MacMillan v. Commissioner

H. R. MACMILLAN, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. MacMillan v. Commissioner Docket No. 6602. United States Board of Tax Appeals 14 B.T.A. 1367; 1929 BTA LEXIS 2947; January 17, 1929, Promulgated *2947 1. Respondent's determination of amount of loss on stock which became worthless, approved. 2. Certain deductions claimed by the petitioner as ordinary and necessary business expenses, disallowed. 3. Money expended by the petitioner in court proceedings in an effort to uncover property subject to the payment of a judgment owned by the petitioner, held deductible as an ordinary and necessary business expense. A. Calder Mackay, Esq., for the petitioner. C. H. Curl, Esq., for the respondent. MARQUETTE *1367 This proceeding is for the redetermination of deficiencies in income taxes asserted by the respondent in the amounts of $456.62 for the year 1921 and $19,459.63 for the year 1922. The deficiencies arise from the disallowance by the respondent of deductions claimed *1368 by the petitioner as ordinary and necessary business expenses and as a loss sustained on certain mining stock. FINDINGS OF FACT. The petitioner was during the years 1921 and 1922, and had been for many years, a practicing attorney at Salt Lake City, Utah. Among his clients were E. R. Wooley and the Great Basin Sugar Co., in which company Wooley owned*2948 all of the capital stock except qualifying shares. The petitioner had represented these clients for a number of years and had assisted them in making profits of more than $2,000,000. In 1921 one Rich, secretary of the Great Basin Sugar Co., informed the petitioner that Wooley was making some questionable investments and intimated that the finances of the corporation were not in the best possible shape. The petitioner thereupon took up with Wooley and Rich the matter of his fees and they agreed that the petitioner was entitled to an additional fee of $225,000 for his services extending over a considerable period of time prior thereto. Wooley admitted that he had no money and that the corporation had no money with which to pay the fee, and he then suggested that the corporation would cause to be deeded to the petitioner, ranch property in Nevada aggregating about 1,600 acres, the title to which was in the Livingston Land and Cattle Co., all of whose capital stock was owned by the Great Basin Sugar Co., and that the petitioner should organize a corporation, transfer the ranch property to it, receive in exchange all of its capital stock, and hold the stock as security for the payment*2949 of his fee, until such time as the Great Basin Sugar Co. should have realized from some of its investments, when it would then pay the petitioner $225,000 and take over the stock. The petitioner consented to this arrangement and the ranch property was immediately transferred to him, and he in turn organized the Clark County Investment Co., a corporation, and transferred the said ranch to that corporation in exchange for its capital stock. The petitioner has held such stock from said date and still holds it. He has never opened a bank account in the name of the corporation, but receives the money from said ranch and deposits the same to his individual account and runs the business as an individual. The expense of organizing the Clark County Investment Co. amounted to $438.73, which the petitioner paid in the year 1921. After the transfer of the ranch to the petitioner, and in turn by him to the Clark County Investment Co., it developed that there were several liens against the property and unpaid bills for labor and water *1369 rent, amounting to $7,229.33, which the petitioner paid in the year 1922 at the request of Wooley and upon his promise that he would repay the*2950 petitioner. In January, 1922, one DeRekowsky secured a judgment for $50,000, together with interest and costs, against the Great Basin Sugar Co., and execution was issued and returned nullo Bono, whereupon his attorney endeavored by other means to find property belonging to the Great Basin Sugar Co. which would be subject to the judgment lien. He discovered that the ranch property held by the Clark County Investment Co. had at one time belonged to the Great Basin Sugar Co., and he threatened to institute suit against the Clark County Investment Co. and the petitioner for the purpose of setting aside the transfer of the ranch and subjecting it to the satisfaction of the DeRekowsky judgment. In order to avert such litigation, and further to protect his fee, and also believing that he could discover other assets of the Great Basin Sugar Co., the petitioner purchased the judgment for $59,558.10. The petitioner then sought to discover assets of the Great Basin Sugar Co. and of Wooley, and employed an attorney and instituted court proceedings for that purpose, but his efforts were unsuccessful. In this effort he expended $3,176.41 in attorney's fees and costs in the year 1922. *2951 Neither Wooley nor the Great Basin Sugar Co. had any property in the year 1922. The petitioner in 1907 purchased 1,700 shares of Little Belle Mining Co. stock for $17,000. The mine was operated up to 1912, when operations ceased, and it was inoperative from that time until 1922, when it was placed in the hands of a receiver and the stock became worthless. There was no active market for the stock of the company on March 1, 1913, and apparently no sales were made near that date, but there was a "bid and asked" market value of 25 cents per share on the exchange. The March 1, 1913, value of such stock was 25 cents per share. The petitioner in his income-tax return for the year 1921 deducted in computing his net income the amount of $438.73, which he had expended in organizing the Clark County Investment Co. In his income-tax return for the year 1922 he deducted in computing his net income the amount of $7,229.33, which he had expended in that year for the purpose of discharging certain obligations of the Navada ranch, and the amount of $17,000 as a loss on the Little Belle Mining Co. stock; and the amounts of $59,558.10 and $3,176.41 as ordinary and necessary business expenses*2952 in buying and attempting to collect the DeRekowsky judgment. The respondent disallowed the deductions. *1370 OPINION. MARQUETTE: There are five assignments of error in this proceeding, four being connected with one transaction. The other, which relates to petitioner's alleged loss on mining stock, we will dispose of first. The petitioner, in 1907, acquired 1,700 shares of Little Belle Mining Co. stock at a cost of $17,000. Prior to March 1, 1913, the mine had ceased operations and it continued inoperative until 1922, when the company went into the hands of a receiver and the stock became worthless. There was no active market for the stock on March 1, 1913, but there was a bid and asked price of 25 cents per share on the exchange at that date. The petitioner claims that he sustained a loss on this stock in 1922 in the amount of $17,000, which is deductible in computing his net income for that year. The respondent has allowed a deduction computed at the rate of 25 cents per share on 17,000 shares, or a total of $425. The only competent evidence before us as to the March 1, 1913, value of the shares of stock in question is the bid and asked price on the exchange, *2953 and on the record we can only affirm the respondent's determination that the deductible loss was $425. The four other assignments of error relate to certain deductions set forth in the findings of fact, which the petitioner claimed as ordinary and necessary business expenses connected with the Nevada land transaction. The first item is the amount which the petitioner expended in organizing the Clark County Investment Co. The amount so expended must be considered as an expense of the corporation and not of the petitioner, and it is a capital expenditure and not an ordinary and necessary business expense. As far as the petitioner is concerned, he either advanced this amount of money for and on behalf of the corporation and became its creditor to that extent, or he contributed it as paid-in capital. In either event it was not an ordinary and necessary business expense to him. We find no error in the determination of the respondent on this point. The petitioner also claims deductions as necessary expenses of amounts totaling $7,229.33, which he expended in 1922 in removing certain liens and paying certain bills which stood against the ranch. Repayments of these amounts was*2954 promised by Wooley, the petitioner's client. These expenditures, therefore, were, and were doubtless considered at the time merely advances made either to Wooley or to the Nevada corporation. For the purpose of this proceeding it makes no difference which one was the debtor. While the expenditures may have had the effect of protecting the security for the petitioner's large fee due from Wooley and the Great Basin Sugar Co., *1371 they were, nevertheless, loans by him which were to be repaid, and did not constitute ordinary and necessary business expenses in any trade or business. We sustain the respondent's determination on this point. The next item is the amount of $59,558.10 which the petitioner claims as a deduction as an ordinary and necessary business expense on account of the purchase of the DeRekowsky judgment. The evidence shows that DeRekowsky had obtained a judgment against the Great Basin Sugar Co. in the amount of $50,000, together with interest and costs, and was threatening suit to set aside the transfer of the Nevada land and subjecting it to the payment of the judgment. The petitioner, in order to avoid litigation, and to protect the security for his*2955 fee, purchased the judgment for $59,558.10. He was also influenced in purchasing the judgment by the belief that he could uncover other assets of the Great Basin Sugar Co. which would be subject to the judgment. Whether DeRekowsky could have set aside the transfer of the Nevada lands we do not know. However, the petitioner apparently thought that there was at least a possibility that he could. If the judgment could have been enforced by DeRekowsky against the Nevada land, the value of the petitioner's security would have been reduced by that amount. The petitioner was, therefore, purchasing, in order to protect himself, the value of what he thought DeRekowsky might recover. This is not, in our opinion, an ordinary and necessary expense but is more in the nature of a capital expenditure, the gain or loss from which can not be determined until the petitioner forecloses on the stock which he holds as security and determines how much will be realized therefrom. They are so closely connected that they can not be separated, one from the other. We hold that the petitioner is not entitled to any deduction in 1922 on account of this item. The petitioner also claims a deduction as*2956 an ordinary and necessary business expense for the year 1922, the amount of $3,176.41, which he expended in his efforts to collect the judgment above discussed. This deduction was disallowed by the respondent on the ground that it was a capital expenditure. We can not agree with this theory of the respondent. The amount in question was made up of court costs and other expenses incident to proceedings for the discovery of property subject to execution. It was an expense, not a capital expenditure. It was not a personal expense, but one incident to the petitioner's business affairs and as such it should have been allowed as a deduction in 1922. See . We think the principle there announced is applicable here. Judgment will be entered under Rule 50.