The Seewald Corporation & Brewster and Priscilla Seewald v. Commissioner of Revenue (October 3,2001)

      
COMMONWEALTH OF MASSACHUSETTS

APPELLATE TAX BOARD


THE SEEWALD CORPORATION		v.	 COMMISSIONER OF REVENUE
& BREWSTER AND PRISCILLA
SEEWALD
     

Docket Nos.: F224513 & F225917	 Promulgated:
  				 	 October 3, 2001



 	These are consolidated appeals filed under the formal procedure pursuant to G.L. c. 62C, § 39, from the refusal of the appellee Commissioner of Revenue to abate personal income taxes assessed to Brewster and Priscilla Seewald for the 1988 tax year and corporate excise taxes assessed to the Seewald Corporation for the taxable year ending August 31, 1988. 
	Former Commissioner Lomans heard these appeals, and was joined in the decision for the appellee by Chairman Burns, former Chairman Gurge and Commissioner Scharaffa.
	These findings of fact and report are promulgated at the request of the appellee, pursuant to G.L. c. 58A, § 13 and 831 CMR 1.32.

Walter Flowers, Esq. for the appellant. 
Karen L. Paino, Esq. for the appellee.
FINDINGS OF FACT AND REPORT
	Based on facts stipulated to by the parties and the testimony and exhibits introduced into evidence at the hearing of these appeals, the Appellate Tax Board ("Board") made the following findings of fact.
	During all times material to these appeals, the Seewald Corporation ("the corporation") was a Massachusetts corporation, organized in 1971 by Brewster Seewald ("Mr. Seewald").  Mr. Seewald was the sole shareholder of the corporation and was also employed as its president.  Mr. Seewald and his wife Priscilla Seewald ("the Seewalds") resided in Massachusetts.  
	In his capacity as corporate president and with his expertise in engineering, engineering design and sales, Mr. Seewald facilitated the overall manufacture of electronic component-part devices.  He functioned as the conduit through which local Massachusetts and other United States designer and engineer customers were "matched" with manufacturers in Japan and Hong Kong.  In this role, Mr. Seewald typically negotiated contracts with customers in need of the custom manufacture of an electronic product.  Following contract negotiations, he traveled to Japan and/or Hong Kong with the customer's design specifications and negotiated a separate contract with an Asian manufacturer.  The specified product was then produced by the Asian manufacturer.  If a specific part or the entire end product needed to be reengineered, Mr. Seewald facilitated communications between his United States customer and the foreign manufacturer.  In addition, he assisted in shipping a limited quantity of the finished product back to the United States for testing.  After the goods were manufactured, the corporation took title and imported them to Massachusetts.  The corporation then resold these manufactured goods to its United States customers.  During any particular year, Mr. Seewald's travels to the Far East were frequent and extensive.
Mr. Seewald's wife Priscilla Seewald ("Ms. Seewald") was also employed by the corporation as corporate clerk.  Her duties included handling telephone calls, sending telexes, delivering samples, delivering parts, picking up drawings, bookkeeping, purchasing, and relaying messages between Mr. Seewald and his customers.  Ms. Seewald also escorted customers from the airport and entertained them until Mr. Seewald arrived.  Her work hours were flexible and would vary on a daily basis.
Although she had taken some courses in accounting, Ms. Seewald's education at Leslie College was in day-care administration and early childhood education.  Unable to read a draftsman's design or understand mechanical designs, she was neither primarily responsible for dealing with the corporation's engineer customers, nor responsible for authorizing or making necessary technical changes to design specifications.  Ms. Seewald was also not involved in any of the corporation's sales activities. 
During the relevant time period, the corporation employed other part-time workers, trained by Ms. Seewald, to answer the telephone, make deliveries and type.  These employees were paid either minimum or close to minimum wage.  None of these employees was ever paid a salary bonus by the corporation. 
In calendar year 1988 ("tax year at issue"), Ms. Seewald received an annual salary of $2,385 and a bonus of $197,645.  Her total 1988 compensation of $200,030 represented 12.54 percent of the corporation's gross sales and 33.15 percent of the corporation's net income.  In the prior year, 1987, Ms. Seewald received approximately $400,000 as compensation from the corporation.  Between 1980 and 1988, Ms. Seewald received approximately $1,200,000 in total compensation from the corporation.
As she testified at the hearing of these appeals, Ms. Seewald never negotiated an annual salary with the corporation.  In addition, she never held any expectation of a predetermined level of compensation to be received in any particular year.  While partial payments of her 1988 bonus were given to her throughout the year as "advances," the final determination of her bonus payment was made by Mr. Seewald at year-end, after consideration of the corporation's financial position and corporate bank account balances. 
During the tax year at issue, and in addition to her employment at the corporation, Ms. Seewald worked approximately forty hours per week as Interim Director of the Early Childhood Learning Center in North Andover, Massachusetts.  In 1988, she received an annual salary of $25,000 for this work.  As she testified at the hearing of these appeals, she occasionally fulfilled some of her corporate duties during her work hours at the Early Childhood Learning Center.
	Throughout its history, the corporation never formally declared nor paid dividends.  As Mr. Seewald testified at the hearing of these appeals, there was never a need to declare dividends because the corporation always paid bonuses.
On May 15, 1989, the corporation filed its Massachusetts corporate excise tax return for the fiscal year ending August 31, 1988 ("corporate tax year at issue"), and paid the tax shown as due.  On that return, the corporation claimed a business deduction for the salary and bonus paid to Ms. Seewald.
The Seewalds jointly filed their Massachusetts individual income tax return for the 1988 tax year.  On that return, the Seewalds reported the corporate bonus paid to Ms. Seewald during the 1988 tax year as "other 5% income."  
 	Following a 1992 audit of the corporation for the corporate tax year at issue, the Commissioner of Revenue ("Commissioner") made adjustments to the corporation's excise tax return. Specifically, the Commissioner determined that only $49,027.00 of the 1988 payments made by the corporation to Ms. Seewald was deductible as reasonable compensation.   
Thereafter, the Commissioner issued his August 7, 1992 Notice of Intention to Assess ("NIA"), notifying the corporation of his intention to assess additional corporate excise taxes for the corporate tax year at issue, in the amount of $16,674.00, plus interest and penalties. 
	Similarly, the Commissioner issued his August 17, 1992 NIA, notifying the Seewalds of his intention to assess additional individual income taxes in the amount of $8,776.00, plus interest and penalties for the 1988 calendar year.  The NIA upheld the Audit Bureau's determination that a certain portion of Ms. Seewald's 1988 compensation was attributable to Mr. Seewald as a constructive dividend from the corporation.  
Following a November 24, 1992 audit conference, and by determination letter dated January 5, 1993, the Commissioner upheld all audit adjustments, but at lower amounts than originally proposed. 
	Accordingly, by a February 10, 1993 Notice of Assessment ("NOA") to the corporation, the Commissioner assessed  additional  corporate   excise  taxes   for   the 
corporate tax year at issue in the amount of $14,345, plus interest and penalties.  By a February 10, 1993 NOA to the Seewalds, the Commissioner assessed individual income taxes for the tax year at issue in the amount of $7,550, plus interest and penalties.  All additional taxes due were timely paid by both the corporation and the Seewalds. 
	On September 15, 1994, both the corporation and the Seewalds timely filed applications for abatement, requesting abatements of the additional assessments for the periods at issue.  The corporation's abatement application was denied by the Commissioner on January 20, 1995.  The Seewald's abatement application was denied by the Commissioner on March 31, 1995.  
Thereafter, on March 13, 1995, the corporation timely filed its petition with this Board.  Similarly, on May 10, 1995, the Seewalds timely filed their petition with this Board.  On the basis of the above facts, the Board determined that it had jurisdiction over the subject appeals. 
	Based on the evidence presented, the Board found that the compensation paid to Ms. Seewald in 1988, in excess of the amount found reasonable by the Commissioner, was neither reasonable nor purely for services rendered.  The Board found and ruled, therefore, that these payments represented unreasonable compensation.  On this basis, the Board found and ruled that the corporation's payments to Ms. Seewald, in excess of the amount found by the Commissioner to be reasonable, could not properly be deducted as an ordinary and necessary business expense.  The Board further found and ruled that this excess payment to Ms. Seewald was a constructive dividend to Ms. Seewald's spouse, Brewster Seewald, the sole corporate shareholder. 
Accordingly, and for the reasons detailed in the following Opinion, the Board denied the appellants' abatement requests and issued a decision for the appellee in these appeals. 

OPINION
	The issues raised by the present appeals are: (1) whether payments made by the Seewald Corporation to its employee Priscilla Seewald constitute compensation deductible as an ordinary and necessary business expense under Internal Revenue Code § 162(a)(1); and (2) if not, whether these payments constitute a constructive dividend to Ms. Seewald's spouse, the corporation's sole shareholder.
	
For Massachusetts tax purposes, the net income of a corporation is defined as: 

gross income less the deductions, but not the credits, allowable under the provisions of the Federal Internal Revenue Code, as amended and in effect for the taxable year. 


G.L. c. 63, § 30(4).  Specifically, § 162 of the Federal Internal Revenue Code ("IRC") allows a corporation to deduct all ordinary and necessary expenses incurred during the taxable year in carrying on its trade or business, including "a reasonable allowance for salaries or other compensation for personal services actually rendered."  IRC § 162(a)(1). 
An employee bonus also may be treated as an ordinary and necessary business expense.  The deductibility of such bonus, however, is premised on whether 

such payments are made in good faith and as additional compensation for the services actually rendered by the employees, provided such payments, when added to the stipulated salaries, do not exceed a reasonable compensation for the services rendered. 


26 C.F.R. § 1.162-9. 
 
The test for deductibility of compensation payments, including bonuses, therefore, "is whether they are reasonable and are in fact payments purely for services."  26 C.F.R. § 1.162-7(a).  See also O.S.C. & Associates, Inc. v. Commissioner, 187 F.3d 1116, 1120 (9th Cir. 1999); Elliotts v. Commissioner, 716 F.2d 1241, 1243 (9th Cir. 1983).  The burden of proving a deduction for ordinary and necessary business expenses rests with the taxpayer.  Botany Worsted Mills v. United States, 278 U.S. 282, 289-290 (1929); Miller Box, Inc. v. United States 488 F.2d 695 (5th Cir. 1974), cert. denied 417 U.S. 945 (1974). 
	Special scrutiny is warranted when payments are made by a closely-held corporation, particularly when the controlling shareholders set their own level of compensation.  26 C.F.R. § 1.162-7(b)(1) (noting that "[a]n ostensible salary paid by a corporation may be a distribution of a dividend on stock.  This is likely to occur in the case of a corporation having few shareholders, particularly all of whom draw salaries.")  See also Eberl's Claim Service v. Commissioner, 249 F.3d 994, 998 (10th Cir. 2001); Alpha Medical, Inc. v. Commissioner, 172 F.3d 942, 946 (6th Cir. 1999); Dexsil Corporation v. Commissioner, 147 F.3d 96, 100 (2nd Cir. 1998); Charles Schneider & Co., Inc. v. Commissioner 500 F.2d 148, 152 (8th Cir. 1974), cert. denied 420 U.S. 908 (1975).


  	Such close examination is necessary because


[i]t is obviously in the tax interest of all parties to characterize the amounts distributed to shareholder/officers as compensation rather than as dividends.  Corporations can deduct salaries and bonuses under § 162(a)(1) but obviously not dividend payments because they are profits, not business expenses.  The concern is to prevent the distribution of corporate profits through the payment of unreasonably large salaries and bonuses to controlling shareholder/officers.
 

Dexsil Corporation v. Commissioner, 147 F.3d at 100, quoting Rutter v. Commissioner, 853 F.2d 1267, 1270-1271 (5th Cir. 1988).  Intra-family corporate transactions must also be closely scrutinized.  See Seven Canal Place Corporation v. Commissioner, 332 F.2d 899, 900 (2d Cir. 1964); Normandie Metal Fabricators, Inc. v. Commissioner, 79 T.C.M. 1738, 1738 (2000), aff'd per curiam No. 00-4169, 2001 WL 618237 (2nd Cir. May 30, 2001); Van Anda's Estate v. Commissioner, 12 T.C. 1158, 1162, aff'd per curiam 192 F.2d 291 (2d Cir. 1951).
 	Whether a particular employee's compensation is reasonable is a question of fact, to be resolved through an examination of all the facts and circumstances of the case. Mayson Mfg. Co. v. Commissioner, 178 F.2d 115, 119 (6th Cir. 1949).  See also Alpha Medical, Inc. v. Commissioner, 172 F.3d at 946; Owensby & Kritikos, Inc. v. Commissioner, 819 F.2d 1315, 1323 (5th Cir. 1987); Charles Schneider & Co. v. Commissioner, 500 F.2d at 151; McCandless Tile Service v. United States, 422 F.2d 1336, 1338 (Ct.Cl.1970). Importantly, "[e]ven a payment deemed reasonable . . . is not deductible to the extent that it is in reality a distribution of corporate earnings and not compensation for services rendered."  McCandless v. United States, 422 F.2d at 1339.  See also O.S.C. & Associates, Inc. v. Commissioner, 187 F.3d at 1119-1120.  
	Although every case of this kind must stand upon its own facts and circumstances, it is well settled that several basic factors should be considered in assessing the reasonableness of an employee's compensation.  Broadly stated, these factors include "(1) the employee's role in the taxpaying company, 'including the employee's position, hours worked, and duties performed;' (2) a comparison of the employee's salary with those paid by similar companies for similar services; (3) the character and financial condition of the company; (4) potential conflicts of interest, such as the 'ability to "disguise" dividends as salary;' and (5) '[i]nternal consistency in compensation . . . throughout the ranks of the company.'" Dexsil Corporation v. Commissioner, 147 F.3d at 100, quoting Elliotts v. Commissioner, 716 F.2d 1241, 1245-1248 (9th Cir. 1983).  See also Rapco, Inc. v. Commissioner, 85 F.3d 950, 954 (2nd Cir. 1996).  
No single factor is decisive.  Rutter v. Commissioner, 853 F.2d at 1270-1271; Mayson Mfg Co. v. Commissioner, 178 F.2d at 119.  Courts have highlighted the importance of scrutinizing those factors that have particular relevance to the case at hand. See generally, Elliotts v. Commissioner, 716 F.2d. 1245-1248. 
More recently, emphasis has been placed on having the reviewing court 

assess the entire tableau from the perspective of an independent investor--that is, given the dividends and return on equity enjoyed by a disinterested stockholder, would that stockholder approve the compensation paid to the employee?


Dexsil Corporation v. Commissioner, 147 F.3d at 100, quoting Rapco, Inc. v. Commissioner, 85 F.3d at 954-955.  Under this hypothetical or independent investor test, the reasonableness of compensation is assessed in terms of 

[w]hether an inactive, independent investor would be  willing to compensate the employee as he was compensated.  The nature and quality of the services should be considered, as well as the effect of those services on the return the investor is seeing on his investment.


Dexsil Corporation v. Commissioner, 147 F.3d at 101, quoting Elliotts v. Commissioner, 716 F.2d at 1245.  See also Exacto Spring Corporation v. Commissioner, 196 F.3d 833 (7th Cir. 1999); Owensby & Kritikos, Inc. v. Commissioner, 819 F.2d at 1327; Acme Construction Co. v. Commissioner, 69 T.C.M. 1596, 1602-1603 (1995).  If most of the corporation's earnings are paid out as compensation, "such that the corporate profits do not represent a reasonable return on the shareholder's investment, then an independent investor would probably disapprove of the compensation arrangement." Dexsil Corporation v. Commissioner, 147 F.3d at 101; Rapco v. Commissioner, 85 F.3d at 954; Elliotts v. Commissioner, 716 F.2d at 1247. 
The Board used the foregoing factors and the "independent investor" test in considering whether the compensation paid to Ms. Seewald during the relevant time period was reasonable.  The Board considered as relevant the factors relating to Ms. Seewald's role within the corporation, including her qualifications and contributions to the success of the corporation, the potential conflicts of interests within the corporation, particularly the ability to disguise dividends as salary, along with the internal consistency in compensation throughout the ranks of the corporation.  After reviewing all facts and circumstances relevant to these appeals and considering the applicable factors as outlined, the Board found that the payments made to Ms. Seewald in 1988, in excess of the amounts allowed by the Commissioner, did not constitute reasonable compensation.
From the outset, the Board found that by any stretch of the imagination, Ms. Seewald's position within the corporation was not arm's length.  She was the wife of the corporate president and sole corporate shareholder. Her husband had sole authority to set the level of her compensation.  Further, there was no history of salary negotiations between Ms. Seewald and the corporation.  The Board found, therefore, that the issue of reasonableness of compensation under these circumstances warranted particularly close scrutiny.	
The Board first considered Ms. Seewald's role in the corporation, including her position, the hours worked, the duties performed, and her general importance to the success of the corporation.  Dexsil Corporation v. Commissioner, 147 F.3d at 100; Elliotts v. Commissioner, 716 F.2d at 1245-1248; Mayson Mfg. v. Commissioner, 178 F.2d at 119.   
While the appellants assert that Ms. Seewald acted in an executive capacity, the Board found that there was nothing in the record to establish that she was employed based on considerations of her qualifications or technical skills. On the contrary, testimony was given that Ms. Seewald was initially hired because the corporation could not afford to pay anyone.  Further, the appellants offered no proof that Ms. Seewald possessed any unique or specialized skills of any significant value to the corporation.  The record, instead, establishes that Ms. Seewald, qualified in early childhood education and having taken accounting courses many years earlier, performed only unskilled or semi-skilled duties.  These duties included handling telephone calls, delivering samples, delivering parts, picking up drawings, bookkeeping, purchasing, relaying messages between Mr. Seewald and his customers, and picking up customers at the airport and entertaining them until Mr. Seewald arrived. 
While Ms. Seewald may have assisted with the flow of information between her husband and customers, the record clearly establishes that Mr. Seewald alone was the key corporate employee.  He was the sole employee responsible for dealing with all technical, engineering and sales aspects of the corporation in the United States and overseas.   In contrast, Ms. Seewald lacked the expertise to perform such functions within the corporation.
Moreover, the Board found that the skills that Ms. Seewald did contribute to the corporation were not indispensable to the corporation's success.  On the contrary, the record establishes that Mr. Seewald, through his knowledge, skills and experience in the area of engineering and product design, was the linchpin to the corporation's success.  Further, many of the duties that Ms. Seewald performed, such as making deliveries, typing and handling telephone calls from customers, were also performed by the corporation's part-time employees.  Unlike the level of compensation received by Ms. Seewald, an amount determined by end-of-year available funds, these employees were paid only minimum or close to minimum wage.  See e.g. Miller Box, Inc. v. U.S. 488 F.2d at 706 (compensation may be excessive when the functions being performed by the highly compensated employee could have been obtained at a lower cost or performed by a lower level employee.)  During the relevant time period, Ms. Seewald was also employed as Director of the Early Childhood Learning Center, working forty hours per week.  Working in such a capacity and for such hours for a second employer strongly suggests that Ms. Seewald did not work full-time for the corporation and therefore would not likely be entitled to commensurate full-time compensation.  The Board found, therefore, that these facts weighed in favor of a determination that the compensation paid to Ms. Seewald in 1988 was not reasonable.  
Secondly, the Board considered potential conflicts of interest within the corporation, including the ability to disguise dividends as salary. Dexsil Corporation v. Commissioner, 147 F.3d at 100; Elliotts v. Commissioner, 716 F.2d at 1245-1248. 
The ability to disguise dividends as salary may suggest that the compensation is not reasonable, particularly if the employee is the sole or majority shareholder, or if a large percentage of the compensation is paid as a bonus.  See Rapco, Inc. v. Commissioner, 85 F.3d at 954.  Payment of bonuses at the end of a tax year when a corporation knows its revenue for the year also may enable it to disguise dividends as compensation. Owensby & Kritikos, Inc. v. Commissioner, 819 F.2d at 1329; Estate of Wallace v. Commissioner, 95 T.C. 525, 555-556 (1990), aff'd 965 F.2d 1038 (11th Cir. 1992).
In the instant matter, Mr. Seewald, as corporate president and sole corporate shareholder, set his wife's salary.  No evidence was presented to even suggest that Mr. Seewald and Ms. Seewald dealt, at any time, at arm's length to negotiate or determine compensation.  See Mayson Manufacturing Co. v. Commissioner, 178 F.2d at 121 (bonus plan established by board of directors for minority shareholders was an arm's length transaction.)
Further, the Board found that the large year-end bonus paid to Ms. Seewald strongly suggested that part of her compensation was a disguised dividend.  Her bonus was determined by her husband, the sole shareholder, at year-end, after consideration of the corporation's financial position and available corporate funds. Such a distribution, therefore, was suggestive of a distribution of profits, rather than an expense of the corporation.  See Petro-Chem Mktg. Co. v. United States, 602 F.2d 959, 968 (Ct.Cl. 1979) (Court inferred that bonuses paid to shareholder-employees near the end of the year which absorbed nearly all of the taxpayer's earnings were at least in part a distribution of profits); Owensby & Kritikos, Inc. v. Commissioner, 819 F.2d at 1329; Builders Steel Co. v. Commissioner, 197 F.2d 263, 264 (8th Cir. 1952). 
The Board also considered the corporation's overall system of compensation. See Dexsil Corporation v. Commissioner, 147 F.3d at 100; Elliotts v. Commissioner, 716 F.2d at 1245-1248; Mayson Mfg Co. v. Commissioner, 178 F.2d at 119.  Inconsistency of such a system may suggest that the employee's compensation is not reasonable. See Rapco, Inc. v. Commissioner, 85 F.3d at 954. 
The Board found that the corporation did not have a fair and consistent method for determining its employees' salaries.  Mr. Seewald based his wife's compensation on the amount of corporate funds available at year-end.  Her level of compensation was never negotiated.  Moreover, despite the fact that other corporate employees performed many of the same job tasks as his wife, the level of compensation for these employees was based on minimum or near-minimum wage.  Finally, while Ms. Seewald was paid a bonus, no other employee was ever paid a bonus.  Cf. Home Interiors & Gifts, Inc. v. Commissioner, 73 T.C. 1142, 1159-1160 (1980) (compensation paid to the taxpayer's shareholder-employees was reasonable in part because the taxpayer had longstanding practice of paying all of its key employees on the basis of commissions.)  The appellants, therefore, presented no evidence to demonstrate that Ms. Seewald was compensated based upon any objective measure of the actual value of her services.   Without question, the corporation did not apply an even-handed salary policy toward all its employees. 
Overall, the Board found that an independent investor would not have been satisfied with the large payment made to Ms. Seewald as compensation in 1988, particularly because it appears that profits were being siphoned out of the company disguised as salary.  See Dexsil Corporation v. Commissioner, 147 F.3d at 101; Elliotts, Inc. v. Commissioner, 716 F.2d at 1247.  This was highlighted by the fact that Ms. Seewald's total 1988 compensation represented 33.15 percent of the corporation's net income.  The Board, therefore, concluded that the payments made to Ms. Seewald in 1988, in excess of those found reasonable by the Commissioner, represented unreasonable compensation. 
The appellants assert that the compensation paid to Ms. Seewald in 1988 was reasonable because a portion of these payments represented compensation for unpaid services from prior years.  Under certain circumstances prior services may be compensated in the current year.  Lucas v. Ox Fibre Brush Co., 281 U.S. 115, 119 1930); Elliotts v. Commissioner, 716 F.2d at 1248; Pacific Grains, Inc. v. Commissioner, 399 F.2d 603, 606 (9th Cir. 1968).  
In order for a corporation to be entitled to a deduction for compensation payments made to an employee for undercompensated past services, it is necessary that the corporation establish both the amount of the undercompensation as well as the intent that the payments were compensation for past services.  See Alpha Medical, Inc. v. Commissioner, 172 F.3d at 950; American Foundry v. Commissioner, 59 T.C. 231, 239 (1972), aff'd on this issue and rev'd on other issues, 536 F.2d 289 (9th Cir. 1976); Pacific Grains, Inc. v. Commissioner, 399 F.2d at 606 ("The failure of the taxpayer's Board of Directors to earmark the funds as being paid for prior services and the lack of any showing as to what percentage of the payment was intended as compensation for earlier periods give support to the Commissioner's contention that the taxpayer's theory of compensation for prior services was only an afterthought developed at the time when the reasonableness of the compensation was already under attack.")   Importantly, the character of the additional payments to the employee cannot be changed retroactively to constitute compensation for services where the corporation did not authorize additional compensation.  Cf. Freeman v. Commissioner, 303 F.2d 580 (8th Cir. 1962); Paula Construction Co. v. Commissioner, 58 T.C. 1055, 1060 (1972), aff'd 474 F.2d 1345 (5th Cir. 1973); Electric and Neon, Inc. v. Commissioner, 56 T.C. 1324 (1971) aff'd 496 F.2d 876 (5th Cir. 1974). 
The appellants failed to introduce any credible evidence concerning the extent of past undercompensation or the intent during the period at issue to compensate Ms. Seewald for past services.  Accordingly, the Board found that the appellants failed to prove that payments in excess of the compensation found by the Commissioner to be reasonable constituted compensation for past, undercompensated services. 
Further, the Board further found that payments made to Ms. Seewald during the tax year at issue were not based purely on the services she rendered.  See 26 C.F.R. § 1.162-7(a) and R.J. Kremer Co., Inc. v. Commissioner, 39 T.C.M. 1212, 1217 (1980) ("Regardless of the reasonableness of total compensation paid, it is a condition precedent to the allowability of a deduction that the payment be solely for services rendered.")
A corporation's history of dividend payments is one factor used in determining whether payments were made purely for services.  The absence of a consistent, developed dividend history may raise a "red flag" that invites the special scrutiny of the Court, Edwin's Inc. v. United States, 501 F.2d 675, 677 n. 5 (7th Cir. 1974), and justifies an inference that some of the purported compensation was actually a distribution of profits.  See Alpha Medical, Inc. v. Commissioner, 172 F.3d at 949; Charles Schneider & Co. v. Commissioner, 500 F.2d at 153.  The Board found that the corporation never declared or paid dividends, thereby creating an inference that some of the payments made to Ms. Seewald were not based purely on services rendered. 
Moreover, the method used by a corporation to compute compensation amounts is also indicative of whether the amounts paid were based purely on services rendered.  R.J. Kremer Co, Inc. v. Commissioner, 39 T.C.M. at 1217.  The presence of a profit-distribution motive is more likely to be found when compensation is authorized at or near the close of the year and is based only on the availability of funds.  Petro-Chem Marketing Co. v. U.S., 602 F.2d at 968. Likewise, "[b]onuses that have not been awarded under a structured, formal, consistently applied program generally are suspect . . . ."  Elliotts, Inc. v. Commissioner, 716 F.2d at 1247.  In addition, "the existence of a family relationship indicates that the terms of the compensation plan may not have been the result of a free bargain."  Id.  Finally, "where the corporation is controlled by the very employees to whom the compensation is paid, special scrutiny must be given to such salaries, for there is a lack of arm's length bargaining as required by Treasury Regulation section 1.162-7(a)(2)."  Charles Schneider & Co., Inc. v. Commissioner, 500 F.2d at 152.  
After consideration of the above facts and circumstances, the Board found that Ms. Seewald's compensation was not based purely on the services she rendered.  At no time did Ms. Seewald have any expectation of a precise dollar amount of compensation, nor did she ever negotiate an annual salary.  Instead, her husband, the corporate president and sole shareholder, made a year-end determination of her annual bonus, after considering the corporation's financial position and available cash in the corporate bank account.   The Board found, therefore, that the available corporate funds and not individual work performance controlled how much money Ms. Seewald was paid.  Based on these facts, the Board found and ruled that the appellants failed to demonstrate that Ms. Seewald's compensation in 1988 was based solely on services she rendered. 
	Based on the foregoing, the Board found that the compensation paid to Ms. Seewald during the tax year at issue, in excess of the amount determined reasonable by the Commissioner, was unreasonable and therefore not deductible by the corporation as an ordinary and necessary business expense.
	Further, the Board found the payments made to Ms. Seewald, in excess of those found reasonable by the Commissioner, were properly treated as constructive dividends to her husband, the sole corporate shareholder.  Pursuant to regulation, excessive compensation that corresponds or bears a close relationship to the stockholdings of the corporation, and is found to be a distribution of earnings and profits, must be treated as a dividend.  26 C.F.R. § 1.162-8.  
A "constructive dividend" or deemed distribution occurs when a corporation confers an  economic benefit upon 
a shareholder, in his or her capacity as such, without an expectation of reimbursement.  Muhich v. Commissioner, 238 F.3d 860, fn. 8 (7th Cir. 2001).  Further, "when services are absent, an alleged salary may be treated as a constructive dividend to the stockholder who received it or whose relative received it."  Medina v. Commissioner, 46 T.C.M. 76 (1983).
	In Alexander Shokai, Inc. v. Commissioner, 63 T.C.M. 1870, 1877 (1992), aff'd 34 F.3d 1480 (9th Cir. 1994), cert. denied 115 S.Ct. 1690 (1995), alleged salary payments were made to the sole shareholder's wife.  Deductions for these payments were disallowed because the taxpayers failed to prove that the payments were for actual services performed.  Because the sole shareholder's wife owned no corporate stock, the Tax Court treated the payments as constructive dividends to her husband, the sole shareholder, since they were considered an intra-family gratuitous assignment of income. Id. at 1878.  Also see Broad v. Commissioner, 59 T.C.M. 997 (1990) ("It is well settled that distributions of corporate funds to the children of the controlling shareholders are deemed to be constructive dividends to the controlling shareholders absent a showing that the payments were made for a bona fide business purpose and were not due to family considerations"); Jolly's Motor Livery v. Commissioner, 16 T.C.M. 1048 (1957) (alleged salary payments to wife of controlling stockholder found to be constructive dividends to stockholder where wife performed no services for the corporation.)
	The Board found that a large portion of Ms. Seewald's 1988 compensation was unreasonable and not based solely on services rendered.   With facts similar to Alexander Shokai, the Board found that these payments to the sole corporate shareholder's wife were no more than a gratuitous intra-family assignment of income.  As such, the Board found that these payments were properly deemed to be constructive dividends to Mr. Seewald. 
A person who claims to be aggrieved by the refusal of the Commissioner to abate a tax in whole or in part has the burden of establishing the right to an abatement.  Staples v. Commissioner of Corporation and Taxation, 205 Mass. 20, 26 (1940). There is a presumption in favor of the Commissioner that the assessment is valid.  Schlaiker v. Great Barrington, 365 Mass. 245 (1972). 
The appellants bore the burden of establishing their claims for abatement.  Towle v. Commissioner of Revenue, 397 Mass. 599, 603 (1986); William S. Rodman & Sons, Inc. v. State Tax Commission, 373 Mass. 606, 610-611 (1977).  

The appellants failed to meet their burden of proof. 
Accordingly, the Board issued a decision for the appellee in these appeals.

					   APPELLATE TAX BOARD

					By: _________________________
					   Abigail A. Burns, Chairman 




A true copy:


Attest:____________________
	   Clerk of the Board

 By written consent dated October 31, 1991, the corporation agreed to extend the assessment period for the fiscal year at issue until October 16, 1992.  By written consent dated June 28, 1992, the corporation again agreed to extend the assessment period until October 16, 1993.  
 The Department of Revenue's Audit Bureau arrived at the $49,027 figure by using a base annual salary of $26,000 for calendar year 1975, and adjusting it upward by five percent for inflation for each year thereafter.   The $26,000 base salary was obtained from the United States Tax Court's calculations in R. J. Kremer Co, Inc. v. Commissioner, 39 T.C.M. 1212 (1980), where the Tax Court determined that a reasonable salary for the predominant stockholder's wife was $26,000 for calendar year 1975.  In analyzing the Tax Court's decision, the Audit Bureau concluded that Ms. Seewald's employee services provided to the corporation were similar to those provided by the taxpayer in Kremer.  
Initially, the Audit Bureau allowed only one-half the amount they determined to be reasonable compensation, because Ms. Seewald was also employed elsewhere during the period at issue.  Following an audit conference on November 24, 1992, however, the Audit Bureau revised the proposed allowable salary amount to the full $49,027.
 By written consent dated June 28, 1992, the Seewalds agreed to extend their income tax assessment period for the 1988 tax year until October 16, 1993.
 During the relevant time period, the income tax rate on dividend income was ten percent, in contrast to the five percent tax rate on wage income and other employee compensation.  
 Other circuits have subdivided some of these factors.  The analysis, however, is similar.  See, e.g. Mayson Mfg. Co. v. Commissioner, 178 F.2d at 119, where the Sixth Circuit considered the following factors: the employee's qualifications; the nature, extent and scope of the employee's work; the size and complexities of the business; a comparison of salaries paid with gross income and net income; the prevailing general economic conditions; a comparison of salaries with distributions to stockholders; the prevailing rates of compensation for comparable positions in comparable concerns; the amount of compensation paid to the employee in previous years; and the salary policy of the taxpayer as to all employees.  See also Rutter v. Commissioner, 853 F.2d at 1270-1271; B.B. Rider Corp. v. Commissioner, 725 F.2d 945, 952-954 (3rd Cir. 1984) (where the Third Circuit analyzed compensation under four broader categories); and Kennedy v. Commissioner, 671 F.2d 167, 173-174 (6th Cir. 1982) (where the Sixth Circuit noted that courts had taken into account other factors in addition to the factors the Court had enumerated in Mayson, including: the success of the employee's efforts; profitability of the business; absence of the usual fringe benefits such as a pension or profit sharing plan or stock options, which are available to executives of other companies of comparable size; unusual capacity of employees; and bonuses not paid in the same ratio as stock holdings.)  
Neither party in these appeals directed the Board's attention to any First Circuit cases addressing the matter at issue, nor did the Board find any such cases. 
 As noted above, the Commissioner found that $49,027 of the $200,030 paid to Ms. Seewald in 1988 represented reasonable compensation for services rendered.  The Commissioner treated the remaining $151,003, therefore, as a constructive dividend to Mr. Seewald, and taxed it accordingly.   Dividend income, defined as Part A gross income under G.L. c. 62, § 2 (b)(1), was taxed during the relevant time period at a rate of ten percent.  G.L. c. 62, § 4(a), as then in effect.   Compensation income, in contrast, was taxed at a rate of five percent. G.L. c. 62, § 4(b), as then in effect.    

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ATB 2001 - 764