Brief Fact Summary. Harolds Club was a gaming operation owned by Raymond Smiths’ two sons. His two sons agreed to pay him $10,000 a year plus 20% of the profits for Smith to manage the operation. Harolds Club attempted to deduct the compensation from its income.
Synopsis of Rule of Law. Contingent compensation may be allowed as a deduction if it is the result of a free bargain between employer and the individual and if the contract for compensation was reasonable under the circumstances.
Issue. Were the amounts paid by Petitioner to Smith reasonable salaries and the result of a free bargain, and thus allowable deductions?
Held. Circuit Judge Hamley issued the opinion for the United States Ninth Circuit Court of Appeals in holding that the salary was not the result of a free bargain and should not be allowed to be deducted.
Discussion. The facts showed that while the two sons were adults, they were always under the control of their father. The Tax Court found that the sons were dominated by their father, thus, there could be no “free bargain.”