Denny v. Commissioner

                  United States Board of Tax Appeals

The issues are whether the amount of $ 11,000 was income to petitioner in either the year 1925 or 1926 and whether the respondent erred in disallowing deductions claimed by the petitioner as business expenses.

FINDINGS OF FACT.

1. The petitioner is and has been steadily since 1921 a motion picture actor. Prior to 1921 he had been an actor at intervals. On April 23, 1924, the petitioner and Universal Pictures Corporation entered into a contract whereby that corporation employed the petitioner to render his exclusive services to it for a term of six months from the date of the contract, with options to renew the employment for nine successive periods of six months each at specified graduated weekly salaries.

On May 28, 1925, the corporation submitted to the petitioner a proposed modification of the contract of employment which on that date was accepted by the petitioner and became a contract. The modification was as follows:

1. Your present term of employment is to be continued and extended for a term of six months from and after June 1st, 1925, at a weekly salary of Two thousand dollars ($ 2000.00), with nine options for extensions thereof, to be exercised in like manner as the options provided for in paragraph twenty-three of said agreement, at the following compensation, namely: Two thousand dollars weekly ($ 2000.00) during the first extended period. Twenty-two hundred and fifty dollars ($ 2250.00) during the second and third, Three thousand dollars weekly ($ 3,000.00) during the fourth and fifth, Thirty-five hundred dollars weekly ($ 3500.00) during the sixth and seventh and Four thousand dollars weekly ($ 4000.00) during the eighth and ninth extended periods.

2. We agree to lend you the sum of Eleven thousand dollars cash ($ 11,000.00) upon the execution of this present agreement, which amount is to be repaid to us without interest on or before June 1st, 1926, provided however that if we exercise the second option hereinabove referred to we agree to give you a full acquittance and release of said indebtedness, but if said option is not exercised for any reason whatsoever, you agree to repay said sum of Eleven thousand dollars to us on June 1st, 1926. The foregoing provision is not to be construed in any manner as a liquidated damage clause.

* * *

The $ 11,000 mentioned in the modification was, at the date of modification, loaned by Universal to the petitioner. In his income tax return for 1925 the petitioner referred to this loan as follows: "(Rec'd loan of $ 11,000 which may ripen into bonus in 1926)." Universal exercised its second option and did not collect the loan. In his return for the calendar year 1926 the petitioner returned "Universal Pictures Corporation, Universal City, California, Bonus - 1925 $ 11,000."

2. In making prize fight pictures in 1925 under his contract of employment with Universal, the petitioner had four upper and three lower teeth knocked out. The dentist employed by Universal attempted to restore the teeth and tighten them so that they would become permanent but he failed after long efforts in this attempt. The dentist was paid $ 1,000 by Universal. Thereafter the petitioner employed the dentist on his own account and paid him $ 400 for bridge work to replace the lost teeth. Petitioner's contract with Universal gave the company the right to suspend the contract of employment if the petitioner suffered "any facial or physical disfigurement materially detracting from his appearance on the screen", and the further right to cancel the contract if the petitioner's incapacity continued in excess of two weeks in any year.

3. In 1924 the petitioner purchased an airplane for his personal use for the sum of $ 750. He remodeled the plane, the cost of which added to his original purchase price made a total cost of $ 5,000. In February 1925 he was required to cease flying by Universal and by the provisions of an insurance policy that he purchased about that time. He thereupon placed the plane with one Leo Nomis, a professional pilot, under an agreement that Nomis would use it for carrying passengers or for doing motion picture work or other commercial purposes. The proceeds from such use of the plane were to be divided equally between petitioner and Nomis. The plane was used by Nomis for commercial purposes during the last ten months of 1925. The venture was a failure financially and petitioner received during 1925 as a share of the proceeds the sum of $ 300 which he reported as income for that year. During that year he expended $ 632.26 for repairs and upkeep, $ 500 for gasoline and $ 375 for garage rent, making a total expenditure of $ 1,507.26. In his return for 1925 petitioner claimed depreciation on the plane in the amount of $ 2,000 which was at the rate of 40 percent of the cost. Petitioner received no income from the use of the plane after 1925. In the early part of 1926 Nomis claimed that petitioner owed him some $ 500 or $ 600 for bills against the plane. Rather than pay the amount claimed, petitioner turned the machine over to Nomis at that time.

4. In 1925 the petitioner purchased a motor boat at a cost of $ 6,050, and in that year he expended for upkeep of the boat the following amounts:

 Repairs                        $ 618.61

 Repairs and upkeep           $ 2,084.65

5. In his return for the year 1926 the petitioner claimed a deduction in the amount of $ 12,618.17 as representing advertising and miscellaneous publicity expenses. On the deductions so claimed, the respondent disallowed $ 9,545.35. The amount so disallowed is made up of $ 1,377.25 representing club dues and $ 8,168.10 representing 40 percent of petitioner's household expenses for the year. During the year 1926 the petitioner was a member of 14 clubs. His family in that year consisted of himself, his wife and a daughter then about nine years old. His residence was a frame house with two bedrooms and a play room upstairs, a living room, dining room and den downstairs, and a kitchen and two bathrooms. He employed two servants regularly and at times brought in outside help. He did a great deal of entertaining at his home, which he considered more economical than entertaining at outside places. He entertained newspaper people, magazine writers, directors and producers of motion pictures and officials of motion picture companies, the purpose being to obtain publicity. On one occasion he entertained a company that produces Gilbert and Sullivan operas for the reason that his father was an original member of the Gilbert and Sullivan Opera Co. and it seemed possible that a good story might be obtained from it. His guests were furnished with expensive refreshments, including alcoholic beverages in considerable quantities. Some of his guests stayed overnight. At times he and his guests played poker, in which the petitioner suffered losses, but he did not claim such losses in his income tax returns. Petitioner's total household expenses for the year 1926 amounted to $ 20,465.27.

6. It was necessary for the petitioner, in order to render the services contracted for, to take the same character of exercise as if he were training for a prize fight. The petitioner expended $ 254 in 1925 for this type of training.

7. In 1925 petitioner presented to Joe Torrillo an automobile that cost the petitioner $ 675. Torrillo was under contract with Universal and played small parts in pictures. His duties under the employment contract included acting as petitioner's valet and assembling costumes for the petitioner.

He received a salary of $ 40 per week from Universal. Outside of his employment under his contract he performed a number of services for the petitioner, including running errands and driving an automobile for the petitioner

when the latter was engaged in road work as a part of his physical training, and driving the petitioner back at the end of his jaunts. In order to make Torrillo's services more readily available in these respects, petitioner presented him with the automobile. The petitioner also gave Torrillo certain sums in cash during the year. The cost of the automobile given Torrillo was claimed as a deduction in petitioner's return for 1925, which deduction was disallowed by the respondent.

8. In 1926 the petitioner expended for wigs and professional supplies, including make-up boxes and toilet articles, the sum of $ 2,288.59, of which the respondent disallowed $ 248.59. These items were necessary to petitioner in his occupation and were not supplied by his employer under the contract of employment.

OPINION.

ARUNDELL: 1. The first question is whether the sum of $ 11,000 received by petitioner from Universal Pictures Corporation was income, and, if so, in what year. The petitioner claims that it was a gift, but that if it was income, it was income in 1925 rather than 1926.

The claim that the sum was a gift needs but a short statement. It is elementary that if there is consideration for a transaction, it is not a gift. Noel v. Parrott, 15 Fed.(2d) 669. Here there was a consideration. The transaction was in connection with the contract of employment and the money was to become the property of the petitioner only in the event that he continued in the employ of the lender upon exercise of the option to retain petitioner's services after a designated date. The option was exercised and petitioner continued in the service of the company. This was ample consideration to remove the transaction from the category of gifts.

We are of the opinion that the item was properly reported by the petitioner and taxed by the respondent as income in 1926. Although the money was received by the petitioner in 1925, it was then a loan. It was neither paid nor received as income in that year. Not until the happening of an event in 1926 did the money become the petitioner's. It then ripened into a bonus, as it was described in petitioner's return. The situation here is distinguishable from those where money is received subject to the possibility of repayment upon the happening of a subsequent event. See North American Oil Co. v. Burnet, 286 U.S. 417. Here the money was received not "under any claim of right and without restriction as to its disposition", as in the North American Oil Co. case, but subject from the first to the definite obligation to repay. That obligation remained in effect until in 1926. The case here is much like that where one receives as compensation property encumbered by a mortgage to the full value of the property. In that situation there would be no income in the year of the receipt. Upon cancellation of the mortgage by the transferor in a subsequent year there would be income to the recipient, and the result would be the same whether the cancellation be regarded as the forgiving of indebtedness or as property then freed for the first time from restriction on use. This question is decided for the respondent.

2. The petitioner has established that in 1925 he expended $ 400 for dental bridge work to take the place of teeth lost in making a prize fight picture, and that the making of that picture was in line with his duties under his contract of employment. We hold that the amount so expended is deductible as an ordinary and necessary expense incurred in the petitioner's business. The situation here is analogous to that in Charles Hutchison, 13 B.T.A. 1187, where we allowed a "stunt actor" to deduct the cost of clothing destroyed in performing the feats required of him in the making of pictures. It is distinguishable from the case of Louis M. Bourne, 23 B.T.A. 1288, where we disallowed a deduction claimed by a lawyer for hospital and medical charges occasioned by an attack of arthritis. While the deduction there was sought as a loss item, rather than as a business expense as here, the important distinction is that in the Bourne case there was no showing of any connection between the expenditure and the taxpayer's occupation. In this case the connection is direct. The expense was directly attributable to the petitioner's performance of services under his contract of employment. We hold that he is entitled to deduct the $ 400 expended as a business expense.

3. The airplane that petitioner purchased in 1924 for his personal use was converted to commercial use in February 1925, and was used in a purely commercial venture during the last ten months of 1925. The expenses of operation and depreciation after February 1925, and the loss on disposition are allowable under the decision in Heiner v. Tindle, 276 U.S. 582. We have set out in the findings of fact the amount of the established expenses. As to the basis for depreciation, it appears that the petitioner had completed remodeling of the plane just shortly before devoting it to commercial use. Original cost, plus remodeling cost, was $ 5,000. That sum, we believe from the evidence, was the value when it was placed in commercial service and is the proper basis for depreciation. The rate used by petitioner, 40 percent, does not appear to be warranted by the evidence. From the petitioner's testimony, we gather that he regarded shrinkage of market value as synonomous with loss of useful value. The two are rarely, if ever, the same. We are of the opinion that a 20 percent rate will give the reasonable allowance for depreciation allowed by the statute. No depreciation deduction is sought for 1926. This is immaterial to a correct determination of income for that year, inasmuch as the petitioner disposed of the plane within the year. What he would gain by depreciation he would lose in the reduction of basis. He turned the plane over to Nomis in 1926 in satisfaction of bills of around $ 500, which amount should be treated as sale price and loss computed accordingly.

4. Deductions are claimed for club dues and cost of operating a motor boat. These are claimed to be "publicity expenses" and allowable as ordinary and necessary business expenses. The evidence is insufficient to support any finding that these expenditures were made with a view to directly benefiting the petitioner in his occupation. He testified that he is not a clubman and that he rarely made any use of the clubs to which he belonged. It is difficult to see how the mere payment of dues can be regarded as an ordinary and necessary expense. According to petitioner's testimony, not more than 25 percent of the usage of his motor boat was for publicity purposes. This, of course, must be regarded an as outside figure, and requires the support of evidence to establish the business character of that portion of the cost of maintaining and operating the boat. The petitioner's efforts to obtain publicity seem to have been directed toward the matter of building up good will rather than the development or increase of a business enterprise. In the years before us he was under contract whereby he was to receive stated weekly salaries for a period of five years, and he has failed to show wherein his business of carrying out his contract would be affected by his socalled publicity expenses. The respondent is sustained in the disallowance of these items.

5. The petitioner's household expenses amounted to $ 20,465.27. He claims 40 percent of that amount as an advertising expense, that percentage he says being attributable to the cost of entertaining in his home for publicity purposes. What we have said above on the subject of petitioner's motor boat is in point here. In addition to the failure to show a direct connection between expenditures and the petitioner's business, and the difficulty of showing the cost of entertaining separately from maintenance for personal and family use, there is the difficulty of segregating purely social entertainments from those staged with a business objective. Entertainments in the home may be prompted by either social or commercial motives or they may partake of both characteristics, with either element predominating. There is a wide gap between entertaining for purely business purposes at public places, where even though exact costs are not known they may be estimated with some degree of accuracy, cf. Blackmer v. Commissioner, 70 Fed.(2d) 225, and entertaining in the home, where not only the family is maintained but where, if the general standard of social conduct obtains, there are at least some personal or social guests. Having due regard for the norm of conduct of the average home, we should have very clear evidence on the point before we say that any particular percentage of its activities are purely commercial. We do not have that evidence here.

The facts in this case distinguish it from the case of Ned Wayburn, 32 B.T.A. 813. In that case the taxpayer, the president of a corporation, used corporate funds for entertaining, partly in his home, parents and others who might send children to the dancing studio conducted by the corporation. The evidence in that case showed the numbers of people entertained at different functions, the occupations or professions of some of the guests, and that business was brought to the corporation as the result of the entertainments. On the evidence in that case we held that so much of the corporate funds as the taxpayer expended for entertainment to further the corporate business was not income to him. As above pointed out, we have no evidence here of any connection between petitioner's outlay and the furtherance of his business. The respondent's disallowance of deductions is presumptively correct, Old Mission Portland Cement Co. v. Helvering, 293 U.S. 289, and the evidence here fails to rebut that presumption.

6. The petitioner was compelled to keep himself in first-class physical condition, and to train as though for a prize fight. For such training he expended $ 254 in the year 1925. This expenditure should be allowed as a deduction. Charles Hutchison, supra.

7. Petitioner is not entitled to the deduction of $ 675 from his gross income for 1925. This amount represents the cost of an automobile presented by the petitioner to one Torrillo, who was in the employ of Universal and who, it appears, never was in the employ of the petitioner. It appears that he ran errands for the petitioner and did other small services. Not only did petitioner give him the automobile, but he also made him presents of sums of money, the amount of which is not given. Gifts of such large amounts to persons not in one's employ can not be considered either an ordinary or necessary expense, at least without a showing that the services were in some way commensurate with the outlay. Welch v. Helvering, 290 U.S. 111.

8. Petitioner was required to furnish all of his costumes and make-up except what were termed period and character costumes. Wigs and other make-up for which the petitioner claims a deduction of $ 2,288.59 were not included in the exception. Petitioner is entitled to the deduction. Charles Hutchison, supra.

Decision will be entered under Rule 50.