Opinion
No. H-129.
January 18, 1932.
Suit by Meyer Hecht against the United States.
Judgment dismissing the petition.
This case having been heard by the Court of Claims, the court, upon the evidence adduced, makes the following special findings of fact:
1. The plaintiff is a resident of New York City, and during all the time involved in this cause was therein engaged in the business of buying and selling hides and skins.
2. In 1920 the plaintiff filed an income tax return for the year 1919, and also an amended return for said year. The amount of tax shown by these returns was duly paid, and a portion of it subsequently refunded in 1922.
3. The plaintiff in his 1919 income tax returns claimed a deduction of $114,309.02 for salary paid or accrued to his son George J. Hecht. About December 23, 1924, the Commissioner of Internal Revenue, having disallowed $94,309.02 of the amount so claimed as unreasonable and allowed only $20,000 as a reasonable deduction for such salary, notified the plaintiff that he had determined a deficiency in the plaintiff's income tax for the year 1919 in the sum of $47,761.41.
About February 19, 1925, the plaintiff appealed to the United States Board of Tax Appeals from the determination of the Commissioner refusing to deduct the amount of $114,309.02 as a reasonable allowance for compensation for services actually rendered by George J. Hecht during said year in computing the taxable income derived by the plaintiff from his said business for the year 1919. In July, 1925, the Board of Tax Appeals approved the determination of the Commissioner, and in August of the same year the Commissioner assessed an additional tax against the plaintiff for the year 1919 in the amount of $47,591.80. On November 21, 1925, the plaintiff paid the additional tax so assessed.
About March 24, 1926, the plaintiff duly filed a claim for refund of $66,459.44 of the income taxes paid by the plaintiff for the calendar year 1919, and stated as reasons therefor in his said claim, in substance, that the Commissioner had disallowed $94,309.02 out of the amount of $114,309.02 which the taxpayer had deducted for compensation to George J. Hecht, as stated above, and had fixed $20,000 as a reasonable salary for George J. Hecht in 1919. On March 10, 1925, George J. Hecht, the plaintiff's son, filed a claim for refund in the sum of $39,239.96 of the taxes paid by him for the year 1919 and interest thereon, and attached to his claim for refund and as a part thereof was the statement that, "* * * if the commissioner's determination to allow as a deduction for Meyer Hecht only $20,000 of this amount should be upheld and if it should be determined that the remainder of said payment, viz., the sum of $94,309.02, or any part thereof, was a gift from said Meyer Hecht to said George Hecht, that then this taxpayer, George Hecht, will be entitled to a refund of so much of the total tax of $41,904.91 paid by him for the year 1919 as will have been computed on the amount of such gift."
Other matters were mentioned as a basis of the plaintiff's claim which are not material to the decision of this case.
Of the said sum of $66,459.44 demanded by the plaintiff in said claim for refund, the amount of 1919 income tax paid by the plaintiff which is attributable to the Commissioner's disallowance of the aforementioned item of $94,309.02 is $66,217.05, of which the sum of $47,591.80 was paid November 21, 1925, and $18,625.25 December 20, 1920.
About June 1, 1926, a certificate of overassessment for the calendar year 1919 in the sum of $4,259.28 was issued on grounds which had no connection with the claim made on account of the salary paid George J. Hecht, and the amount of this overassessment was shortly thereafter refunded to the plaintiff. About June 24, 1926, the Commissioner rejected plaintiff's aforesaid claim for refund.
4. Plaintiff's business was established by his father, Joseph Hecht, in 1855, and has consisted of the importation of hides and skins from various countries, principally China, Africa, Mexico, East Indies, Germany, Austria, Australia, and South America, and the sale thereof to tanners or manufacturers of raw materials. Plaintiff entered into the business with his father in 1873. From 1899 to 1908 plaintiff conducted the business under his father's name, but at that time the firm name was changed from Joseph Hecht to Meyer Hecht. In December, 1918, plaintiff's business was the oldest business of its kind in the city of New York.
5. The hide and skin business in which plaintiff was engaged is based peculiarly upon the confidence reposed in the dealer by his customers. This is due to the fact that merchandise of this character is generally sold to customers who are insufficiently informed with the quality of the same to judge of the value thereof, and also for the reason that mere inspection is frequently insufficient to enable the customer to determine the condition, quality, and class of merchandise delivered. As a general rule, it is necessary for the buyer to rely upon the integrity of the seller. The confidence and reputation for fair dealing which the dealer enjoys in the trade has always been a determining factor in the success of the business. The plaintiff, and his father before him, have been known in the trade throughout the world since plaintiff's father established the business in 1855, and have always been known for honest and fair dealing, and have at all times enjoyed the confidence of the trade.
6. In 1917 plaintiff's family consisted of his wife; a daughter, then about seventeen years of age; a son, George J. Hecht; and himself. The son, George, graduated from the College of Arts and Sciences at Cornell University in 1917, at the age of 22, with a degree of Bachelor of Arts.
As a boy, when the son, George, went to high school, he was frequently at plaintiff's place of business, and at times assisted plaintiff's employees in inspecting goods. In a general way he was acquainted with the business and knew what was going on, as the plaintiff frequently explained the business to him. George attended some of the trade conferences, and knew a great many of his father's customers.
7. While at the university George studied economics, business law, accounting, statistics, foreign languages, sociology, labor problems, and other kindred subjects. During his time at Cornell University he was the business manager of the College Era, the college magazine at the University. He was in charge of the circulation promotion, and solicited advertising and directed others in soliciting advertising. During his administration as the business manager of the college magazine it carried more pages of advertising than any other college magazine in the United States; the advertising in some issues being in excess of fifty pages. His management was so successful that he earned approximately his college expenses during his senior year from his share of the profits of the magazine. His duties in connection with the college magazine brought him in contact with many of the large advertisers and advertising agencies.
8. After his graduation from Cornell, George was for a time connected with the American Ambulance Field Service and the National Committee of Patriotic Societies. In the fall of 1917 he went to Washington, where he served in the Bureau of Research of the War Trade Board, working on statistics of hides and skins and tanning materials. After serving in this capacity for a few months, he was enlisted in the United States Army as a private, and served in the statistical division of the General Staff, working on statistics of hides and computing the raw material requirements of the Army. While serving in this capacity, he calculated the civilian requirements for hides and skins in the United States; made a classification of hides, skins, and tanning materials which was printed at the time and became the official government classification of hides and skins; made studies of the tanning material consumption of the country; computed the raw material requirements of the United States Army, and translated the requirements for shoes, harness, and other leather goods into terms of hides and skins.
He was honorably discharged from the Army on or about December 18, 1918.
9. It was always plaintiff's desire that his son, George, should enter and succeed to his business, as the plaintiff had entered and succeeded to his father's business. George had always known of this desire of his father's, but, while attending college, he conceived the idea of entering the advertising and publishing business. During his last year in college, and during the time that he was in the Army, he had offers to enter other business firms, of which his father had knowledge. During the time that the son was in the Army as well as many times before, his father insisted that he give up the idea of entering some other business and come with him as soon as he was discharged from the Army.
10. Immediately after his discharge from the Army, on or about December 18, 1918, the son George returned to New York. Conferences were then held between the plaintiff, his wife, and the son, George, with reference to George entering the business with plaintiff. Plaintiff's wife insisted that George enter his father's business and that he be made a full partner with a 50 per cent. interest in the profits. George insisted that he deserved a 50 per cent. interest in the profits of the business if he entered the same, but the plaintiff refused this arrangement. In the latter part of December, 1918, after many discussions, an agreement was entered into by and between plaintiff and his son, George, whereby George agreed to give up his desire to enter some other business and to enter the business of plaintiff and to render services in the conduct thereof, for which he was to receive annually, as compensation for his services, a sum equal to 25 per cent. of the net annual profits of the business. It was not known at the time this agreement was entered into what the profits of the business would be for any succeeding year as the nature of the business made it more or less speculative.
The sales made in plaintiff's business for the years 1908 to 1918, inclusive, were as follows:
1908 ..................... $554,434.75 1909 ..................... 876,123.20 1910 ..................... 834,501.18 1911 ..................... 802,295.13 1912 ..................... 1,082,698.95 1913 ..................... 1,152,413.97 1914 ..................... 1,283,815.71 1915 ..................... 2,291,997.11 1916 ..................... 3,610,825.43 1917 ..................... 2,863,819.81 1918 ..................... 1,902,973.50
The net profits of plaintiff's business for the years 1908 to 1918, inclusive, were as follows:
1908 ..................... $48,967.09 1909 ..................... 85,103.67 1910 ..................... 65,129.02 1911 ..................... 78,746.92 1912 ..................... 107,042.86 1913 ..................... 71,094.09 1914 ..................... 71,660.67 1915 ..................... 163,107.50 1916 ..................... 193,739.67 1917 ..................... 138,231.90 1918 ..................... 62,597.80
The years 1915, 1916, and 1917 were years of abnormally high profits in the hide and skin business because of the great demand for merchandise of this kind due to the war. The profits in 1918 were reduced because of the fact that after the entry of the United States into the war a maximum price was established.
11. In the year 1919 the maximum price as fixed by government authorities was abolished, and, as a result of the accumulated demand and the scarcity of merchandise of the kind sold by plaintiff, prices soared to points that were before unknown in the business. In some lines of merchandise handled by plaintiff prices arose 155 per cent. above the prices in previous years. The result was that the profits for the year 1919 were far in excess of any year ever known in the business. It was generally believed by the trade in December, 1918, that conditions would return to the pre-war status prevailing prior to 1915, and that profits would not continue to be as large as those prevailing during the war. The conditions existing in 1919 were wholly unexpected, and, at the time the agreement of employment was entered into between the plaintiff and his son, George, the extraordinary profits of 1919 were not and could not have been foreseen by either of them. At that time it appeared, and the plaintiff and his son reasonably believed, that the profits of the plaintiff's business after 1918 would return to the general level or average existing prior to 1914, and that 25 per cent. of the profits would be from $15,000 to $35,000 per annum. This was discussed by them in their negotiation previous to entering into the agreement.
12. George J. Hecht entered the plaintiff's business on January 2, 1919. During that year the son devoted his entire time and attention as the assistant of plaintiff in the management and control of plaintiff's business, interviewing customers, inspecting hides, making business trips, selling hides and skins, attending trade conventions, handling correspondence, and otherwise assisting plaintiff in every way possible. George held power of attorney from the plaintiff, and had access to the plaintiff's vault, signed checks for plaintiff, looked after the legal and financial matters of the business, entered into contracts of purchase and sale for the business, and otherwise performed managerial functions theretofore performed by the plaintiff. He was the only employee of the plaintiff who signed checks for him, had access to his vault, or acted for plaintiff in arranging financial and legal matters. He also attended to the advertising for the business, and instituted a new system of bookkeeping in the business.
Prior to 1919 plaintiff had never handled any tanning materials and knew nothing about them. In 1919 he handled such materials because George knew about them, and imported quebracho, in which he had never dealt before, and made a large amount of profit therefrom.
13. In 1919 the total net profit of plaintiff's business was $457,236.09, 25 per cent. of which amounted to the sum of $114,309.02. In 1919 the sales made in plaintiff's business amounted to $4,988,814.16.
The sum of $114,309.02 was actually credited to George J. Hecht in the year 1919 on the books of plaintiff against which George drew sums in and after 1919 at his own will. No restriction or limitation as to the time when or the amount which George could draw against the sum credited to him was imposed by the plaintiff, and the entire amount credited to him was unqualifiedly subject to withdrawal by George at any time. Plaintiff was well able to pay the full amount of credit to George at any time, and the entire amount was later withdrawn by George.
George J. Hecht reported the amount of $114,309.02 in his income tax return for 1919 as income from salary.
14. The books of plaintiff's business in 1918 and 1919 were kept, and his income tax returns for 1918 and 1919 made upon the accrual basis.
15. In the years 1920 and 1921 plaintiff's business was operated at a loss. In 1920 the net loss was $129,720.14, and in 1921 the net loss was $36,907.73. Beginning in 1922 and ending in 1927 the net profits of plaintiff's business were as follows:
1922 ....................... $97,941.73 1923 ....................... 115,301.66 1924 ....................... 166,289.84 1925 ....................... 167,069.13 1926 ....................... 85,847.03 1927 ....................... 177,408.04
During all of the years subsequent to 1919 until 1928 the son George continued to work for his father under the agreement entered into with him in December, 1918. He received no salary whatever for the years 1920 and 1921. For the years subsequent to 1921 he received 25 per cent. of the net profits of the business.
16. The ordinary and necessary expense of employing a person competent and willing to perform the services which George J. Hecht performed for his father in the business carried on as above stated would not exceed $20,000.
17. About November 25, 1925, the Commissioner allowed a claim of George J. Hecht for refund in the sum of $39,239.96 on the ground that $94,309.02 deducted in his father's return for salary paid to him had been eliminated therefrom and by reason thereof the same amount had been eliminated from his taxable income. The amount of this refund, except a very small sum barred by the statute of limitations, together with interest thereon, was subsequently paid to George J. Hecht.
18. Plaintiff is a citizen of the United States, has at all times borne true allegiance to the government of the United States, has never in any way aided, abetted, or given encouragement to rebellion against said government, and has never made any assignment of his said claim.
Albert S. Lisenby, of Washington, D.C. (Henry F. Wolff, I. Herman Sher, and Weill, Wolff Satterlee, all of New York City, on the brief), for plaintiff.
Ralph C. Williamson, of Washington, D.C., and Charles B. Rugg, Asst. Atty. Gen., for the United States.
Before, BOOTH, Chief Justice, and WHALEY, WILLIAMS, LITTLETON, and GREEN, Judges.
The plaintiff brings this suit to recover $66,217.05 with interest, alleged to have been overpaid on his taxes for the year 1919. This overpayment is alleged to have arisen as follows:
The plaintiff for many years has been a dealer in hides and skins in the city of New York. The plaintiff has a son, George J. Hecht, who was graduated at Cornell University with a degree of Bachelor of Arts, pursuing the ordinary course for that degree, and who had been in 1917 serving on the Bureau of Research of the War Trade Board, working on statistics of hides and skins and tanning materials. He also enlisted in the Army as a private and served in the statistical division of the General Staff, working on statistics of hides and computing the requirements of the United States Army of the products thereof. The plaintiff had desired that his son should enter into his business and succeed him, but George seems to have had the idea of entering the advertising and publishing business. In the latter part of 1918, the father persuaded his son to give up his idea of entering some other business and to enter the business conducted by the father, and, on condition of the son so doing, the plaintiff agreed that he should have 25 per cent. of the profits of the business. It does not appear very definitely just what services it was agreed George should perform, but the findings show that after he entered the business on January 2, 1919, the son devoted his entire time and attention as an assistant to plaintiff in the management and control of the plaintiff's business and performed managerial duties. The total net profit of plaintiff's business in 1919 was $457,236.09, and on this basis George Hecht's salary for that year amounted to $114,309.02. This last-named amount was listed by plaintiff in his income tax return for 1919 as a part of the ordinary expense of the business and a deduction in that amount was claimed. The Commissioner allowed only $20,000 as a deduction for this item, and the sole issue in the case is whether the Commissioner's action was correct.
We find nothing in the evidence that indicates that the Commissioner's action was erroneous. There is much in the testimony as to the capacity of George J. Hecht, in a general way, and his value and usefulness to the business, but $20,000 is not a small salary, and men of high capacity are often employed for less sums. The evidence is entirely wanting in any testimony by competent witnesses as to what would be the reasonable and ordinary expense in the way of hiring a man to perform the duties which George performed and in general to fill his place. It will be noted that he had had no previous experience in the business, and had just entered into it the year in which these abnormally high profits occurred, which the evidence shows were entirely unexpected. Taking the evidence as a whole, we can find nothing which shows that the high profits that were made in the year 1919 were attributable to the services which George rendered. Rather the evidence tends to show that they were due to extraordinary conditions that prevailed that year. We have therefore found that the reasonable and ordinary expense of employing a competent and willing person to perform the services which were rendered by George would not exceed $20,000, and sustain the action of the Commissioner in this respect. As a result of this finding, it follows that the Commissioner was justified in refusing to permit anything above that amount to be taken as a deduction from the plaintiff's income for 1919 on account of this item under the Revenue Act of 1918, § 214(a)(1), 40 Stat. 1066. See Botany Worsted Mills v. United States, 278 U.S. 282, 289, 290, 293, 49 S. Ct. 129, 73 L. Ed. 379.
Another and novel contention is made by counsel for plaintiff. It is urged in argument that the plaintiff is either entitled to a deduction from his gross income of the full amount of the compensation paid George Hecht pursuant to the contract made with him, or to have a determination that the total amount of said compensation is not a part of his taxable income. In other words, it is urged that, even if plaintiff is not allowed the amount which he agreed to pay his son as a statutory deduction, he is nevertheless liable on the contract, which is a valid and subsisting one, and therefore the amount so agreed upon should be taken out in determining plaintiff's income for the year in question.
With reference to the question thus raised, the findings show that the contract was a valid one, made without any purpose to defraud the government, and counsel for plaintiff cite authorities which it is contended show that the son thereby acquired a lien on the profits of the business for the agreed proportion thereof which was to be paid to him as salary. It appears that George Hecht originally returned the total amount of his salary for the year 1919 as part of his income for that year, but that, after the Commissioner had refused to allow this amount as a deduction from his father's income, he filed a claim for refund based on the amount disallowed, and that his claim for refund was sustained and a refund made accordingly. Apparently the Commissioner regarded the amount of the salary over and above what he considered a reasonable and ordinary expense to be a gift and not taxable. But what was done with reference to the income tax of George Hecht and the reasons for the action of the Commissioner in connection therewith is immaterial in this case. It is doubtful whether the plaintiff's application for a refund covered the claim which is now being considered, but, in any event, we do not think the position of his counsel well taken.
It is contended in argument, as above stated, that George Hecht acquired a lien on the profits of the company for the amount of compensation which he was to receive under the contract, and that this compensation was income to him and not to the father. Therefore, it is said it should not be included in the income required to be returned by the father. It should be observed that, if this contention is sustained, it would practically nullify the statute with reference to deductions for salary in such cases as the one at bar. Unless it could be shown that the contract was made for the purpose of defrauding the government or evading just taxes — a very difficult matter to prove — while the amount of the salary could not be allowed as a deduction, the same effect would be accomplished by reducing the income to the same extent. As a practical matter, it would make no difference which way it was done, but we do not need to consider whether we should so construe the statute as to prevent evasion, for we think the powers of Congress and the principles upon which income taxes are levied are not in accord with the argument presented on behalf of plaintiff.
Congress has power, with the approval of the President, to levy an income tax, and it is for Congress to say, within reasonable limits at least, how the tax shall be measured and what deductions should be made in computing the tax on the income, or, in its wisdom and discretion, it may refuse to allow any. Accordingly, Congress had the right to specify how the tax upon the income from plaintiff's business should be measured, also what sums might be deducted in so measuring it, and that the provisions limiting the sums which might be taken out of this income should apply, regardless of whether the claim is made that they were taken under some special provision of the statute for deductions, or whether it is claimed that they should be taken out in ascertaining what the net income was. One of the most difficult things to ascertain in many kinds of business is the amount of the net income resulting therefrom. We do not think that the constitutional amendment required Congress to impose a tax on net income in a technical sense, for, if it did, the income tax would be almost impossible to administer in many if not in most cases. It is true that the statute provides that the tax shall be levied upon "net income," but this is "net income" as defined by another section, and means the gross income as elsewhere defined, less the deductions as specified in other sections. In other words, Congress has in the law defined what net income means, and in our opinion it had authority so to do. The intent and meaning of the statute is plain that a deduction of the kind sought to be taken cannot be made unless the expense is reasonable and ordinary, and the statute does not permit the deduction to be made under some other guise. We therefore hold that the Commissioner properly refused to make the refund.
It follows from what has been said above that the petition of the plaintiff must be dismissed, and it is so ordered.