Bramer v. Commissioner

Samuel Eugene Bramer, Petitioner, v. Commissioner of Internal Revenue, Respondent Bramer v. Commissioner Docket No. 6715 United States Tax Court 6 T.C. 1027; 1946 U.S. Tax Ct. LEXIS 196; May 9, 1946, Promulgated *196 Decision will be entered under Rule 50. 1. A syndicate was formed in September 1929, composed of the petitioner and two business associates, for the purpose of buying and selling the shares of stock of a certain corporation. Profits and losses were to be shared equally. The syndicate purchased 60,000 shares of the stock at a cost of $ 236,752.50. The syndicate borrowed this amount of money from a bank upon a joint note signed by the petitioner and his two associates, collateralized by the 60,000 shares plus additional securities belonging to petitioner's associates. The syndicate was closed out in 1935 at a large loss. On August 1, 1935, the petitioner gave his promissory note in the amount of $ 100,839.17, which evidenced the amount of his loss on the syndicate operations, plus interest paid by his associates for him, plus an amount of collateral of his associates which was used to pay his indebtedness to the bank on two other notes of the petitioner held by it. In 1941 the petitioner paid $ 13,492.70 on the principal of the note, which amount he claimed as a deduction from gross income in his return for that year. Held, that the deduction was properly disallowed by*197 the respondent, except as to the aliquot part of the interest included in the $ 13,492.70 payment. 2. In October 1929 petitioner's associate in business, L. B. Foster, purchased 5,000 shares of stock of a corporation at a cost of $ 30,000. Petitioner entered into an agreement with Foster whereby gains and losses from the sale of the shares were to be shared equally. The shares were sold at a large loss. On December 31, 1930, petitioner gave Foster his promissory note in the amount of $ 14,034.85 to cover his share of the loss, plus interest. In 1941 the petitioner paid a balance due on the principal of the note in the amount of $ 2,534.85. Held, that the amount is a legal deduction from gross income. Samuel Kaufman, Esq., and T. G. Councilor, C. P. A., for the petitioner. Richard L. Shook, Esq., for the respondent. Smith, Judge. SMITH *1028 This proceeding is for the redetermination of a deficiency in income tax for 1941 in the amount of $ 14,560.18. The questions in issue are: (1) Whether the petitioner is entitled to deduct from gross income in his income tax return for 1941 $ 13,492.70, or any part thereof, representing the payment of a part of the*198 principal of a note given by the petitioner on August 1, 1935. (2) Whether the petitioner is entitled to deduct from the gross income of 1941 the amount of $ 2,534.85 representing the balance paid on a note given by the petitioner on December 31, 1930, representing his share of a loss on the purchase of shares of stock made by petitioner's associate in 1929. The payment is claimed as a deduction upon the ground that the petitioner had no ownership of the shares purchased by his associate and that, since he made his income tax returns on a cash basis, the loss is deductible from gross income of the year in which a loss was paid. The facts were in large part stipulated. The stipulation of facts is incorporated in our findings of fact by reference. FINDINGS OF FACT. The petitioner is a resident of Aspinwall, Pennsylvania. He filed his income tax return for 1941 with the collector of internal revenue for the twenty-third district of Pennsylvania, at Pittsburgh. For a number of years prior to 1929 the petitioner was (and still is) president of Copperweld Steel Co., whose plant is in Pittsburgh. The company is engaged in the manufacture of Copperweld wire, with steel in the center and*199 copper on the exterior. Prior to the middle of 1929 the petitioner had never speculated in securities. In the summer of 1929 he became interested in International Rustless Iron Corporation, which was developing a novel method of stainless wire. That company was in need of capital and Copperweld Steel Co. was interested in the use of stainless steel wire in the place of Copperweld wire for part of its production. Copperweld Steel Co. purchased 200,000 shares of International Rustless Iron Corporation in the fall of 1929 at a price of $ 3 per share. The president of the Bank of Pittsburgh, N. A., was the chairman of the board of directors of Copperweld Steel Co. The bank gave the petitioner an oral option to buy 18,800 shares of Rustless stock at a price of $ 3 per share. At the same time it gave L. B. Foster and William K. Frank, who were directors of Copperweld Steel Co. and friends of the petitioner, like options to purchase 10,500 shares and 12,500 shares, respectively, at the same price. Frank and Foster invited the petitioner to participate in a syndicate for the purchase of 60,000 shares of Rustless stock. Petitioner was without sufficient funds or collateral of his own*200 to finance the purchase of the 18,800 shares which had been allotted to him and he agreed to *1029 pool his allotment with those of Foster and Frank after they had assured him that they would finance and handle the syndicate without any contribution of cash or securities by him. The petitioner accepted the proposition. A syndicate agreement dated September 24, 1929, signed by the petitioner, Foster, and Frank, reads in material part as follows: At a special meeting called Monday, September 23, 1929, a Syndicate was formed to be known as the Bramer, Foster, Frank Syndicate, Lee B. Foster, Trustee, and W. T. Davidson, Secretary, to operate in the purchase and sale of International Rustless Iron Corporation stock. It was agreed that Messrs. Lee B. Foster and William K. Frank were to finance the Syndicate by negotiating a loan through The Bank of Pittsburgh, N. A., secured by the following: 236 shares Weirton Steel Company owned by Wm. K. Frank 250 shares Weirton Steel Company owned by Lee B. Foster The Bramer, Foster, Frank Syndicate is composed of Messrs. S. E. Bramer, Lee B. Foster, and Wm. K. Frank. Each member is to receive one-third of the net profits from the sale *201 of the International Rustless stock, or one-third of all such stock remaining at the termination of the Syndicate after all debts have been paid and the above mentioned Weirton Steel, or any other borrowed securities, returned to its respective owners. It is also agreed that any losses sustained by the Syndicate shall be borne equally. It is further agreed that this Syndicate may be terminated, or any of the stock sold, upon the written direction of any two members. Along the lines of the above agreement, the following purchases of International Rustless Iron Corporation stock have been made: * * * * [60,000 shares total cost $ 236,752.50.] All shares of the International Rustless Iron are to be paid for as delivered, and when delivery is completed the Syndicate will contain 60,000 shares at a total cost of $ 236,752.50. * * * * Foster and Frank negotiated a loan from the Bank of Pittsburgh, N. A., in the amount of $ 236,752.50. One note signed by petitioner, Foster, and Frank was given to the bank to evidence that loan and the bank held all the 60,000 shares of Rustless stock purchased as collateral on the loan. None of the 60,000 shares of Rustless stock were ever registered*202 in petitioner's name and at least 41,800 of the shares were in street names. From January 1, 1930, to July 14, 1930, 21,849 of the 60,000 shares of Rustless stock owned by the syndicate were sold for $ 45,209.55, and the proceeds were applied on the loan by the Bank of Pittsburgh, N. A. The petitioner claimed on his 1930 return a loss of $ 13,667.41, being one-third of the excess of the average cost of 21,849 shares over the sales price thereof. Between September 23, 1929, and July 14, 1930, Weirton Steel Co. was reorganized into National Steel Corporation and William K. Frank deposited additional collateral on the syndicate note, with the result that at July 14, 1930, the collateral deposited with the Bank *1030 of Pittsburgh, N. A., as security for the unpaid balance of the loan of $ 236,752.50 was as follows: William K. Frank, 2,000 shares National Steel Corporation common. Lee B. Foster, 1,161 shares National Steel Corporation common. S. E. Bramer, nothing. Bramer, Foster, Frank Syndicate, 38,151 shares International Rustless Iron Corporation stock. On January 14, 1931, the petitioner gave to the Bank of Pittsburgh, N. A., his individual note in the amount of $ 66,647.64, *203 representing one-third of the unpaid balance of the loan mentioned above, and, pursuant to arrangements made with the bank by William K. Frank, the bank continued to hold as collateral on petitioner's note the 2,000 shares of National Steel Corporation stock previously deposited by Frank as collateral on the joint note and 12,717 shares, one-third the balance of 38,151 shares, of International Rustless Iron Corporation remaining in the hands of the bank after the sales in 1930 of 21,849 shares out of the original 60,000 shares. Foster and Frank made all arrangements with the bank for the split-up of the syndicate note into three parts without consulting petitioner and the only thing petitioner was asked to do was to sign a new note for $ 66,647.64 after Frank and Foster had settled with the bank for the other two-thirds of the balance of $ 199,942.93. The 12,717 shares of Rustless stock mentioned above were not registered in petitioner's name, but were continued to be held by the bank in street names after January 14, 1931, the same as before. At January 14, 1931, the Bank of Pittsburgh, N. A., held two other notes of petitioner on which the unpaid balances were $ 2,077.17 and $ *204 15,915.94, respectively. One of these notes had been given to the bank by the petitioner on October 2, 1929, in the original amount of $ 17,400, secured by collateral consisting of 7,000 shares of Rustless stock. The second note had been given on June 17, 1930, for $ 15,915.94, collateralized as follows: 100 shares International Telephone & Telegraph Co. 300 shares Lone Star Gas Corporation. Also loan of $ 10,733.88 secured by 7,500 shares International Rustless Iron. These two notes and the above mentioned note for $ 66,647.64 provided that the property deposited as collateral security for payment of each note was also secured for "any other liability or liabilities of the undersigned to the holder hereof, now due or to become due, or that may be hereafter contracted." From the inception of the transactions relating to the Bramer, Foster, Frank Syndicate to August 5, 1935, (a) no payment of any kind was made by the petitioner or by anyone on his behalf on account of the transactions described above relating to the syndicate *1031 operations other than the payments and credits mentioned below, and (b) all the shares of Rustless stock, namely, 38,151 shares, were held *205 by the Bank of Pittsburgh, N. A., as collateral security until sold by the bank. From October 3, 1932, to August 1, 1935, the Bank of Pittsburgh, N. A., received, and applied on the principal and interest of the petitioner's three notes, dividends from 2,000 shares and proceeds of sales of 1,880 shares of stock of National Steel Corporation deposited by Frank in amounts aggregating $ 101,051.11. In May 1935 the bank sold the 38,151 shares of Rustless stock. The aggregate credits from May to August 1935 on the note of $ 66,647.64 and accrued interest thereon were out of proceeds of sales of National Steel stock (aggregating $ 101,051.11) and out of the proceeds of sales of Rustless stock by the bank as follows: Principal, $ 66,647.64, and interest, $ 16,040.37. Petitioner's other two notes were paid out of the remaining proceeds of the collateral held by the bank. Petitioner had nothing to do with the arrangements for the sales by the Bank of Pittsburgh, N. A., of any of the National Steel or Rustless shares. The sales were ordered by Frank and the bank did not consult the petitioner. Prior to August 1, 1935, W. K. Frank, whose collateral had largely been used in paying off the*206 debt to the bank, transferred all of his claims against the petitioner to W. K. Frank, Inc. The petitioner gave to such corporation his promissory note dated August 1, 1935, in the amount of $ 100,839.17 to cover the dividends from and proceeds of sales of Frank's collateral applied by the bank on petitioner's notes, less a small amount of cash refund to Frank by the bank in 1935 out of the proceeds of the sale of Rustless stock. Included in the principal of the note of $ 100,839.17 was $ 19,539.51 interest which had been paid by Frank on behalf of the petitioner. Petitioner claimed as deductions on his 1935 return the interest of $ 19,539.51 which had been paid on his behalf by Frank in that year. He did not claim the deduction of any loss upon the sale of his pro rata share of the 38,151 shares of Rustless stock which had been owned by the syndicate. The respondent, however, on an audit of petitioner's 1935 return, determined that the petitioner sustained a loss of $ 86,203.33 from the sale of his collateral and his interest in the syndicate stock and allowed the deduction of a capital loss limited to $ 2,000. In 1941 the petitioner paid $ 13,492.70 on the principal of his note*207 of $ 100,839.17 given by him on August 1, 1935, and interest of $ 2,672.20. In the determination of the deficiency the respondent allowed the deduction of the interest paid in the amount of $ 2,672.20 but disallowed the deduction of $ 13,492.70 paid on the principal of *1032 the note. The deduction of the interest in the amount of $ 2,672.20 is not involved in this proceeding. On or about October 2, 1929, L. B. Foster purchased 5,000 shares of Rustless stock for $ 30,000 or at the rate of $ 6 per share. After the purchase Foster asked the petitioner and Frank to participate with him in the profits and losses on these shares. Frank refused to go along. Petitioner informed Foster that he did not have the funds to put up. Foster stated that he had already made the purchase and would purchase and finance the transaction. The petitioner agreed with Foster to share to the extent of 50 percent any profits or losses which might be realized in connection with future sales which might be made of these 5,000 shares of stock. Petitioner paid out no cash in connection with this transaction nor did he deposit any collateral, the entire deal being financed by Foster and his brothers. *208 During the first six months of 1930, 1,817 of the 5,000 shares were sold at an aggregate selling price of $ 3,761.19, leaving 3,183 shares unsold, and the proceeds of the sale or sales were retained by the Foster interests. Thereafter, and as a result of the foregoing transactions, petitioner gave his demand, unsecured, promissory note dated December 31, 1930, to L. B. Foster, trustee, who was the nominee of Foster. This note was in the amount of $ 14,034.85 and included accrued interest in the amount of $ 915.45. This note in the amount of $ 14,034.85, together with the remaining 3,183 shares of Rustless stock, were subsequently acquired by L. B. Foster Co., a corporation. In July 1933 International Rustless Iron Corporation was reorganized as Rustless Iron & Steel Corporation and shareholders of the old company received one share of no par common stock of the new company for each 20 shares of $ 1 par value common stock of the old company. Thus, the remaining 3,183 shares of the old company were converted into 159.15 shares of the new company, which shares were sold by L. B. Foster Co. during 1939 for an aggregate selling price of $ 2,300.45, of which one-half, or $ 1,150.23, was*209 credited on the petitioner's note of $ 14,034.85. Petitioner was not consulted by the Foster interests with respect to the sales in 1930 and 1939 of the Rustless shares. He was informed about the sales after they had been made. Petitioner claimed no deduction on his returns for 1930 and 1939 on account of the 1930 and 1939 sales of the 5,000 shares of Rustless stock by the Foster interests, but on audit of his 1939 return the respondent allowed him a loss of $ 4,199.39 (50 percent of $ 8,398.78) on account of the 1939 sale. In years prior to 1941 the petitioner partially paid off his note *1033 to Foster. During 1941 he paid in cash $ 2,534.85 representing the remaining unpaid principal of the note originally given and claimed the deduction of this amount from gross income in his income tax return for 1941, which deduction was disallowed by the respondent. For a number of years prior to 1941 the petitioner owed debts of more than $ 600,000. These debts far exceeded his assets. His financial condition gradually improved and much of his income for 1941 and for a number of prior and subsequent years was used in liquidating his debts. The petitioner has always filed his income*210 tax returns on a cash basis. OPINION. The first question presented is the right of the petitioner to deduct from his gross income of 1941 $ 13,492.70 paid in 1941 on the principal of the note for $ 100,839.17 given by him on August 1, 1935. Petitioner claims the right to this deduction upon the ground that his return for 1941, as well as for all prior years, was made on the cash receipts and disbursements basis and that, since he had never had any benefit of the deduction of any part of the $ 13,492.70 in years prior to 1941, the loss is a legal deduction from gross income of the taxable year. The position of the respondent is that the petitioner was a part owner of the 60,000 shares of Rustless stock purchased by the syndicate in 1929 at a cost of $ 236,752.50; that the petitioner correctly claimed on his return for 1930 his pro rata share of the loss sustained by the syndicate from the sale by the bank of 21,849 shares of Rustless stock on July 14, 1930, namely, $ 13,667.41; that the respondent correctly determined that the petitioner in 1935 sustained one-third of the syndicate's loss from the sale in that year of the balance of the Rustless stock held by the bank as collateral*211 on the syndicate's original note; and that the petitioner is not entitled to deduct any part of the $ 13,492.70 paid by him in 1941 on the principal of his note; that such payment was simply a liquidation of a liability of the petitioner, which did not result in a deductible loss. The evidence shows that the petitioner and his two associates, Frank and Foster, borrowed $ 236,752.50 from the Bank of Pittsburgh, N. A., in 1929 upon collateral consisting in part of the 60,000 shares of Rustless stock owned by the syndicate; that additional collateral was provided by Frank and Foster. The 60,000 shares of Rustless stock was owned by the syndicate. It is immaterial that the shares were in street names. The bank held the collateral merely as security upon the joint note of the three members of the syndicate. It did not have the ownership of those shares except as security upon the loan. If the note had been paid by the makers the collateral would have been returned to the depositors, regardless of its value at the time. *1034 We are of the opinion that the respondent is correct in his contention that the petitioner sustained deductible losses of one-third of the net losses sustained*212 by the syndicate on the sales of shares of Rustless stock by the bank in 1930 and 1935. The petitioner was as much an owner of one-third of those shares as either of the other members of the syndicate. The facts in this case are much the same as those which obtained in J. J. Larkin, 46 B.T.A. 213. In that case the taxpayer and others had executed a joint note to a bank for the purpose of acquiring stock then pledged by other borrowers as security for their loan. The amount of the loan to the taxpayer and his associates was applied in cancellation and satisfaction of the note of the parties from whom the stock was being purchased, and the stock was retained by the bank as collateral for the new loan. Subsequently the original note of the taxpayer and his associates was canceled and separate notes were executed by each, secured by an aliquot part of the collateral then held by the bank, the taxpayer having also deposited other collateral and his note being also secured by a general guaranty of his associates. In 1934 the collateral deposited by the taxpayer was sold for a nominal sum and prior to 1935 it became worthless. In 1936 the taxpayer paid*213 approximately $ 11,000 upon his indebtedness to the bank, but was reimbursed by a business associate for one-half of the amount. The taxpayer claimed a deduction of the $ 5,500 from his gross income for 1936. We held that the loss was sustained in a year prior to 1936, following A. W. D. Weis, 13 B.T.A. 1284. Our opinion in that case is dispositive of the present issue. We hold that the petitioner is not entitled to deduct from his gross income of 1941 any part of the loss sustained by him upon the sale of the syndicate's collateral in 1930 and in 1935. It is also to be noted that in the principal of the note were included, in addition to the petitioner's one-third loss on the sales of Rustless stock by the bank in 1930 and 1935, certain other amounts which had been used by the bank out of sales of collateral belonging to his associates for the purpose of liquidating petitioner's liability on other notes. To the extent of such amounts included in the principal of the note, there is no ground for contending that they resulted from losses sustained upon the sales of the 60,000 shares of Rustless stock. The petitioner makes the further contention *214 that, if he is not entitled to deduct the full amount of the $ 13,492.70 here in question, he is entitled to deduct from his gross income of 1941 a pro rata share of the $ 19,539.51 interest included in the principal amount of $ 100,839.17. This contention is based upon the claim that under the statute a person making his returns on the cash receipts and disbursements basis is entitled to deduct interest when paid and that the giving of the note by the petitioner on August 1, 1935, in the principal *1035 amount of $ 100,839.17 was not a payment of the $ 19,539.51 of interest owed by the petitioner at that time. It has many times been held that a taxpayer making his returns on the cash basis is not entitled to deduct interest represented by the giving of a promissory note. See George S. Silzer, 39 B.T.A. 841, and cases cited therein. We are of the opinion that this contention of the petitioner is well founded. When the petitioner made his payment of $ 13,492.70 in 1941 he was in part paying interest that was included in the face amount of the note given by the petitioner on August 1, 1935. The aliquot part of the $ 19,539.51 included in the *215 $ 13,492.70 payment made in 1941 is $ 2,614.47. We are of the opinion that the petitioner is entitled to the deduction of this amount of interest paid in 1941. The record indicates that in 1935 the petitioner deducted from gross income an amount of interest paid by the giving of the promissory note. The petitioner was not entitled to any such deduction. Error in the 1935 return should be corrected in accordance with section 3801 of the Internal Revenue Code. The second question presented is the right of the petitioner to deduct from his gross income of 1941 $ 2,534.85 paid upon the principal of his note given December 31, 1930, in the total amount of $ 14,034.85. The payment made in 1941 was the balance due on that note. The facts with regard to this transaction are substantially different from those relating to the syndicate transaction. Under the agreement which the petitioner made with Foster he was to bear one-half of any loss which might be sustained by Foster upon the sale of 5,000 shares of Rustless stock. Those 5,000 shares belonged to Foster. The petitioner had no deductible loss when those shares were sold at a large loss; this for the reason that he had no ownership*216 of them. His out-of-pocket loss was when he made his settlement with Foster. The deduction of a loss by the petitioner had to be deferred until the payment was made. A payment of the balance of the note of $ 2,534.85 was when the loss was sustained by the petitioner. This follows from our holding in E. L. Connelly, 46 B.T.A. 222. The facts in that case were that a business associate of the taxpayer acquired bank stocks, borrowing the money and pledging stocks as collateral. Thereafter an agreement was made under which the two were to share equally the profits or losses resulting. The collateral was sold in 1934 and became worthless prior to January 1, 1935. The taxpayer's associate in 1936 paid the bank approximately $ 11,000 and the taxpayer paid him one-half of that amount. We held that under the stipulated facts the taxpayer's loss was sustained when his obligation was performed and his payment was made, citing Eckert v. Burnet, 283 U.S. 140, 75 L. Ed. 911, 51 S. Ct. 373. We further pointed out in our opinion in that case that the parties were not joint adventurers since they had not contributed either money or *1036 property in*217 carrying out an adventure for their common benefit. The same is true with respect to the present proceeding. We therefore hold that the respondent erred in his disallowance of the deduction from gross income of the $ 2,534.85 in question. Decision will be entered under Rule 50.