Docket No. 7361 9238.
11-14-1927
M. COHN & SONS CO., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
E. C. Gruen, C. P. A., for the petitioner. J. E. Marshall, Esq., for the respondent.
E. C. Gruen, C. P. A., for the petitioner.
J. E. Marshall, Esq., for the respondent.
These consolidated proceedings are for the redetermination of a deficiency in income and profits taxes in the amount of $773.24 and a 25 per cent penalty in the amount of $1,190.17, totaling $1,963.41, for the fiscal year ended January 31, 1918, and a deficiency in the amount of $1,665.26 in income and profits taxes for the fiscal year ended January 31, 1919, as asserted by the respondent in separate deficiency letters.
The petitions, as amended to conform to the evidence adduced at the hearing, allege that the Commissioner erred:
(1) By including in income for both the fiscal years involved, undrawn salaries left in the business and not reflected as liabilities on the incorrect balance sheets attached to the original returns; and
(2) By computing a penalty for failure to file a return on Form 1120 under the Revenue Act of 1918 as 25 per cent of the total tax shown to be due on a Form 1120 for the entire fiscal year ending January 31, 1918, when petitioner duly reported its income for that fiscal year on Forms 1031 and 1103 and paid the tax as computed by it.
FINDINGS OF FACT.
The petitioner, M. Cohn & Sons Co., is a New York corporation, domiciled in the City of Bath, and engaged in the business of retailing women's and men's ready-to-wear. The business was started by M. Cohn and later became a partnership, M. Cohn & Son. Upon the death of M. Cohn in 1912, the Cohn family decided to incorporate to preserve their respective shares in the business. The petitioner was incorporated April 14, 1913, with an authorized capital stock of $40,000 and stock was issued to the extent of $37,000, the actual value of the inventory at the date of incorporation. During the years involved the outstanding capital stock of petitioner was held as follows:
-------------------------------------------------------------------------------------------------- | Fiscal year | Fiscal year | ended Jan. | ended Jan. | 31, 1918 | 31, 1919 -----------------------------------------------------------------------|-------------|------------ M. Cohn Estate _______________________________________________________ | 209 | 209 Charles Cohn (son of M. Cohn) ________________________________________ | 140 | 140 Harry Cohn (son of M. Cohn) __________________________________________ | 20 | None C. Pauline Cohn (daughter of M. Cohn) ________________________________ | 1 | 6 Other members of Cohn family _________________________________________ | None. | 15 |_____________|_____________ Total __________________________________________________________ | 370 | 370
Since its organization petitioner has been a close corporation and Charles Cohn has been its president and general manager. Harry Cohn was secretary and treasurer until his death in an army camp in October, 1918. C. Pauline Cohn has been buyer of women's ready-to-wear and saleslady, and since Harry's death has been secretary and treasurer. Lillian and Ethel Cohn have been employed regularly as salesladies. Each of the above persons gave their entire time to the business.
The petitioner has regularly made and filed its income-tax returns upon a fiscal year basis, its fiscal year ending January 31. Petitioner's accounts and records were not kept on any strict accounting basis by Harry Cohn, who practically kept no books, but made memoranda in a loose-leaf book of sales, accounts receivable and payable, income, expenses, purchases, inventories, etc., on a single-entry basis. Such accounts were accurate as to assets and liabilities except as to money transactions between the corporation and the members of the Cohn family, who regarded the business as a family affair. Whenever any member of the Cohn family withdrew a portion of his or her salary a memo or cash slip was made out and those slips constituted petitioner's record of salaries actually paid. The stockholders and directors, upon advice of counsel held the necessary formal meetings, but the questions of business policies, salaries, etc., were decided informally by the family circle as such questions arose and no formal corporate minutes were kept of such informal meetings. During the years involved none of the members of the Cohn family withdrew all of his or her salary for it was agreed that as much cash as possible should be left in the business, but that the undrawn salaries should remain a liability of the corporation to be paid at some time in the future.
On the returns, Forms 1031 and 1103, under the Revenue Act of 1917, for the fiscal year ended January 31, 1918, petitioner deducted $4,000 for officers' salaries, and $2,316 for wages for other members of the family. Each of the Cohn's left a portion of his or her authorized salary with the corporation as follows:
--------------------------------------------------------------------------------------------------- | | | Left with | Salary | Drew | corporation -----------------------------------------------------------------|--------|----------|------------- Charles Cohn, president ________________________________________ | $2,500 | $1,300 | $1,200 Harry Cohn, secretary __________________________________________ | 1,500 | 780 | 720 C. Pauline Cohn, buyer _________________________________________ | 1,300 | 562 | 738 Lillian Cohn, saleslady ________________________________________ | 650 | 337 | 313 Ethel Cohn, saleslady __________________________________________ | 366 | 196 | 170 |________|__________|____________ Total ____________________________________________________ | 6,316 | 3,175 | 3,141
On the return, Form 1120, under the Revenue Act of 1918, for the fiscal year ended January 31, 1919, petitioner deducted $4,085 for officers' salaries and $1,036 for wages for other members of the Cohn family. The full amount of salaries and wages was not withdrawn, as follows:
----------------------------------------------------------------------------------------------------- | Salary | | | deducted | Drew | Left with | on return | | corporation ----------------------------------------------------------------|-----------|-----------|------------ Charles Cohn, president _______________________________________ | $2,600 | $1,300 | $1,300 Harry Cohn ____________________________________________________ | 415 | 415 | 0 C. Pauline Cohn, secretary and treasurer ______________________ | 1,070 | 520 | 550 Lillian Cohn, saleslady _______________________________________ | 560 | 560 | 0 Ethel Cohn, saleslady _________________________________________ | 476 | 476 | 0 |___________|___________|____________ Total ___________________________________________________ | 5,121 | 3,271 | 1,850 -----------------------------------------------------------------------------------------------------
However, for the same fiscal year, ended January 31, 1919, it had been agreed by all the stockholders and directors that additional salaries should be paid, as follows:
Charles Cohn _________________________________________ $1,300 C. Pauline Cohn ______________________________________ 1,300 Lillian Cohn _________________________________________ 300 Ethel Cohn ___________________________________________ 300 ______ 3,200
none of which sums were withdrawn nor deducted on the return.
In the preparation of balance sheets to accompany the returns, single-entry lists of assets and of liabilities to others than the Cohn family were used; capital stock value was inserted as a liability and a balance forced by arbitrarily including an item designated "Surplus" in an amount sufficient to cause the liability total to equal the asset total. The amounts of undrawn salaries due the members of the Cohn family were not included among the liabilities at the beginning and close of the years involved.
For the fiscal year ending January 31, 1918, return Forms 1031 and 1103, under the Revenue Act of 1917, were filed within the period of an extension granted by the collector of internal revenue at Buffalo, New York. No return, Form 1120, under the Revenue Act of 1918, was filed on or before the due date thereof. It has not been established whether petitioner did or did not file at any time a return on Form 1120.
In his audit of the returns for the years involved, the Commissioner included the undrawn salaries in income for the respective years. Because of the nonfiling prior to the due date thereof of Form 1120 under the Revenue Act of 1918, due by reason of the fiscal year of petitioner ending January 31, 1918, the Commissioner has asserted a 25 per cent delinquency penalty, computed as 25 per cent of the total tax as computed by him on Form 1120 as due for the entire fiscal year.
OPINION.
TRUSSELL:
The uncontradicted testimony and evidence adduced establishes the fact that petitioner was liable to the members of the Cohn family for undrawn salaries, that such undrawn salaries have been included in surplus and thus in petitioner's income for the years involved.
For the fiscal year ended January 31, 1918, the amount of undrawn salaries totaling $3,141 should be eliminated from surplus, included in liabilities as accounts payable and excluded from income. No question has been raised as to the allowance or disallowance of the deduction of $6,316 taken on the returns as salaries for the fiscal year ended January 31, 1918, and apparently that deduction has been allowed, but the inclusion in surplus of a portion of said salaries, namely $3,141, left with the petitioner, has distorted petitioner's income to that extent.
For the fiscal year ended January 31, 1919, petitioner deducted on its return $5,121 for salaries which deduction apparently has been allowed, but that total of salaries was not withdrawn and the balance of $1,850 left with the corporation has been included in surplus and income. For the same year the members of the Cohn family were due additional salaries totaling $3,200, which amount was inadvertently not deducted as salary expense, was not withdrawn from petitioner and which was also included in surplus and income. There is no question as to the reasonableness of the salaries for the work performed by members of the Cohn family; the uncontradicted evidence establishes that the additional salaries were informally but actually agreed upon by the stockholders, directors and officers of petitioner and should be allowed as a deduction from gross income in addition to the said $5,121 originally deducted. The undrawn salaries, both original and additional, totaling $5,050, should be excluded from surplus; included in liabilities as accounts payable and excluded from income for the fiscal year ended January 31, 1919.
We have now for consideration the question of the propriety of the Commissioner's assertion of a 25 per cent delinquency penalty computed upon the total tax as computed for the entire fiscal year ended January 31, 1918, where petitioner filed its returns and paid its tax for said year under the Revenue Act of 1917 and failed to file before the due date thereof a return under the Revenue Act of 1918 for the same fiscal year. The president of petitioner testified that he believed that all necessary returns were filed, but he was not certain as to the filing of Form 1120 under the 1918 Act. A return on Form 1120 was not in the file of Commissioner's counsel, but he stated that he did not have sufficient time to make a thorough search therefor prior to the hearing. However, petitioner admits that if the return Form 1120 was filed it was not filed before the due date thereof. If we knew as a fact that petitioner had voluntarily filed a return Form 1120 under the Revenue Act of 1918 even though it were filed after the due date thereof we would be inclined to hold that no penalty is due, for upon this record it would then appear that there was a reasonable cause for the technical delinquency which was not a willful neglect. See Dayton Bronze Bearing Co. v. Gilligan, 281 Fed. 709. However, we do not decide that question here, for upon this record we do not know whether petitioner filed at any time a return Form 1120 under the Revenue Act of 1918 and we are forced to decide the question at issue upon the basis that no such return has been filed by petitioner.
The pertinent portion of section 3176 of the Revised Statutes as amended by the section 1317 of the Revenue Act of 1918, provides:
SEC. 3176. * * * In case of any failure to make and file a return or list within the time prescribed by law, or prescribed by the Commissioner of Internal Revenue or the collector in pursuance of law, the Commissioner of Internal Revenue shall add to the tax 25 per centum of its amount, except that when a return is filed after such time and it is shown that the failure to file it was due to a reasonable cause and not to willful neglect, no such addition shall be made to the tax.
Section 200 of the Revenue Act of 1918 defines the first taxable year to be called the taxable year 1918, as the calendar year 1918 or any fiscal year ending during the calendar year 1918.
Section 205 (a) of the Revenue Act of 1918 provides:
Sec. 205. (a) That if a taxpayer makes return for a fiscal year beginning in 1917 and ending in 1918, his tax under this title for the first taxable year shall be the sum of: (1) The same proportion of a tax for the entire period computed under Title I of the Revenue Act of 1916 as amended by the Revenue Act of 1917 and under Title I of the Revenue Act of 1917, which the portion of such period falling within the calendar year 1917 is of the entire period, and (2) the same proportion of a tax for the entire period computed under this title at the rates for the calendar year 1918 which the portion of such period falling within the calendar year 1918 is of the entire period: Provided, That in the case of a personal service corporation the amount to be paid shall be only that specified in clause (1).
Any amount heretofore or hereafter paid on account of the tax imposed for such fiscal year by Title I of the Revenue Act of 1916 as amended by the Revenue Act of 1917, and by Title I of the Revenue Act of 1917, shall be credited towards the payment of the tax imposed for such fiscal year by this act, and if the amount so paid exceeds the amount of such tax imposed by this act, or, in the case of a personal service corporation, the amount specified in clause (1), the excess shall be credited or refunded in accordance with the provisions of section 252.
The above quoted section, together with the similar section 335 (a) of the same Act and relative to profits taxes, provide for the method of computing petitioner's tax liability under the Revenue Act of 1918 and the said sections also provide that the taxes paid under the Revenue Act of 1917 for petitioner's same fiscal year shall be credited against the taxes computed under the 1918 Act. The above quoted section 3176 of the Revised Statutes as amended by the Revenue Act of 1918 provides that a 25 per cent delinquency penalty be added to "the tax," for failure to file the required return. However, that term "the tax" is not clear and unequivocal for sections 205 (a) and 335 (a) in providing a method for computing "the tax" also provide for a credit, of the tax under the 1917 Act for the same fiscal year, towards the payment of the tax imposed by the 1918 Act. The question arises, does "the tax" as used in section 3176 of the Revised Statutes as amended by section 1317 of the Revenue Act of 1918, mean the total tax as computed under that Act, or does it mean the said total tax less the credit provided for? Under such circumstances the statute is to be construed most strongly against the Government and in favor of the citizen. See Gould v. Gould, 245 U. S. 15.
Statutes should receive a sensible construction, such as will effectuate the legislative intention, and avoid, if possible an unjust or absurd construction.
See also In re Chapman, 166 U. S. 661.
The unstrained, natural and just conclusion to be reached upon the reading of the above quoted sections of the Revenue Act of 1918 is that the amount of tax paid under the 1917 Act should be credited against the amount found due for the same fiscal year under the 1918 Act and that if there be a balance due or a deficiency under the 1918 Act then the delinquency penalty should attach to such deficiency. We do not believe that Congress ever intended to penalize a taxpayer for taxes duly paid upon a return made under an existing law. In the case at bar a recomputation pursuant to this decision of the petitioner's tax liability for its fiscal year ended January 31, 1918, will probably show no deficiency and if there be no deficiency there is no additional tax due for that fiscal year under the provisions of the Revenue Act of 1918 and there exists no basis for a penalty under that Act. The Government would have already received its due for that particular year and what could be more unjust than to require a taxpayer to pay a 25 per cent penalty, upon a sum he had paid to the Government, because of a technical delinquency to file a second set of returns for the same fiscal year. True, the 1918 Act required this taxpayer to file a new return for the fiscal year ended January 31, 1918, but only for the purpose of determining if this taxpayer owed the Government any tax in addition to what it had paid under its return duly filed under the 1917 Act.
The petitioner's tax liability should be recomputed for both fiscal years in accordance with this opinion. As to the year ended January 31, 1918, if there are no additional taxes due, there should be no penalty, but if there be additional taxes due there should be added thereto a penalty of 25 per cent of the amount of such additional taxes.
Judgment will be entered upon 15 days' notice, pursuant to Rule 50.
Considered by LITTLETON, SMITH, and LOVE.