                            T.C. Memo. 1995-539


                          UNITED STATES TAX COURT



        GUY SCHOENECKER, INC., BUSINESS INCENTIVES, INC.,
             AND CAROUSEL BY GUY, INC., Petitioners v.
           COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket Nos. 11462-93, 1268-94.         Filed November 14, 1995.



      James E. O'Brien and Wayne A. Hergott, for petitioners in

docket Nos. 11462-93 and 1268-94.

     Steven Z. Kaplan, for petitioners in docket No. 11462-93.

     Genelle F. Forsberg, for respondent.



                  MEMORANDUM FINDINGS OF FACT AND OPINION

     SCOTT, Judge: Respondent determined deficiencies in the

consolidated income tax of Guy Schoenecker, Inc., and its two

subsidiaries for the years and in the amounts as follows:

    Fiscal year ended                   Deficiency

     June   30,   1988                   $254,535
     June   30,   1989                    587,024
     June   30,   1990                  1,305,103
     June   30,   1991                     82,587

     All section references are to the Internal Revenue Code in

effect for the years in issue, and all Rule references are to the
                                - 2 -


Tax Court Rules of Practice and Procedure, unless otherwise

indicated.



     Some of the issues raised by the pleadings have been

disposed of by agreement of the parties, leaving for our decision

whether the deduction claimed by Guy Schoenecker, Inc., and

subsidiaries (petitioner) for compensation to Guy Schoenecker

(Mr. Schoenecker) exceeds reasonable compensation for services

rendered by Mr. Schoenecker and, if so, the proper deduction for

compensation to Mr. Schoenecker in each of the years in issue.

                             FINDINGS OF FACT

     Some of the facts have been stipulated and are found

accordingly.

     Guy Schoenecker, Inc. (hereinafter GSI), is a corporation

formed on November 9, 1978, with its principal place of business

in Minneapolis, Minnesota.   During the years here in issue 99

percent of the stock of GSI was owned by Mr. Schoenecker and

certain family trusts, and 1 percent was owned by his son, Larry

Schoenecker (Larry).   GSI owns and has owned since its inception

100 percent of the stock of Business Incentives, Inc. (BI).    GSI

also owns and has owned since its inception 100 percent of the

stock of Carousel By Guy, Inc. (formerly Animal Fair, Inc., and

hereinafter referred to as Animal Fair).   GSI and its

subsidiaries kept their books and reported their income on an
                                - 3 -


accrual basis for the fiscal years ending June 30 for the years

here in issue.    In 1981 the fiscal yearend was changed from March

31 to June 30.

      GSI, BI, and Animal Fair filed a consolidated Federal income

tax return for each of the fiscal years ended June 30, 1988,

1989, 1990, and 1991.

      Mr. Schoenecker was born on September 22, 1927.   In 1950 Mr.

Schoenecker and Mr. Robert MacDonald (Mr. MacDonald) incorporated

BI.   From the time of its incorporation until 1979, Mr.

Schoenecker and Mr. MacDonald each owned 50 percent of the stock

of BI.

      In 1960 Mr. MacDonald had a driving accident and became a

paraplegic.    He returned to work for BI on a part-time basis in

1963, and in 1979 he retired as an officer and director of BI

because of his health, but remained as a consultant of BI until

1988.    On January 12, 1979, Mr. MacDonald sold his 50-percent of

the common stock in BI to GSI for $3,079,925.    The terms and

conditions of the stock purchase by GSI from Mr. MacDonald were

incorporated in an agreement.   The purchase of the 353 shares

originally owned by Mr. MacDonald included 17 shares which Mr.

MacDonald had given to a charity, which shares were purchased by

GSI at the same time and at the same price per share as the

shares which at that time were owned by Mr. MacDonald.     Under the

provisions of the stock purchase agreement, GSI paid $175,000 in
                                 - 4 -


cash to Mr. MacDonald and executed a promissory note to him in

the aggregate principal amount of $2,756,600.    Installment

payments of $58,915 principal, plus accrued interest, were to be

made on April 5, June 5, September 5, and December 5 of each

year, plus $200,000 principal was due on January 15, 1980, and

January 15, 1981.    The promissory note was due and payable in

full by December 5, 1988.

     After the incorporation of GSI and its purchase of Mr.

MacDonald's stock, the following dividends were declared by BI

and paid in cash to GSI by BI:

    Fiscal year       Dividends declared        Amount paid

     3/31/79               $310,640              $310,640
     3/31/80                524,888               524,888
     3/31/81                489,426               489,426
     6/30/811               169,440               169,440
     1982                 1,613,012             1,613,012
     1983                   204,740               204,740
     1984                   420,070               420,070
     1985                   388,300               388,300
     1986                    76,248                76,248
     1987                   105,900               105,900
     1988                      0                     0
     1989                      0                     0
     1990                 5,000,002             5,000,002
     1991                      0                     0
          1
              Short period due to change in fiscal year.


In addition, in 1990, BI transferred improved real estate having

a value of approximately $2,700,000 to GSI as a dividend.

Dividend payments in 1988 and prior years were used by GSI to pay

Mr. MacDonald.    The 1990 real estate dividend was paid as a
                               - 5 -


result of advice received by Mr. Schoenecker that restructuring

of BI to transfer the real estate it owned to Mr. Schoenecker was

advisable.

     From the time of its incorporation in 1978, no dividends

were declared by GSI until its fiscal year 1990.   On May 18,

1990, GSI transferred and paid dividends in cash to Larry of

$85,097.96 and to Mr. Schoenecker of $4,915,899.25, and

transferred real estate located at 7625 Bush Lake Road valued at

$1,950,000 to Mr. Schoenecker and real estate located at 7630

Bush Lake Road valued at $2,400,000 to Mr. Schoenecker.   The real

estate transferred by GSI to Mr. Schoenecker was the property in

which the business offices of GSI and BI were located.    The cash

dividend from GSI to Mr. Schoenecker was paid out of cash

dividends from BI to GSI and enabled Mr. Schoenecker to have

readily available funds with which to pay the taxes resulting

from the dividend paid to him in real estate.

     BI is engaged, and has been since its incorporation, in the

business of business incentive awards, which awards are primarily

merchandise and travel given by the clients of BI to their

customers in return for stamps or certificates and as promotions

by BI's clients.   Approximately 60 percent of the revenues of BI

in 1990 came from its incentive awards activities.   However, BI

is also engaged in communication, media, direct mail, print,

theater, and video work, and approximately 16 percent of its
                                - 6 -


revenues in 1990 were derived from these activities.   It also is

engaged in training of employees of BI's clients, and from this

activity derived approximately 10 percent of its revenues in

1990.    BI was also engaged in measurement of the efforts by the

client firms to satisfy their customers, and approximately 15

percent of its revenues in 1990 came from this activity.   BI was

not engaged in the business of advertising or placing for clients

advertisements in newspapers, in magazines, on television, or on

radio.    Advertising agencies were not primary competitors of BI.

     In connection with its incentives award and travel program,

BI arranges for the certificates or the stamps for the clients,

arranges the availability of the merchandise or the travel, and

generally handles the work in connection with the program.    BI

attempts to have a 50-percent markup on merchandise used to

redeem certificates, but this target is not often received on

large volume.    BI also attempts to make a profit by obtaining a

discount on the travel provided for certificates.   In addition,

it very often receives the normal travel commission for

transportation and hotel sales.

     Mr. Schoenecker grew up in a small town in rural Minnesota.

He attended the University of St. Thomas in St. Paul, Minnesota,

where he received a degree in political science in 1949.   He then

attended the University of Minnesota Law School for a time.

While still in college, Mr. Schoenecker became interested and
                                - 7 -


involved in the business of selling diamonds as engagement gifts

to other college students.    Following his formal schooling, Mr.

Schoenecker decided to join forces with Mr. MacDonald and, as a

result of their agreement, BI's predecessor was incorporated in

1950.    In the early days of its operation BI sold various items

such as diamonds, dishes, and sporting goods, but it soon

developed and began the incentives promotion business.

Initially, BI's clients were merchants, service stations, banks,

and other businesses which were mostly local and relatively

small.    Variations of these programs were the primary aspect of

BI's business until approximately 1970 when it began to expand

into the other areas discussed above.    BI's business steadily

grew during the first 25 years of its existence.    Sales grew from

approximately $313,000 in 1953 to $11,926,000 in 1974.    The

aspects of BI's business, other than incentive awards, developed

by Mr. Schoenecker in 1979, were geared toward selling incentive

programs to large businesses.    In 1990, BI had 19 sales offices

throughout the country.    It had 80 sales employees, of whom 60

were account executives and 20 managers.    The account executives

reported to field sales managers, who reported to one of three

area regional vice presidents, who reported to the senior vice

president of sales and marketing of BI, Mr. William Shaw (Mr.

Shaw).
                                - 8 -


     The sales, other income which was principally interest

income, total revenues, and net income before taxes, of BI for

book purposes for its fiscal years 1981 through 1991 were as

follows:

                                                        Net income
               Sales     Other income     Revenues      before taxes

3/31/81    $39,213,635    $857,938           --        $1,929,356
6/30/81      9,781,114     290,969      $10,072,083       600,972
6/30/82     38,857,285     923,654       39,780,939       599,321
6/30/83     35,347,336     513,695       35,861,031    (1,564,606)
6/30/84     65,700,275     702,776       66,403,051     2,409,636
6/30/85     72,255,521     764,275       73,019,796       (50,720)
6/30/86     81,916,703     829,481       82,746,184     1,752,870
6/30/87     94,305,548     962,317       95,267,865     4,098,466
6/30/88    112,993,217   1,725,585      114,718,802     6,871,287
6/30/89    143,612,396   4,476,187      147,088,583     9,650,154
6/30/90    159,302,147   2,822,959      162,125,106    11,430,723
6/30/91    149,671,091   2,045,944      151,717,035     2,805,387


     On April 1, 1974, BI and Mr. Schoenecker entered into a

written employment agreement whereby BI employed Mr. Schoenecker

as its president and chief executive officer (CEO).      Mr.

MacDonald signed the agreement on behalf of BI.       At the time the

employment agreement was entered into, Mr. MacDonald was the vice

president and a director of BI, as well as a 50-percent

stockholder.   The employment agreement provided that Mr.

Schoenecker would act as BI's president and CEO, and that he

would devote his attention and best skills and energies toward

the profit, benefit, and advantage of BI.     The employment

agreement provided for BI to pay Mr. Schoenecker a base salary of

$9,000 a month ($108,000 per year) and an annual bonus of 8
                                  - 9 -


percent of the net profits of BI and its subsidiaries before

taxes.    Mr. Schoenecker was 46 years old when the employment

agreement was entered into.     The employment agreement contained

no provision for long-term incentives or retirement benefits.

       The following table shows the book income before taxes for

GSI and its subsidiaries taken from GSI's financial statements.

Also included is the net income before taxes for GSI, which is

income before taxes adjusted for losses or income from

discontinued operations.




                         Net income before        Income before taxes
  FY ended          taxes of GSI & subsidiaries    GSI & subsidiaries

June   30,   1988          $4,302,286                $5,748,557
June   30,   1989           9,725,667                 9,759,287
June   30,   1990          11,111,080                11,111,080
June   30,   1991           3,224,665                 2,237,628


       BI's transition from providing services only to local

merchants, service stations, and banks, to serving some large

companies was gradual.     During the years here involved and for

some years prior to those here involved, BI would design and sell

integrated performance improvement programs involving numerous

types of services and products designed to meet the specific

needs of its clients.     BI's clients for these services have

included such companies as AT&T, Cadillac, GTE, Quaker Oats, and

IBM.    Not all of these clients, after engaging the services of
                              - 10 -


BI, have remained with it, since BI is in competition with other

companies engaged in a similar business.   Mr. Schoenecker has

personally directed efforts toward the securing of large

companies as clients of BI, and through his efforts and personal

discussions with the officers of some of these companies, many of

BI's clients have been obtained.

     The employment agreement between BI and Mr. Schoenecker was

ratified by unanimous action of the directors of BI dated

January 3, 1976.   At that time, the directors were Mr.

Schoenecker, Mr. MacDonald, and Mr. James E. O'Brien, an

attorney.

     Up through its fiscal year ended March 31, 1979, Mr.

Schoenecker's base salary remained at $108,000 a year, but

starting in its fiscal year ended March 31, 1980, after the

purchase by GSI of Mr. MacDonald's stock, his base salary began

to increase.   Mr. Schoenecker's base salary was $400,000 for BI's

fiscal year ended June 30, 1988, and $500,000 for each of BI's

fiscal years ended June 30, 1989, 1990, and 1991.

     There are no corporate minutes or similar documents relating

to the salary of Mr. Schoenecker and his bonus for BI's fiscal

years 1988 and 1989.   The bonus for BI's fiscal year 1988 was

computed at 10 percent of net book income of BI before taxes, and

for its fiscal year 1989 it was computed at 12 percent of the net

book income of BI before taxes.    By action of the sole director
                              - 11 -


of BI dated June 19, 1991, Mr. Schoenecker's annual base salary

of $500,000, and a bonus equal to 12 percent of corporate net

income before taxes of GSI and subsidiaries, was ratified for the

prior year, the fiscal year 1990.   Corporate net income was

defined as net income of GSI and subsidiaries before income taxes

and before Mr. Schoenecker's bonus.    By action of the sole

director of BI dated June 19, 1991, Mr. Schoenecker's annual base

salary of $500,000 and a bonus equal to 12 percent of corporate

net income before taxes of GSI and subsidiaries was ratified for

its fiscal year 1991.   Corporate net income was defined in the

same way as it was defined for BI's fiscal year 1990.    For BI's

fiscal years here in issue, 1988 through 1991, Mr. Schoenecker's

bonus was computed as a percentage of the book income before

taxes of BI, and not the book income of GSI and subsidiaries,

which for each of these years was less than the book income of

BI.   In some years prior to those here in issue Animal Fair had

profits, and, in those years, book income of GSI and subsidiaries

would for that reason have been greater than book income of BI

alone.

      Mr. Schoenecker participated in all employee fringe benefits

of BI in the same manner as all employees of the corporation.

During the years here in issue BI had a section 401(k) plan, a

group health insurance plan, and a group life insurance plan in

which Mr. Schoenecker participated.    BI paid a portion of Mr.
                              - 12 -


Schoenecker's health insurance premiums and the full premium for

Mr. Schoenecker's life insurance.   The section 401(k) plan of BI

was adopted July 1, 1984, and provided for salary reduction

contributions by persons covered by the plan of a minimum of l

percent to a maximum of 13 percent of certified earnings.

     Animal Fair was acquired by BI in 1965.   The corporate and

business names were changed to Carousel By Guy, Inc., in 1989.

In its fiscal year 1991 a large portion of the assets of Animal

Fair, including its name, was sold.    The corporate name was then

changed back to Animal Fair, Inc.   Originally Animal Fair

manufactured and sold stuffed animals.    Animal Fair, after its

acquisition by BI, expanded to three divisions: a toy division, a

gift division, and a premium division.    In its fiscal year 1988

the toy division of Animal Fair was liquidated, and in its fiscal

year 1991 the gift division was sold.    Animal Fair paid

compensation to Mr. Schoenecker for each of its fiscal years

1988, 1989, and 1990 of $100,000.   For its fiscal year 1991,

compensation of $100,000 was awarded to Mr. Schoenecker, but was

not paid until after June 30, 1991.    Mr. James Kelly was paid

$90,000 by Animal Fair for its fiscal year 1988, $110,000 for its

fiscal year 1989, $122,500 for its fiscal year 1990, and $215,000

for its fiscal year 1991.   For its fiscal year 1988 Animal Fair

paid Mr. Richard Duff $103,750 and Mr. Dean Fitch $156,922 for

service for three-quarters of the year, and Mr. William Jeurgens
                              - 13 -


$122,047.   For its fiscal year 1989 Animal Fair paid Mr. Richard

Duff $137,500 and for its fiscal year 1990 paid him $157,000.

Mr. Duff was paid $34,692 for a part of Animal Fair's fiscal year

1991.   Mr. Schoenecker's son Larry was paid $50,000 by Animal

Fair for its fiscal year 1990 and $150,000 for its fiscal year

1991.

     Other senior executives of BI were paid on a basis of a base

salary plus a bonus, which was generally computed on a percentage

of either sales, or income, or both, above specified amounts.

For its 4 fiscal years involved in this case, the total salary

and bonus of the five highest paid employees of BI, other than

Mr. Schoenecker, were as follows:
                                - 14 -


FY-88              Position               Salary    Bonus      Total

William Shaw      V.P. Sales &           $85,000   $196,889   $281,889
                   Marketing

Jim Dinwoodie     St. Acct. Exec.         30,000    184,849    214,849
                  (Dallas)

Jim Discher       Sr. Acct. Exec.         25,000    213,426    238,426
                  (Detroit)

William Shumate   V.P. Travel            110,000     92,500    202,500


Earl Nelson       V.P. Travel            110,000     92,500    202,500


FY-89

William Shaw      V.P. Sales &            85,000    651,997    736,997
                  Marketing

Jim Discher       Sr. Acct. Exec.         25,000    370,643    395,643

Roger Ackley      Sales V.P.-East         65,000    323,824    388,824

Edward Thompson   Regional V.P.           55,000    304,614    359,614

Terry Winzeler    Sales V.P.-West         55,000    289,402    344,402


FY-90

Terry Winzeler    Sales V.P.-West         65,000    327,500    392,500

James McGivern    Reg. Sales Mgr.         25,000    299,500    324,500

David Terry       Sales V.P.-Central 55,000         217,100    272,100

William Shaw      V.P. Sales &            85,000    172,100    257,100
                   Marketing

Jim Morrissey     Sales Manager           55,000    200,300    255,300
                  (Chicago)
                                - 15 -



FY-91

James McGivern       Reg. Sales Manager 40,000     122,100    262,100

Wayne Heus           Sales Manager        40,000   212,400    252,400
                     (Indianapolis)

William Shaw         V.P. Sales &         85,000   155,000    240,000
                      Marketing

Robert Van           Sr. Account Exec.    50,000   176,200    226,200
 Buskirk             (Dallas)

Larry                V.P. Merchandise    150,000    70,000    220,000



    Mr. Shaw's employment agreement with BI provided for a bonus

composed of five elements, including sales, contributions to

profits, and performance based on both sales and contributions to

profits.     For BI's fiscal years 1990 and 1991, Mr. Shaw's stated

sales plan (the amount required before a bonus applied) was

increased over the prior year and the fixed bonus for achieving

the stated sales plan was decreased from the prior year.     For

1990 and 1991 the stated contributions to the profits plan amount

before application of a bonus were increased over the prior

years, and the fixed bonus for achieving the stated contributions

to profits plan was decreased in amount.      The performance bonus

was also changed to include 11 levels in BI's fiscal year 1990

and 10 levels in BI's fiscal year 1991, as opposed to 6 levels in

1989, and had a cap placed on it for BI's fiscal years 1990 and

1991, less than the cap in 1989.      Each of the other five top paid
                               - 16 -


officers had bonuses computed on amounts above a certain level,

somewhat comparable, but not identical or equal in amount to the

bonus arrangement with Mr. Shaw.    There were employees other than

the five highest paid employees for the years here in issue, who

were compensated by BI with a fixed salary, plus a bonus related

to sales or profits or both.

      During the years here in issue BI had an excellent management

team which was experienced, capable, and had long service with

BI.    As of 1990 the various vice presidents of BI had been

employed by BI for periods of time ranging from 11 to 36 years.

The average length of employment was more than 17 years.

However, Mr. Schoenecker was the key man of the organization as

its CEO.    As CEO, Mr. Schoenecker's duties included building the

purpose and mission of BI, integration of quality strategies with

the business strategies, signing contracts of over 1 year's

duration, involvement in changes in the organizational structure,

working with the handbook, and meeting and greeting customers,

which involved considerable travel.     As CEO, Mr. Schoenecker had

the overall responsibility for the operations and policies of BI.

Mr. Schoenecker uses a hands-on type of management.    He

interviews all account executives hired by BI.    He has client

contact, particularly with the high-ranking executives of BI's

clients.    He customarily works 60 to 70 hours per week.
                                - 17 -


    BI's two major competitors are Maritz, Inc. (Maritz),

headquartered in St. Louis, Missouri, and Carlson Marketing, also

known as E.F. MacDonald (hereinafter referred to as MacDonald)

headquartered in Minneapolis, Minnesota.    In addition to its two

major competitors, BI has a number of other competitors.    Maritz

was organized in 1923 and is sometimes referred to as the

grandfather of the incentive industry.   According to a Dunn &

Bradstreet Corp. report the business of Maritz consists of: (1)

Providing employee-motivation programs through merchandise and

travel incentives (48 percent of its revenue); (2) arranging and

providing travel tour services on a corporate and business group

level (34 percent of its revenue); (3) providing data

communication services and audio-visual production for business

meetings (9 percent of its revenue); and (4) providing marketing

research and analysis services (9 percent of its revenue).

Maritz, in its fiscal year ended March 31, 1989, according to the

Dunn & Bradstreet report, generated revenue in excess of $1

billion, and net income of $38.5 million.   According to Dunn &

Bradstreet, Maritz employs approximately 5,000 individuals in

various capacities, has 200 offices in 35 states, and has

international offices in England; Mexico City, Acapulco, Cancun,

Mexico; and Montego Bay, Jamaica.

    MacDonald was incorporated in 1960 as Premium Corp. of

America and Grand Union Corp.    In 1969 the company was acquired

by Carlson Companies and operated as a subsidiary of that
                                  - 18 -


organization.      According to Dunn & Bradstreet, MacDonald had

assets of $347 million with stockholder's equity of $208 million

as of December 31, 1988.      Management of BI estimated that in the

late 1980's MacDonald generated yearly revenues of approximately

$325 million.

      The following is a summary of a survey by the Executive

Compensation Service (ECS) of top executive compensation of CEO's

by industry categories as of May 1990, showing results for the

year 1989 classified under all industries and categories of

industries for companies that had sales of approximately $162

million:

Title       Year         Sales        Average      +1 SD     +2 SDs

                             All Industries
CEO         1989      $162.416      $340.72       $497.96   $655.21

                            All Manufacturing
CEO         1989        162.416       345.71       505.38    665.04

                       Durable Goods Manufacturing
CEO         1989        162.416       343.92     522.82      701.72

                     Non-Durable Goods Manufacturing
CEO         1989        162.416       351.03     488.82      626.61

                          All Non-Manufacturing
CEO         1989        162.416       343.83       488.25    632.67

                             Wholesale Trade
CEO         1989        162.416       380.49       580.02    779.55

                                  Services
CEO         1989        162.416        362.71      508.11    653.51

                            Business Services
CEO         1989        162.416       359.46       497.23    634.99
                              - 19 -


    Sales are in millions, +1 SD is one standard deviation over
the average, and +2 SDs is two standard deviations over the
average.



    The +1 SD and +2 SDs are adjustments to the average

compensation by ECS for superior performance.   The ECS survey of

top executives' compensation in the business services and

wholesale trade industries for companies with sales in the range

of $135 to $175 million showed the top compensation of any CEO to

be $703,530 for 1988, $779,555 for 1989, $882,680 for 1990, and

$838,970 for 1991.   The compensation shown in the ECS survey was

total cash compensation, including salary, bonuses, and cash

fringe benefits.

    The following schedule shows information taken from proxies

of the advertising agencies indicated with respect to revenues

and net income before taxes for the years 1988, 1989, 1990, and

1991:
                                                    - 20 -



                              Proxy Analysis - Advertising Agency Profiles
                                           (Data in thousands)


                                  Revenue                            Net income before taxes
Company            1988        1989       1990         1991        1988     1989     1990    1991

Dimark,           $14,510     $16,054   $24,419        $30,208    $1,106      $407    $1,394    $2,024
 Inc.

Foote             386,050     326,075   338,138        341,987    21,203    32,857    34,402   (16,509)
 Cone &
 Belding
 Comm.

Grey              373,293     411,083   481,282        528,299    33,986    30,726    31,975     9,364
 Advertising,
 Inc.

Greenstone          3,695       5,828     8,216          9,044       800       955       518       624
 Roberts Adv.

Inter-          1,152,870   1,218,141 1,329,488      1,634,670   132,570   143,614   155,625   187,486
 public
 Group
 of Cos.

Laser               N/A          N/A       2,483         1,274      N/A       N/A       (96)      (199)
 Vision
 Centers,
 Inc.

Omnicom           881,286   1,007,173   1,178,233    1,236,158    83,557    98,612   111,796   121,198
 Group




                The following table shows the cash compensation paid to the

           CEO of each of the companies listed above for the years

           indicated:
                                  - 21 -


                         Proxy Analysis - CEO Pay

              Cash Compensation - Top Paid Individual

Company            1988          1989         1990        1991

Dimark,            N/A           N/A          N/A       $555,909
 Inc.1

Foote Cone       $540,000      $715,000     $715,000     615,000
 & Belding

Grey Adv.,      1,558,784     1,748,268    1,943,815   1,979,855
 Inc.2

Greenstone        305,000       250,000      377,051     367,000
 Roberts
 Adv.3

Interpublic     1,652,525     1,705,044    1,635,232   1,437,983
 Group of
 Cos.4
Laser              N/A            N/A          N/A       109,826
 Vision
 Centers, Inc.

Omnicom Group     780,000       957,500    1,053,750   1,168,750


75th %tile       965,600        964,800    1,106,100     955,7005
 Regression Est.


1
  Employment contract (9/89) calls for base of $312,000 plus
15% of pretax earnings greater than $1,250,000.
2
  Employment agreement (2/84) calls for employment through
1990 with annual base of $1.3 million (1988); agreement
amended to increase base pay to $1.5 million (1989) and
$1.7 million (1990-1991).
3
  Employment agreement calls for base salary of $365,000 and
bonus equal to 3% of EBIT (through 1994).
4
  Employment contract which, in 1992, calls for employment
through 6/96 and base of $965,000.
5
  The 75th percentile regression estimate is a variation of
"average".
                               - 22 -


    The size of a company, the amount of its sales, and the

volume of its sales have a definite effect on the compensation

paid to the top executives.

    The following schedule shows the base salary, bonus estimated

and paid in the applicable year, and the earned bonus paid in the

following year by BI to Mr. Schoenecker, and the amounts deducted

on the corporate income tax return by BI as compensation to Mr.

Schoenecker.

                 FY-88        FY-89       FY-90       FY-91

Base salary    $400,000    $500,000      $500,000    $500,000

Bonus:
 Estimated and
 paid in the
 applicable
 year          600,000    1,000,000     1,000,000     300,000

 Earned and
 paid in the
 following
 year             --          163,476     315,930     558,735

Amount paid
and deducted
on corporate
income tax
return       1,000,000     1,663,476    1,815,930   1,358,735



    In addition, as heretofore stated, Mr. Schoenecker received

$100,000 from Animal Fair in each of its fiscal years 1988, 1989,

and 1990.

    Respondent, in her notice of deficiency, determined that the

proper allowable deductions for compensation to Mr. Schoenecker

by petitioner were $354,000 for its fiscal year 1988, $380,000
                              - 23 -


for its fiscal year 1989, $296,816 for its fiscal year 1990, and

$338,475 for its fiscal year 1991.     Accordingly, respondent

disallowed the balance of the compensation claimed to be

deductible by GSI and subsidiaries for Mr. Schoenecker in each of

these years.

                              OPINION

    Section 162(a)(1) allows as a deduction a reasonable

allowance for salaries or other compensation paid for personal

services rendered.   In order to be deductible, the amount must be

paid for services rendered and not a substitute for dividends,

and must be reasonable for the services rendered.     Charles

Schneider & Co. v. Commissioner, 500 F.2d 148, 152 (8th Cir.

1974), affg. T.C. Memo. 1973-130.    The Schneider case, citing

Mayson Manufacturing Co. v. Commissioner, 178 F.2d 115, 119 (6th

Cir. 1949), lists the following factors that are often considered

in determining the reasonableness of compensation:     (1) The

employee's qualifications; (2) the nature, extent, and scope of

the employee's work; (3) the size and complexities of the

business; (4) a comparison of salaries paid with the employer's

gross income and net income; (5) the prevailing general economic

conditions; (6) a comparison of salaries with distributions to

stockholders; (7) the prevailing rates of compensation for

comparable positions in comparable concerns; (8) the salary

policy of the taxpayer as to all employees; and (9) in the case

of small corporations with a limited number of officers, the
                                - 24 -


amount of compensation paid to the particular employee in

previous years.    The Schneider case also quotes the provision of

section 1.162-7(b)(2), Income Tax Regs., that while a fixed

method of compensation is not decisive as to its deductibility,

generally speaking, if contingent compensation is paid pursuant

to a free bargain between the employer and the individual made

before the services are rendered, not influenced by any

consideration on the part of the employer other than that of

securing on fair and advantageous terms the services of the

individual, it should be allowed as a deduction even though in

the actual working out of the contract it may prove to be greater

than the amount which would ordinarily be paid.

    Petitioner in this case argues that Mr. Schoenecker had

superior qualifications which would justify a high level of

compensation.     Petitioner contends that Mr. Schoenecker's

education, which included a college degree and some study of law,

his experience, motivation, leadership, managerial skills,

business judgment, specialized training, personal contacts, and

personal selling attributes, justify a high salary.     We have

concluded that Mr. Schoenecker was a very competent CEO and have

given weight to this fact in our conclusion as to reasonable

compensation for his services.     However, limits to reasonable

compensation exist, even for very valuable employees.     Owensby &

Kritikos, Inc. v. Commissioner, 819 F.2d 1315, 1325 (5th Cir.

1987), affg. T.C. Memo. 1985-267.
                                - 25 -


    Petitioner next refers to the nature, extent, and scope of

Mr. Schoenecker's work at BI.    Petitioner states that it is no

small task to be the person responsible for keeping over 750

employees, including such diverse groups as salespeople, creative

personnel, and accounting personnel moving in the same direction.

However, this is the normal expected job of a CEO, and though a

lack of ability in that area might warrant less compensation,

competence in that area is expected.     Nevertheless, we consider

Mr. Schoenecker to have been shown by this record to be a CEO who

kept close tabs on the work of his organization in a very

competent manner.   Petitioner states that Mr. Schoenecker's

duties included those of CEO, as well as chief operating officer,

and chief quality officer.   However, the record shows that there

were a number of other competent employees in BI, and Mr.

Schoenecker's work was primarily that of the CEO.    Certainly as

the CEO, he had general supervision and control over operations

and quality of the work, but he did have other competent officers

to perform the daily aspects of that work.    Mr. Schoenecker, as

CEO, had final responsibility of all aspects of BI's business.

Mr. Schoenecker's devotion to the business is certainly

unquestioned on this record.    He had been with the company since

its inception, and was the sole owner of the company during the

years here in issue.   The record shows he worked 60- to 70-hour

weeks, but this again is not uncommon for a CEO, nor is it

necessarily one of the prime criteria on which to judge the
                              - 26 -


competency and value to the company of a CEO.   It is the

accomplishments of the executive and not necessarily the hours

worked, although the working of long hours is to be considered.

Again, petitioner cites the responsibility for BI's success and

"irreplaceability" of Mr. Schoenecker.   While Mr. Schoenecker

would certainly be a great loss to the company were he not there,

it is fairly clear from this record that there are other

competent officers of BI, such as Mr. Shaw and, during the latter

years here in issue, Mr. Schoenecker's son Larry was taking more

responsibility for the business.   However, the fact that there

are other competent officers employed by BI does not detract from

the fact that Mr. Schoenecker is a very competent CEO.

    Petitioner points out that the growth, profitability, and

financial condition of the business are important in determining

whether compensation paid to an employee is reasonable.     Home

Interiors & Gifts, Inc. v. Commissioner, 73 T.C. 1142, 1157-1158

(1980).   The record here shows that BI has grown substantially

since its incorporation in 1950.   Certainly that growth is to an

appreciable extent due to the work of Mr. Schoenecker.    However,

unlike the situation in Home Interiors & Gifts, Inc. v.

Commissioner, supra, the growth of BI was in line with that of

BI's competitors.

    Petitioner contends that an unrelated investor would be

satisfied with the return on his investment in BI from the income

of BI after the payment of Mr. Schoenecker's salary.   Respondent
                              - 27 -


contests this assertion and particularly the comparison

petitioner's expert made to mutual fund returns.    It is difficult

to determine what an independent investor would expect from the

risk of his funds in a business such as BI's.    However, it is

reasonable to assume that an independent investor would be

unwilling for an officer to realize compensation out of line with

compensation paid by similar businesses, thus unnecessarily

reducing the income produced by the business in which he had

invested.

    Petitioner discusses the general economic conditions and the

growth of the incentives industry in general, and contends that

BI's growth was outstanding, even compared to the general

economic conditions and the economic conditions in the incentives

industry.   Unfortunately, the record has very little information

with respect to other members of the incentives industry, which

are petitioner's prime competitors.    The record has some

indications that petitioner's growth did not exceed that of the

incentives industry in general.   Petitioner's expert witness, Mr.

Locke, indicated that information as to the salaries paid to the

CEO by Maritz and MacDonald might be available to his firm, but

he did not produce the information, even when it was suggested to

him that it might be quite helpful.    The information that is in

the record indicates that petitioner did not grow faster than its

competitors and may have grown less fast than its prime

competitor Maritz.
                               - 28 -


    Finally, petitioner argues that Mr. Schoenecker's

compensation was paid under a formula agreed to in 1974 in an

arm's-length transaction.   If this were the fact, it might have a

bearing on the reasonableness of Mr. Schoenecker's compensation,

although it would not be conclusive as to its reasonableness if

the conditions in the company had changed.   See Patton v.

Commissioner, 168 F.2d 28 (6th Cir. 1948), affg. a Memorandum

Opinion of this Court dated Apr. 30, 1947.   However, here it is

not at all clear that the agreement entered into in 1974, when

petitioner was a 50-percent owner of BI, and because of an injury

the other 50-percent owner-officer could work only part-time, was

at arm's length.   However, even if we assume that the agreement

made in 1974 was an arm's-length agreement, Mr. Schoenecker's

compensation for the years here in issue was not computed under

this agreement.    The 1974 agreement provided for $108,000 yearly

base compensation and a bonus of 8 percent of net income of BI

and subsidiaries before taxes.   By 1988 the base compensation of

Mr. Schoenecker had been upped to $400,000, and in 1989, 1990,

and 1991 it was $500,000, and the bonus percentage had become 10

percent in 1988, and 12 percent in 1989, 1990, and 1991.     The

information to determine exactly the amount Mr. Schoenecker would

have received in each of the years here in issue under the 1974

agreement is in this voluminous record and shows that applying

the formula under the 1974 agreement, Mr. Schoenecker's salaries

and bonuses would have been $567,884 for BI's fiscal year 1988,
                                   - 29 -


$888,742 for BI's fiscal year 1989, $996,886.40 for BI's fiscal

year 1990, and $287,010 for BI's fiscal year 1991.      This

computation is as follows:

                  Income before      8-percent of    8-percent of
                  taxes of GSI       income before   income before
  FY ended        & subsidiaries     taxes           taxes + $108,000

June 30,   1988     $5,748,557        $459,884.56      $567,884.56
June 30,   1989      9,759,287         780,742.96       888,742.96
June 30,   1990     11,111,080         888,886.40       996,886.40
June 30,   1991      2,237,628         179,010.24       287,010.24
   Total            28,856,552       2,308,524.16     2,740,524.16


    For the years 1990 and 1991 Mr. Schoenecker's bonuses were to

be computed on the income of GSI and its subsidiaries, but were,

in fact, computed on BI's income and, apparently, with some small

error even in that computation.       Since BI's income in the years

here in issue was in excess of that of GSI and its subsidiaries,

the bonuses were overstated under the compensation formula set

forth in the corporate minutes for BI's 1990 and 1991 years.      The

1974 agreement as to base compensation was honored through 1979,

while Mr. MacDonald was still a 50-percent stockholder of BI.

Once GSI acquired all of BI's stock, and Mr. Schoenecker, as the

sole stockholder of GSI was the owner of BI, the $108,000 began

to increase, and by the years here in issue it was greatly

increased.    This is an indication that Mr. Schoenecker, as sole

owner, fixed his own salary without real reference to the value

of his services to BI.    This is further demonstrated by the

difference in the formula for bonuses for other officers and for

Mr. Schoenecker and the fact that when the formula for Mr. Shaw's
                               - 30 -


bonuses resulted in a bonus which apparently Mr. Schoenecker

considered too high in an uncommonly good year for BI, the

formula was changed to reduce the bonus base.

    Since a reasonable salary is one that would be agreed to in

arm's-length negotiations, the amount paid for comparable work by

comparable companies is a very important factor in determining

reasonable compensation.    In a competitive market for a CEO the

going salary paid by a comparable business to a CEO would set a

pattern for negotiations.   Experts for each party testified in

the case and used various statistics to support the opinions

given.   One of petitioner's experts, Mr. Locke, relied on

materials from the advertising industry, which even he admitted

were not representative of petitioner's business.   We have set

forth the statistics Mr. Locke used, since the figures themselves

show that some of the companies were ten times the size of BI.

Also, the record shows the businesses were different from and

more complex than BI's business.   The record is clear that the

advertising companies are not a good comparison to BI.   However,

even the 75-percentile regression estimate of these advertising

companies, which was used in effect as an average, was except for

1 year less than $1 million for the CEO, and in the 1 year just

slightly over $1 million.   In order to attempt to justify Mr.

Schoenecker's salary, petitioner's expert made adjustments to the

salaries paid to advertising executives for retirement and other

fringe benefits.   In our view, the testimony of Mr. Locke, based
                              - 31 -


on the statistics from the advertising field, is of little value.

If any consideration were warranted of the salaries paid by

advertising agencies, the payments by Grey Advertising, Inc.,

Interpublic Group of Companies, and the Omnicom Group, one of

which had revenues of about three times that of BI, another of

which had revenues of almost 10 times BI's, and the third about

six times BI's revenues would have to be eliminated.    The

salaries paid to CEO's by the other advertising firms as shown in

the proxies ranged from $250,000 to $715,000.    None approached

the salary including bonuses paid to Mr. Schoenecker by BI for

any year here in issue.

    The clear indication from the testimony of Mr. Locke is that

he was aware of salaries paid by BI's direct competitors, Maritz

and MacDonald, but would not disclose them.

    Respondent's expert, Mr. Brennan, used the ECS statistics

along with other information in his reports.    Mr. Brennan's

report was received in evidence as his opinion, and petitioners'

counsel did not cross-examine him on the report.

    Petitioner argues that the business services and wholesale

trade from the ECS statistics primarily relied on by Mr. Brennan

are not comparable to BI: (1) Because the area of business

services and wholesale trade are not comparable to petitioner's

business, and (2) because the officers in these companies may

have received pensions and other benefits that Mr. Schoenecker

did not get.   It is reasonably clear that the compensation in the
                               - 32 -


ECS reports included all cash compensation paid to the CEO's.    If

some fringe benefits or contributions to a retirement plan were

cash payments, this amount was included.   Mr. Schoenecker had

some fringe benefits.   BI had a section 401(k) plan in which Mr.

Schoenecker was entitled to participate, and Mr. Schoenecker had

his life insurance premiums paid for him by BI, and a portion of

his medical insurance premiums, just as other BI employees.

    However, we do agree with petitioner that while the

categories of business services and wholesale trade might include

the type of business engaged in by petitioner, they are far too

broad to be representative of petitioner's business.

    While Mr. Brennan did not know the exact amount of the salary

of the CEO of petitioner's main competitor, Maritz, he did have

information from the company that it was less than the maximum

range of companies its size in the ECS survey.   Maritz was a much

larger company than BI.

    As petitioner points out, there is no way of knowing from the

record the reason the CEO of Maritz had the salary he had without

knowing more facts about how the salary was determined than this

record shows.    However, that is true of any determination based

on statistics.   The burden here is on petitioner to show error in

respondent's determination.   Petitioner has produced little

evidence to show what a reasonable salary would be for Mr.

Schoenecker in the years here in issue.
                              - 33 -


    The record here shows no payments of dividends by BI, except

to GSI to buy out Mr. MacDonald, until a rearrangement of

financial affairs was made for BI, GSI, and Mr. Schoenecker in

1990 when it was determined to be advantageous to get real estate

out of the ownership of BI or GSI.     The real estate was declared

as a dividend by BI to GSI and by GSI to Mr. Schoenecker, and a

cash dividend was declared for Mr. Schoenecker to use to pay the

taxes on the real estate dividend.     The main business offices of

BI were located on the real estate declared as a dividend to Mr.

Schoenecker.   Neither BI nor GSI had a regular dividend policy.

                   In evaluating Mr. Schoenecker's ability as a

CEO, it should be noted that he was also the CEO of Animal Fair,

which was not very successful in its operations.

    From the record here, we conclude that Mr. Schoenecker set

his salary in the years here involved on a basis to take out of

the company as salary amounts he wished to withdraw from the

company, and not on the basis of a reasonable salary which would

have been paid in an arm's-length transaction.

    This record is clearly inadequate to establish the amount of

a reasonable salary for Mr. Schoenecker.    However, there are

indications that a reasonable salary for Mr. Schoenecker would be

in excess of the amounts allowed by respondent in each of the

years in issue.   In fact, respondent in her brief requests as an

ultimate finding of fact, that "Reasonable compensation for Guy

[Mr. Schoenecker] as CEO was in the range of $354,920 to $415,100
                               - 34 -


for FY-88, $380,490 to $408,300 for FY-89, $422,500 to $460,690

for FY-90, and $435,060 to $483,200 for FY-91."    The minimum of

this range was in excess of the amount determined by respondent

in the notice of deficiency to be reasonable compensation.

Respondent, of course, based this requested finding on her

interpretation of the evidence as a whole.    However, a review of

the report of respondent's expert witness, Mr. Brennan, indicates

that the ranges probably came to an appreciable extent from his

report.    The ECS figures included in that report by Mr. Brennan

contained, as we have stated, amounts of "maximum" amounts paid

to CEO's of companies in business services and wholesale trade

which receive revenues comparable to those received by GSI and

subsidiaries in the years 1988 through 1991.    Mr. Brennan's

report stated that to justify a salary of this amount Mr.

Schoenecker would have to be the outstanding executive in the

entire country, which, in Mr. Brennan's opinion, the record did

not support.    It is not absolutely clear how the "maximum"

amounts of compensation were computed in the ECS statistics.     It

does appear that this amount is basically the top salary paid to

an executive of a company in the business services and wholesale

trades industry, the revenues of which were comparable to those

of BI.    Although we recognize that the business services and

wholesale trade industries are not good comparisons on an average

basis to petitioner's more limited type of business, it appears

to us that a reasonable salary for Mr. Schoenecker would not be
                              - 35 -


greater than the top salaries paid.    If, in fact, petitioner had

been among the companies included in the ECS report, the salary

paid to Mr. Schoenecker would have been the top salary since it

exceeded the top salary shown in the ECS report.   However, BI and

GSI were not public companies, the financial operations of which

were available to ECS from published sources.   It appears that

neither BI nor GSI information was reported to ECS.   Another

difficulty with the ECS statistics is the difference in the

number of companies included in different years.   However, we

have compared the figures of the top salaries in the business

services and wholesale trade classification for the years 1988

through 1991 with the salaries paid by advertising firms that

were close in size to BI.   Overall the top salaries in the

business services and wholesale trade classification are in

excess of the salaries paid by advertising firms of the

approximate size of BI.   According to petitioner's witness, the

salaries in the business services and wholesale trade industries

did not include certain fringe benefits, such as retirement pay.

However, there is nothing to show that in addition to the

reported salaries, such fringe benefits were paid by the

companies.   The ECS figures of top pay in the business service

and wholesale industry are also in total in excess of the amount

of salary that would have been paid to Mr. Schoenecker under the

1974 agreement for the years here in issue.   We are aware, of

course, that under an arm's-length arrangement, the base salary
                                - 36 -


of Mr. Schoenecker would probably have been increased to some

extent through the years.   However, there is nothing to show that

the percentage of income before taxes which Mr. Schoenecker was

to receive would have been increased, and, in fact, if an

unusually good year occurred, the percentage might have been

decreased, as was the situation with Mr. Shaw after an unusually

good year for BI.   The top amounts paid or "maximum" amounts

shown in the ECS survey exceed substantially the amounts

determined under the formula for the fiscal years 1988 and 1991

in our computation of the amount that Mr. Schoenecker would have

received under the 1974 agreement.       For the fiscal years 1989 and

1990 the amounts computed under the formula are somewhat in

excess of the amounts shown as the maximum amounts paid in the

ECS survey.   However, it was the results of the very high amount

received by Mr. Shaw under his bonus plan in BI's fiscal year

1989 that caused the method of computing the bonus to be changed

so that the amounts received by Mr. Shaw in fiscal years 1990 and

1991 were approximately back to the level of the amount he

received in fiscal year 1988.    It would, therefore, seem logical

that had Mr. Schoenecker been negotiating compensation at arm's

length, the amount resulting from the high income in the fiscal

year 1989 would have caused some form of decrease in the

percentage of income amount he would receive as a bonus in

subsequent years.   On an overall basis, it is more favorable to

petitioner to use the amounts of the top pay as shown by the ECS
                               - 37 -


reports of CEO's of business services and wholesale companies

receiving comparable revenues to those received by BI, than to

use the amount computed under petitioner's 1974 salary agreement

with BI.    It is certainly more favorable than using the salary

payments from advertising companies in the same general revenue

receipt area as BI, unless they are to be substantially increased

for items which it is not clear were not already included, or

were benefits which were not part of the compensation of the

officer involved.    It is not unusual that higher cash

compensation be paid to an officer who does not receive noncash

benefits.

    Therefore, considering this record as a whole, and being

unwilling to sustain respondent's determination on the basis of

failure of proof by petitioner, we conclude that the evidence

most indicative of a proper amount to be paid to Mr. Schoenecker

in each of the years here in issue from this record is the

"maximum" amounts paid CEO's of companies in business services

and wholesale trade that received revenues comparable to those

received by GSI as shown by the ECS survey for the years 1988

through 1991.    These amounts are $703,530 in BI's fiscal year

1988, $779,550 in BI's fiscal year 1989, $882,680 in BI's fiscal

year 1990, and $838,970 in BI's fiscal year 1991.    Therefore,

based on this record as a whole, and considering the outstanding

contribution Mr. Schoenecker made as CEO of BI, we hold that the

above-set forth amounts constitute reasonable compensation to Mr.
                               - 38 -


Schoenecker for serving as CEO of BI in the fiscal years here

involved and, therefore, hold that these amounts are the

appropriate amounts of deductible compensation by petitioner for

Mr. Schoenecker, rather than the amounts determined by respondent

in the notice of deficiency.



                                        Decisions will be entered

                               under Rule 155.
