## Facts

- James F. Patton and Vincent Patton operated a Cleveland partnership, Patton Company, in a general jobbing business.
- William Kirk was employed by the partnership from 1937 and performed clerical and office functions, including bookkeeping, billing, payroll/social security records, and reporting bank balances.
- In 1941 the partners and Kirk executed a written compensation agreement providing a base salary and additional compensation tied to a percentage of net profits and, under certain conditions, net sales; Kirk was not made a partner.
- For 1943, the partnership had gross sales of $460,494.06 and deducted $46,049.41 as Kirk’s compensation under the agreement as applied.
- The Commissioner disallowed the deduction above $13,000 as exceeding “reasonable compensation” for services actually rendered under the Internal Revenue Code.
- The Tax Court sustained the Commissioner, emphasizing the clerical character of Kirk’s work and the taxpayers’ failure to provide comparative salary data or detailed support for the claimed amount.
- The taxpayers appealed, challenging the Tax Court’s factual findings, its approach to “reasonableness,” and alleging the decision was affected by passion or prejudice.

## Issues

1. Whether the Tax Court erred in finding that only $13,000 of the $46,049.41 paid to Kirk in 1943 was deductible as “reasonable compensation” for services actually rendered under § 23(a)(1)(A).
2. Whether the Tax Court’s factfinding and evaluation of the evidence were clearly erroneous or improperly influenced by bias.

## Decision

- The Sixth Circuit affirmed the Tax Court’s decision.
- The court held that determining reasonable compensation under § 23(a)(1)(A) is essentially a question of fact.
- The court found the taxpayers failed to carry their burden to show that the Commissioner’s determination and the Tax Court’s $13,000 finding were erroneous.
- The court rejected claims of prejudice or improper conduct, concluding the challenged findings and comments did not show disqualifying bias and the result was supported by the record.

## Legal Principles

- A deduction is allowed only for “a reasonable allowance for salaries or other compensation for personal services actually rendered” under § 23(a)(1)(A).
- Reasonableness of compensation has no fixed formula and depends on the circumstances; it is primarily a factual determination for the Tax Court.
- The taxpayer bears the burden to substantiate that the claimed compensation is reasonable, including by evidence of duties performed, volume and nature of work, and comparable compensation for similar positions.
- A contractual compensation arrangement, including profit- or sales-based terms, does not control tax deductibility; the Commissioner and courts may limit the deduction to the amount found reasonable for services rendered.
- Appellate review is deferential; the Tax Court’s finding will stand unless clearly erroneous or lacking evidentiary support.

## Conclusion

The Sixth Circuit upheld limiting the partnership’s 1943 deduction for an employee’s contract-based, profit- and sales-tied compensation to $13,000, concluding that reasonable compensation is a fact question and that the taxpayers did not substantiate the much larger claimed amount with adequate proof.


Patton v. Commissioner, 168 F.2d 28 (6th Cir. 1948)