Eckert v. Commissioner

A. JAMES ECKERT, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. Eckert v. Commissioner Docket No. 29656. United States Board of Tax Appeals 17 B.T.A. 263; 1929 BTA LEXIS 2322; September 17, 1929, Promulgated *2322 The amount of a note given by the petitioner in settlement of his liability as an indorser of a note is not deductible from gross income, he being on the cash receipts and disbursements basis and no cash having been paid on the note during the taxable year. Henry T. Dorrance, Esq., for the petitioner. Hartford Allen, Esq., and Hugh Brewster, Esq., for the respondent. ARUNDELL *264 This proceeding was instituted to redetermine a deficiency of $3,378.89 in income tax for the year 1925. The question in controversy is whether the sum of $22,400, representing one-half of the amount of a note given by the petitioner and another individual in payment of their liability as indorsers of a note, is deductible from gross income as a loss or a bad debt. FINDINGS OF FACT. Prior to 1922 the petitioner and William A. Ainsworth were engaged in business as partners under the firm name of Electric Refrigeration Co. In 1922 they organized a corporation under the name of Electric Refrigeration Co., Inc., which acquired all of the assets and assumed all of the liabilities of the partnership, including certain notes, totaling $25,419.65, payable to and*2323 held by the Citizens Trust Co. of Utica, N.Y., for money loaned to the partnership. The bank subsequently accepted notes executed by the corporation for the partnership notes. Between 1922 and 1925 the corporation issued several additional notes in the amount of $19,375.25, in favor of the same bank for loans. All of the notes issued by the corporation in favor of the bank were indorsed by the petitioner and Ainsworth. In September, 1925, the bank made a demand upon the corporation for payment of the latter's notes. Subsequently in 1925 the corporation discontinued business and proceeded to wind up its affairs, its assets on dissolution being insufficient to pay the amount due on the notes in excess of about $600. This amount was paid on the notes by the corporation in December, 1925, leaving an unpaid balance of $44,800, after charging about $5 to the personal account of the petitioner. Concurrently with the payment of $600 by the corporation, the petitioner and Ainsworth delivered to the bank, their joint note for $44,800 in settlement of their liability as indorsers of the corporation's notes and in return received the corporation's notes stamped "paid." The notes were*2324 subsequently destroyed by the petitioner. The liquidation of his liability as an indorser of the corporation's note did not involve the payment of any cash. The petitioner has never collected anything on the notes he and Ainsworth paid. He did not keep books of account. His return for the taxable year was filed on the basis of cash received and disbursed. In his determination of the deficiency in controversy, the respondent declined to allow any amount of the note as a deduction from gross income on the ground that no cash payments were made on the notes during the taxable year. *265 OPINION. ARUNDELL: The position of the petitioner is that by reason of the fact that he was compelled to make good his liability as an indorser of the corporation's notes, he is entitled to a deduction of $22,400 (one-half of the amount of the note given by the petitioner and Ainsworth), even though the note was not paid by cash. The respondent contends on the other hand that the amount is not deductible either as a loss sustained or a bad debt, since the petitioner did not during the taxable year disburse any cash or its equivalent in property. The facts are not in dispute. *2325 Section 212 of the Revenue Act of 1924 provides: (a) In the case of an individual the term "net income" means the gross income as defined in section 213, less the deductions allowed by sections 214 and 206. (b) The net income shall be computed upon the basis of the taxpayer's annual accounting period (fiscal year or calendar year, as the case may be) in accordance with the method of accounting regularly employed in keeping the books of such taxpayer * * *. Section 214(a) of the same Act provides that in computing net income there shall be allowed as deductions: (4) Losses sustained during the taxable year and not compensated for by insurance or otherwise, if incurred in trade or business. (7) Debts ascertained to be worthless and charged off within the taxable year * * *. In Jackson County State Bank,2 B.T.A. 1100, we said: "The expression 'losses sustained' means actual losses and not paper losses." To be entitled to a deduction for a loss, a taxpayer "must prove as a fact that it was actually sustained within the year." *2326 Carl Muller,4 B.T.A. 169. In Electric Reduction Co. v. Lewellyn, 11 Fed.(2d) 493 (reversed 275 U.S. 243, on other grounds) the following appears: Failure to keep that which one has is a loss. Foehrenbach v. German-American Title & Trust Co.,66 A. 561, 217 Pa. 332, 12 L.R.A.(N.S.) 465, 118 Am.St.Rep. 916. There are many kinds of loss: Money out of pocket; a judgment, changing the status from solvency to insolvency. Schambs v. Fidelity & Casualty Co.,259 F. 55, 58, 170 C.C.A. 55, 6 A.L.R. 1231. The petitioner in the case of Morris Sass,12 B.T.A. 156, claimed the right to deduct as a loss the amount of a note he gave a bank in satisfaction of his contract of guaranty on a number of loans, he being on the cash basis in the year in which the instrument was executed. In sustaining the Commissioner's action disallowing the sum of the note as a deduction, we said: The giving of a note does not constitute a disbursement or deprivation of cash, nor does it necessarily constitute a disbursement of the equivalent thereof. In giving his note to the bank, petitioner gave evidence*2327 of his indebtedness in *266 the amount of $19,253.54 incurred as a guarantor, but being on the cash receipts and disbursements basis, he did not sustain an actual and deductible loss, i.e., a deprivation of his property, until he paid the note subsequent to 1919. An identical situation exists here. The petitioner did not at any time during the taxable year pay out any cash or its equivalent in property in satisfaction of his liability to the holder of the corporation's notes. He merely exchanged his note under which he was primarily liable for the corporation's notes under which he was secondarily liable, without any outlay of cash or property having a cash value. Not having paid out anything either prior to or during the taxable year, the petitioner had no investment to lose or to charge off as valueless. His cash assets were not diminished in any amount by the giving of the note. In our opinion the petitioner is not entitled to a deduction of the amount claimed either as a loss or as a worthless debt of the corporation. See Morris Sass, supra, and *2328 Morris Sass,17 B.T.A. 261. Reviewed by the Board. Judgment will be entered for the respondent. SMITH dissents.