FINDINGS OF FACT.

The petitioner filed its corporate income tax return for 1944 with the collector of internal revenue for the second district of New York. Frederick Pfeifer (hereinafter called Pfeifer) was 82 or 83 years old in 1944. He had been engaged for many years representing hardware manufacturers in the New York area. He was well and favorably known throughout the hardware industry. He was active in the business and in good health in the spring of 1944.

His attorney suggested to him in the spring of 1944 that he should incorporate his business in order to protect his two sons, who were then active in the business with him, and to provide a pension for his wife after his death. The suggested plan was carried out.

The petitioner was organized in April, 1944. Its outstanding stock consisted of 100 shares of no par value common stock.

Pfeifer wrote to the petitioner on April 12, 1944, offering to sell his business to it in consideration of the issuance to him of all of its stock, "with the express understanding and condition, and as a further consideration, that you will enter into an agreement with me, by which I shall be continued as President of the said Corporation, and that a contract is entered into between the corporation, that in the event of my death, my widow, Mrs. Ida Pfeifer, of Garden City, New York, shall receive a pension of the sum of three hundred and fifty ($350) dollars per month, as long as she may live."

The petitioner accepted Pfeifer's offer and his business was transferred to the petitioner in exchange for all of its capital stock on or about April 13.

Pfeifer drew his last will and testament on April 13, 1944, leaving one-half of the stock of the petitioner to each of his sons and leaving his residuary estate to his wife.

The board of directors of the petitioner, consisting of Pfeifer and his two sons, at its first meeting, on April 13, 1944, fixed Pfeifer's annual salary at $12,500 and the salary of each of his sons at $7,500. Pfeifer died in October, 1944, survived by his two sons and his widow, Ida.

The petitioner, after the death of Pfeifer, paid $875 to Ida at the rate of $350 a month in accordance with its agreement.

The petitioner on its return for 1944 showed net income of $1,841.16 after claiming a deduction of $875 representing the amount paid to Ida. The Commissioner, in determining the deficiency, disallowed that deduction. That amount did not represent an ordinary and necessary expense of the business of the petitioner.

OPINION.

MURDOCK, Judge: Counsel for the petitioner, who advised Pfeifer to carry out the plan outlined in the findings of fact, contends that the payments of $350 a month to the widow of Pfeifer are deductible under section 23 (a) (1) (A) as ordinary and necessary expenses incurred during the taxable year in carrying on its business. He cites Seavey & Flarsheim Brokerage Co., 41 B. T. A. 198. That case is not in point and no case supporting the petitioner's contention has come to our attention. The payments to the widow were not ordinary and necessary expenses of the business of the petitioner. They may have been a part of the cost of the business purchased by the petitioner from Pfeifer, but, if so, they would not be deductible as ordinary and necessary expenses. Cf. Acer Realty Co. v. Commissioner, 132 Fed. (2d) 512, affirming 45 B. T. A. 333; Autenreith v. Commissioner, 115 Fed. (2d) 856, affirming 41 B. T. A. 319; Frank L. Newburger, Jr., 13 T. C. 232.

This Court said in McLaughlin Gormley King Co., 11 T. C. 569, a case involving somewhat similar payments:

in the absence of a contract liability, an established pension policy, or a showing that such payments were for past compensation and were reasonable in amount, the payments may not be deducted under section 23 (a). Here there was no established pension policy and no showing that the payments were for past compensation and were reasonable in amount. They were paid pursuant to a contract, but the contract referred to in the above quotation is one for pension payments arising out of an employment contract, in no way related to any contract for the purchase of property, entered into at arm's length in order to obtain the services of a valuable employee. Seavey & Flarsheim Brokerage Co., supra. It is apparent from the findings of fact that the payments to the widow were not pursuant to a contract entered into at arm's length to retain the services of a valuable employee. Pfeifer was still active in the business and he was well and favorably known in that business, but he was 82 or 83 years old, he was in effect dealing with himself, the value of his services is not shown, it is not shown that they exceeded his compensation, and the age of his wife is not shown. The determination of the Commissioner was correct.

Decision will be entered for the respondent.

E. A. TERRELL, PETITIONER, v. COMMISSIONER OF INTERNAL
REVENUE, RESPONDENT.

Docket No. 19679. Promulgated April 10, 1950.

SECTION 107 (a)-SPECIAL SEPARATE SERVICES BY AN OFFICER TO A CORPORATION.-The services which the petitioner rendered to a corporation in a patent controversy with a licensee were sufficiently separate and distinct from his regular duties as an officer to justify taxation under section 107 (a) of his separate compensation for those services.

Richard E. Thigpen, Esq., and Arthur M. Jenkins, Esq., for the petitioner.

Paul E. Waring, Esq., for the respondent.

The Commissioner determined a deficiency of $13,382.20 in the income tax of the petitioner for 1944. The only issue for decision is whether the petitioner is entitled to have $29,996.67, which he received from the Terrell Machine Co. for alleged special services, taxed under section 107 (a).

FINDINGS OF FACT.

The petitioner filed his individual income tax return for 1944 with the collector of internal revenue for the district of North Carolina. He was president and general manager of the Terrell Machine Co. (hereinafter called the corporation) at all times material hereto, conducted its affairs, and received a regular salary and, at times, a small bonus for those services. His salary and bonus for 1944 amounted to $11,848.57. The business of that corporation was the manufacture of textile machinery, some of which the petitioner designed. It also did some war work.

The petitioner was the principal stockholder of that corporation. About one-tenth of the stock was owned by a former employee and the rest was owned by the petitioner, his son, his wife, and his brother.

The petitioner has a B. S. degree in engineering and is a highly trained, skillful, and experienced mechanical engineer. He has also had experience in connection with inventions pertaining to textile machinery and the obtaining of patents thereon.

The petitioner acquired a one-half interest in the "Reynolds inventions" pertaining to textile machinery and transferred them to the corporation in 1927. W. G. Reynolds, the inventor, owned the other one-half. Saco-Lowell Shops was granted a license under the Reynolds patents in 1933 and paid royalties thereon until some time in 1937. This licensing was unlike the other activities of the corporation. The petitioner discovered in April, 1937, that Saco-Lowell Shops was putting out a machine of its own, using the basic concept of the

Reynolds invention in violation of the license agreement and the patents. A long, drawn out controversy then ensued between Reynolds and the corporation on one side and Saco-Lowell Shops and another on the other side. The petitioner tried but failed to adjust the differences amicably.

An interference proceeding was begun in the Patent Office in December, 1937, but the patents on the Reynolds invention prevailed in April, 1941. A suit by the licensors against the licensees for royalties was begun in October, 1941, which terminated successfully for the licensors early in 1944, at which time the corporation received $112,486.95 as its part of the royalties and interest resulting from the judgment.

The petitioner throughout the interference proceeding and the suit performed extraordinary services entirely distinct from and beyond his duties as an officer of the corporation. Those services included, but were not limited to, the actual preparation of claims, editing papers to be filed, examining patents of the opposition, and giving expert opinions thereon to counsel, preparing exhibits, assisting the attorneys prepare for trial by educating them on the technicalities of the patents and inventions involved, preparing to testify and testifying as the only expert witness for the licensors, and assisting in the preparation of briefs. These activities consumed much time. The success of the interference proceeding and the lawsuit was due in large measure to these extraordinary services of the petitioner.

The petitioner's brother, who was vice president and sales manager of the corporation, had suggested that the petitioner should be compensated for his services beyond those as an officer should the licensors be successful.

The board of directors of the corporation adopted the following resolution on June 20, 1944:

WHEREAS in the year 1927 this Company's President, Mr. E. A. Terrell, entered into an arrangement with Mr. W. G. Reynolds, as a result of which this Corporation acquired a one-half interest in certain Reynolds inventions, which inventions were the subject of litigation started in 1941 by Reynolds, Terrell and this Corporation against Saco-Lowell Shops, the licensee of the Reynolds inventions; and

WHEREAS from the inception of the arrangement with Reynolds, Mr. Terrell has increasingly devoted his time, talent and energy to the promotion and protection of the Company's interest in the said Reynolds inventions, particularly performing extra and valuable services in connection with (a) interference proceedings begun in 1937, (b) negotiations for the settlement of claims against the licensee under the licensing contract and (c) the preparation for and participation in the successful suit against the licensee; and

WHEREAS the ordinary and regular compensation of Mr. Terrell has been and is now considered inadequate compensation for his services.

NOW THEREFORE BE IT RESOLVED

1. THAT the sum of $29,996.67 be paid to Mr. Terrell as additional compensation for services rendered in connection with the Reynolds inventions.

2. THAT the officers of this Company be and they are hereby directed to procure the approval of the Salary Stabilization Unit of the Treasury Department for the payment of this additional compensation.

Permission to pay the $29,996.67 was obtained from the Salary Stabilization Unit of the Treasury and the amount was paid to the petitioner in 1944.

The petitioner reported the $29,996.67 on his 1944 return and computed his tax liability as to that amount under section 107 (a) of the Internal Revenue Code.

The Commissioner, in determining the deficiency, held that section 107 (a) did not apply because the amount was merely additional compensation from the corporation.

The stipulation of facts is incorporated herein by this reference.

OPINION.

MURDOCK, Judge: There is no question involved herein of the amount, reasonableness, or propriety of the compensation received in 1944 by the petitioner. The only issue is whether it is taxable under section 107 (a). The amount was compensation for personal services covering a period of thirty-six calendar months or more, was received by an individual in one taxable year, and was included in his gross income for that year. There seems to be no dispute about the above facts. The Commissioner contends, however, that it was just like the petitioner's other salary for 1944 and did not constitute 80 per cent of the total received in 1944. He cites no authority which supports this contention.

Congress added section 107 to the code by the Revenue Act of 1939, section 220. The Senate Committee on Finance, which was responsible for the new provision, said:

It has been considered a hardship to tax fully the compensation of writers, inventors, and others who work for long periods of time without pay and then receive their full compensation upon the completion of their undertaking. Under existing law, such persons have their income for the whole period aggregated into the final year. This results in two inequities: First, only the deductions, expenses, and credits of the final year are chargeable against the compensation for the full period; second, under our graduated surtax, the taxpayer is subjected to a considerably greater burden because of the aggregation of his compensation. [See S. Rept. No. 648, 76th Cong., 1st sess., p. 7.]

1 SEC. 107. COMPENSATION FOR SERVICES RENDERED FOR A PERIOD OF THIRTYSIX MONTHS OR MORE AND BACK PAY.

(a) PERSONAL SERVICES.-If at least 80 per centum of the total compensation for personal services covering a period of thirty-six calendar months or more (from the beginning to the completion of such services) is received or accrued in one taxable year by an individual or a partnership, the tax attributable to any part thereof which is included in the gross income of any individual shall not be greater than the aggregate of the taxes attributable to such part had it been included in the gross income of such individual ratably over that part of the period which precedes the date of such receipt or accrual.