McCutcheon v. Commissioner

HOWARD MCCUTCHEON, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. McCutcheon v. Commissioner Docket Nos. 24401, 25554. United States Board of Tax Appeals 18 B.T.A. 834; 1930 BTA LEXIS 2585; January 15, 1930, Promulgated *2585 Held, that petitioner is entitled to deduct from his gross income for each of the taxable years an amount of $5,000, representing the extent to which a debt due him became uncollectible in each of such years. J. D. Bowersock, Esq., for the petitioner. Philip M. Clark, Esq., for the respondent. LANSDON *834 The respondent has asserted deficiencies in income tax for the years 1921, 1922, and 1923, in the respective amounts of $421.79, $252.67, and $387.54. The only issue is whether petitioner is entitled to deduct from his taxable income for each of the taxable years the amount of $5,000, alleged to represent that part of a debt due him that became worthless and uncollectible in each of such years. The two proceedings have been consolidated for hearing and decision. FINDINGS OF FACT. Petitioner is an individual who resides in Kansas City, Mo. On or about February 1, 1909, one A. E. Hasbrook, a brother-in-law of the petitioner, bought a newspaper plant located at Du Bois, Pa., and agreed to pay therefor the amount of $26,599. The contract provided for an initial cash payment of $3,000, with the remainder of the purchase price to*2586 be discharged by equal monthly payments. All the payments were completed about the year 1916. For the purpose of making his first payment, Hasbrook borrowed $4,000 from the Fidelity National Bank of Kansas City, Mo., and gave his note therefor, endorsed by the petitioner. He was unable to pay such note, which was renewed from time to time, and, in 1923, the petitioner paid the same, together with all interest due at that time in the total amount of $4,067.14. The total payments by petitioner *835 on account of the principal and interest of this note amounted to $7,321.65. From 1910 to 1920, inclusive, petitioner advanced Hasbrook various amounts of money for use in paying the installment purchase notes under the newspaper contract and for other purposes in connection with the operation of the newspaper, in the total amount of $20,158.94. In the years 1923, 1925, 1926, and 1927, he made further advancements in the respective amounts of $200, $1,750, $2,000, and $500. From 1910 to 1914, inclusive, the petitioner paid interest on money borrowed for advances to Hasbrook in the total amount of $961.59. At December 31, 1920, his total advances to Hasbrook amounted to $23,867.51. *2587 He took no notes evidencing such loans or advances but on his personal account books charged the same to Hasbrook. The amounts of such advances are not in controversy in this proceeding. At no time between 1909 and 1927 did Hasbrook have any means or any property except his former residence in Kansas City and his newspaper. Prior to December 31, 1920, petitioner received from Hasbrook the amount of $800.31 in repayment of advances above set forth. In 1921, 1922, and 1927, he received further payments in the respective amounts of $665.50, $1,654.35, and $8,000. Except $200, received in 1916, none of the payments by Hasbrook were made from the income of the newspaper. The payments, aggregating $2,920.16, were from the sales price of a residence in Kansas City, which Hasbrook sold in 1920, receiving therefor $600.31 in cash, and the balance in deferred payments in 1921 and 1922. The amount of $8,000, paid to the petitioner by Hasbrook in 1927, was all that remained from the sale of the newspaper property in that year for $25,000 after the debts of that enterprise were paid. Thereafter Hasbrook had no property. The newspaper purchased by Hasbrook as set forth above during*2588 his ownership earned no considerable profits in any year, and in many years between the date of purchase in 1909 and the date of sale in 1927 it lost substantial amounts. During the years from 1909 to 1927 the only addition to the newspaper plant was a typesetting machine, on the purchase price of which a balance of $1,463 was still unpaid at the time of the sale of the plant. After purchasing the paper Hasbrook formed a corporation with a capital stock of $20,000 divided into 200 shares of the par value of $100 each, and paid in the plant for the capital stock thereof, all of which he caused to be issued to himself or to members of his family. Between 1916 and the close of 1919 there were some small profits in amounts not disclosed by the record. In 1920 there was an operating loss of about $6,000, of which petitioner was advised in 1921; in 1921 there was a profit of about $100; in the remaining years of *836 Hasbrook's ownership the losses averaged about $1,000 per year. At the close of 1921 Hasbrook had bank loans in the amount of $5,000, which was reported to the petitioner in 1922. At the date of sale such loans had increased to $7,466.22 and there were unpaid*2589 salary accounts in the amount of approximately $3,000. The total liabilities at such date exceeded $16,500. In 1917 Hasbrook turned over to the petitioner 155 out of 200 shares of the capital stock of the newspaper corporation. The stock certificates were endorsed by Hasbrook in blank. There was no agreement respecting the disposition of the stock, which petitioner held as trustee for Hasbrook until the newspaper was sold in 1927. The petitioner desired to have possession of the stock certificates in order that Hasbrook might not hypothecate or secure a loan on them. In the early part of 1920 Hasbrook, then almost 70 years old, had a five weeks' attack of "flu" which seriously impaired his capacity for business. In the following year his health became increasingly bad and he developed cataracts on both eyes, which resulted in almost total blindness. About 1920, and for several years thereafter, Hasbrook had troubles within his own family that cost him considerable money and greatly disturbed his mind to the disadvantage of his business. All these conditions that impaired the earning capacity of Hasbrook and of his newspaper were known to the petitioner in 1921 and thereafter. *2590 In his income-tax returns for 1921, 1922, and 1923, the petitioner deducted from his gross income in each of such years the amount of $5,000, which represented his best judgment of the decline in value or collectibility of the debt owned to him by Hasbrook or the extent to which such debt had become worthless in each of such years. Upon audit of such returns the Commissioner disallowed said deductions and determined the deficiencies here in controversy. OPINION. LANSDON: In these proceedings it is not questioned that the advances made by the petitioner to Hasbrook constituted a bona fide debt, nor that the amount claimed as a deduction in each taxable year was charged off in such year as worthless. The only question is whether the facts justified the petitioner's action in ascertaining the respective portions of the debt to be worthless. The Revenue Act of 1921 provides in section 214(a)(7) that, in computing the net income of an individual, there shall be allowed as deductions debts ascertained to be worthless and charged off within the taxable year, and when satisfied that a debt is recoverable only in part, the Commissioner may allow such debt to be charged off in*2591 part. *837 The respondent disallowed the claimed deductions on the theory that the petitioner's debt was secured by the stock of the newspaper corporation, and since the corporation was not liquidated until subsequent to the taxable years, the amount of the debt which became worthless in such years could not be ascertained. The only evidence we have on this point is the testimony of the petitioner, who stated under oath that the stock certificates were endorsed in blank by Hasbrook and turned over to him, the petitioner, in 1917 without any agreement respecting the disposition of the stock. He further testified as follows: Q. Did you ever hold that stock, at all, or have the certificates in your possession, or - ? A. The stock was in my possession, yes, sir. Q. When? A. Well, I had him turn it over to me in 1917, on the occasion of a visit there. Q. State the occurrence, Mr. McCutcheon? A. Well, my only thought at that time was that the stock would be safer in my hands, perhaps, than it would be in his; that, in an extremity, he might be inclined to hypothecate it, make a loan on it, or something of that sort, and I didn't want that to happen. *2592 * * * Q. Did you ever have any conversation with Mr. Hasbrook with regard to that stock being pledged to you? A. No; it never was pledged to me, at all. Q. What became of it, Mr. McCutcheon, the stock? A. I sent it to him and it was turned over when the sale was made. Q. In 1927? A. 1927. We are unable to conclude from this testimony that the petitioner's debt was secured by the stock of the corporation, but if it were in effect so secured, we think, in the circumstances disclosed here, such fact would not justify disallowance of the deductions claimed. At the beginning of the first taxable year, 1921, Hasbrook was approximately 70 years of age, in bad health, and almost blind. It was extremely improbable that he would ever be able to earn enough money to pay any substantial part of the debt. The assets of the newspaper corporation constituted the only probable, if not possible, source of recovery of any portion of the petitioner's debt. There is nothing to indicate that Hasbrook was not entirely willing to pay over to the petitioner the net proceeds from the sale of the newspaper to apply on his indebtedness, and the net proceeds were in fact so applied*2593 when the plant was finally sold in 1927. During the taxable years, then, the petitioner could look only to the net assets of the newspaper corporation, the stock of which was owned by Hasbrook, for reimbursement of his advances, and anything that occurred *838 to reduce the net value of those assets increased to that extent the worthlessness of the debt. At December 31, 1920, the petitioner's total advances to Hasbrook amounted to $23,867.51, of which he had been repaid $800.31. The newspaper plant had been purchased in 1909 for $26,599, and the only addition in the way of new equipment was a typesetting machine, the cost of which was not established, but which undoubtedly was not more than sufficient to offset exhaustion and wear and tear of the plant generally. It was perfectly apparent that the newspaper plant had not appreciated in value, nor was there any reasonable expectation of such an increase. On the other hand, it was apparent that the plant did not at any time subsequent to 1920 have a gross value in excess of approximately $25,000. Since the indebtedness due the petitioner in 1920 was almost equal in amount to the gross value of the plant, any further advances*2594 in the taxable years must have constituted worthless debts when made, or any events which occurred in the taxable years to reduce the net value of the newspaper assets rendered the petitioner's debt to that extent uncollectible. "The ascertainment of the worthlessness of a debt, either in whole or in part, is the exercise of sound business judgment based upon as complete information as is practically obtainable." . Such an ascertainment must be viewed in the light of the surrounding facts and circumstances, which must be such as to cause a reasonably prudent business man to conclude that the debt is worthless to the extent so ascertained. A remote hope of ultimate salvage is not sufficient to deny a deduction. "The taxing act does not require the taxpayer to be an incorrigible optimist." . In the case last cited, the Supreme Court in its opinion said: The statute obviously does not contemplate and the regulations * * * forbid the deduction of losses resulting from the mere fiuctuation in value of property owned by the taxpayer. * * * But with equal certainty*2595 they do contemplate the deduction from gross income of losses which are fixed by identifiable events, such as the sale of property * * *, or caused by its destruction or physical injury * * * or, in the case of debts, by the occurrence of such events as prevent their collection * * *. What events, then, occurred in the taxable years to prevent the collection of the petitioner's debt to the extent he determined it to be worthless and charged it off? We will consider the three years separately. In 1921, the petitioner was advised that the newspaper had sustained an operating loss for the previous year of approximately $6,000. This loss could be met only out of the assets of the plant *839 or by the petitioner increasing his advances. In either event, the debt became worthless in that amount. It is true that in 1921 he received $665 from the sale of Hasbrook's old home in Kansas City, but this credit was in part offset by the amount of interest which the petitioner was required to pay on Hasbrook's $4,000 note. From these facts, we think the petitioner was justified in ascertaining in 1921 that the indebtedness had become worthless in the amount of $5,000, which amount*2596 he charged off and claimed as a deduction from his income for that year. In 1922, the petitioner learned that Hasbrook had secured bank loans in the amount of $5,000 (which amount was ultimately increased to more than $7,000 before the newspaper plant was sold in 1927), and for the preceding year 1921, the newspaper produced an operating profit of only $100. These facts, in our opinion, also sustain the petitioner's action in ascertaining in 1922 that the indebtedness due to him from Hasbrook became worthless in the amount of $5,000. In 1923, the petitioner was required to pay Hasbrook's note to the bank for money borrowed in 1909 to make the first payment on the newspaper plant, which note the petitioner had endorsed. The amount paid by the petitioner in 1923 on this note was $4,067.14, which became a worthless debt at the time of payment. In addition, the petitioner learned in 1923 that the newspaper was operated during the preceding year at a loss of $800, and in December, 1923, the petitioner advanced $200 for a pay-roll in order to keep the plant in operation. Efforts were being made to sell the newspaper, and the chances of sale would have been impaired if publication*2597 had been suspended. In the light of these facts, we think the action of the petitioner in ascertaining in 1923 that his debt had become uncollectible in the additional amount of $5,000 was reasonable. Not only did the circumstances in the respective taxable years justify the petitioner's actions, but the events in the subsequent years fully demonstrated the soundness of his judgment. When the newspaper plant was sold in 1927, after paying the debts of the corporation, there remained the net amount of only $8,000 which could be applied in payment of the petitioner's indebtedness, leaving a substantial amount to be charged off in excess of the amounts here claimed as deductions. The respondent erred in disallowing the deductions in question, and the deficiencies should be recomputed accordingly. Reviewed by the Board. Judgment will be entered under Rule 50. MURDOCK dissents.