Cass v. Commissioner

CLAUDE D. CASS, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. Cass v. Commissioner Docket No. 75521. United States Board of Tax Appeals 32 B.T.A. 713; 1935 BTA LEXIS 904; June 7, 1935, Promulgated *904 Respondent disallowed a deduction for loss on sale of stock on the ground of worthlessness of the stock prior to the year of sale. Held, the evidence is insufficient to overcome the presumptive correctness of respondent's determination and the disallowance of the claimed deduction is sustained. John E. McClure, Esq., for the petitioner. T. G. Histon, Esq., for the respondent. ARUNDELL *714 The respondent determined a deficiency in petitioner's income tax for the year 1931 in the amount of $986.66. The deficiency arises from the disallowance of a claimed loss on the sale of stock in 1931, the respondent holding that the stock was worthless prior to that year. The propriety of the respondent's action in this respect is the only issue. FINDINGS OF FACT. Petitioner is an individual, with legal residence at Waterloo, Iowa. Since 1896 he has been connected in various capacities with the Waterloo, Cedar Falls & Northern Railway Co., and since 1901 has been continuously in its employ. Prior to 1904 the name of the company was Waterloo & Cedar Falls Rapid Transit Co., the change of name being accomplished by charter amendment in 1904. *905 The term "Railway Co." used hereinafter will include both names of the company. The Railway Co. was organized as an Iowa corporation in 1895. It was organized by petitioner's two older brothers, L. S. Cass and J. F. Cass, and two other persons. It started as a small street car line with about two and a half miles of track in Waterloo, Iowa, in 1896 and expanded until in 1914 it had about one hundred and thirty miles of track reaching a number of towns, one of them, Cedar Falls, being about seventy miles from Waterloo. By 1914 it was handling all kinds of general commercial railroad business. From 1914 to 1918 it further expanded its properties by constructing additional freight facilities, freight tracks, and spur tracks in and about Waterloo. The property of the Railway Co. was under Federal control during the period from January 1, 1918, to February 29, 1920. During that period petitioner was general manager of the Railway Co. property. About 1920 or 1921 the Railway Co. defaulted on its bond interest. In 1922 a bondholders' protective committee was organized, which took over control of the Railway Co. in 1923 and has since then continued to control and manage the company*906 and its property. About 95 percent of the bondholders deposited their bonds with the committee. In 1923 petitioner owned 2,831 1/2 shares of common stock of the Railway Co. In October of that year, petitioner, his brother, and others, owning a majority of the outstanding common stock, assigned their stock to the bondholders' protective committee. The directors and officers resigned at that time, and petitioner was reelected a director and made vice president of the company, which position he now holds. The stockholders who surrendered their common stock received therefor certificates issued by the bondholders' protective committee. The common stock is the stock which carries the right of election of directors and control of the Railway Co. *715 The common stock of the Railway Co. was never listed on any exchange and was not subject to market quotations; the majority was closely held by a few persons. The petitioner acquired his stock prior to March 1, 1913, for services rendered. The fair market value thereof at March 1, 1913, was $100 per share. In each of the years 1926 to 1931 the Railway Co.'s bonds amounted to $9,235,000, of which $7,033,000 were outstanding. *907 In each of those years it operated at a loss. Following are statistics as reported in its income tax returns: Year Gross income Loss reported Deficit Matured interest unpaid — 1926 — $118,065.13 $366,118.53 $2,954,891.35 $2,251,684.27 — 1927 — 109,558.34 371,618.65 3,325,643.38 2,948,619.66 — 1928 — 206,456.12 270,037.21 3,595,680.59 3,359,837.20 — 1929 — 229,869.11 333,822.44 3,929,503.03 3,766,766.89 — 1930 — 143,047.34 329,902.31 4,259,405.34 4,176,010.80 — 1931 — 9,226.07 458,921.83 4,718,326.97 4,580,273.30 The item of gross income, so designated in schedules attached to returns, consists of the excess of both operating and nonoperating income over expenses and taxes assignable to operations. In its capital stock tax return for the calendar year 1920 the Railway Co. returned its capital stock, preferred and common, as having a fair value of $3,071,441.20. That return was filed in 1921. In subsequent returns, filed in each of the years 1922, 1923, 1924, and 1925, it reported its capital stock as having no fair value. In each of the years there were outstanding 6,640 shares of 6 percent cumulative preferred stock, par value $100 per share. *908 Common stock outstanding in 1920 amounted to 23,670 shares of a par value of $100 per share. In subsequent years there were 23,330 1/2 shares of common stock outstanding. The railway company has been in continuous operation since its organization. It has never been in receivership and is not in process of liquidation. In 1929 petitioner sold 300 shares of his Railway Co. common stock at auction in Philadelphia, Pennsylvania, for $25. In 1930 he sold 300 shares of the common stock to his brother, L. S. Cass for $1.50 per share. In 1931 petitioner sold 300 shares of the common stock to C. M. Cheney for 25 cents per share, a total of $75. The net amount received by petitioner after payment of transfer charges was $62.80. C. M. Cheney was a friend of the petitioner and was president of the Railway Co. in 1931. The sale was made without any arrangement for repurchase by the petitioner. The reason for the transaction was to establish a loss for income tax purposes. In his *716 income tax return for 1931 petitioner claimed a loss on the sale of the stock of $29,937.20, computed as follows: March 1, 1913, value $30,000.00 Net sales price 62.80 Loss 29,937.20 *909 The respondent disallowed the deduction for the loss so claimed. For the year 1929 the respondent determined a deficiency in petitioner's income tax which petitioner appealed to this Board. After appeal was filed, the parties entered into a stipulation of no deficiency and decision was entered accordingly without a hearing on the merits. The deduction claimed for u930 was allowed by the respondent. The petitioner has never claimed nor been allowed a deduction on the ground of worthlessness of the Railway Co. stock. OPINION. ARUNDELL: In the notice of deficiency the respondent states that the loss deduction claimed by petitioner "has been disallowed for the reason that this office holds that the stock became worthless prior to 1931." In a written stipulation of facts filed prior to the hearing, it is stated, "The respondent disallowed this loss on the ground that the stock was worthless prior to 1931." The one error alleged in the petition for redetermination is the finding of the Commissioner that the stock was worthless prior to 1931. This allegation of error is denied in the respondent's answer. On this state of the record we have presented for decision the single question*910 of whether the respondent erred in his determination that the Railway Co. stock was worthless prior to 1931. As the issue is thus narrowly framed we have no occasion to go into other matters which obtrude in a reading have no occasion to go into other matters which obtrude in a reading of the facts, for instance, the question of the bona fides of the sale in 1931. A deduction for worthless stock may be taken in the year in which the stock becomes worthless, art. 177, Regulations 77; art. 23(c)(4), Regulations 86, and in the case of worthlessness the owner has no option to take the loss in a later year on a sale for a nominal amount, ; ; . But where stock is not in fact worthless in the year of sale for a nominal amount, the holder is not precluded from taking a loss deduction on another sale of similar stock in a subsequent year. ; *911 . In the present case the petitioner's evidence against the respondent's determination of worthlessness was, in substance, that the Railway Co. has been in continuous existence and operation ever since organization and that it has always had earnings, has never been in receivership *717 or bankruptcy, and has never been in process of liquidation. Respondent, on the other hand, points to losses sustained by the Railway Co. over a period of years, to the mounting deficit of the company, and its annually increasing amount of unpaid interest. The determination of the respondent is prima facie correct, ; , and it "presumably rests on a correct determination of the facts." . "The burden of disproving a deficiency as determined by the Commissioner is recognized to be upon the taxpayer." *912 Having in mind these rules, we inquire whether petitioner's evidence establishes error in the respondent's finding of worthlessness of the stock prior to 1931. Petitioner offered no direct evidence as to the value of the stock in any year. His nearest approach to it is his testimony that he has always considered the stock to be of value. Despite his long connection with the corporation his knowledge concerning any sales of the stock was limited to one, other than his own, and he did not know the price in that case. His own sales can hardly be said to be indicative of value, one being at the rate of 8 1/3 cents per share, the second at $1.50 per share, and the third at 25 cents per share. The last two were made to persons who naturally would give the petitioner the benefit of any doubt as to the worth of the stock. The circumstances were not such as to affirmatively establish a value. Continued operation of a corporation does not in itself demonstrate that the stock had worth. *913 ; . Particularly is this true in the case of railroads and other public utilities, which are often required by public utility commissions to continue operations long after reaching the state of hopeless insolvency and when it is obvious that there is not the slightest possibility of the stockholders ever realizing anything on their investment. While the corporation had gross income in each year prior to and in 1931, that gave no value to the stock, inasmuch as it was far from sufficient to meet fixed charges. The ever mounting deficit is at least an indication of decreasing value of the stock. The deficit increased from $2,954,891.35 in 1926 to $4,718,326.97 in 1931. In the same period the unpaid interest more than doubled. It was $2,251,684.27 in 1926 and $4,580,273.30 in 1931. This situation would not inspire hope for the salvaging of the stock investment. In the face of these facts we are of the opinion that the petitioner's showing of continuous operation and the absence of receivership or bankruptcy is insufficient to establish error in the respondent's determination of worthlessness*914 of the stock prior to 1931. Reviewed by the Board. Decision will be entered for the respondent.