Pollak v. Commissioner

Leo L. Pollak and Virginia M. Pollak, Husband and Wife, Petitioners, v. Commissioner of Internal Revenue, Respondent Pollak v. Commissioner Docket No. 38483 United States Tax Court 20 T.C. 376; 1953 U.S. Tax Ct. LEXIS 156; May 19, 1953, Promulgated *156 Decision will be entered for the respondent. Deduction -- Nonbusiness Bad Debt or Ordinary Loss -- Section 23 (k) (4) -- Section 23 (e) (2). -- The endorser of a corporation's notes who was required to pay the notes when the corporation became insolvent sustained a loss from the worthlessness of a nonbusiness debt rather than from a transaction entered into for profit where the corporation was solvent at the time the notes were endorsed but was insolvent though still in existence at the time payment was made under the endorsement. Benjamin Alpert, Esq., for the petitioners. John E. Mahoney, Esq., for the respondent. Murdock, Judge. MURDOCK *376 The Commissioner determined deficiencies in the income tax of the petitioners *157 of $ 15,452.86 for 1948 and $ 16,683.98 for 1949. The petitioners have conceded the correctness of the deficiency for 1948 and all issues relating to 1949 except whether they are entitled to a deduction under section 23 (e) for a loss instead of a deduction for a nonbusiness bad debt under section 23 (k) (4). FINDINGS OF FACT. The petitioners, husband and wife, filed joint returns for 1949 with the collector of internal revenue for the fifth district of New Jersey. *377 The petitioners each purchased 200 shares of stock of Pollak Engineering and Manufacturing Corporation for $ 20,000 at its inception in January 1947. Leo was an officer and employee of the corporation. Leo and another stockholder joined on January 12, 1949, in a guarantee to a bank of loans by the bank to the corporation up to $ 200,000. They had endorsed notes of the corporation to the bank, for $ 200,000 during the period from October 4, 1948, to December 13, 1948, Leo believing that the corporation would prosper and he would not lose as a result of the endorsements. The corporation, on April 6, 1949, filed a petition for reorganization under the Bankruptcy Act. Leo paid the bank $ 100,000 under his guaranty. *158 The first payment was made on March 14, 1949, and the last on June 23, 1949. The assets of the corporation were sold during the last 6 months of 1949 pursuant to the plan of reorganization under which the general creditors, including Leo, received 3.59 per cent on their claims. The corporation was indebted to Leo, at the date of the consummation of the plan, in the total amount of $ 141,928.33 and Leo received, on or about December 15, 1949, $ 5,095.24, representing 3.59 per cent of the total amount due him as a general creditor. The affairs of the corporation became progressively worse after it began to be apparent late in 1948 and early in 1949 that it would not be able to perfect an electrical cigarette vending machine on which it was working and spending large amounts for tools, parts, raw materials, and other items. Leo knew, when he made the payments to the bank under his guaranty, that he would eventually recover only a small part of the amount which the corporation would owe him. The petitioners, on their joint return for 1949, claimed under "Miscellaneous" a deduction of $ 94,904.76 for "Payment as Guarantor on Note." The Commissioner, in determining the deficiency for*159 1949, disallowed the entire deduction claimed in the return under "Miscellaneous." All facts stipulated are incorporated herein by this reference. OPINION. The only question here is whether the petitioners are entitled to a deduction under section 23 (e) (2) for a loss of $ 96,410 sustained in a transaction entered into for profit. The Commissioner argues that the only deduction to which they are entitled is for a worthless nonbusiness debt under section 23 (k) (4). Both agree that the two sections are mutually exclusive. . The petitioners agree that if there was a debt it was a nonbusiness debt but they point out that there was no debt owed by the corporation to Leo until he began to make *378 payments to the bank on his guaranty on March 14, 1949, and, they argue, by that time and thereafter the corporation was obviously insolvent and although it continued to exist, "no debt exists for tax purposes" where, as here, it was obvious, when the money was paid, the debtor was insolvent and there was no expectation of it being repaid except in a "trifling amount." They argue that the lack of*160 assets of the debtor at the time the payments were made is controlling rather than the nonexistence of a debtor at that time 1 and cite cases where no deduction for a bad debt was allowed because the money was advanced without expectation of repayment. The cases cited are not in point because there the deduction was disallowed because the transaction was not a genuine arm's-length loan. Here there was no such lack of genuine business purpose or motive at the time when Leo first became involved in the loans, which is the time to be considered because it was then, but never thereafter, that he exercised his free will. Leo, when he endorsed the notes, fully intended and expected to be repaid by the then existing solvent corporation if he was ever called upon to make good his endorsement or guaranty. He had no altruistic motive in endorsing the notes. He anticipated that he would become and have the rights of a creditor if called upon to repay the loans to the bank. He filed a claim against the bankrupt for the debt and received a dividend on his claim. *161 A deduction for any bad debt was just as beneficial tax-wise as a deduction for loss prior to 1942 when Congress first provided that nonbusiness bad debts were to be considered a short-term capital loss. Thus, the present question might not have been in the mind of the Court in a case involving earlier years. The petitioners cite no case which considers the present question and decides it in their favor. There was a debt due Leo from the corporation and he suffered because the corporation was unable to pay what it owed him. Section 23 (k) (4) applies. Cf. . Decision will be entered for the respondent. Footnotes 1. This case differs from , reversed , in which there was no debtor in existence at the time the alleged debt arose.↩