Defendant has identified two different categories of private inurement allegedly received by the Ruuds during 1979 and 1980. The first are personal expenses charged on the corporate "Chargex" account, and the second are personal expenses paid out of the corporate checking account.
According to defendant, the Chargex amounts at issue total $ 4,153.66 for 1979 and $ 4,811.29 for 1980. The other personal items paid for by the corporation total $ 16,299.56 in 1979 and $ 10,812.02 in 1980. Thus, defendant maintains, corporate earnings amounting to $ 36,076.53 inured to the benefit of the Ruuds during the two-year period.
While plaintiff does not deny that personal expenses of the Ruuds were paid by the corporation, it does dispute the $ 36,076.53 figure. First, plaintiff concedes that food and gasoline expenses listed on the Chargex account and the other personal expenditures category are a mixture of personal and business expenses. While plaintiff is unable to determine precisely what portion of these expenses were personal, it notes that the personal expense portion was covered by food and auto allowances given to the Ruuds by the corporation. The allowance provided for $ 3,000 in food expenditures, and $ 2,400 in automobile-related expenditures. See Exhibit 209-HB. According to Joint Exhibits 104-CZ and 133-EC, the Ruuds exceeded their $ 3,000 food allowance in 1979 and 1980. Their automobile expenses in those years amounted to approximately $ 1,000 per year. See, e.g., Exhibit 96-CR.
These food and automobile allowances were recommended by BRI's accountant in recognition of the fact that many such expenses were for a combination of business and personal purposes. They were recorded as income and reported on the Ruuds' personal income tax statements. See Joint Exhibit 209-HB. Such employee expenses may legitimately be paid to employees without constituting inurement. Saint Germain Foundation v. Commissioner, 26 T.C. 648 (1956); A.A. Allen Revivals, Inc. v. Commissioner, 22 T.C.M. (CCH) 1435 (1963). The Court finds that the total amount of personal inurement should not include the food and automobile expenses that were covered by the allowance, and that the personal expenditures category should be reduced by $ 3,000 per year, and the Chargex expenses by approximately $ 1,000 per year. The reductions bring the total down to $ 28,076.53.
Plaintiff next claims that the amount of personal inurement identified by defendant should be further reduced because $ 8,966.00 in personal expenditures during calendar year 1978 were identified by the corporation, charged to Ruud's officer receivable account, and repaid by salary withholding. See Joint Exhibit 209-HB. Furthermore, plaintiff asserts that medical expenses totalling $ 2,644.03 in 1979 and $ 2,300.19 in 1980 (Canadian dollars) should not be included as personal inurement because BRI's Board of Directors had voted in 1977 to cover the medical expenses of Ruud and his family. See Joint Exhibit 34-AH. Such expenses of employees may be paid under Section 105 of the Internal Revenue Code.
Defendant challenges these explanations as insufficient because they are based on authorization by the Board of Directors at a time when the Board was controlled entirely by Brian Ruud. Thus, although the $ 8,966 charged to the officer receivable account was repaid by salary withheld, the Board retroactively authorized whatever annual salary was needed in order to pay off the account. Similarly, in 1977 when the Board "voted" to pay medical expenses of the Ruuds, there was only one member of the Board who was not a member of the Ruud family. See Exhibit No. 34-AH. In fact, it appears that the Board did not even actually meet to approve many of its decisions.
This is a terrible way to conduct business. And decisions by corporations whose Boards of Directors are dominated by one person to this degree are subject to more careful scrutiny than are others. Basic Unit Ministry v. United States, 511 F. Supp. 166, 168 (D.D.C. 1981), aff'd, 216 U.S. App. D.C. 391, 670 F.2d 1210 (D.C.Cir. 1982). Nevertheless, this alone is not sufficient to deprive the corporation of its tax exempt status. Bubbling Well, 74 T.C. at 535. It is important to look not to what the corporation potentially could do, but to what it actually does in determining whether net proceeds inured to any individual's benefit. Universal Church of Scientific Truth v. United States, 74-1 U.S. Tax Cas. (CCH) P 9360 (N.D.Ala. 1973). In this case, although the Board could have authorized retroactively any outrageous salary to cover the Ruuds' personal expenses, in 1979 it in fact authorized a salary of only $ 22,500, an amount that was very reasonable in light of past practice and of Ruud's value to the corporation.
The fact that it was authorized retroactively does not alter the fact that this was reasonable compensation. Similarly, the fact that Ruud controlled the Board that authorized payment of his family's medical expenses does not make this an unreasonable practice. Thus the payments of medical expenses and the repayment of $ 8,966 authorized by the Board of Directors should also be deducted from the estimated amount of personal inurement. This reduces the total to approximately $ 15,000 for the two-year period.
Finally, plaintiff claims that only $ 2,686.21 of the remaining amount consists of pure personal expenses. These expenses include pre-school tuition, dry-cleaning bills, and traffic tickets. According to plaintiff, the remaining travel and restaurant expenses, the housekeeper's salary, photography expenses, and several other expense items are mixed personal and business expenses which it cannot separate.
Defendant maintains that this very inability to determine what percent of the remaining $ 12,000 in expenditures were personal is fatal to plaintiff's case -- that if its accounting system is unable to break down these expenses, then the plaintiff, and not the government, must bear the responsibility for and the cost of such a failure. Defendant cites Basic Unit Ministry v. United States for the proposition that in cases where there is evident potential for abuse, the plaintiff must disclose all facts pertaining to the operation and finances of its organization. 511 F. Supp. 166, 168 (D.D.C. 1981), aff'd, 670 F.2d 1210 (D.C.Cir. 1982); see also, Bubbling Well, 74 T.C. at 535. In those cases, however, plaintiffs had simply refused to cooperate with the government. They refused to supply any information about their source of funds or their membership. That is entirely different from the instant case in which plaintiff has supplied the government with substantial amounts of information and records, has actively negotiated with the government, and is simply unable, several years after the fact, to determine whether business was or was not conducted in the course of specific meals eaten at specific restaurants on specific days.
Furthermore, although the state of the records in this case is indefensible, it is not necessary to determine precisely what portion of these expenses is business related and what portion is personal. Even if all of these expenses are personal, they still constitute reasonable compensation when added to the salaries paid to the Ruuds. As stated above, the expenses that have not satisfactorily been accounted for total approximately $ 15,000, or $ 7,500 per year. When added to Brian Ruud's salary in 1979, the total is $ 30,000. Moreover, although the salary approved for Ruud in 1980 was $ 36,000, he was actually only paid $ 6,000. Therefore when the $ 7,500 is added to Ruud's payments in 1980, he still received less than the salary approved by the Board.
Several courts have held that payments in addition to salary are not necessarily private inurement if, when these payments are added to the salary, compensation is still reasonable. A.A. Allen, 22 T.C.M. (CCH) 1435 (1963); Universal Church of Scientific Truth v. United States, 74-1 U.S. Tax Cas. (CCH) P 9360 (N.D.Ala. 1973); Saint Germain Foundation v. Commissioner, 26 T.C. 648 (1956). The amounts received in A.A. Allen were approximately equal to the salary plus personal expenditures of Brian Ruud. And that case was decided in 1958. Whether compensation is reasonable or not is a question of fact to be decided in light of all the circumstances. Founding Church, 412 F.2d at 1200; Enterprise Railway Equip. Co. v. United States, 142 Ct. Cl. 192, 161 F. Supp. 590, 595, (1958). Brian Ruud was almost single-handedly responsible for the earnings of the corporation. In 1979 those earnings totalled $ 331,628 and in 1980 they totalled $ 309,841. Joint Exhibits 139-EJ and 142-EM. Brian Ruud's compensation, even including payments for personal expenses by the corporation, was not excessive.
It is true that some courts have stated that the amount of the inurement is not determinative. See, e.g., Founding Church of Scientology, 412 F.2d at 1200; Freedom Church, 588 F. Supp. at 698; Church of the Transfiguring Spirit, Inc. v. Commissioner, 76 T.C. 1, 5 (1981). In these cases, however, the amounts received could not be justified as part of reasonable compensation. In Freedom Church, for example, no claim was raised that the expenditures at issue were part of reasonable compensation. In fact, no explanation was given for corporate expenditures totalling $ 335,592.23.
In Transfiguring Spirit, an amount less than the $ 15,000 at issue in this case was found to constitute personal inurement. Id. However, as a percentage of the corporation's net earnings it was very large, the Court holding that payments totalling $ 1,390.32 for the church leader's housing allowance constituted personal inurement because that amount represented virtually all of the corporation's earnings. Id. This raised serious questions not only as to private inurement, but also as to what public purpose the corporation served. In this case, the corporation earned over $ 300,000 and Ruud kept a relatively modest amount for himself -- even counting all of the personal expenditures listed by the government.
The court in Founding Church of Scientology considered payments to L. Ron Hubbard and his family. These payments exceeded over $ 108,000 during the years between 1955 and 1959. In addition, Hubbard received a percentage of the gross income from affiliated Scientology organizations. Payments to Hubbard included royalties, commissions, loans and reimbursements for expenses. The nature of the loans and reimbursements was not explained in the record. In addition, there were unjustified or unexplained payments to Hubbard's family including loans, rent that was not shown to be reasonable, and salary paid to Hubbard's daughter without any showing that she performed any services to the organization. On this basis, the Court concluded that the payments to the Hubbards were "disguised and unjustified distributions of plaintiff's earnings." 412 F.2d at 1201. They therefore constituted personal inurement and could not be justified as part of reasonable compensation.
The government does not allege that payments to Ruud are disguised distributions of corporate dividends. Rather, the claim is that the accounts of the organization and of the Ruuds were not kept sufficiently separate so that the organization may have paid up to $ 15,000 in personal expenditures for Ruud over a two-year period. Any suggestion of an effort to disguise distributions of corporate dividends is belied by the fact that the nature of the expenditures was clearly recorded and an effort was made to repay personal expenditures through the officer receivable account. Furthermore, any personal expenditures that remained unaccounted for were more than compensated for in 1980 when Ruud received only $ 6,000 of the $ 36,000 salary that was approved for him. The Court finds there was no private inurement because the sums at issue are part of reasonable compensation.
There is no question that there was ample potential for abuse in this case. Brian Ruud and his family controlled completely a religious organization with income exceeding $ 300,000 per year. In addition to its income, the corporation owned valuable assets including the retreat where the Ruuds lived and several cars. The corporate and personal accounts were not adequately separated. In the end, however, after a lengthy investigation, the government has no quarrel with the cars or the retreat. It only disputes relatively minor expenses that easily fall within the bounds of reasonable compensation. Thus it does not appear to this Court that any such abuse actually occurred. Because the Court finds that BRI was organized exclusively for religious purposes and no portion of its earnings inured to the personal benefit of Brian Ruud, the Court finds that its tax exempt status should not have been revoked, and summary judgment will be granted to the plaintiff.
Upon consideration of the parties' cross-motions for summary judgment, the oppositions thereto, the entire record herein, and in accordance with the Memorandum issued contemporaneously herewith, it is this 21st day of April, 1989
ORDERED that plaintiff's motion for summary judgment be and it is hereby granted; and it is further
ORDERED that defendant's motion for summary judgment be and it is hereby denied; and it is further
ORDERED that judgment be and it is hereby entered in favor of plaintiff declaring that plaintiff is a tax-exempt organization pursuant to 26 U.S.C. § 501(c)(3).