2003 Tax Ct. Memo LEXIS 15">*15 Decision will be entered under Rule 155.
MEMORANDUM FINDINGS OF FACT AND OPINION
COHEN, Judge: Respondent determined a deficiency of $ 25,086 in petitioner's Federal income tax for the fiscal year ended February 28, 1995. After concessions, the issue for decision is whether deductions claimed by petitioner for salary and bonuses paid to one of its officers, who was also a shareholder, exceeded reasonable compensation. Unless otherwise indicated, all section references are to the Internal Revenue Code in effect for the year in issue, and all Rule references are to the Tax Court Rules of Practice and Procedure.
FINDINGS OF FACT
Some of the facts have been stipulated, and the stipulated facts are incorporated in our findings by this reference.
Petitioner is a Pennsylvania corporation with its principal place of business in Havertown, Pennsylvania. Petitioner has been operating as a family-run mechanical contractor business, performing heating, air conditioning, and plumbing services since 1918. The business2003 Tax Ct. Memo LEXIS 15">*16 was started by Michael F. Devine and his brother James Devine. In the mid-1950s, Michael F. Devine's son, Richard E. Devine, Sr. (Richard, Sr.), began working for petitioner. Petitioner incorporated in 1954.
Richard, Sr. held a bachelor of science degree in engineering. Richard, Sr. began working for petitioner when he was about 25 years old. Richard, Sr. continued the business started by his father and his uncle and by 1961 had acquired 100 percent of petitioner's outstanding common stock. After becoming the sole shareholder of petitioner, Richard, Sr. had responsibility for human resources, finances, sales and marketing, training and supervising employees, and accounting and legal matters.
In the late 1970s, petitioner experienced problems with the business due to delayed projects and the bankruptcy of a general contractor. Petitioner released all of its employees and scaled back operations, and Richard, Sr. became the sole employee of petitioner. Richard, Sr. changed the direction of the company in the 1980s. Petitioner began to increase its retained earnings to increase its bonding capacity in order to compete in the direct bid market. To meet bonding requirements, petitioner2003 Tax Ct. Memo LEXIS 15">*17 needed to have 10 percent of its revenue in liquid assets. To accomplish this result, petitioner underpaid Richard, Sr. in order to keep liquid assets in the company. Petitioner incrementally increased its bonding capacity each year.
From April 30, 1986, until April 30, 1989, Richard, Sr. transferred 220 of his 550 shares of common stock to his son, Richard E. Devine, Jr. (Richard, Jr.). Discussion began before December 27, 1993, regarding the sale of Richard, Sr.'s remaining shares of common stock to Richard, Jr. On January 15, 1996, Richard, Jr. purchased the remaining shares of petitioner for $ 305,000. Richard, Jr. paid the purchase price to Richard, Sr. with a note payable in monthly installments over 10 years at an 8-percent interest rate.
During the year in issue and continuing until January 1997, Richard, Sr. was petitioner's president and chairman of the board of directors. Likewise, Richard, Jr. was petitioner's vice president and a member of the board of directors. In January 1997, Richard, Jr. became president of petitioner.
For the taxable year ended February 28, 1994, Richard Sr.'s salary was $ 51,663 and Richard, Jr.'s salary was $ 66,897. For the year in issue, Richard, 2003 Tax Ct. Memo LEXIS 15">*18 Sr.'s salary was $ 260,378 and Richard, Jr.'s salary was $ 112,599.
Richard, Sr. determined the compensation that petitioner paid. Petitioner never paid dividends to any of its shareholders from its inception to the tax year in issue. Petitioner provided to Richard, Sr. a retirement plan, health insurance, life insurance, disability insurance, and use of a vehicle. Petitioner paid $ 50,000 into Richard, Sr.'s retirement plan each year for 5 years from 1989 until 1993.
Petitioner filed a Form 1120, U.S. Corporation Income Tax Return, for the taxable year ended February 28, 1995. Petitioner claimed a deduction of $ 260,378 for compensation of Richard, Sr. Respondent allowed $ 195,378 and disallowed the remaining $ 65,000. The parties stipulated that "Richard Sr.'s annual salary for the taxable year ended February 28, 1995 falls in the range of salaries paid to presidents/chief executive officers of comparable companies in the same industry during the taxable year."
OPINION
Whether an expense that is claimed pursuant to
Cases traditionally set forth a lengthy list of factors that are relevant in the determination of reasonableness, including: (1) The employee's qualifications; (2) the nature, extent, and scope of the employee's work; (3) the size and complexities of the business; (4) a comparison of salaries paid with gross income and net income; (5) the prevailing general economic conditions; (6) comparison of salaries with distributions to stockholders; (7) the prevailing rates of compensation for comparable positions in comparable concerns; (8) the salary policy of the taxpayer as to all employees; and (9) the amount of compensation paid to the particular employee in previous years.
Recent cases in some Courts of Appeals have adopted a somewhat different view of this analysis, substituting instead an independent investor test. See, e.g.,
Whatever analysis is applied, petitioner has made a prima facie case for reasonableness. Respondent has provided no evidence to the contrary. Respondent conceded in the stipulation that Richard, Sr.'s salary was within the range of salaries paid to similarly situated executives. Respondent allowed all but $ 65,000 of Richard, Sr.'s compensation. Respondent gives no reasoning for his calculation of the "excessive" compensation.
Under certain circumstances, prior services may be compensated in a later year.
To reflect the foregoing and the concessions of the parties,
Decision will be entered under Rule 155.