Springfield, Massachusetts, in October 1943 and1950 U.S. Tax Ct. LEXIS 76">*78 conducted its business on those premises. It sold the property in January 1945 to Patrick and Beatrice Curran and they, in that same month, conveyed it to the petitioner in return for the capital stock of the petitioner consisting of 745 shares of which 375 shares were issued to Patrick and 370 to Beatrice. Thereafter, Liberty Liquors, Inc., rented the premises from the petitioner and continued to conduct this business from those premises. There was no written lease.
The lessee paid to the lessor rental of $ 2,000 per month from January 1, 1945, through August 1946 and $ 2,500 per month beginning September 1, 1946.
Curran was president and his wife was treasurer of each corporation in the latter part of 1946.
A revenue agent, auditing the return of Liberty Liquors, Inc., for its fiscal year ended August 31, 1945, determined that a reasonable rent for the premises which it occupied was $ 1,250 a month. Curran consented to the disallowance of the excess over $ 1,250 per month claimed by that taxpayer on its return and determined in 1946 upon behalf of the petitioner to adjust the liability for rent accordingly. An entry dated December 6, 1946, was made on the books of the petitioner1950 U.S. Tax Ct. LEXIS 76">*79 debiting "rental income" $ 20,000 for the calendar year 1946 and crediting "accounts payable" by a like amount.
The total rents accrued on the books of the petitioner for 1946, after the above adjusting entry, was $ 9,000, and that amount was reported on its return for 1946.
Entries were made on the books of Liberty dated in 1946, debiting $ 20,000 to "prepaid rent" and crediting $ 15,000 to "earned surplus" and $ 5,000 to "rental expense" for its fiscal year ended August 31, 1947.
The petitioner paid $ 20,000 to Liberty Liquors, Inc., by a check dated January 8, 1947.
The petitioner did not report the $ 20,000 as a part of its rental income for 1946. The Commissioner, in determining the deficiency, increased rental income for 1946 by $ 20,000. The $ 20,000 did not represent taxable income of the petitioner for 1946.
The petitioner paid to Beatrice Curran, its treasurer, for part time services, $ 1,000 per month for the last 4 months of 1946 and $ 500 per month for each of the 12 months in 1947, and claimed those amounts as deductions on its returns. The Commissioner, in determining the 15 T.C. 341">*343 deficiency, held that $ 100 per month represented reasonable compensation for the 1950 U.S. Tax Ct. LEXIS 76">*80 services rendered to the petitioner by Beatrice Curran and disallowed the claimed deductions for her salary in excess of $ 400 for 1946 and $ 1,200 for 1947.
A reasonable allowance for salary or other compensation for personal services actually rendered to the petitioner by Beatrice Curran is not in excess of $ 400 for 1946 and is not in excess of $ 1,200 for 1947.
The Commissioner, in determining the deficiency for 1946, made several adjustments which changed a net loss, as shown on the return, to a substantial amount of net income. One of the adjustments which he made was to allow a deduction of $ 1,188.42 which he described as additional Massachusetts excise tax. The adjustments for 1947 included the allowance of a deduction of $ 422.54 which he described as additional Massachusetts excise tax. He explained that by reason of the changes made, the taxpayer will be called upon to pay additional income tax to the State of Massachusetts, and "Since this tax accrued upon and is deductible from the income which gives rise to it the same as the original tax, deduction therefore has been made."
The facts stipulated by the parties are incorporated herein by this reference.
OPINION.
Patrick1950 U.S. Tax Ct. LEXIS 76">*81 J. Curran and his wife owned all of the stock of the petitioner and of its lessee. Curran was the president of both corporations. He learned in the latter part of 1946 that the revenue agent would not allow a deduction to Liberty for rent in excess of $ 1,250 a month, which the agent considered reasonable for the premises. Curran agreed to the adjustment made by the agent, determined upon behalf of the lessor to adjust the liability for rent to conform, and caused adjusting entries to be made on the books of the petitioner, as well as on the books of Liberty, reversing the accrual of rent in excess of $ 1,250 a month. Liberty had actually paid the petitioner during 1945 and 1946, $ 20,000 in excess of rent at the rate of $ 1,250 a month, and the petitioner refunded to Liberty that amount of money on January 8, 1947. The petitioner reported the net amount of rent accrued on its books for 1946 as due from Liberty. Its books at the end of that year did not show an accrual of a total amount in excess of that reported. In other words, it reported rent in accordance with the method of accounting regularly employed in keeping its books as required by section 41. The Commissioner 1950 U.S. Tax Ct. LEXIS 76">*82 erred in adding any additional amount to its income for that year on account of rent. Cf. ; ; ; ; ; . , is distinguishable because there the adjustment 15 T.C. 341">*344 occurred after the close of the taxable year so that the books showed the larger amount of income accrued for that year.
There is practically no evidence on the second issue and such as there is fails to show that reasonable compensation for the services of Beatrice Curran was in excess of $ 400 for 1946 or in excess of $ 1,200 for 1947.
The Commissioner has recognized that the Massachusetts excise tax is a deductible item in computing net income in this case for the year to which that excise tax applies. It is proper to compute, accrue, and deduct the correct amount of state income or excise tax. 1950 U.S. Tax Ct. LEXIS 76">*83 . The petitioner deducted the amount which it thought would be proper. The Commissioner, thereafter, determined that the net income of the petitioner was greater for 1946 and 1947 than the amounts shown on the returns. He allowed larger deductions for the Massachusetts excise tax to include that which would be applicable to the increased income. He now contends that he erred. Obviously, he erred in so far as the increased tax deduction was based upon improper increases in income. However, some of the adjustments made by the Commissioner to increase income were proper. One of those adjustments, the disallowance of a deduction for an officer's salary, was contested by the petitioner. The increased Massachusetts tax on the additional net income resulting from the disallowance of that deduction was not accruable or deductible in 1946 or 1947. . The Commissioner, who raised this issue, has not shown that the petitioner disputed any other proper adjustment and the additional Massachusetts tax based on those adjustments was properly1950 U.S. Tax Ct. LEXIS 76">*84 allowed as a deduction.
