The opinion of the court was delivered by: MCCUNE
The instant litigation issued from deficiencies assessed against the plaintiff taxpayers for the years 1963, 1964 and 1965. The taxpayers paid the deficiencies and filed claim for refund. After six months had passed the taxpayers filed these two actions for refund of those portions of the assessed deficiencies attributable to the Commissioner's disallowance of part of taxpayers' deductions for salaries and rentals. The cases were consolidated at an early stage and were tried together nonjury.
For fiscal year 1964 (the only year involved for Auburn Engineering), Auburn Engineering, Inc. (hereinafter "Engineering") had taken a deduction of $155,503.50 for compensation paid to officers. The Commissioner disallowed $79,750.00 of this as unreasonable. This and other minor disallowances not relevant here resulted in a tax deficiency of $40,490.93 plus $6,578.40 interest. The taxpayer paid this $47,069.33 and filed a refund claim for an overpayment of $39,875.00 plus $6,478.33 interest for a total of $46,353.33.
The deficiency assessed against Auburn & Associates, Inc., (hereinafter "Associates") arose from disallowances of certain deductions for three tax years, 1963, 1964 and 1965. For 1963 and 1964 only the deductions for office rental paid were in issue. For 1965 both rental and compensation to officers were in issue.
Of the rental deductions for 1963 the Commissioner disallowed $4,185.54. This and other minor disallowances not relevant here resulted in a deficiency of $3,204.97 plus $825.17 interest. After payment of this $4,030.14 the taxpayer filed a refund claim for $1,578.95 contesting disallowance of the rental. The refund claimed was divided as follows: $1,255.66 for overpayment and $323.29 for interest.
For 1964 the Commissioner disallowed $6,624.82 of office rental deductions claimed by Associates. A total deficiency of $3,416.76 was assessed with interest of $674.70. Associates paid the $4,091.46 but again contested the rental disallowance. Associates claimed $1,762.46 overpayment and $348.03 interest or a total of $2,110.49.
For 1965 the Commissioner disallowed $17,958.53 of office rental deductions and $146,573.00 of compensation deductions. With other disallowances not material here there was assessed a total deficiency of $82,217.45 plus $11,302.09 interest. Associates paid the deficiency and filed a refund claim contesting the rental and compensation disallowances. Associates claimed for 1965, $80,904.40 overpayment and $11,121.59 interest.
The evidence presented at trial covered the history of the two taxpayers. Associates was formed in 1948 by B. J. Auburn and H. G. Deardorf. A. J. Mosso and R. C. Avondo whose salaries have caused the main controversy here joined Associates in 1949. Mr. Deardorf thereafter left the firm (1950). At that time Mosso and Avondo assumed the position of officers in Associates. The minutes of a Board of Directors meeting held on April 3, 1950, reflects the understanding of the then sole stockholder of Associates, B. J. Auburn, and Mosso and Avondo that the latter would put forth extraordinary effort to make Associates successful but would defer adequate compensation pending the event. These minutes will appear hereinafter.
The testimony showed that Mosso and Avondo were the driving forces in both taxpayers. Both men appear to have worked tirelessly to insure the success of these firms. During the early years their salaries were small. The success of the two firms was rather dramatic. Associates' sales went from $179,689.55 in 1950 to $4,313,847.18 in 1965. Engineering's sales went from $327,889.81 in 1956 to $1,666,456.29 in 1965. Auburn had continued as president of Associates until 1961. That year he assumed the position of Chairman of the Board and Mosso became the president. Mr. Auburn moved to the west coast and from his correspondence in the form of monthly reports we conclude that he represented the firm on the West Coast and maintained an office there.
The office building in dispute was constructed in 1959. It was built by Parkway Land Company, a partnership consisting of Auburn, his wife Roxanne, Mosso, Avondo and Leech. Both Associates and Engineering needed ever increasing office space suitable for engineering work. Approximately three acres of ground were purchased for $30,000.00. The location is adjacent to the Parkway just east of Pittsburgh in an area where there are many research facilities and much commercial development. A building suitable for engineering offices was constructed for $430,000.00. Mr. Mosso testified that the partners effected substantial savings by acting as their own architect, engineer and contractor.
Gross rentals deducted by the taxpayer consisted of cash payments made to lessor plus certain supplies and maintenance of the building and depreciation on certain improvements. These rentals are set forth hereinafter. The government's Exhibit GG sets forth the deductions taken by taxpayer. The question was whether the ...