Jerpe v. Commissioner

J. P. JERPE, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. Jerpe v. Commissioner Docket No. 103377. United States Board of Tax Appeals 45 B.T.A. 199; 1941 BTA LEXIS 1155; September 26, 1941, Promulgated *1155 Where the petitioner made a sale of certain stock for a cash payment and five further payments to be made annually, and elected to report income on the installment basis; and thereafter the petitioner-creditor in 1931 agreed to cancel two of the payments, and did cancel them; held, that the percentage of the 1938 payment returnable as income under section 44, Revenue Act of 1928, must be adjusted to the reduced sale price, the petitioner having neither claimed nor taken any deduction for a loss in the year of the reduction. George E. H. Goodner, Esq., and D. F. Prince, Esq., for the petitioner. E. M. Woolf, Esq., for the respondent. KERN *200 This proceeding involves a deficiency of $927.66 in petitioner's income tax for the calendar year 1938, of which $784.52 is in dispute. The only question in issue is the amount of profit taxable from the payment of an installment note of $50,000 in that year. Petitioner filed his Federal income tax return with the collector of internal revenue for the district of Nebraska, at Omaha. FINDINGS OF FACT. For more than two years before August 3, 1929, petitioner was an officer in and holder*1156 of one-half of all the capital stock of the Jerpe Commission Co., a corporation engaged in business at Omaha, Nebraska; and a holder of half of the stock of its subsidiaries. Carl W. Swanson was the owner of the other half of the stock of the several companies. On August 3, 1929, petitioner entered into an agreement with Swanson to sell his stock in the Jerpe Commission Co. and the other wholly owned subsidiary companies for the sum of $374,644.54. The stocks had a cost basis to petitioner of $101,123 for the purpose of computing profit or loss on the sale, and petitioner's expected profit on the sale was $273,521.54. Swanson paid $124,644.54 at the time of executing the agreement, partly by the transfer of certain land, and agreed to pay the balance of $250,000 in five $50,000 payments, for which he gave petitioner five promissory notes of $50,000 each, the first payable on March 1, 1931, and the others payable on March 1, 1932, 1933, 1934, and 1935, respectively. The agreement provided that Swanson should execute the five notes "as evidence of said indebtedness, but in no event to be considered as taken in payment of said indebtedness * * *." He also agreed to pledge the stock*1157 as collateral security for the payment of the notes and further agreed that on or before March 1, 1930, and before the consummation of the sale and as a condition precedent to it, the petitioner was to be wholly absolved, released, and discharged from any and all personal liability for the notes or other obligations of the Jerpe Commission Co. or the other companies involved, by Swanson's procuring payment or cancellation of the notes. Petitioner was to remain a director and/or officer of the several corporations until consummation of the sale. The said agreement further provided in its seventh paragraph that: * * * the certificates of the aforesaid shares of capital stock, the subject of this agreement, shall be assigned on the back thereof by party of the first part [petitioner] at the time of executing this agreement, and at the same time be deposited with Alvin F. Johnson of Omaha, Nebraska, to be held by him until the consummation of the said sale and purchase of said shares of capital stock, whereupon said certificates of stock shall be delivered to party *201 of the second part. The voting power of said shares of capital stock shall, however, remain in party*1158 of first part, or his duly appointed proxy, until said sale and purchase thereof is consummated and said certificates delivered to party of second part. The plan further provided that, if certain contemplated reorganizations of the corporations should be carried out, the new stock might be substituted for that of the old as collateral security for performance of the agreement. Petitioner executed the certificates of stock in blank and delivered them to the escrow agent, Johnson. The agent never delivered the certificates to Swanson but instead delivered them back to petitioner, who held them until the last note was paid in 1939. Since the initial payment was less than 40 percent of the selling price, petitioner elected to report the sale of his stock on the installment basis and in 1929 included in his income tax return as profit from it the sum of $91,000.14, which was the proper pro rata share of profit on the first payment. In 1931 business conditions became bad and Swanson was unable to pay the note which became due on March 1, 1931. He offered to rescind the contract and turn the stock back to petitioner. Finally petitioner agreed to cancel the two $50,000 notes which*1159 were due, respectively, on March 1, 1931, and March 1, 1932, and Swanson agreed to continue the contract as so modified. Petitioner thereupon canceled the two notes and delivered them to Swanson. The note due March 1, 1933, was paid in 1937; and the last of the five notes, that due March 1, 1935, was paid in 1939. In 1938, the tax year here in question, the note due on March 1, 1934, was paid and, in his income tax return for 1938, petitioner reported income thereon in the sum of $13,753.57, which was one-half of the total profit on the installment payment as determined by him, that being the taxable proporetion of gain on stock held for more than two years. Respondent determined the total profit on the transaction to be $36,604.16 and half of this amount to be taxable. He arrived at this figure by dividing $273,521.54 (total profit) by $374,644.54 (total sale price), multiplying this quotient by $50,000 (amount of 1938 note), and, in turn, dividing this product by 2. He, therefore, increased petitioner's income by the sum of $4,498.51, and found the deficiency. OPINION. KERN: The single issue is the amount of income taxable in 1938 under the installment plan elected*1160 by the taxpayer, after the reduction in a prior year of the amount of the purchase price agreed on in the contract sale of August 3, 1929. The relevant provisions of *202 the statutes are set out in the margin. 1 Petitioner contends that this contract was an agreement to sell and not a contract of sale; in other words, that it was executory in character. Resting on this premise, he then argues that the sale price was altered and reduced by the sum of $100,000, involved in petitioner's cancellation in 1931 of two notes, each in the face amount of $50,000; and that this readjustment must, therefore, be reflected in the profit taxable on the next to the last installment paid and returned in 1938. The petitioner makes the same contention on the reflection of actual profit, apparently regardless of the nature of the contract. Respondent, on the other hand, argues that a deductible loss resulted under section 44(d) in the year 1931, through the cancellation in that year of the two notes for a total amount of $100,000, and that this loss did not operate to change the taxable percentage of profit as originally computed, realized on the payment in 1938. In other words, his theory*1161 appears to be that, once the installment method is elected, gain or loss is determined for tax purposes in each year on the basis of the original sale price without regard to the outcome of the whole transaction. He relies on his ruling G.C.M. 11845, C.B. XILL-1 (June 1933), p. 52, and on our decision in Gilbert W. Lee,6 B.T.A. 135. *1162 The installment provision obviously was intended to relieve the petitioner, where he gets less than 40 percent of the sale price as a cash payment, from the burden of returning the full amount of the profit at the time the sale is executed, and to allow him to apportion the profit evenly over the later payments as received. The introductory clause of section 44 seems to indicate this intention in plain language. See 70th Congress, S. Rept. 960 (Committee on Finance), p. 24; H. Rept. 2 (Committee on Ways and Means), p. 16; on the 1928 Revenue Act. If the installment method is open to the petitioner, it becomes of no consequence whether the obligation has fully accrued to him in the year of the contract by the passage of *203 title, whether he has retained a vendor's lien, or whether the contract is executory until the final payment. He is to return a percentage of each payment as profit when made in any case. We leave on one side, therefore, any consideration of petitioner's argument that the contract was executory, and proceed to discuss the question solely on the ground that it was an installment contract and, as such, income under it was to be determined in accordance*1163 with the statute. The respondent's argument takes little account of the actualities of taxation, and does too much homage to the mere form of the statute. A profit never made and income never received can scarcely be taxable, Kerbaugh Empire Co. v. Bowers,271 U.S. 170. While it is true that the installment loss of 1931, if it had been claimed by the petitioner and allowed in that year, might have offset other gain in the same year and have thus become a real factor in the determination of taxable income in that year, that was not the case here. The loss was neither claimed nor allowed in that year, nor is there any intent expressed in the statute that it shall be so taken, as respondent contends. The whole deferred payment plan of returning income looks to the whole transaction, and not to separate losses or gains in the several years of payment. The percentage return of gain is a logical means to this end. While section 44(d) provides, therefore, for the reckoning of a loss on such payments, it must look to such a loss on the whole transaction, which can not properly be reflected in vacuo, but must be reflected either in the reduction of total gain*1164 or as a net loss on the whole transaction, which can not be known until the final payment. On the other hand, the same section provides for reckoning gain also on the basis of actual realized gain; and, consequently, where the seller has reduced the buyer's obligation, the seller's gain must be reduced accordingly, and the percentage of gain to be return for tax purposes must be readjusted to the new condition of things. Although no case has been called to our notice in which the question has been fully considered before, we are clearly of the opinion that any other reading of the section would stultify its obvious purpose. Cf. Daniel Tracy Beers,31 B.T.A. 117, 121; affirmed on another issue, 78 Fed.(2d) 447. Lee's case, supra, relied on by the respondent, is not in point, for it holds merely that the petitioner may not elect the installment basis and thereafter change to another basis. Obviously, adherence to the elected basis is necessary to protect the revenue. But here we are concerned with the proper application of that basis to the final fulfillment of the contract. Although the final payment was not made until 1939, the seller's*1165 gain could not be greater than the amount he now claims for 1938. Nor does the Commissioner's ruling, supra, help more, for it involved a net loss on a transaction which was *204 nondeductible, since it was not entered into for profit, the object of the sale being the taxpayer's own dwelling house. The Commissioner, consequently, denied the refund of "gain" earlier returned in installment payments. We think that the reduction of $100,000 in the selling price of petitioner's stocks, through cancellation of the two notes in 1931, must be reflected in the percentage of taxable gain returned thereafter, and that the gain for 1938, now before us, must be reduced accordingly. Reviewed by the Board. Decision will be entered under Rule 50. Footnotes 1. Revenue Act 1928. - SEC. 44. INSTALLMENT BASIS. (a) DEALERS IN PERSONAL PROPERTY. - Under regulations prescribed by the Commissioner with the approval of the Secretary, a person who regularly sells or otherwise disposes of personal property on the installment plan may return as income therefrom in any taxable year that proportion of the installment payments actually received in that year which the gross profit realized or to be realized when payment is completed, bears to the total contract price. * * * (d) GAIN OR LOSS UPON DISPOSITION OF INSTALLMENT OBLIGATIONS. - If an installment obligation is satisfied at other than its face value or distributed, transmitted, sold, or otherwise disposed of, gain or loss shall result to the extent of the difference between the basis of the obligation and (1) in the case of satisfaction at other than face value or a sale or exchange - the amount realized, or (2) in case of a distribution, transmission, or disposition otherwise than by sale or exchange - the fair market value of the obligation at the time of such distribution, transmission, or disposition. The basis of the obligation shall be the excess of the face value of the obligation over an amount equal to the income which would be returnable were the obligation satisfied in full. ↩