Salomone v. Commissioner

Dominick J. Salomone and Marie M. Salomone, Petitioners, v. Commissioner of Internal Revenue, Respondent Salomone v. Commissioner Docket No. 53846 United States Tax Court 27 T.C. 663; 1957 U.S. Tax Ct. LEXIS 284; January 17, 1957, Filed *284 Decision will be entered for the respondent. 1. During the period 1946 through 1952, petitioner Dominick J. Salomone carried on a sole proprietorship business as a broker and wholesaler of food products. In 1948 and 1949, he invested about $ 7,500 in the common stock of a Florida grapefruit company and at an undisclosed date became its president and manager and as such was instrumental in persuading local citizens to lend the company $ 100,000 and in obtaining for the company a loan of $ 150,000 from the R. F. C. During 1951, he advanced to the company a total of $ 25,000. During the period 1941 through 1952, he had also made advances to other organizations or individuals with whom he had relations either as an employee, stockholder, or in connection with his sole proprietorship business. During the taxable year 1952, the R. F. C. foreclosed on its loan to the Florida company and petitioner's advances to that company of $ 25,000 became worthless. Held, since a debtor-creditor relationship was established between petitioner and the Florida company by virtue of the advances made by petitioner to the company, any deduction for the worthlessness of such advances can be had*285 only under section 23 (k) and not under section 23 (e) of the Internal Revenue Code of 1939. Spring City Foundry Co. v. Commissioner, 292 U.S. 182. Held, further, the losses resulting from the worthlessness of the advances are not deductible under section 23 (k) (1) as business bad debts because the debts were not incurred in, or proximately related to, any trade or business conducted by petitioner, but are only deductible as nonbusiness bad debts under section 23 (k) (4) as determined by the respondent. 2. Petitioner also guaranteed two loans of $ 500 each made by others to the Florida company and in 1952 he made good on his guaranty. Held, the guaranty payments were in the same category as the advances by petitioner and were likewise deductible only as nonbusiness bad debts under section 23 (k) (4). Putnam v. Commissioner, 352 U.S. 82 (1956). Bernard Weiss, Esq., for the petitioners. Emil Sebetic, Esq., for the respondent. Arundell, Judge. ARUNDELL *664 Respondent determined deficiencies in petitioners' income tax for the calendar years 1951 and 1952 in the amounts of $ 2,480.10 and $ 2,641.28, respectively. The principal issue is whether loans of $ 25,000 and guaranty payments of $ 1,000 are deductible as losses under section 23 (e) of the Internal Revenue Code of 1939 or as bad debts under section 23 (k) and, if the latter, whether the debts are deductible during 1952 as business bad debts under section 23 (k) (1) or as nonbusiness bad debts under section 23 (k) (4). Depending upon the outcome of the principal issue, a further issue is whether petitioners are entitled to a net operating loss deduction under section 23 (s) of the 1939 Code for the year 1951. Other adjustments made in the deficiency notice are not at issue except as to some automatic adjustments that will be necessary if the decision is to be made under Rule 50. FINDINGS OF FACT. The stipulation of facts is incorporated*287 herein by this reference. Petitioners are husband and wife residing in Brooklyn, New York. They filed their income tax returns for the taxable years 1951 and 1952 on the cash basis with the then collector of internal revenue for the first district of New York. Petitioner Marie M. Salomone is involved herein only because she filed a joint return with her husband, petitioner Dominick J. Salomone. 1 *665 Between February 19 and December 20, 1951, petitioner made six advances, aggregating $ 25,000, to the Florida Grapefruit Canning Co., Inc., of Bradenton, Florida, hereinafter sometimes referred to as the Florida company or company. This amount was charged off as a business bad debt on petitioner's records and in his tax return for the calendar year 1952. The respondent allowed the deduction as a nonbusiness bad debt, deductible as a short-term capital loss. During 1952, petitioner paid $ 500 to each of two individuals on guaranties, who had advanced*288 said amounts to the Florida company in consideration of such guaranties. This loss of $ 1,000 was also claimed as a business bad debt on petitioner's books and records and on his 1952 income tax return. The respondent allowed the deduction as a nonbusiness bad debt, deductible as a short-term capital loss. During the years 1948 and 1949, petitioner invested a net amount of $ 7,496.68 in the common stock of the Florida company. This sum was charged off as a capital loss on petitioner's books and on his income tax return for 1952, and has been allowed by the respondent. At a date not disclosed by the record herein, petitioner also became the president and an employee of the Florida company. During 1951 and 1952, he devoted a substantial portion of his time and efforts to the management and supervision of the operations of the company. In the tax return for 1951, petitioner reported $ 4,650 as compensation received from the Florida company. The company had been one of the first to engage in the processing and canning of citrus products. The company processed and sold both juice and fruit sections in cans. The plant of the company on a replacement value was worth close to half*289 a million dollars. The outstanding capital stock of the company as of September 16, 1952, was $ 423,162.50. At the time petitioner became interested in the company, the company needed considerable new equipment. It employed over 400 people and needed funds to meet the payroll. Petitioner approached the Reconstruction Finance Corporation (sometimes referred to herein as the R. F. C.), which agreed to lend the company $ 150,000 provided the company raised $ 100,000 of local capital. Petitioner appealed to the spirited citizens of the community and was successful in getting them to lend the company $ 100,000 on certificates of indebtedness at 6 per cent, whereupon the R. F. C. made the loan. At about the same time, the frozen and concentrated juice-processing businesses began to appear on the market with a tremendous amount of advertising and people began to buy the frozen and concentrated product rather than the unfrozen single-strength juice. The company was not equipped to meet this new competition, and its operations continued to be unsuccessful. In order that the company might meet the coming season's operations, petitioner made the six advances referred to above. These*290 loans were evidenced by notes bearing interest at 6 per cent. *666 Petitioner's advances and other efforts were not sufficient to extricate the company from its financial plight and the R. F. C. foreclosed its mortgage in 1952, the company failed, and petitioner's advances became worthless in 1952. The Florida company was not dissolved or liquidated during 1952 and was still in existence at the time of the hearing of this proceeding. After the foreclosure, its liabilities, exclusive of capital stock and paid-in surplus, amounted to $ 212,024.31 and its only assets consisted of the following: Cash $ 0.38 Accounts receivable 3,349.25 Fuel oil 414.00 Organization costs 798.44 $ 4,562.07 During the period 1946 through 1952, petitioner carried on a sole proprietorship business under the name of D. J. Salomone Company, as a broker and wholesaler of food products. The principal products handled by him during this period were tomatoes and other products of Stockton Food Products Corp., of Stockton, California, and codfish processed by various joint ventures of which he was a party. He also reported on his tax returns for 1951 and 1952 various commissions and salaries*291 which he received as an employee-salesman of the Colorado Cheese Company, of Trinidad, Colorado, as a part of the gross receipts from his sole proprietorship during 1951 and 1952. During the taxable years 1951 and 1952, petitioner reported gross profits from his sole proprietorship business as follows: Total receipts from business [1952] or profession $ 49,538.36 $ 31,644.79 Opening inventory $ 3,906.00 $ 6,244.00 Purchases 48,584.70 16,831.57 Total $ 52,490.70 $ 23,075.57 Less closing inventory 6,244.00 None Cost of goods sold 46,246.70 23,075.57 Gross profit $ 3,291.66 $ 8,569.22 Petitioner sold the products of the Florida company in the capacity of an officer or employee of the company. The business of the Florida company and the losses resulting from petitioner's loans to that company had no proximate relation to petitioner's sole proprietorship business. Between July 17, 1941, and December 11, 1952, petitioner made 39 separate loans, aggregating $ 167,759.37, to various named persons, other than the Florida company, summarized as follows: *667 Date Number Recipient Amount 1941-42 [3] Riverbank Canning Co $ 9,000.00 1945-47 [3] Stockton Food Products Corp 27,500.00 [1] Leo Traina 6,000.00 [1] Irwin Zeimer 10,000.00 1941-48 [15] Colorado Cheese Co 47,779.37 1941-47 [12] Riverbank Wine Co 45,480.00 [1] F. Pirrone & Sons 5,000.00 [1] Waterford Winery 10,000.00 [1] Charlotte Harbor Farms, Inc 5,000.00 [1] Jay Trading Co 2,000.00 Total [39] $ 167,759.37 *292 All of these loans, aggregating $ 167,759.37, were repaid to petitioner. The three loans made to the Riverbank Canning Co. by petitioner were made while petitioner was employed by that company as a salesman. He resigned his employment with that company in 1945. Upon severing his connection with Riverbank Canning Co., petitioner's services and financial assistance were solicited by W. A. Bundy, the principal owner of the Stockton Food Products Corp. Petitioner responded with making three loans to this company, one on March 15, 1945, for $ 10,000, one on March 18, 1946, for $ 7,500, and one on March 1, 1947, for $ 10,000. Petitioner had an arrangement with Bundy whereby petitioner could buy merchandise from the Stockton company and sell it for his own account. It was while this arrangement was in effect that petitioner started his sole proprietorship business. The loans to Traina and Zeimer in 1947 and 1948 were in connection with joint ventures between these individuals and petitioner in the dry salted codfish business. These men were up on the Gaspe Peninsula and required money to pay the fishermen. Because of these loans, petitioner obtained several carloads of fish to sell*293 on which he made a profit of from $ 7 to $ 8 a box. Sometime about 1941, petitioner met Paul Surace of the Colorado Cheese Company. Surace explained the manufacture of cheese to petitioner and told petitioner he needed financial assistance for the purpose of acquiring additional facilities, vats, and a storage building and asked petitioner if he would help him in that respect. Petitioner responded with 15 separate loans between July 12, 1941, and November 10, 1948, in amounts ranging from $ 1,000 to over $ 5,000. He also purchased 37 shares of stock in the cheese company in 1948 for $ 3,714.28 in cash. In 1952, petitioner was both an officer and employee of the Colorado Cheese Company, and he also bought cheese from the company to sell for his own account in his sole proprietorship business. Petitioner has been on the payroll of the Riverbank Wine Company ever since it started soon after the repeal of prohibition. During each of the taxable years 1951 and 1952, petitioner reported $ 10,600 as compensation received from that company. Between November 14, 1941, and October 27, 1947, petitioner made 12 loans to the Wine *668 Company in amounts ranging from $ 2,000 to $ 10,000. *294 In 1952, petitioner was both an officer and employee of the company. He did not sell any products of the Wine Company other than as an officer or representative of the company. The loan to F. Pirrone & Sons in 1944 of $ 5,000 was made in connection with the business of the Wine Company. During 1952, petitioner and one Leto organized the Charlotte Harbor Farms, Inc., at Punta Gorda, Florida. On December 11, 1952, petitioner loaned this corporation $ 5,000. The business of the corporation consisted of farming operations, including the raising of tomatoes, cucumbers, and watermelons. It has about 250 acres under cultivation. Petitioner was a stockholder, officer, employee, and creditor of the corporation. He sold the products of the corporation solely in the capacity of an employee. During 1952, petitioner advanced $ 2,000 to the Jay Trading Company in connection with some codfish which he had sold to that company. He did not participate in any way in the promotion, organization, or management of the Jay Trading Company. Petitioner was not engaged in the separate trade or business of promoting, organizing, financing, and managing businesses during 1952. OPINION. Petitioners *295 contend that the total amount of the loans of $ 25,000 and guaranty payments of $ 1,000 is deductible 2 under section 23(k)(1) or, in the alternative, under section 23(e). 3 The respondent contends that the total loss of $ 26,000 is a "non-business debt" as that term is used in section 23(k)(4)3 and shall be considered as a loss from the sale or exchange of a capital asset held for not more than 6 months. *296 As far as the $ 25,000 of loans is concerned, it is clear that since the loans established a debtor-creditor relationship, any deduction for the *669 worthlessness thereof can be had only under section 23(k) and not under section 23(e) for the reason that the two subsections (e) and (k) are mutually exclusive. Spring City Foundry Co. v. Commissioner, 292 U.S. 182 (1934). Whether the debt is deductible as a business bad debt under section 23(k)(1) or as a nonbusiness bad debt under section 23(k)(4) depends upon whether the debt is one the loss from the worthlessness of which is or is not incurred in the taxpayer's trade or business. "The question whether a debt is one the loss from the worthlessness of which is incurred in the taxpayer's trade or business is a question of fact in each particular case." Sec. 39.23(k)-6, Regs. 118. This section of the regulations 4 also provides in part as follows: (b) The character of the debt for this purpose is not controlled by the circumstances attending its creation or its subsequent acquisition by the taxpayer or by the use to which the borrowed funds are put by the recipient, but is to be determined*297 rather by the relation which the loss resulting from the debt's becoming worthless bears to the trade or business of the taxpayer. If that relation is a proximate one in the conduct of the trade or business in which the taxpayer is engaged at the time the debt becomes worthless, the debt is not a nonbusiness debt for the purposes of this section. [Emphasis supplied.] In Jan G. J. Boissevain, 17 T. C. 325, 329, we recognized as a statutory requirement*298 "that the year of the loss is the year in which must exist the proximate relation of the loss to the taxpayer's business in that year." In the instant case the year of the loss is the year 1952. In that year petitioner was still engaged in his sole proprietorship business as a broker and wholesaler of food products. Petitioner has not shown, however, that the worthless debt had any relation to the sole proprietorship business. At one place in the record, petitioner testified that the D. J. Salomone Company, which was the name under which petitioner did business as a sole proprietor, was the agent for the Florida company. Although petitioner reported total gross receipts from this sole proprietorship business in 1952 of $ 31,644.79, he was not able, under intensive questioning by counsel for respondent, to show that any of these receipts had any relation to the Florida company. Other testimony given by petitioner was that the grapefruit he sold was sold by him as an employee of the Florida company. The business of that company is not petitioner's business. Dalton v. Bowers, 287 U.S. 404; Burnet v. Clark, 287 U.S. 410;*299 Commissioner v. Smith, (C. A. 2, 1953) 203 F. 2d 310, reversing Weldon D. Smith, 17 T. C. 135; Jan G. J. Boissevain, supra;Estate of William P. Palmer, Jr., 17 T. C. 702; Langdon L. Skarda, 27 T. C. 137. We have, *670 therefore, found as an ultimate fact that the loss resulting from petitioner's loans to the Florida company had no proximate relation to petitioner's sole proprietorship business. It is obvious, of course, that an individual may have more than one trade or business at the same time. In Langdon L. Skarda, supra, we said: A worthless debt, resulting from a loan by a stockholder to his corporation, may qualify as a business bad debt if the stockholder was in reality engaged in the trade or business of promoting, organizing, managing, financing, and making loans to business enterprises. Henry E. Sage, 15 T. C. 299; Vincent C. Campbell, 11 T. C. 510. In such a case the taxpayer, though a stockholder in the corporation to*300 which he loaned money, is also in the business of being a "promoter" of business enterprises, and the loss resulting from the bad debt would be proximately related to that business. Petitioner relies heavily upon these so-called promoter cases and especially the case of Giblin v. Commissioner, (C. A. 5, 1955) 227 F. 2d 692, reversing a Memorandum Opinion of this Court. In Charles G. Berwind, 20 T. C. 808, affirmed per curiam (C. A. 3, 1954) 211 F. 2d 575, we determined that the authority contained in such promoter cases as referred to above "is applicable only to the exceptional situations where the taxpayer's activities in promoting, financing, managing, and making loans to a number of corporations have been regarded as so extensive as to constitute a business separate and distinct from the business carried on by the corporations themselves." In 1952, the year in which must exist a "trade or business" and a "proximate relationship" of the bad debts to such business, the record shows that in addition to his sole proprietorship business, petitioner with another person organized the Charlotte*301 Harbor Farms, Inc., to which corporation petitioner loaned $ 5,000. In 1952, he also made a loan of $ 2,000 to the Jay Trading Company in connection with some codfish which he had sold to that company. He was also, in 1952, a stockholder, officer, and employee of each of the Riverbank Wine Company and the Colorado Cheese Company. We do not think these activities are extensive enough to establish the existence of a separate business of promoting, organizing, financing, and managing businesses during 1952 and we have so found as an ultimate fact. On very similar facts the Court of Appeals for the Second Circuit, to which court an appeal would lie in this case, reached a like view to that at which we arrive. Commissioner v. Smith, supra;Hickerson v. Commissioner, (C. A. 2, 1956) 229 F. 2d 631, affirming a Memorandum Opinion of this Court. We think that a comparison of the facts in Henry E. Sage, 15 T. C. 299, Vincent C. Campbell, 11 T. C. 510, and Giblin v. Commissioner, supra, and other cases relied upon by petitioner, *302 with the facts in the instant case makes the cases relied on readily distinguishable. We, therefore, hold that *671 the debt of $ 25,000 is deductible only as a nonbusiness bad debt under section 23 (k) (4). As far as the $ 1,000 of guaranty payments is concerned, it is now settled that they should receive the same treatment as we have given to the $ 25,000 of loans. See Putnam v. Commissioner, 352 U.S. 82 (1956), which affirmed Putnam v. Commissioner, (C. A. 8, 1955) 224 F. 2d 947, which in turn affirmed our Memorandum Findings of Fact and Opinion filed May 12, 1954. It thus becomes unnecessary to consider the issue relating to the net operating loss deduction. Decision will be entered for the respondent. Footnotes 1. Hereafter, the husband will be referred to as petitioner.↩ 2. Unless otherwise indicated, all references to section numbers used herein have reference to section numbers of the Internal Revenue Code of 1939.↩ 3. SEC. 23. DEDUCTIONS FROM GROSS INCOME. In computing net income there shall be allowed as deductions: * * * * (e) Losses by Individuals. -- In the case of an individual, losses sustained during the taxable year and not compensated for by insurance or otherwise -- (1) if incurred in trade or business; or (2) if incurred in any transaction entered into for profit, though not connected with the trade or business; or * * * * (k) Bad Debts. -- (1) General rule. -- Debts which become worthless within the taxable year; * * * This paragraph shall not apply in the case of a taxpayer, other than a corporation, with respect to a nonbusiness debt, as defined in paragraph (4) of this subsection. * * * * (4) Non-business debts. -- In the case of a taxpayer, other than a corporation, if a non-business debt becomes worthless within the taxable year, the loss resulting therefrom shall be considered a loss from the sale or exchange, during the taxable year, of a capital asset held for not more than 6 months. The term "non-business debt" means a debt * * * other than a debt the loss from the worthlessness of which is incurred in the taxpayer's trade or business.↩ 4. This section of Regulations 118 is the same as section 29.23 (k)-6 of Regulations 111 except for stylistic changes, revision of section numbers and references, and change of dates in the illustrations. Section 29.23 (k)-6 of Regulations 111 was derived from H. Rept. No. 2332, 77th Cong., 2d Sess., p. 76, 1942-2 C. B. 431, and in Hickerson v. Commissioner, 229 F. 2d 631↩, the Second Circuit referred to this part of Regulations 111 and said, "We think this is a valid regulation."