Nor-Cal Adjusters, AKA Nor-Cal Insurance Adjusters, Formerly Hobson Adjusters, a Corporation v. Commissioner of Internal Revenue

503 F.2d 359 74-2 USTC P 9701 NOR-CAL ADJUSTERS, aka Nor-Cal Insurance Adjusters, formerly Hobson Adjusters, a corporation, Appellant, v. COMMISSIONER OF INTERNAL REVENUE, Appellee. No. 72-1361. United States Court of Appeals, Ninth Circuit. Sept. 5, 1974. 1 Lee M. Galloway (argued), of Ingraham, Deming & Galloway, Sacramento, Cal., for appellant. 2 Wesley J. Filer, Atty. (argued), Tax Div., U.S. Dept. of Justice, Washington, D.C., for appellee. OPINION 3 Before BARNES and TRASK, Circuit Judges, and THOMPSON, * District Judge. THOMPSON, District Judge: 4 This is an appeal from a decision of the United States Tax Court affirming the Commissioner's determination that bonuses paid to officer-shareholders of appellant Nor-Cal Adjusters (Nor-Cal) are not deductible business expenses within the meaning of 162(a)(1) Internal Revenue Code of 1954. The Court has jurisdiction pursuant to 7482 I.R.C. 1954. 5 Nor-Cal is a California corporation engaged in the business of insurance adjustment. Appellant was incorporated on October 2, 1963 by Joseph R. Hobson, who became its sole shareholder. Soon after incorporation, R. H. Wetterer and W. R. Wincapaw, who were adjusters employed by Hobson,…

(dissenting):

As the majority correctly points out Internal Revenue Code of 1954, section 162(a) (l) 1 requires that for compensation paid by a corporation to its officers to be deductible as expenses, the compensation must (1) be reasonable in amount and, (2) must be for personal services actually rendered.

Here the notice of deficiency told the taxpayer that:

Reading that notice, the thrust of the charge of deficiency is clearly based upon the theory of excessiveness of sums paid. There is no suggestion that would notify a reasonable person that the real ground of the Commissioner’s attack would be based upon a theory that the monies paid constituted a distribution of dividends and not an excessive amount paid for services rendered.

The Commissioner could have relied upon a quantitative impropriety, i. e., that the amounts paid for the services rendered were excessive. He could alternatively have relied upon a qualitative impropriety, i. e., that the amounts paid were not for services rendered at all but were in the nature of a distribution of earnings and profits. When the notice of deficiency to the taxpayer was in terms of excessiveness and the decision was predicated…

Before BARNES and TRASK, Circuit Judges, and THOMPSON, * District Judge.

This is an appeal from a decision of the United States Tax Court affirming the Commissioner’s determination that bonuses paid to officer-shareholders of appellant Nor-Cal Adjusters (Nor-Cal) are not deductible business expenses within the meaning of § 162(a)(1) Internal Revenue Code of 1954. The Court has jurisdiction pursuant to § 7482 I.R.C. 1954.

Nor-Cal is a California corporation engaged in the business of insurance adjustment. Appellant was incorporated on October 2, 1963 by Joseph R. Hobson, who became its sole shareholder. Soon after incorporation, R. H. Wetterer and W. R. Wincapaw, who were adjusters employed by Hobson, each purchased 25% of Nor-Cal’s stock from Hobson. Later in 1966 another employee, Gene Theison, purchased 15% of taxpayer’s stock from Hobson. The following schedule lists Nor-Cal’s officers and their respective shareholdings in Nor-Cal at the beginning of the taxable year in question:

Sometime between July 30, 1967 and September 30, 1967, taxpayer redeemed the 35% of its stock held by Hobson. *361 In exchange for his agreed to pay Hobson 35% of its net profits for a 5…