Mendelson v. Commissioner

JULIUS MENDELSON, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. Mendelson v. Commissioner Docket No. 21243. United States Board of Tax Appeals 21 B.T.A. 958; 1930 BTA LEXIS 1766; December 29, 1930, Promulgated *1766 Losses claimed by the petitioner as "net losses" disallowed as such for lack of proof to show that said amounts constitute "net losses" within the meaning of sections 204(a) and 206(a) of the Revenue Acts of 1921 and 1924, respectively. Joseph Getz, C.P.A., for the petitioner. Ralph S. Scott, Esq., for the respondent. TRAMMELL *958 This is a proceeding for the redetermination of deficiencies in income tax for the years 1923 and 1924 in the amounts of $695.06 and $139.01, respectively. The issue is whether or not certain losses resulting from the operation of a waist-manufacturing business in 1921 and 1922 constitute "net losses" of the petitioner deductible from his income for the taxable years. FINDINGS OF FACT. The petitioner is a citizen of the United States, residing at 167 Westminster Road, Brooklyn, N.Y. During the early part of 1919 petitioner became connected with a corporation engaged in the business of manufacturing waists, which operated under the name of Roth & Sachs. Petitioner invested the amount of $10,000 in the stock of said company, and thereby acquired a 50 per cent interest. About three or four months later the*1767 name of the corporation was changed to Juno Waist company. The petitioner was the president and treasurer of the corporation, and the duties performed by him consisted of general supervision of the business, and in particular he took charge of the credits and supervised the buying and selling of merchandise. During the latter part of 1919 the petitioner acquired the stock in the corporation owned by Roth, and a portion of the stock owned *959 by Sachs. Also during the year 1919, petitioner made a loan to the corporation of $40,000. In the early part of 1919 the corporation had profits of approximately $19,000, which were offset by losses during the latter part of 1919 of about $15,000. During the year 1920 the corporation sustained losses amounting to $25,500. Shortly after December 31, 1920, an inventory of the merchandise was taken and it was determined that the losses sustained by the corporation had exceeded its capital stock of $20,000 and the book surplus as of that date. In the early part of January, 1921, the petitioner called a meeting of the stockholders of the corporation and informed them that the capital invested in the corporation had been lost*1768 and requested that additional capital be provided to continue the business. Thereupon, the stockholders turned their certificates of stock over to the petitioner, who destroyed all the outstanding stock, including his own, and advised the stockholders that he would continue the business personally. He then employed one of the former stockholders, Sachs, as a salesman to work for him on a commission basis. The petitioner instructed his attorney to take the necessary legal steps to dissolve the corporation and was advised by his attorney that in the meantime he, the petitioner, could continue the business of manufacturing and selling waists, as a sole proprietorship, under the name of Juno Waist Co. As a creditor of the corporation, holding its notes for $40,000, the petitioner transferred to himself the corporate assets, consisting of the outstanding accounts receivable, the merchandise inventory and machinery and fixtures, and assumed all liabilities to other creditors. The notes were then destroyed in satisfaction of the debt due him. An entry was made on the books as of December 31, 1920, canceling capital stock of $20,000 against the operating deficit of that date. Entries*1769 were made on the books as of January 1, 1921, transferring the loans payable to the petitioner, in the amount of $40,000, to a new capital account of the same amount. The same books of account were used during the periods when the business was operated by the corporation under the names of Roth & Sachs and Juno Waist Company, Inc., and by the petitioner as a sole proprietorship. After the capital stock and the notes held by the petitioner were destroyed no new stock in the corporation was issued to him. Shortly after January 1, 1921, the petitioner advised all creditors that he had taken over the business of the corporation and would continue same personally, and thereafter bought merchandise for manufacture and to meet the requirements of the business under his personal *960 name. He also advised all persons having business relations with the Juno Waist Co., except customers, that he was conducting the business personally. He was advised by his attorney that it was not necessary to notify customers. During the year 1921 a loss was sustained in the operation of the waist business, amounting to $14,471.17. During the year 1922 a loss was sustained in the operation*1770 of the waist business, amounting to $12,157.69. Said losses resulted from the operation of a trade or business regularly carried on by the petitioner. No Federal Or State tax returns were filed by or on behalf of the corporation for the years 1921 and 1922. The petitioner conducted the said waist business during the years 1921 and 1922 as owner and proprietor. A certificate of dissolution of the corporation was issued by the Secretary of State of the State of New York on October 31, 1922. OPINION. TRAMMELL: The allegations of error contained in the original petition were abandoned by the petitioner at the hearing, and on motion duly granted, the petition was amended to allege that the respondent erred in failing to find that the petitioner "sustained in the conduct of a trade or business a net operating loss, during the years 1921 and 1922, as successor of the Juno Waist Company, after December 31, 1920; which net loss, under Section 204 of the Revenue Act of 1921, is applicable to the years 1923 and 1924." The respondent entered a general denial. The petitioner's proposed findings of fact have been adopted by us, as set out hereinabove, without material change. *1771 The petitioner contends that in the early part of 1921 he took over the business formerly carried on by the corporation, Juno Waist Co., Inc., and thereafter continued the business as a sole proprietorship. This we have found to be a fact. He also contends that he sustained losses in the operation of this waist business in 1921 and 1922, amounting to $14,471.17 and $12,157.69, respectively. These facts we have also found from the evidence. The petitioner further avers, and the respondent denies, that said operating losses constitute "net losses" under the statute, deductible from income for the taxable years 1923 and 1924. With respect to net losses, the Revenue Act of 1921 provides: SEC. 204. (a) That as used in this section the term "net loss" means only net losses resulting from the operation of any trade or business regularly carried on by the taxpayer * * * and when so resulting means the excess *961 of the deductions allowed by section 214 or 234, as the case may be, over the sum of the following: (1) the gross income of the taxpayer for the taxable year, (2) the amount by which the interest received free from taxation under this title exceeds so much of the*1772 interest paid or accrued within the taxable year on indebtedness as is not permitted to be deducted by paragraph (2) of subdivision (a) of section 214 or by paragraph (2) of subdivision (a) of section 234, (3) the amount by which the deductible losses not sustained in such trade or business exceed the taxable gains or profits not derived from such trade or business, (4) amounts received as dividends and allowed as a deduction under paragraph (6) of subdivision (a) of section 234, and (5) so much of the depletion deduction allowed with respect to any mine, oil or gas well as is based upon discovery value in lieu of cost. The Revenue Act of 1924, in section 206(a) contains provisions substantially similar to those above quoted from the 1921 Act, in so far as pertinent to this proceeding. We have found that the losses sustained in the operation of the waist business were losses resulting from the operation of a trade or business regularly carried on by the petitioner, but something more is necessary in order to constitute them "net losses" within the meaning of the statute above referred to. Only the first requirement of the statute has been met. To sustain the petitioner's contention, *1773 it must be shown in addition that the losses in question represent the excess of his allowable deductions for the respective years over the sum of (1) the gross income for each taxable year, plus (2) the amount by which any tax-free interest received by him exceeded nondeductible interest paid or accrued, plus (3) the amount by which deductible losses not sustained in said business exceeded the taxable gains not derived from said business, and plus (4) the amount of any depletion allowance based upon discovery value in lieu of cost. We do not know the amount of the petitioner's allowable deductions, nor the amount of his gross income, for either of the years in question. So far as we are informed, the petitioner may have had income from rents, interest or many sources other than the waist manufacturing business sufficient to reduce materially or indeed to wipe out entirely the losses sustained from the operation of said business, nor does the record disclose the amount, if any, by which tax-free interest received by the petitioner exceeded the amount of nondeductible interest paid. We can not say, therefore, that the losses sustained in the operation of the waist business constitute*1774 "net losses" within the meaning of the statute. For lack of evidence to show error, the determinations of the respondent are approved. Reviewed by the Board. Judgment will be entered for the respondent.