Comm'r of Internal Revenue

Tax Court of the United States.Sep 25, 1953
20 T.C. 1069 (U.S.T.C. 1953)

Docket No. 29816.



David R. Shelton, Esq., and Aaron L. Ford, Esq., for the petitioner. John J. O'Toole, Esq., for the respondent.

The alleged indebtedness in the sum of $26,389.65 advanced by petitioner to a corporation of which he was a stockholder and officer was not wholly worthless as of the close of the taxable year 1943, and was consequently not the subject of a bad debt deduction under section 23(k)(1), Internal Revenue Code. Nor did $1,509.05 of such sum constitute an ordinary and necessary expense of petitioner. David R. Shelton, Esq., and Aaron L. Ford, Esq., for the petitioner. John J. O'Toole, Esq., for the respondent.

Respondent has determined a deficiency in income tax of the petitioner for the calendar year 1943 in the amount of $10,913.37. Certain minor adjustments in determining the deficiency are not contested. The issue present for decision is the correctness of respondent's action in disallowing a deduction taken by petitioner upon his return for the year in question in the sum of $26,389.65 as representing a business bad debt deduction by reason of certain alleged indebtedness in this amount claimed to have become worthless in the taxable year. Sec. 23(k)(1), I.R.C.


Certain of the facts are stipulated and are so found.

Petitioner is an individual with residence at Kenmore, New York. The return for the period have involved was filed with the collector for the twenty-eighth district, at Buffalo, New York.

Petitioner has, since 1920, been engaged in the building and building supply business as a sole proprietor under the name of James M. Hawkins Company until 1946, when the business was incorporated as the James M. Hawkins Corporation.

In his business petitioner handles all types of building and construction material, including brick, tile, insulating, and acoustical material. One of the important materials handled was brick, it being important that petitioner be in a position to supply such material, as building contractors were inclined to give their orders for other construction material to the firm supplying them with brick.

During the year 1941 there was a shortage of brick in the western New York district. In the Buffalo, New York, area there were two brick manufacturing plants but one of them, the Buffalo Brick Corporation, hereinafter called ‘Buffalo,‘ had not been in operation for approximately 2 years. In July 1941 petitioner was approached by representatives of Buffalo with a view toward interesting him in securing financing for the corporation permitting it to resume operations. As a result of this contact petitioner in 1941 acquired 133 1/3 of that corporation's 400 shares of outstanding capital stock and succeeded in procuring for the corporation a loan of $35,000 from the Reconstruction Finance Corporation. This loan was conditioned upon petitioner advancing to the corporation personally the sum of $10,000, which advance was made by him, and the corporation was able to put its plant in operation. It carried on its manufacture of brick for only a short period, during which petitioner received from it one delivery. The termination of its work of brick manufacturing was due to its being ruled a nonessential defense plant, making it impossible to obtain the skilled labor necessary to such operation.

Petitioner had become a director of Buffalo following his acquisition of one-third of its stock, and in 1943 became president of the corporation. Following the cessation of its work in brick manufacture, the corporation obtained a contract from the Bethlehem Steel Company for the processing of a certain type iron ore into briquettes, in which form the furnaces were able to use such ore.

Petitioner, in negotiating the aforementioned loan from the Reconstruction Finance Corporation, and in connection with other things done by him for Buffalo, expended in travel and incidental expenses, from May through August 1943, the sum of $1,509.05. These expenditures were from his personal funds. The petitioner's original advance to the corporation of $10,000 had been on August 19, 1942. Following this, between February and August 1943, he advanced additional sums necessary to the corporation to meet payrolls, the last of these advances being on August 25, 1943, at which time the total amounts advanced were in the sum of $26,389.65. All of these advances were carried on the books of Buffalo as indebtedness due to petitioner.

The contract with the Bethlehem Steel Company under date of July 3, 1943, was for the conversion of 50,000 to 60,000 tons of Princeton ore into briquettes at the rate of 10,000 tons per month, for which Buffalo was to be paid the sum of $195,000. By October 21, 1943, Bethlehem had accepted delivery of and paid Buffalo the sum of $23,380.80 for the conversion of 7,194 tons of Princeton ore under the contract. As of this date, Buffalo was in default under its delivery schedule, and Bethlehem did not accept deliveries after this date.

Petitioner's return for the calendar year 1943 was filed on March 14, 1944, on which return deduction was taken for the entire amount of petitioner's advances to Buffalo in the sum of $26,389.65, upon the ground that these advances represented an indebtedness of Buffalo to petitioner which had become wholly worthless as of the close of the year 1943.

In the latter part of the year 1943 petitioner had negotiated a loan of $30,000 to Buffalo by the Smaller War Plants Corporation. This load was approved in December 1943, and on December 16, 1943, Buffalo, through petitioner as its president, executed an assignment to the Smaller War Plants Corporation of all payments to be made to it under is aforesaid contract with Bethlehem. This assignment provided, inter alia :

all invoices rendered by Assignor for payments under said contracts shall contain a notation of the existence of this assignment and shall direct the disbursing party to make all payments to Smaller War Plants Corporation, * * *

Shortly after the close of the year 1943 Buffalo received payment of the $30,000 loan by Smaller War Plants Corporation, and a short time thereafter, in July 1944, received payment of $45,000 from Bethlehem in settlement of all claims against it by Buffalo as a result of its cancellation of the aforesaid contract, it having notified Buffalo formally on February 23, 1944, that the contract was to be considered canceled.

As of December 31, 1943, a summary of Buffalo's financial condition as reflected by its books was as follows:

+--------------------------------------------------------------+ ¦Current assets ¦ ¦$1,612.92 ¦ +-------------------------------------+----------+-------------¦ ¦Liabilities: ¦ ¦ ¦ +-------------------------------------+----------+-------------¦ ¦Current liabilities ¦$25,150.13¦ ¦ +-------------------------------------+----------+-------------¦ ¦RFC first mortgage loan, In default ¦34,004.22 ¦ ¦ +-------------------------------------+----------+-------------¦ ¦Total ¦$59,154.35¦ ¦ +-------------------------------------+----------+-------------¦ ¦Other loans & advances payable ¦43,000.00 ¦ ¦ +-------------------------------------+----------+-------------¦ ¦Total liabilities ¦ ¦$102,154.35 ¦ +-------------------------------------+----------+-------------¦ ¦Deficiency to meet liabilities ¦ ¦-(100,541.43)¦ +-------------------------------------+----------+-------------¦ ¦Other assets: ¦ ¦ ¦ +-------------------------------------+----------+-------------¦ ¦Plat & equipment (net of reserves for¦ ¦ ¦ +-------------------------------------+----------+-------------¦ ¦depreciation of $37,795.11) ¦21,983.08 ¦ ¦ +-------------------------------------+----------+-------------¦ ¦Deferred charges ¦1,464.99 ¦* 23,468.07 ¦ +-------------------------------------+----------+-------------¦ ¦Deficiency in capital ¦ ¦-($77,073.36)¦ +--------------------------------------------------------------+ FN* Mathematical error of $20.

The payment of $45,000 in July 1944 from Bethlehem to Buffalo was used in part to retire the Reconstruction Finance Corporation loan which was secured by a first mortgage on the properties of Buffalo and amounted at that time to $34,004.22. On August 30, 1944, petitioner was reimbursed by Buffalo for the $1,509.05 in traveling and incidental expenses advanced on its behalf and included in the $26,389.65 in total indebtedness which petitioner had deducted as a business bad debt on his return for the prior year.

The stock of Buffalo during the years 1942, 1943, and 1944, was owned as follows:

+----------------------------------------+ ¦ ¦1942 ¦1943 ¦1944 ¦ +----------------+-------+-------+-------¦ ¦ ¦ ¦ ¦ ¦ +----------------+-------+-------+-------¦ ¦Henry C. Mills ¦133 1/3¦60 ¦60 ¦ +----------------+-------+-------+-------¦ ¦Howard Crooker ¦133 1/3¦-0- ¦-0- ¦ +----------------+-------+-------+-------¦ ¦James M. Hawkins¦133 1/3¦147 1/2¦147 1/2¦ +----------------+-------+-------+-------¦ ¦Floyd Wellington¦-0- ¦45 ¦45 ¦ +----------------+-------+-------+-------¦ ¦Charles Simon ¦-0- ¦147 1/2¦147 1/2¦ +----------------+-------+-------+-------¦ ¦Total shares ¦400 ¦400 ¦400 ¦ +----------------------------------------+

Advances made to Buffalo by stockholders thereof other than petitioner during the years 1941 through 1944 were as follows:

+---------------------------------------------+ ¦Henry C. Mills ¦Apr. 21, 1941¦$3,000¦ ¦ +----------------+-------------+------+-------¦ ¦Floyd Wellington¦Nov. 19, 1943¦3,000 ¦ ¦ +----------------+-------------+------+-------¦ ¦ ¦(Feb. 5, 1943¦12,500¦ ¦ +----------------+-------------+------+-------¦ ¦Charles H. Simon¦(Feb. 3, 1944¦1,000 ¦ ¦ +----------------+-------------+------+-------¦ ¦ ¦(Feb. 8, 1944¦1,000 ¦$14,500¦ +---------------------------------------------+

At the date of the hearing of this proceeding, September 15, 1952, Buffalo was still in existence and carrying on its business of brick manufacture, and petitioner was still president. On April 30, 1952, petitioner, through his business, then incorporated as James M. Hawkins Corporation, made an advance to Buffalo in the sum of $4,700.


BRUCE, Judge:

Petitioner's first contention is that the deduction taken of $26,389.65 represents a business bad debt which became wholly worthless during the calendar year 1943. By amended petition he contends that if the deduction does not represent a business bad debt, the $1,509.05 expended by him as travel expenses on behalf of Buffalo is allowable as an ordinary and necessary expense in the operation of petitioner's business conducted as James M. Hawkins Company, incurred in efforts made by such business to procure an essential supply of brick for its customers.

Respondent contends that the advances in question, if held to constitute indebtedness to petitioner, are not business debts, as they have no direct connection with the operation of petitioner's individual business but are ones incurred in connection with an entirely different business, namely, the operation of a corporation of which the petitioner was a stockholder and officer, and that the evidence fails to establish that such indebtedness was wholly worthless as of the close of the year 1943. He contends further that the record establishes that the advances made by petitioner to Buffalo were in fact contributions to the capital of that corporation by petitioner as a stockholder, and consequently not in fact debts owing to petitioner but merely items of cost to him of his investment in that corporation.

Petitioner argues that the facts justify the finding that as of the close of the year 1943 the advances in question were wholly uncollectible by reason of the fact that the capital of Buffalo was impaired and that its only business at that time was a contract with Bethlehem Steel Company which had been in October of that year canceled by that Company. He points to the fact that as of the close of 1943 Buffalo owed the Reconstruction Finance Corporation $34,004.22, secured by a first mortgage on all the assets of the corporation, and that this loan was in default. He argues, on these facts, that the corporation was then shown to be in a hopeless situation with no possibility for the recovery of any portion of the advances made by him.

We do not think the record supports the petitioner in this contention. Although he testifies that the Bethlehem contract was canceled in October 1943, the record shows a formal cancellation on February 23, 1944, and shows further that on December 16, 1943, subsequent to the date on which he claims the Bethlehem contract was canceled, Buffalo, acting through him as its president, executed an assignment to the Smaller War Plants Corporation of payments to be made on deliveries under that contract, this being in connection with a loan which it had negotiated with that corporation for the sum of $30,000.

The record shows that as of the close of 1943 the condition of Buffalo was not hopeless, and on the basis of the facts then known it could not, in our opinion, reasonably be expected that advances made to it were without possibility of future payment. It is true that, as of the close of 1943, the loan by the Reconstruction Finance Corporation was in default, but at that time a loan had been negotiated and approved from the Smaller War Plants Corporation in the sum of $30,000, the proceeds of which were received shortly after the close of the year. It is further indicated that the contract of Buffalo with Bethlehem was at that time still considered as in existence. In fact, Buffalo was in receipt of $45,000 from Bethlehem several months later as compensation for cancellation of the contract.

The summary of Buffalo's financial condition as of the close of 1943, as stipulated by the parties and set out in our findings, does not, in our opinion, justify a conclusion as to its financial position as argued by petitioner. The liabilities shown thereon of $43,000 appear to be the advances made by stockholders. Its assets, represented by plant and equipment which is shown as $21,983.08, appear to be the original cost of such plant less depreciation taken of $37,795.11. This is not conclusive evidence of the value of the assets but of a net book cost.

As of the close of 1943 the petitioner had been able to negotiate for Buffalo an additional loan of $30,000 from the Smaller War Plants Corporation for use in its further operations, and we think it manifest that the condition of Buffalo was not hopeless and was not so regarded by petitioner at that time. Our attention has been called to no identifiable event in 1943 upon which a finding of hopeless insolvency could be predicated. The corporation was not in receivership. There is no indication that receivership was contemplated, and at the time of the hearing of this proceeding, more than 8 years later, the corporation was still in existence and operating with petitioner as its president.

It is our conclusion that at the close of 1943 the advances made by petitioner to Buffalo, if representing debts due him from that corporation, were not wholly worthless. Cf. Coleman v. Commissioner, 81 F.2d 455.

Our conclusion that the advances made by petitioner did not represent debts wholly worthless as of the close of the taxable year, makes it possible to dispose of the question presented without passing upon the issue raised by respondent as to the character of these advances.

Petitioner's contention, by amended petition, that the item of $1,509.05 expended by him in 1943 in traveling on behalf of Buffalo in an endeavor to secure for it additional financing constituted an ordinary and necessary expense of his individual business deductible under section 23(a), Internal Revenue Code, requires little discussion. It is admitted by petitioner that this expense was incurred in the interest of Buffalo. As such, it is of a character deductible by Buffalo in computing net income. For all we are advised, it may have been the subject of a deduction by that corporation. An expense, to be deductible under the cited section, must be both ordinary and necessary, and for one business to voluntarily pay the expenses of another is not an expenditure ordinary in character. Welch v. Helvering, 290 U.S. 111. It is, moreover, shown that the item in question was recorded on the books of Buffalo as an indebtedness due petitioner by that corporation and was reimbursed to him in full in the following year. Petitioner's contention is denied.

Reviewed by the Court.

Decision will be entered for the respondent.