Opinion
Docket No. 13301.
1948-04-21
JAMES NEWTON DEAN, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
Albert W. Fox, Esq., for the petitioner. E. M. Woolf, Esq., for the respondent.
Incentive pay measured by a percentage of sales of certain departments of a manufacturing corporation was authorized by its board of directors in 1943, but was withheld because of a ruling of the Salary Stabilization Unit of the Bureau of Internal Revenue that additional compensation for 1943 could not exceed the amount paid during 1942. In 1944 the Unit reversed its 1943 ruling and authorized the payment of this additional compensation. Held, amount received by petitioner in 1944 for services rendered in 1943 is ‘back pay‘ as defined in section 107(d)(2), I.R.C. Albert W. Fox, Esq., for the petitioner. E. M. Woolf, Esq., for the respondent.
Respondent determined a deficiency in the income tax of petitioner for the year 1944 in the amount of $2,760.41. The sole question is, Does the amount of $13,045.32 paid by Engineering and Research Corporation to petitioner on April 5, 1944, constitute ‘back pay‘ within the meaning of section 107(d)(2) of the Internal Revenue Code?
FINDINGS OF FACT.
Petitioner is an individual, who resided in Hyattsville, Maryland, during the years 1942, 1943, and 1944. His return for 1944 was filed with the collector of internal revenue for the district of Maryland. His returns for 1943 and 1944 were prepared and filed on a cash receipts and disbursements basis.
The petitioner during the years 1943 and 1944 was employed as assistant general manager of Engineering and Research Corporation of Hyattsville (hereinafter referred to as ERCO). ERCO was engaged in the aircraft business and manufactured gun turrets, radar equipment, machine tools, and propellers. During the years 1943 and 1944 it kept its books on the calendar year basis.
Petitioner entered the employ of ERCO on June 17, 1940, as Aircraft Production Manager at a salary of $70 per week. On November 1, 1941, he became superintendent at a salary of $100 per week, and this was the salary he was receiving on April 1, 1942, when he and his employer executed an agreement, the pertinent provisions of which are the following:
(1) ERCO agrees to pay the employee, in addition to the present rate of remuneration of said employee, additional compensation equal to 1/4 of 1% of the net selling price received by ERCO for all articles manufactured or processed by ERCO in the following department or departments of the ERCO plant at Riverdale, Maryland:
a. TURRET DEPARTMENT
b. AIRCRAFT SUB-CONTRACTING DEPARTMENT
c. ANTENNA DEPARTMENT.
(2) Said additional compensation shall be paid at any time or times during the ERCO fiscal year, or as soon thereafter as shall be most practicable or convenient to ERCO.
(5) It is understood that the payment under this and like contracts shall not result in a net loss to the company. In the event the aggregate compensation payable under this and like agreements exceeds the annual corporate net income as shown by the books of the company, the additional compensation payable hereunder shall be reduced proportionately.
Similar agreements were entered into by ERCO with twenty of its employees. On March 31, 1943, the basic salary of petitioner was increased to $125 per week.
Under date of July 9, 1943, petitioner received a letter from the president of ERCO, stating that its board of directors, under date of June 23, 1943, had approved the payment of the second quarterly installment under the employment contract.
On October 6, 1943, the board of directors of ERCO authorized the payment to those employees who had entered into contracts with the company and were in its employ on September 30, 1943, of ‘the amount to which each of said employees is entitled according to his contract on the production of the company during the quarter ended September 30, 1943, in an amount not to exceed $90,000.00; PROVIDED, however, that these payments shall not be made until the propriety of payment is approved by the general counsel of this corporation.‘ A list attached to the resolution shows that the petitioner was entitled to $7,246.82 during the quarter ended September 1943, according to his contract.
On November 5, 1943, ERCO filed with the Salary Stabilization Unit of the Bureau of Internal Revenue an ‘Application for Approval of Salary Adjustment‘ requesting, among other things, the approval of increased basic salary of petitioner from $100 to $125 per week and payment of commissions provided for in the contracts with its employees. The letter contained the statement that ‘These contracts provided that the employee was to receive in addition to his basic salary, incentive compensation measured by a fixed percentage of sales (substantially the same as production) by certain departments.‘
Under date of December 13, 1943, the Regional Office of the Salary Stabilization Unit issued the following ruling on the application filed by ERCO on November 5, 1943:
Reference is made to your application form SSU-1, dated November 5, 1943, for approval of bonus payments for the year 1943 for certain of your personnel. Receipt is acknowledged of your letter dated December 1, 1943, in which you request approval of bonus payments for the year 1942 as set forth in the schedules attached thereto.
The additional compensation paid to the employees for the year 1942 as set forth in the schedules attached to your letter of December 1, 1943, is approved.
The proposed payments of additional compensation to certain employees for the year 1943 as outlined in your application form SSU-1, dated November 5, 1943, are approved in amounts which do not exceed the amount of additional compensation paid the same employee for the year 1942.
A protest to this ruling was filed with the Salary Stabilization Unit by ERCO on December 22, 1943.
At a special meeting of the board of directors of ERCO held on December 22, 1943, its president presented to the meeting a list containing the names of the employees who had employment contracts with the company and the amounts due each employee based on the business done by its departments, and stated that he felt that the payment of these amounts should be authorized, but that the company was unable to make payment due to the ruling of the Salary Stabilization Unit which prohibited the company from paying to any of its contract employees a greater amount than was paid during 1942 to each employee. He also told the board he had requested a review of the decision of the Salary Stabilization Unit. At this meeting the board adopted a resolution that each employee having an employment contract be paid ‘such amount, which, together with his previous earnings from the company during the year 1943, would equal or be not more than the total amount paid to him during the year 1942, the aggregate of the payments to such employees not to exceed $80,000.00, provided, that the total amount due each employee in accordance with the attached list is hereby authorized, but shall not be paid until the propriety of such payment is approved by the general counsel of the corporation.‘ The ‘attached list‘ showed that the petitioner was entitled to $5,798.50 for October, November, and December, according to the terms of his contract.
Under date of December 24, 1943, the petitioner received a letter from the president of ERCO stating that it was unable to pay him any additional commissions on his contract due to the Federal regulation that would not permit the company to pay anyone an amount in excess of his 1942 earnings, and that if its pending application for permission to pay additional compensation was granted, it would pay such compensation, as it had done in the past.
In his income tax return for 1943 petitioner included in his gross income, as compensation received for personal services from ERCO, the sum of $15,682.07.
The Salary Stabilization Unit wrote to ERCO under date of April 1, 1944, as follows:
Reference is made to your letter dated January 15, 1944, submitting additional information in support of the changes in the compensation of certain officers and employees of your company as proposed in your application dated November 5, 1943, and amended by letter dated December 1, 1943.
Careful consideration has been given to your case. You may pay the twenty employees of your company with whom you have contracts providing for additional compensation based on sales the basic annual salaries in effect on October 26, 1943, as shown in the schedule which accompanies your application, and also commissions at the rate and on the basis set out in the several agreements.
Under this authorization the petitioner, on April 5, 1944, received $13,045.32, being the total of the two payments formerly authorized by ERCO's directors, one of $7,246.82 and one of $5,798.50. The total amount received exceeded 15 per cent of petitioner's gross income for the year 1944.
The general counsel of ERCO reported to its board of directors, at their meeting on June 9, 1944, that the Salary Stabilization Unit had approved the company's contracts with its employees, and the board was also advised of the payments made to contract employees under date of April 5, 1944, of the balance due them under their contracts for the year 1943.
OPINION.
HARLAN, Judge:
The respondent contends that the $13,045.32 received by petitioner in 1944, under the contract of April 1, 1942, was a share of the profits of ERCO, and did not constitute ‘back pay‘ under the provisions of subsection (2) of section107(d) of the Internal Revenue Code. Section 107(d) is set forth in the margin.
SEC. 107. COMPENSATION FOR SERVICES RENDERED FOR A PERIOD OF THIRTY-SIX MONTHS OR MORE AND BACK PAY.(d) BACK PAY.—(1) IN GENERAL.— If the amount of the back pay received or accrued by an individual during the taxable year exceeds 15 per centum of the gross income of the individual for such year, the part of the tax attributable to the inclusion of such back pay in gross income for the taxable year shall not be greater than the aggregate of the increases in the taxes which would have resulted from the inclusion of the respective portions of such back pay in gross income for the taxable years to which such portions are respectively attributable, as determined under regulations prescribed by the Commissioner with the approval of the Secretary.(2) DEFINITION OF BACK PAY.— For the purposes of this subsection, ‘back pay‘ means ('a) remuneration, including wages, salaries, retirement pay, and other similar compensation, which is received or accrued during the taxable year by an employee for services performed prior to the taxable year for his employer and which would have been paid prior to the taxable year except for the intervention of one of the following events: (1) bankruptcy or receivership of the employer; (ii) dispute as to the liability of the employer to pay such remuneration, which is determined after the commencement of court proceedings; (iii) if the employer is the United States, a State, a Territory, or any political subdivision thereof, or the District of Columbia, or any agency or instrumentality of any of the foregoing, lack of funds appropriated to pay such remuneration; or (iv) any other event determined to be similar in nature and under regulations prescribed by the Commissioner with the approval of the Secretary; and (B) wages or salaries which are received or accrued during the taxable year by an employee for services performed prior to the taxable year for his employer and which constitute retroactive wage or salary increases ordered, recommended, or approved by any Federal or State agency, and made retroactive to any period prior to the taxable year; and (C) payments which are received or accrued during the taxable year as the result of an alleged violation by an employer of any State or Federal law relating to labor standards or practices, and which are determined under regulations prescribed by the Commissioner with the approval of the Secretary to be attributable to a prior taxable year. Amounts not includible in gross income under this chapter shall not constitute ‘back pay.‘
The petitioner contends that the $13,045.32 payment was for services performed prior to the taxable year, that it was made retroactive with the approval of the Salary Stabilization Unit, and that it constituted ‘back pay‘ under t e provisions of section 107(d)(2)(B).
Both the respondent and the petitioner cite Norbert J. Kenny, 4 T.C. 750. In that case the taxpayer's employer in 1937 was required to defer payment of part of the salaries of certain officers, including the taxpayer, as a condition to receiving a loan from the Reconstruction Finance Corporation. The agreement between the employer and R.F.C. provided that $7,800 of the taxpayer's annual salary of $12,000 should be payable and that the remaining $4,200 should be withheld by the borrower and credited to the taxpayer on its books. The employer was obligated to pay the portion of the annual salary credited to the taxpayer when the R.F.C. loan was repaid. Credits were made in 1938, 1939, and 1940 for deferred salary earned in those years. In 1940, without the consent of R.F.C., the employer and the taxpayer entered into a verbal agreement that the taxpayer should be credited on its books with 6 per cent of the profits. In 1941 the taxpayer received $9,704.96 in full payment of the credits, $8,400 of this amount representing salary and $1,304.96 a share of the profits. This Court held that the $8,400 constituted ‘back pay‘ and that the tax on this amount was limited as prescribed in section 107(d)(1) of the code. We also held that the sum of $1,304.96 did not constitute ‘back pay‘ and that this amount was taxable in the regular way without the benefit of section 107(d)(1). In connection with the latter holding, we said:
* * * Section 107(d)(2) limits the definition of back pay to wages, salaries, retirement pay, and similar ‘compensation.‘ Sharing in profits is not to be assumed to be compensation similar to salaries, and petitioner has not proved that it was. The holding made above is premised upon the conclusion that the restrictions on salary payments made by R.F.C. resemble the restrictions imposed by a receiver. The agreement made in 1940 with National was made without the consent of R.F.C.
Respondent on brief states that the Kenny case brings out the distinction between payment of salary and payment of amounts as a share of profits. He then argues that the $13,045.32 received by petitioner in 1944 represented a share of ERCO's profits. A share of profits paid by a corporation to an employee can, however, be ‘back pay‘ within the meaning of that term as defined in section 107(d)(2), and the Kenny case does not hold otherwise. In that case the evidence disclosed only that $1,304.96 of the amount the petitioner received in 1941 represented a share of the corporation's profits and that he received this share of profits as a result of a verbal arrangement in 1940 between him and the corporation, made without the consent of R.F.C., whereby, in addition to the salary withheld in that year, he was to be credited with 6 per cent of the corporation's profits. In order to bring this share of profits within the statutory definition of ‘back pay‘ we would have had to assume, without proof, that it was compensation similar to salaries paid for services rendered in the prior year. We refused to make this assumption. We have no such failure of proof in the instant proceeding.
Subdivision (B) of section 107(d)(2), supra, provides that the term ‘back pay‘ embraces wages or salaries which are received or accrued during the taxable year by an employee for services performed prior to the taxable year for his employer and which constitutes retroactive wage or salary increases ordered, recommended, or approved by any Federal or State agency, and made retroactive to any period prior to the taxable year. Section 29.107-3 of the Regulations 111 provides in part that the term ‘wage or salary increases‘ as used in this section includes payments not made until after the close of the taxable year on account of rulings under the Inflation Control Act of 1942, even though the total amount paid for services rendered does not exceed the amount payable by contract.
The payment of $13,045.32 by ERCO to petitioner in 1944 qualifies as ‘back pay‘ under these provisions of the code and the respondent's regulations. It represents compensation for services performed by petitioner during 1943. It was authorized by the board of directors of ERCO during that year, but was withheld because on December 13, 1943, the Salary Stabilization Unit of the Bureau of Internal Revenue, under the Inflation Control Act of 1942, ruled that this payment could not be made because it was in excess of additional compensation paid to petitioner in 1942. It was made after the close of the taxable year 1943 because of the ruling of the unit on April 1, 1944, which reversed in 1943 ruling and authorized the payment of this ‘additional compensation based on sales.‘ The benefits of section 107(d)(2) are not restricted to compensation received in the form of fixed salaries. The term ‘back pay‘ includes ‘all compensation received or accrued during the taxable year by an employee for services performed prior to the taxable year for his employer‘ where ‘the payment is deferred by reason of the unusual circumstances of the type specified in the definition.‘ See Conference Report, Revenue Act of 1943, H.R. No. 1079, 78th Cong., 2d sess., pp. 44-45. Even though the petitioner's compensation of $13,045.32 was measured by a percentage of sales of certain departments of ERCO, and was contingent upon the realization of profits by that corporation, it is nevertheless ‘back pay‘ within the meaning of that term as defined in section 107(d)(2)(B). The income tax thereon is, therefore, limited as is prescribed in subsection (1) of section 107(d).
However, if, for the sake of the argument, we were to hold with the Commissioner that compensation which consisted of a share of profits is not to be taxed as back pay as provided for in section 107(d)(2) of the code, nevertheless we would be constrained to decide the ultimate point for the taxpayer herein, for the reason that the incentive pay, consisting of one-fourth of 1 per cent of the amount received by the turret department, the aircraft subcontracting department, and the antenna department of ERCO, has little or no resemblance to a ‘share of the profits‘ of ERCO.
The contract provided that unless ERCO earned enough profits to pay the incentive pay, such pay would not be paid. It is, of course, obvious that no matter how high the profits of ERCO might rise, the incentive pay is limited to a percentage of production and not to a percentage of profits. Also, ‘since the incentive pay is based upon the amount received by the three specified departments and not upon the amount produced in those departments, the incentive pay might well be received in one year for work that had been performed in a prior year. The work could well be performed in a year of large profits to ERCO, but the incentive pay might never be paid to the employee because during the year these departments received compensation for their products ERCO might not have earned the necessary profits to pay the incentive pay. The only possible manner by which ERCO's profits could affect petitioner's incentive pay was by becoming nonexistent. We can not construe such a situation as creating a profit-sharing arrangement.
Reviewed by the Court.
Decision will be entered for the petitioner.