Harolds Club v. Commissioner

340 F.2d 861 (9th Cir. 1965)

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Nature of the Case

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Facts

Harolds Club (P) was a casino in Las Vegas, Nevada. It paid annual salaries and bonuses to Smith in the amount of $350,000 to $650,000 per year. The IRS disallowed the deduction of these payments in that Smith was not a shareholder in the corporation stock, all of which was owned by his two sons. The business was also a continuation of one that Smith had earlier operated illegally in California but subsequently moved to Nevada. When it moved, the business was a sole proprietorship of one of the sons and then became a partnership of the two sons and then became a corporation. The business did not prosper at first, but eventually, Smith agreed to take over the casino. Smith was paid a salary and a bonus, and eventually, Smith was given a fixed percentage arrangement of 20% of the profits as a bonus. This was not an uncommon situation in the gaming business. By 1952 employment at the casino was in excess of 800 people. Competitors testified that the salary arrangement was reasonable for the industry and that Smith was worth that much. The Tax Court determined that the amounts were unreasonable and should not be allowed as a deduction because they were not the result of a free bargain between the parties; this because of the family relationship and the circumstances that indicated that he dominated the parties.