Willoughby Camera Stores, Inc. v. Commissioner , 44 B.T.A. 520 ( 1941 )

WILLOUGHBY CAMERA STORES, INC., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

Willoughby Camera Stores, Inc. v. Commissioner

Docket No. 100707.

United States Board of Tax Appeals

44 B.T.A. 520; 1941 BTA LEXIS 1319;

May 16, 1941, Promulgated

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Where petitioner set up a reserve for bonus payments to employees before the legal liability for their payment existed, the amounts so set up are not thereupon deductible.

James H. Douglas, Esq., and Menahem Stim, C.P.A., for the petitioner.

Conway N. Kitchen, Esq., and Allen T. Akin, Esq., for the respondent.

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LEECH

Respondent has determined deficiencies in income tax of $7,917.92 and $9,624.26 for the calendar years 1935 and 1936 and a deficiency in excess profits tax of $278.34 for the latter year. The issues presented are upon the correctness of the action of the respondent in disallowing deductions of $57,584.83 and $95,169.66 taken by petitioner upon its returns for 1935 and 1936, respectively, which represented in each instance an amount set up on petitioner's books at the close of the taxable year as a "Reserve for Bonus" to be paid employees in the following year.

FINDINGS OF FACT.

Petitioner is a New York corporation, with its principal office in New York City, and was incorporated in the year 1927 as a successor corporation and continuation of a business known as Charles G. Willoughby, Inc., which had been in existence for many years. Petitioner, for the taxable years here involved and for many years prior thereto, kept its books and filed its tax returns upon the accrual basis.

On December 31, 1934, the petitioner credited an account upon its books termed "Reserve for Bonus" in the amount of $47,584.83, and charged its profit and loss account with this amount. The amount so credited was paid to employees at various times during the year 1935 pursuant to resolutions adopted at various times during that year by petitioner's board of directors. As each payment was made in 1935 out of the total amount of $47,584.83, a debit entry was made in a ledger account of petitioner termed "Bonus as Extra Compensation." The offsetting debit entry in the account "Reserve for Bonus" in the amount of $47,584.83 was made on December 31, 1935. During the year 1935 the petitioner paid to its employees as extra compensation a total amount of $65,840.25, which included the amount of $47,584.83 which had been credited to the bonus reserve at the end of 1934. The balance of $18,255.42 which was paid out in 1935 was charged to the petitioner's profit and loss account in that year.

On December 31, 1935, the petitioner credited its "Reserve for Bonus" account with $57,584.83 and charged the sum of $57,584.83 to its profit and loss account.

In his notice of deficiency for that year the respondent disallowed the deduction of $57,584.83 from the petitioner's 1935 income on the ground that no legal liability was incurred in 1935 for the payment of this amount. This amount of $57,584.83 was paid to employees at various times during the year 1936 pursuant to resolutions of petitioner's board of directors adopted at various times during the year 1936.

During the year 1936 the petitioner paid to its employees as extra compensation the total amount of $97,221.50, which included the $57,584.83 that had been credited to the bonus reserve at the end of 1935. The balance of $39,636.17 which was paid out in 1936 was charged to the petitioner's profit and loss account in that year.

On December 31, 1936, the petitioner credited its "Reserve for Bonus" account with $95,169.66 and charged this sum to its profit and loss account. In his notice of deficiency the respondent disallowed as deduction from petitioner's 1936 income the sum of $37,584.83 on the ground that no legal liability was incurred in 1936 for the payment of this amount. The $37,584.83 represented the difference between the $95,169.66 credited on December 31, 1936, to the "Reserve for Bonus" and $57,584.83 which was the credit balance in the reserve account at the beginning of 1936, which amount was paid out in 1936 and for which no deduction from the petitioner's 1935 income was allowed by the respondent.

The amount of $95,169.66 was paid out at various times during the year 1937 pursuant to resolutions of the petitioner's board of directors adopted at various times during that year.

As each payment was made in 1935 and 1936 the "Bonus as Extra Compensation" account was debited by the amount paid with a credit to cash. At the end of each of the taxable years the bonus reserve was debited with the total amount by which it had been credited.

The petitioner kept a cash book in which entries were made from time to time showing the dates and amounts of extra compensation paid by it to individual employees but when the aforesaid amounts of $57,584.83 and $95,169.66 were credited to the bonus reserve at the end of 1935 and 1936 as hereinbefore detailed, no specific amount thereof was credited to or set aside for any individual employee.

Petitioner in its dealings with its employees termed the latter "coworkers." When employing personnel petitioner ordinarily advised the individuals that it was the plan of the company to permit its employees to share in the earnings of the company and that its custom was to pay to employees bonuses from the earnings of the company in addition to the salary.

OPINION.

LEECH: The deduction of amounts which petitioner actually paid to its employees as bonuses or extra compensation during each of the years 1935 and 1936, is not in issue.

However, petitioner contends that since it is on an accrual basis the right to deduct the two contested additions to the reserve for bonuses matured when those additions were made and not when actually paid to employees.

Respondent concedes the existence of the premise, but disagrees with the conclusion. He argues that the additions to bonus reserves were not legally accruable as deductions in the years in which the additions were set up and deductions therefor are claimed and did not become so in either instance until the following year which was the year in which payment to the employees was actually made.

The issue is resolved by a determination as to whether at the close of each year, the amounts set aside and credited to the bonus reserve then constituted, in each instance, a legal liability in the amount so credited. If, by the setting aside of these amounts petitioner incurred no legal liability to make payment of those sums it is clear, we think, that these amounts were the estimated sums which the corporation deemed necessary to meet such payment of bonuses in the following year as its board of directors would then, by voluntary action, authorize. It would then follow that these additions to the reserve would not constitute proper deductions for the year in which set up, since, in neither instance, had the liability at that time matured. As was said in :

* * * An item accrues when all events have occurred necessary to fix the liabilities of the parties concerned therewith and to determine the amount of such liabilities. * * *

The record reveals that petitioner for many years had maintained a custom of paying bonuses from earnings to its employees and that these employees were told that they might expect such payments. There is, however, no indication that the contract of employment of these employees obligated the petitioner to make bonus payments nor is it indicated that there was any fixed method of computing the actual payment made to any employee. It is testified that the bonuses paid were in accordance with length of service, but whether they were based upon the salary received is not disclosed nor is it indicated that any liability was assumed or admitted by petitioner to make a bonus payment to an employee unless the latter was in the service at the time the payment was actually authorized by petitioner's board of directors and made. In fact, the action taken by petitioner's directors in paying the bonuses in the year following that in which the reserve was set aside and deducted as an accrued liability, indicates that it was not a liability enforceable against petitioner by its employees at the close of the year in which set up. If it represented a liability it would be due and payable to the employees upon the expiration of the year. It seems inconsistent with this condition that petitioner should pay the amounts of these accruals in specific bonus allowances throughout the course of the following year upon successive resolutions adopted by its board of directors specifically authorizing the payments.

It is our conclusion that the amount determined at the close of each of the taxable years here involved and set aside in the reserve for bonus did not in either instance then constitute a legal liability of the petitioner to its employees. It follows that these amounts were not subject to deduction in either of those years and that respondent's action in allowing the deduction in the following year in which payment was made and in disallowing the deduction in the year in which the reserve was credited was proper. ; certiorari denied, ; .

Decision will be entered for the respondent.