Rosenblatt v. Commissioner

Gertrude Rosenblatt, Petitioner, v. Commissioner of Internal Revenue, Respondent Rosenblatt v. Commissioner Docket No. 23719 United States Tax Court 16 T.C. 100; 1951 U.S. Tax Ct. LEXIS 314; January 17, 1951, Promulgated *314 Decision will be entered under Rule 50. Petitioner, one of the shareholders and bondholders of a corporation, was in 1938 indebted to the corporation by reason of prior borrowing from the corporation. The remaining stockholders and bondholders were also indebted to the corporation but in varying and lesser amounts. Interest at 6 per cent based on the average borrowings of all stockholders was adjusted among the accounts of the stockholders. In December 1938 petitioner and the remaining stockholders conveyed all of the assets of the corporation, including the claims of the corporation against petitioner and the remaining stockholders, to a trust which is conceded to be revocable. Interest was adjusted by the trustee among the accounts of the former bondholders in a manner similar to the adjustment made by the corporation. Petitioner by reason of her previous borrowings from the corporation was debited with interest of $ 3,327.41 and the remaining former bondholders' accounts were credited with $ 1,109.13, $ 1,109.14, and $ 1,109.14, respectively. Petitioner was credited on the books of the trust with $ 7,848.39 which was her distributive share of the trust as stated on the*315 books of the trust and which amount was included by petitioner as income in her return for 1945. Held, the $ 3,327.41 representing interest on indebtedness of petitioner is deductible by her. Joseph M. Lobel, Esq., and Carl S. Serling, C. P. A., for the petitioner. Graham Loving, Jr., Esq., for the respondent. Black, Judge. BLACK *100 This proceeding involves a deficiency of $ 1,197.60 in petitioner's income tax for the calendar year 1945. In his amended answer respondent asks for an increase in the deficiency to $ 2,334.51 due to the addition of certain amounts to petitioner's net income. The parties have stipulated that certain additional amounts added to petitioner's income by respondent in the deficiency notice and the amended answer are properly taxable to petitioner if the Goldsmith Trust is found to be a revocable trust. Petitioner having conceded in her brief that the Goldsmith Trust is a revocable trust the additions to net income in the deficiency notice and also the amounts affirmatively pleaded in the amended answer are sustained. The adjustments for medical expenses in the deficiency notice and asked for in the amended answer are adjustments*316 made because of the redetermination of petitioner's income and will be settled in a recomputation under Rule 50. We have, therefore, only one adjustment to petitioner's net income which is in controversy and this was explained by respondent in a statement attached to the deficiency notice as follows: (b) The item of $ 3,327.41 claimed as interest paid to the Goldsmith Trust has been disallowed for the reason that no competent evidence or appropriate information was submitted in substantiation thereof. *101 By appropriate assignment of error petitioner contests this adjustment thereby leaving for our determination one issue namely: whether respondent erred in disallowing as interest expense $ 3,327.41 claimed by petitioner. FINDINGS OF FACT. The facts which were stipulated are so found and are incorporated herein by reference. Petitioner residing in New York City reported her income for Federal income tax purposes on the cash basis and filed her return for the year 1945 with the collector for the second district of New York in New York City. Petitioner, from at least as early as July 25, 1935 to and including 1938, was a stockholder of the F. & H. G. Corporation (hereinafter *317 called F. & H. G.) owning one-fourth of all the capital stock. During the existence of F. & H. G. petitioner and the remaining stockholders borrowed varying sums of money from the corporation. On or about July 25, 1935, petitioner was indebted to F. & H. G. on account of such advances in the amount of $ 124,146.75 and the remaining stockholders were indebted to F. & H. G. on account of such advances in varying but lesser amounts. On July 25, 1935, petitioner and the remaining stockholders of F. & H. G. entered into an agreement whereby interest at 6 per cent, compounded semiannually, would be charged to each stockholder's account on the excess amount of his borrowings over the average borrowings of all stockholders, and interest would accordingly be credited to each stockholder's account on the amount his borrowings were under the average borrowings of all stockholders. At all times since June 1, 1938, petitioner and the remaining stockholders were the income beneficiaries of the estate of Hennie Goldsmith. On or about June 1, 1938, petitioner, in her capacity as one of the income beneficiaries of the estate of Hennie Goldsmith, and the remaining stockholders assigned their shares*318 of the income of the estate to F. & H. G. The bondholders and stockholders of the F. & H. G. Corporation, were the petitioner herein, Ruth V. Bair, Lillian Goodman and jointly Rosetta C. and Walter C. Goldsmith, each of whom owned in equal amounts all of the outstanding bonds and stock of the corporation. Petitioner owned $ 150,000 of F. & H. G.'s bonds and by reason of previous borrowings owed the corporation $ 112,368.16 on December 1, 1938. On or about December 14, 1938, petitioner and the remaining stockholders created the Goldsmith Trust (conceded by the parties to be a revocable trust), which was modified and amended by agreements dated July 31, 1939, and February 23, 1940. No physical distribution *102 of the assets of F. & H. G. took place but, pursuant to the agreement creating the trust, petitioner and the remaining stockholders transferred to the trustee of the Goldsmith Trust all of the assets of F. & H. G. in kind. Included among the assets of F. & H. G. were the advances receivable from each of the stockholders and/or bondholders of the corporation. The trust agreement sets out the indebtedness of F. & H. G. to the former bondholders as of December 31, 1938, *319 which indebtedness was the difference between the face amount of the bonds held and the individual "drawing accounts." Paragraph III of the trust indenture provides for the computation of interest as follows: III. In computing the interest on the indebtedness of F. & H. G. Corp'n to its bondholders, such indebtedness is to be determined as of the 1st day of December, 1938 and thereafter each bondholder shall be credited semi-annually with interest at the rate of 6% per annum upon the excess of the amount still due him over the average amount due each bondholder and shall be charged semi-annually with interest at the same rate upon the sum by which the amount still due him is exceeded by the average amount due each bondholder. * * * The adjustment for interest under the trust agreement was based on the net amount due the former bondholders, whereas the July 25, 1935, agreement provided for an adjustment based on the amount owing to F. & H. G. by the bondholders. In a letter dated May 27, 1941, petitioner assigned the proceeds of the sale of certain assets to the trustee with the specific direction that these proceeds be applied in payment of interest. As of January 1, 1945, the advances*320 receivable from the petitioner totaled $ 117,618.30, while the advances receivable from each of the remaining stockholders totaled $ 40,627.32, $ 40,627.32, and $ 40,627.25, respectively. During 1945, the trustee advanced an additional $ 9,000 to each of the remaining stockholders other than petitioner. Pursuant to the terms of the deed of trust, the income of all of the assets held by the trustee was divided equally among petitioner and the remaining stockholders. Petitioner's distributive share of the Goldsmith Trust income for the year ended December 31, 1945, as stated on the books of the Goldsmith Trust amounted to $ 7,848.39, which amount was included by her as income in her return for the taxable year involved. It is agreed that the income reported by petitioner on her return shall be increased by $ 3,379.77. In accordance with the terms of the trust, the trustee debited interest to the account of any former bondholder whose net balance was less than the average balance of all the former bondholders. During the taxable year 1945, the net balance of petitioner was less than the average balance of all the former bondholders, and the trustee therefore debited petitioner's account*321 with $ 3,327.41 and credited the accounts *103 of the other three former bondholders with $ 1,109.13, $ 1,109.14, and $ 1,109.14, respectively. In her return for the year 1945, petitioner claimed as a deduction the $ 3,327.41 as interest which respondent disallowed. OPINION. The sole issue herein is whether petitioner may deduct in her return for 1945 the amount of $ 3,327.41 debited to her account on the books of the Goldsmith Trust. The Goldsmith Trust (conceded by the parties to be a revocable trust) was created in 1938 by petitioner and the other former stockholders and bondholders of the F. & H. G. Corporation, by transferring to the trust all the assets of every kind owned by the stockholders, creditors and bondholders of F. & H. G. Included in the assets transferred to the trust were the claims against petitioner and the remaining bondholders for the indebtedness to F. & H. G. arising out of prior borrowings from F. & H. G. by petitioner and the other bondholders. Petitioner from 1935 on was indebted to F. & H. G., and later to the Goldsmith Trust as the assignee of F. & H. G.'s stockholders in an amount larger than the average indebtedness of all the other former *322 stockholders and bondholders. Pursuant to the terms of the trust, the trustee in 1945 debited petitioner's account with $ 3,327.41 and the other three former bondholders' accounts were credited with $ 1,109.13, $ 1,109.14, and $ 1,109.14 respectively. This debit to petitioner's account represented an interest adjustment attributable to petitioner's net indebtedness to the trust. Petitioner's distributive share of the Goldsmith Trust's income for the year 1945 as stated on the books of the trustee amounted to $ 7,848.39, which amount was included by her as income in her return for 1945. Prior to the creation of the trust petitioner in 1935 entered into an agreement with the other three stockholders and bondholders of F. & H. G. whereby interest would be charged to each stockholder's account on the excess amount of his borrowings over the average stockholder's borrowings, and a credit would likewise be given the stockholder whose individual borrowings were under the average stockholder's borrowings. This was done because the parties were all equal stockholders and bondholders and therefore only the net difference in their accounts needed to be adjusted for interest. When the Goldsmith*323 Trust was created in 1938 by transferring all of the assets of F. & H. G. to the trust, the provision relating to interest adjustments arising from the indebtedness to F. & H. G. was continued as part of the trust agreement. Although the interest adjustment under the trust agreement was computed on the average amount owed the former bondholders rather than on the average amount owed F. & H. G. (as under the July 25, 1935 agreement), the interest adjustment *104 under the trust agreement results from petitioner's indebtedness to F. & H. G. The manner of computing the interest adjustment under the trust agreement only varied in form from the 1935 agreement. Respondent argues that the claimed interest deduction represented interest to petitioner on something owed to her. We cannot agree with this. Each of the stockholders of F. & H. G. owned equal amounts of the stock and bonds of the corporation. If there had been no borrowings by the stockholders, or if the borrowings had been equal, all of the stockholders would have been entitled to an equal share in the assets of F. & H. G. upon dissolution. However, the borrowings were unequal, and therefore included in each stockholder's*324 share of the assets of F. & H. G. was a one-fourth interest in the claim against each individual stockholder for his indebtedness to F. & H. G. The individual stockholder's one-fourth share in his own indebtedness would be cancelled out because an individual cannot be indebted to himself; however, petitioner being indebted in a larger amount than any of the other stockholders, these other three stockholders had an enforceable claim against petitioner which they transferred to the trust. This was an indebtedness of petitioner to the trust as assignee of F. & H. G.'s stockholders. The interest adjustment of $ 3,327.41 under the trust agreement therefore represents interest at 6 per cent on petitioner's indebtedness. This is especially true where, as here, the trust is a revocable trust and pursuant to respondent's regulations petitioner is required to report as income one-fourth of all the trust income as her income whether distributed or not (which petitioner concedes) and petitioner is "* * * allowed those deductions with respect to the corpus as he [she] would have been entitled to had the trust not been created." Regulations 111, section 29.116-1 (c). See ,*325 this day decided. The $ 3,327.41 being interest on indebtedness, petitioner as a cash basis taxpayer, is entitled to deduct the amount claimed as a deduction if it was paid in the taxable year. . When, as here, there are concurrent debits and credits to petitioner's account, the debits relating to interest are considered as payments by a cash basis taxpayer when the charges do not exceed the credits included in income. , affd., , certiorari denied, ; . Petitioner's account with the trust having been credited in 1945 with $ 7,848.39 by the trustee, which amount of trust income is taxable to petitioner, she is entitled to deduct the $ 3,327.41 interest debited to her account by the trustee in 1945. This debit was in effect an actual payment of the interest and nothing more is required to entitle *105 petitioner to the deduction. It is just as an effective payment of interest*326 as if petitioner had received a check from the trust for $ 7,848.39 income and then, in turn, had given the trust a check for $ 3,327.41 interest. Such mechanics were altogether unnecessary. Decision will be entered under Rule 50.