were in effect a method of distributing income so as to avoid the supertaxes. In the case of corporations, any salary paid to an employee who is not a stockholder would be a proper deduction unless the payment could be attacked for lack of good faith. Where the employee is also a stockholder, the salary deduction will be scrutinized with greater care, and in such cases it is important that the following rules be observed: (a) the services must be actually performed; (b) the amount must be no more than a fair and reasonable compensation for services rendered, and (c) the compensation should not depend upon the employee's interest in the corporation as a stockholder, or vary from year to year with the earnings of the corporation.28 Under the 1909 Law it was held that in addition to the foregoing rules it was necessary that the salary paid to an officer who was also a stockholder should be authorized by the board and made a matter of record on the minute book of the corporation, in order to be an allowable deduction,29 but this has not been required by any ruling under the present laws. It seems reasonable that an officer or employee of a corporation should be entitled to compensation for the services he actually performs, in addition to his dividends as a stockholder, since as a stockholder he is under no duty to devote any part of his time to the business of the corporation. What constitutes a reasonable salary is a question of fact, and it would seem that a fair criterion is the amount which similar services would command if the officer or employee were not a stockholder, or which he could get by rendering the same services to another

28 T. D. 2152; letter from Treasury Department dated February 2, 1915; I. T. S. 1917, ¶ 1284.

29 T. D. 1742.

employer. When the sum paid him exceeds such amount, the question will arise as to the propriety of deducting the salary as a business expense. It is conceivable, of course, that an individual may render services of great value to a corporation of which he is the chief stockholder, and if such services can be shown to be reasonably worth the salary paid, the courts will probably sustain the deduction as a proper expense, but the burden would be upon the corporation to prove that the payment was not compensation based on stockholding.

COMPENSATION BASED ON STOCKHOLDING. Where amounts paid as compensation or additional compensation to officers or employees are based upon the stock holdings of such officers or employees, such amounts are not allowed to be deducted as a business expense, but are held to be dividends even though paid in lieu of salaries or wages.30 Where a company was composed of two stockholders who divided the net profits between them, calling it compensation, it was held that the money paid out was equivalent to a dividend and must be treated as such.31

SALARIES PAID TO ENLISTED MEN. A corporation continuing to pay an employee his salary, or part thereof, during his services in the United States Army is permitted to deduct the amount as an expense. 32

Bonus and Profit Sharing Payments. Special payments made by a corporation as extra compensation to

30 Reg. 33, Art. 119.

31 Jacobs and Davies (Inc.) v. Anderson, 228 Fed. 505, T. D. 2262.

32 Letter from Treasury Department, dated October 4, 1916; I. T. S. 1917, ¶ 1286.

certain of its employees may be deducted as an expense, if it is clearly shown that such payments are made as compensation for services rendered and are paid in pursuance of a contract, express or implied.33 If, however, there is no contractual relation between the employee and the employer by reason of which the employee could enforce his claim for the additional compensation, such payments will be held to be gratuities and not allowable as expense.34 Such payments as extra compensation, when added to the salary received by the employee, must not exceed a reasonable compensation for the services rendered. A long time practice regularly employed of paying the employees certain sums in addition to the stipulated salaries constitutes a condition, if not a contract, under which the employees may reasonably expect, for the greater or better service which they render, additional pay, and if, in fact, such payments are made as additional compensation for services actually rendered and are reasonable in amount they may be treated as expense. The payments must be conditioned upon the services rendered by the employees, and not upon the earnings of the corporation. If dependent upon the earnings of the corporation, rather than upon the services rendered, or if such payments are made only occasionally, and then at the option of the corporation as a sort of a thank-offering because of a prosperous year, the payments will be held to be gratuities.35

GIFTS OR GRATUITIES TO EMPLOYEES.

Gifts or gratuities made by an employer to his employees are not

33 T. D. 2152.

34 Letter from Treasury Department dated June 25, 1914; I. T. S. 1917, ¶ 1293.

35 Mimeograph letter to collectors No. 1314.

proper deductions as an expense. Even where such a payment is called extra compensation, if it is a gratuity or voluntary payment for which no service is rendered, its character as a gift is not changed. The custom of paying bonuses or Christmas gifts to employees, even though it has been the practice of the employer for a long time to make such gifts, does not make the amount so paid proper deductions as expense so long as the gifts are voluntary and gratuitous.36

Pensions. Amounts paid as pensions to retired employees, or their families, or others dependent upon them, or paid on account of injuries received by employees, are ordinary and necessary expenses,37 but where the salary of an employee is paid for a limited period after his death to a relative or dependent, in recognition of the services rendered by the employee, no service being rendered by the recipient, the payment is held to be a gratuity, and not allowed as an expense of the business.38

Donations. Donations by business concerns may or may not be held to be proper deductions as expense. There must be a consideration in some form to take the donation out of the class of gratuities. It has been held that a corporation engaged in the agricultural business cannot be allowed to make deductions on account of donations to fairs, churches and associations; such donations, although made for the purpose of obtaining and preserving the good will of the farmers, being mere

36 T. D. 2090; T. D. 2152; mimeograph letter to collectors No. 1314.

37 T. D. 2090.

38 T.D. 2090,

gratuities. When a donation legitimately represents a consideration for a benefit flowing, directly or indirectly, to the donor, as an incident of its business, it is an allowable deduction. Thus, a donation to a hospital, under agreement that employees of the donor are to have a ward for their use in case of accident or illness,

is a proper deduction. Donations made for purposes connected with the operation of the business, when limited to charitable institutions, hospitals or educational institutions, conducted for the benefit of employees or their dependents, are within this class.39

Lessees of Mines. Where an individual or a corporation operates a mine under a lease on a royalty basis, the lessee may deduct all royalties paid to the owner. If, in addition to royalties, the lessee has paid a stipulated sum for the right to explore, develop and operate a mine the amount so paid may be ratably distributed over the life of the lease, or the probable life of a mine under ordinary operating conditions, and the lessee may deduct annually as a rental payment an aliquot part of the amount of the bonus so paid, until such amount has been extinguished. If the annual deduction of the bonus is based on the probable life of the mine, under ordinary operating conditions, it seems that the lessee may compute the annual deductions of the bonus payment on the same basis as the owner computes depletion."

Farmers. A farmer is permitted to deduct all legitimate expenses incident to the production of the year, or future years, although the products to which such expenses and deductions are incidental may not have

39 T.D. 2090.

40 T. D. 2446. See Chapters 33 and 34 on depletion.