Watson v. Commissioner

JOHN H. WATSON, JR., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. Watson v. Commissioner Docket No. 89671. United States Board of Tax Appeals 38 B.T.A. 1026; 1938 BTA LEXIS 797; October 26, 1938, Promulgated *797 1. Certain stock in one company, and interests in another, both admittedly worthless, became so during the calendar year, 1934, and their cost to the taxpayer is deductible as a loss sustained in that year. 2. Where a taxpayer's mother, living with the taxpayer, a single man, possessed an estate of $100,000, and an annual income in excess of $3,000, though taxpayer paid out approximately $5,000 because of her residence with him during the taxable year, he was not the "head of a family" within Regulations 86, article 25-4, and is, therefore, not entitled to personal exemption in the amount of $2,500, under the Revenue Act of 1934, section 25(b)(1). Louise C. Ball,16 B.T.A. 785, followed. Robert W. Wheeler, Esq., for the petitioner. W. H. Payne, Esq., for the respondent. LEECH *1026 Respondent determined a deficiency of $8,579.77 in petitioner's income tax for the calendar year, 1934. The issues raised by the pleadings are: (1) Did petitioner sustain a loss in the amount of $46,250 in that year; (2) was he entitled to the personal exemption of $2,500, as the head of a family, for that year? *1027 FINDINGS OF*798 FACT. On March 26, 1930, at a cost of $46,250, petitioner purchased 5 certificates evidencing, in the aggregate, ownership of 500 shares of the capital stock of the Union Trust Co., hereinafter called the Trust Co., of Cleveland, Ohio, and of interests in the Union Cleveland Corporation. He has held the same as his own since that date. The Trust Co. is and, during the period pertinent herein, was a banking corporation, organized under the laws of the State of Ohio, and had an authorized issued and outstanding capital stock of 914,000 shares of a par value of $25 per share. It was the largest bank in Cleveland. During the year 1932, there was a gradual reduction in the ratio of deposit credits to withdrawals from the bank, which caused a constant shrinkage of its net deposits. In the early part of 1933, withdrawals of deposits increased rapidly, due, in part, to the fact that many large depositors drew on their accounts in the Trust Co. to meet obligations in other communities, notably Detroit and Toledo, where banks had already suspended payment, and, in part, to the fact that other banks, of which the Trust Co. was a depositary, withdrew their funds from the Trust Co. to meet*799 their own needs. In January or February 1933, the Trust Co. deposited with the Reconstruction Finance Corporation a "good bit" of its readily liquid collateral. The result of the deposit withdrawals and the pledging of this liquid collateral with the Reconstruction Finance Corporation was the depletion of the Trust Co.'s liquid assets and its increase in proportion of its assets consisting of real estate loans and the like, which could not be readily converted into cash, so that these latter assets were out of proper proportion to their other investments and, so long as such. disproportion existed, the Trust Co. was not in a safe condition to engage in the banking business under the provisions of the Ohio statute requiring that a bank's real estate loans be not greater than 20 percent of the amount of its reserves. On February 25, 1933, together with most of the other Cleveland Clearing House banks, the Trust Co. imposed restrictions upon withdrawal of 95 percent of its deposits. The Trust Co. was closed at the beginning of the "bank holiday" in March 1933 and was not thereafter licensed to reopen. Subsequent thereto, and throughout 1933, promising attempts were made to reorganize*800 the Trust Co. with the consent of the state banking department. No reorganization was consummated during that year. On April 8, 1933, the Superintendent of Banks of Ohio appointed Oscar L. Cox, Deputy Superintendent of Banks, as conservator of the Trust Co. On June 15, 1933, the Superintendent of Banks of Ohio took possession of the Trust Co. pursuant to the laws of Ohio, appointing such Oscar L. Cox, liquidator, because the *1028 bank was then deemed to be in an unsound or unsafe condition to transact its business because of the heavy withdrawals and the frozen condition of its assets, and not because of insolvency. The book value of the Trust Co.'s assets, as of that date, showed a margin of about 25 percent of assets over liabilities. In July or August of 1933, at the direction of the superintendent of banks, the liquidator began an appraisal of the assets and liabilities of the Trust Co. On December 30, 1933, he released to the Cleveland papers a so-called "interim report", which report was published in the papers of that city on December 31, 1933, and January 1, 1934. It was directed "To Depositors, Stockholders and Friends of The Union Trust Company" and contained*801 the following: It seems appropriate that an interim report be made to the depositors, stockholders, and friends of The Union Trust Company, not only as to the progress so far made in liquidation, which has been done from time to time, but also as to estimates of the values of the assets and the liabilities there against. This is particularly timely at this time of year when such information is necessarily required for statements and tax purposes. Following the heavy duties imposed upon our staff in preparation of borrowings from the Reconstruction Finance Corporation and The National City Bank in July, and the unprecedented volume of activity resulting in the payment of a dividend, specific attention has been given to the appraisal of the many thousand of asset items, using the schedules as of August first, the work being done in the three succeeding months, and resulting in the following tentative classifications in round figures. ASSETS: Good $18,599,000.00 Slow 105,456,000.00 Doubtful 17,093,000.00 Loss 41,508,000.00 LIABILITIES: Bills Payable, Depositors' Certificates, and Reserves for non-book liabilities, without provision for excess of expenses over income $153,097,000.00 *802 These studies and valuations have necessarily been made and directed by our staff under the stress of our current duties and under business conditions rendering any forecast more than normally difficult. It is recognized that the limited collection experience, and exceedingly unsettled business conditions prevalent during the period of this valuation, emphasize the propriety of a re-check of our estimates against actual and further collection experience, after some opportunity to view the business outlook after the turn of the year. When the further survey is made, an appropriate certificate as to the results then found will be made to the Superintendent of Banks in connection with the levying or non-levying of stockholders' liability. In the classification of assets, those shown as "Good" or "Slow" were appraised at amounts believed to be realizable, or maintainable over a reasonable period. The assets classified as "Loss" were those concerning which our investigators found no basis for belief that collection can be reasonably expected. *1029 The "no man's land" between the first two classifications and the fourth was recognized as thoroughly "Doubtful" and so*803 classified. It is appropriate to mention the value of the information and counsel supplied by the Depositors' Committee as to very many of the assets covered, and also to note the services of the Stockholders' Committee. While concurrence has been had in the main, all decisions arrived at are those of our own staff. For these decisions and the methods of the appraisal, the writer takes responsibility and with few exceptions concurs in the results shown. This appraisal was abandoned as any determination of the bank's insolvency when the liquidator reported to the superintendent of banks that he was of the opinion that it was inaccurate, that those responsible for the immediate preparation of the report did not have sufficient experience and were not sufficiently familiar to undertake such a large task. A subsequent appraisal of the assets and liabilities of the Trust Co. was made under the direction of the liquidator as of January 31, 1934, and completed in July 1934. This appraisal showed an excess of liabilities over the appraised value of the assets of approximately $26,000,000. This report was filed with the superintendent of banks of the state. Immediately thereafter, *804 on July 27, the liquidator wrote to the superintendent of banks of the State of Ohio, recommending that the stockholders' double liability be enforced. This letter provides, in part, as follows: Somewhat more than one year's experience has now been had in dealing with the assets of The Union Trust Company, and two appraisals have been made by our staff under the writer's direction, at six months' intervals. Our exhaustive consideration of these appraisals, the last as of January 31st, 1934, and recently available, in our judgment discloses: Book Value of Assets $167,534,482.13 Estimated Liquidation Value of Assets 111,500,000.00 Liabilities 137,346,957.22 Approximate Excess Liabilities over Liquidation Value 26,000,000.00 Par Value of Shares Outstanding 22,850,000.00 On July 30, 1934, under the instructions of the superintendent of banks, the 100 percent assessment of their individual liability was made, as of August 1, 1934, against the stockholders of the Trust Co., pursuant to the laws of Ohio. The investment of the petitioner in the stock of the Trust Co. became worthless during 1934. The Union Cleveland Corporation, hereinafter called the Cleveland*805 Corporation, was a security affiliate of the Trust Co. and did their securities and investment business. Petitioner's ownership of the interests in the Cleveland Corporation was evidenced by an endorsement on the reverse side of the Trust Co.'s stock certificates, and were transferable only upon transfer of stock in the Trust Co. The two corporations were separate and distinct entities. Following the appoiintment of a liquidator for the Trust Co., the Cleveland Corporation *1030 continued its business under its own management. Its assets consisted largely of securities, the major portion of which were placed with the Trust Co. as security for loans, with power of sale on default. Summarized, the facts regarding these collateral loans with the Trust Co. are as follows: Notes payable, the Union Trust Co. - secured $3,571,606.21 Investments $4,329,106.08 Less securities not pledged 1,241,897.31 Balance pledged 3,087,208.77 Undercollateralized 484,397.44 About July 1933, petitioner became attorney for the Cleveland Corporation. At that time it owned a large number of securities having various degrees of marketability. It also held stocks*806 of the Trust Co., Chagrin Falls Banking Co., and Western Mortgage Co., which it alleged had been purchased for the Trust Co. The balance sheet of the Cleveland Corporation as of December 31, 1933, shows assets of $4,837,371.11 and liabilities of $4,769,202.35. The assets therein appear at book value except those pledged, which in practically all instances were carried at market. The liabilities set out therein were not admitted by the corporation to be correct because it was then contended that the several purchases of stock, mentioned above, had been made for the Trust Co. and it was then claiming that these assets be taken over by the receiver and credit be given for their cost against the indebtedness of the Cleveland Corporation to the Trust Co. Shortly after July 1933, Louis West, an experienced man in the securities business, was elected president of the Cleveland Corporation, to carry out an orderly plan of liquidation which contemplated securing from the liquidator of the Trust Co. acknowledgment of that company's responsibility for the purchases made for it by the Cleveland Corporation and the allowance of the consequent credits of the cost of the Cleveland Corporation*807 for those assets, against the loans of that corporation from the Trust Co. At the end of November, West resigned to become Finance Director of the City of Cleveland, and in January 1934 petitioner was elected president of the Cleveland Corporation, to carry on the program adopted. During 1934, the liquidator of the Trust Co. acceded to the claims of the Cleveland Corporation that the Western Mortgage Co. stock held by the Cleveland Corporation had been purchased for the Trust Co. and took over that stock, crediting the Cleveland Corporation in the amount of its cost to it against its loans from the Trust Co. However, in May 1934 the liquidator, exercising the power of sale contained in the collateral notes of the Cleveland Corporation to the Trust Co., sold out the collateral, which consisted of substantially all of the assets of the Cleveland *1031 Corporation except the stock of the Trust Co. and the Chagrin Falls Banking Co. This forced sale left the Cleveland Corporation with insufficient assets to meet its remaining liabilities even had the liquidator of the Trust Co. then acceded to the claims of the Cleveland Corporation with respect to the remaining assets which*808 the Cleveland Corporation claimed that it had purchased for the Trust Co. The interests in the Cleveland Corporation, owned by petitioner, became worthless during 1934. Petitioner's father and mother formerly lived at Montpelier, Vermont. Subsequent to the death of petitioner's father, petitioner, in 1931, brought his mother to Cleveland to make her home with him. She was then mentally and physically frail from age. The petitioner, who was a single man, had formerly occupied an apartment, but to meet the changed conditions occasioned by his mother's coming to live with him, he then rented and furnished a house. This house was later sold at foreclosure sale and petitioner there bought it. During the calendar year 1934, the portion of the total household expenses paid by petitioner, made necessary by his mother's residence with him, amounted to approximately $5,000. During the time petitioner's mother made her home with petitioner, she was possessed of an estate of approximately $100,000 in liquid assets. Petitioner handled all her business matters, was familiar with her property, and disbursed her income. During the taxable year 1934, the income of petitioner's mother from*809 her property amounted to $3,231.65, plus a profit on the retirement of Liberty bonds in an undisclosed amount. Of this income, petitioner applied the sum of $588.90 in expenditures necessary in connection with her home in Vermont, $935 in payment of her personal nurse, and $433.60 for her support and maintenance. The balance was held intact as an addition to her estate. Petitioner's mother has since died, intestate. Her only heirs are petitioner and his brother, who each inherited one-half of her property. In his return for the calendar year 1934, petitioner took credit for a deduction of $2,500 as the head of a family. Respondent reduced this deduction to $1,000, as the amount deductible by a single person not the head of a family. During the taxable year, 1934, the petitioner was not the head of a family, within the meaning of Regulations 86, article 25-4. OPINION. LEECH: It is admitted that petitioner has sustained a loss of his investment in the stock of the Trust Co. and his interest in the Cleveland Corporation. The first issue here raises only the question of whether he is entitled to deduct this admitted loss in either of these companies, in the computation*810 of his income tax for 1934. He *1032 has that right if, and only if, such loss was sustained in that year by reason of that investment then becoming worthless. Revenue Act of 1934, sec. 23(e). The time when a loss is sustained is generally fixed by some closed and completed transaction, but both the statute, supra - see United States v. White Dental Manufacturing Co.,274 U.S. 398 - and Regulations 86, article 23(e)-1, permit the deduction of losses fixed by the occurrence of other identifiable events. Thus, if the worthlessness of petitioner's investment in the Trust Co. and the Cleveland Corporation was "fixed by identifiable events" 1 which happened in 1934, he is entitled to the disputed deduction. Whether it was so fixed is a question of fact, John B. Marsh,38 B.T.A. 878, the answer to which requires the application of a practical, not a legal, test. Lucas v. American Code Co.,280 U.S. 445. To be deductible in 1934, this loss must be fixed by events which would satisfy neither "an incorrigible optimist", *811 United States v. White Dental Manufacturing Co., supra, nor a confirmed pessimist. Although these events need not be ascertained by the taxpayer to support a deductible loss, Alfred Hafner,31 B.T.A. 338, they must be such events as would clearly evidence to the person of average intelligence, under the circumstances, that no probability of realization of anything of value from this investment, by sale, liquidation, or otherwise, thereafter existed. Royal Packing Co. v. Commissioner, 22 Fed.(2d) 536; William E. Metzger,21 B.T.A. 1271; George H. Horning,35 B.T.A. 897. Respondent argues that petitioner's investment in both the Trust Co. and the Cleveland Corporation became worthless in 1933, because of events occurring in that year. As to the Trust Co. stock, he points to the series of events then happening, including the successive appointments of a conservator, then a liquidator, and culminating in the report of that liquidator published December 30 and 31, 1933, and January 1, 1934, in the Cleveland newspapers. Petitioner answers*812 that none of these occurrences clearly evidence the absence of probability of later realization on this stock. He contends the final report of the liquidator filed in July 1934, showing the status of the Trust Co. as of January 31, 1934, and the assessment of the stockholders' liability immediately made upon the basis of the recommendation accompanying that report, were the events which "fixed" the loss. Since the issue is entirely factual, its decision must, of course, rest upon the facts disclosed by the present record. Other cases may be helpful, but none, so far as we have found, are controlling here. *1033 Neither the appointment of a conservator nor that of a liquidator "fixed" the loss here. Jarvis v. Heiner, 39 Fed.(2d) 361; Burnet v. Imperial Elevator Co., 66 Fed.(2d) 643; W. W. Hanly,6 B.T.A. 613; Oscar K. Eysenbach,10 B.T.A. 716. The bank was the largest in Cleveland. So far as was then known, it was solvent. The book value of its assets then exceeded its liabilities by a margin of about 25 percent. Its only disclosed difficulty was the disproportionate deplepletion of its cash*813 and liquid assets to other assets. Attempts at reorganization and reopening were continuing with the open encouragement of the state banking department. No assessment of the shareholders' liability was then made. Certainly, then, nothing happened in 1933 which eliminated the reasonable probability that petitioner would realize something from this stock, unless it was the "interim report" of the liquidator during the last day of that year. In viewing the picture as a whole, instead of intimating a finding of insolvency, we think this "interim report" shows rather that the liquidator, at the close of 1933, had real doubt on that question. It must be remembered that under Ohio law, 2 the Superintendent of Banks of Ohio was charged with the duty of enforcing stockholders' liability upon ascertainment of its insolvency. The immediate responsibility of ascertaining the condition of the bank and, if insolvlent, to recommend the assessment of the stockholders' liability, either partial or entire, restred primarily upon the liquidator. He made no recommendation after his "interim report." In fact, he never filed that report with the superintendent of banks of the state. It was abandoned*814 for all purposes relating to any determination of the bank's then insolvency. Whatever the intent prompting it, the liquidator of the bank, the person in closest touch with its financial position and who issued the report, refused himself to accept it. He did not then recommend the assessment of any part of the shareholders' liability. It was not then assumed as it was in the case of other banks which were insolvent. Thus, unless we improperly ascribe to the liquidator a dereliction in his duty, he must have then believed the bank solvent. A necessary practical complement of that premise is that, at the close of 1933, the author of this "interim report" who, the taxpayer, as a man of average intelligence, had a right to assume, knew the actual financial condition of the bank, undoubtedly permitted the implication that he thought something of value would probably be realized by the stockholders from their stock. It follows, we think, that such report can not have operated as an event eliminating a reasonable hope of realization upon this stock. See *815 Henning Bruhn,11 B.T.A. 809. Although of no controlling influence here, it may be interesting to note that the respondent has recognized as the general rule of administration, *1034 in such cases, that the assessment of the shareholders' liability "fixes" their stock loss. 3 In fact, that was the administrative position taken here by respondent as disclosed in a letter to shareholders of the Trust Co. early in 1934, advising that nothing had yet occurred fixing the loss on such stock. Indeed, at the direction of the collector of internal revenue at Cleveland, who was then familiar with the "interim report", two radio broadcasts were made early in 1934, pointedly advising shareholders of the Trust Co. to the same effect. It is now indicated that, for some unexplained reason, this administrative position was changed and published in 1935. Failure, as here, to show sales of this stock during 1933, undoubtedly tends to show absence of market value for this stock in that year. *816 Mark D. Eagleton,35 B.T.A. 551; affd., 97 Fed.(2) 62. But we do not consider it decisive in the present circumstances, on the question of reasonableness of petitioner's hope of realizing from the liquidation of this stock at the end of that year. Considering only the record before us, we think the effect of that evidence, as well as the burden of proof, has been overcome by petitioner. Petitioner's loss in the stock of the Trust Co. was "fixed" by the report of the liquidator of July 1, 1934, as of January 31, 1934, his accompanying recommendation, and the assessment of the shareholders' liability immediately pursuant thereto. Cf. W. C. Coleman,31 B.T.A. 319; affd., 81 Fed.(2d) 455. Respondent contends that petitioner's interest in the Cleveland Corporation also became worthless in 1933. He attempts to support this conclusion upon the premise that the Trust Co. stock then became worthless and the further fact that, at the end of 1933, the loans of the Cleveland Corporation from the Trust Co. were undercollateralized. But we have found that the Trust Co. stock did not become worthless until 1934. And, if the claim*817 of the Cleveland Corporation that securities, then held by it, were purchased for and should be taken over by the Trust Co. and credited against its loans from that company at their cost to the Cleveland Corporation, were proved, the loans of the Cleveland Corporation from the Trust Co. were not undercollateralized. At the close of 1933, the balance sheet of the Cleveland Corporation showed assets of $68,168.76 over and above its liabilities, and in this balance sheet the pledged assets, representing the greater portion of its total holdings, were not included at cost but at their market value. In view of that fact and its then undecided claim against the Trust Co., this record reveals no event, either in the beginning of its liquidation, or otherwise, which "fixed" petitioner's *1035 loss of his investment in the Cleveland Corporation during 1933. William H. Redfield,34 B.T.A. 967; Wiilliam E. Metzger, supra;W. W. Hanly, supra. However, in May 1934 the liquidator of the Trust Co., by virtue of the power of sale contained in the notes of the Cleveland Corporation, sold out the collateral for the loans evidenced by those*818 notes. This collateral constituted almost all of the assets of the Cleveland Corporation except its claims with reference to the securities, above mentioned, consisting of Trust Co. stock and Chagrin Falls Banking Co. stock. This forced sale eliminated all reasonable probability of holders of interests in the Cleveland Corporation realizing anything on their investments therein, even though the contention of the Cleveland Corporation as to the Trust Co. stock and the Chagrin Falls Banking Co. stock held by it, was sustained. This is so, since the result of that sale of the pledged securities of the Cleveland Corporation was the definite insolvency of the Cleveland Corporation. That forced sale was the event, therefore, which "fixed" the petitioner's loss of his investment in Cleveland Corporation. Petitioner's loss of his cost of that investment was sustained in 1934 and we have so found. Our decision that petitioner's stock in the Trust Co. and interests in the Cleveland Corporation became worthless during 1934, eliminates the necessity of deciding whether the loss could be allocated. See *819 Stanley Hagerman,34 B.T.A. 1158. The remaining issue is whether respondent was correct in denying petitioner a credit of $2,500 against his net income, under section 25(b)(1) of the Revenue Act of 1934, as the "head of a family." Respondent has allowed a credit to the extent of $1,000, on the ground that petitioner was a single person, not the head of a family. The cited section grants the credit to the head of a family but does not define that term. The wording of this provision is the same as that appearing in prior revenue Acts. Respondent has construed it consistently in his regulations. Thus, article 25-4 of Regulations 86, issued in connection with the Revenue Act of 1934, which applies here, construed the term as follows: A head of a family is an individual who actually supports and maintains in one household one or more individuals who are closely connected with him by blood relationship, relationship by marriage, or by adoption, and whose right to exercise family control and provide for these dependent individuals is based upon some moral or legal obligation. * * * This consistent interpretation of the language by regulation, with its continued*820 use unchanged in succeeding revenue acts, gives the regulation the force and effect of law. Maryland Casualty Co. v. United States,251 U.S. 342. Upon this ground we sustained the *1036 regulation as correctly construing the statute in Alfred E. Fuhlage,32 B.T.A. 222. See also Louise C. Ball,16 B.T.A. 785, and Joseph H. Rudiger,22 B.T.A. 204; Olive Ross,37 B.T.A. 928. It is true he expended approximately $5,000 in the taxable year, from his income because of his mother's residence with him. However, it is also apparent that his mother was possessed of an estate in excess of $100,000 and had a yearly income of more than $3,000. Obviously, petitioner's mother was not financially dependent upon him within the meaning of the regulation. We sustain the respondent on this issue. Louise C. Ball, supra. Decision will be entered under Rule 50. Footnotes 1. Regulations 86, art. 23(e)-1, supra.↩ 2. Ohio General Code, sec. 710-95. ↩ 3. I.T. 2617XI-1 C.B. 129; I.T. 2843XIV-1 C.B. 77↩.