Comm'r of Internal Revenue

Tax Court of the United States.Sep 25, 1950
15 T.C. 299 (U.S.T.C. 1950)
15 T.C. 299T.C.

Docket No. 22349.



Harold E. Mitchell, Esq., for the petitioner. W. C. W. Haynes, for the respondent.

1. BUSINESS— REGULARLY CARRIED ON— NET OPERATING LOSS CARRY-OVER— SECTION 122(d)(5).— A deduction for bad debts was attributable to the operation of a business regularly carried on by the petitioner.

EARNED INCOME CREDIT.— Earned income credit proper although petitioner spent a part of the year in the Air Corps. Harold E. Mitchell, Esq., for the petitioner. W. C. W. Haynes, for the respondent.

The Commissioner determined a deficiency of $17,915.08 in income tax for 1943. The errors assigned are the disallowance of a deduction of $19,452.46 for 1942 representing a net operating loss carry-over from 1941 and the disallowance of an earned income credit with respect to income from the Modern Tools Co., a partnership, for the year 1942, or for that portion of the year prior to the petitioner's entry into the Army.


The petitioner filed his individual return for 1943 with the collector of internal revenue for the district of Connecticut.

The petitioner studied civil and mechanical engineering at Yale and geology at Princeton. He was graduated from the latter institution in February 1923. Thereafter for about a year he was employed as a geologist by Standard Oil of Indiana. He and an associate operated a company drilling oil wells following that for about a year and a half. He returned to his home in Connecticut in 1925 at the time of his father's death.

He received about $500,000 from his father's estate, together with a one-fourth interest in a family personal holding corporation, the Oakstone Corporation. He became president and treasurer of that corporation and continued in that capacity. It was engaged in investing its funds primarily in investment, as opposed to speculative, securities. Its assets were worth about $400,000 in 1925 and about $800,000 in 1950. The petitioner spent a few hours each week conducting the business of that corporation.

The petitioner, in the late 1920's, acquired a patent on a safety razor but made no effort to manufacture the razor. He became interested about the same time, along with an architect, in radiant heating for which a patent was obtained. He dropped it because the architect became ill and the petitioner could not have business discussions with him. The petitioner's brother-in-law, at some time not shown by the record, started a literary magazine. The petitioner wrote some articles for the magazine and furnished $1,000 in an effort to assist his brother-in-law. The magazine was a failure. The petitioner went to Canada on a number of occasions with a college classmate who was one of the leading mining geologists of Canada. They visited mineral properties. They had a joint brokerage account from which a small profit was made at some time and in some way not disclosed by the record. The petitioner obtained some equipment to make a concrete which would be the equivalent of natural sandstone. He invested about $25 but did not develop his idea further.

The Die Cast Steel Co., located near Hartford, was a small steel company engaged in manufacturing high speed steel and high speed steel castings. It was using a new process. The petitioner began to work for that company in 1926 as an understudy of a metallurgist whom he considered a genius. He invested about $20,000 in that corporation. The metallurgist was working on a number of ideas and had a process which he though would work well on cast iron and petitioner, in an effort to assist, operated a foundry for a short while. He hoped that the company would become successful. His employment continued for about two years when the company went out of existence and his investment was lost.

The petitioner for 6 months during 1929 had a firm manufacture tungsten carbide tools which he then sold.

The petitioner had little to do during the depression years from 1930 to 1934 so he decided in 1930 to study law, not with the intention of practicing but only to round out his education. He went to law school for a year and a half, studied in an office, passed the bar examination, and was admitted to the Bar of Connecticut in 1934. He never engaged actively in the practice of law at any time material hereto and his income from law work was relatively insignificant. He maintained an office, beginning in 1934, from which, thereafter, he conducted business.

The petitioner, in order further to occupy his time in 1932 and for some time thereafter, designed and made some miniature furniture with equipment which cost him about $500. He never sold any of the furniture.

The petitioner learned, through a friend, of J. W. Delcoe, said to be clever in mining operations in Colorado, and went West in 1933 to meet him. The petitioner examined mining properties in 1933 and 1934 and finally, with Delcoe, organized the Revenue Development Corporation in March 1935. The capital of the corporation was purchased for $25,000 by Oakstone Corporation. The petitioner was to furnish additional money and was to do some executive work. Delcoe did not furnish any money but was to be the active manager in the development of the property. The petitioner obtained a lease on mining property in his own name and assigned it to the corporation. He loaned money to the corporation from time to time. The total amount loaned was $70,750. He knew that the amount of money which he intended to advance would not thoroughly equip a first class mine. He had no exact plans but he wanted to see the property put in first class shape as a profitable mining property in which he might or might not retain some interest. He spent several months at the mine during the summers of 1935 and 1936 checking into the operation. He kept in touch with it at other times through frequent reports. He also interviewed some people with regard to the financing and operation of the mine. The development continued through 1939 and thereafter at a slower pace. Delcoe proved unsatisfactory to the petitioner. Action to cancel the lease for failure to comply with the terms was started in 1940, a receiver was appointed in 1941, and the operation ceased at that time. The debts owed to the petitioner in the amount of $70,750 became worthless in 1941.

Hans Neilson was operating a small tool shop in East Hartford when the petitioner became acquainted with him. They formed a corporation in 1934 known as Modern Tools Corporation for the manufacture of tools. The petitioner turned over some material and furnished a small amount of money to start the corporation, but no real financing of that business ever became necessary. Neilson operated the shop and manufactured the products. The petitioner took an active part and spent considerable time in the affairs of the business. The petitioner had friendly relations with the operating heads of Pratt-Whitney Aircraft which was the best market for the tools manufactured by Modern Tools Corporation. The business was successful. The corporation continued until 1940, when a partnership in which the petitioner and Neilson each had a one-half interest, took over the business. The petitioner's share of the income of the partnership, as reported, was $35,305 for 1941, $60,435 for 1942, and $28,480 for 1943. The partnership had a serious fire in its plant in 1943. The partnership is still in existence.

The petitioner's wife wanted to go into business for herself in 1935. She wanted to operate a restaurant known as the Englewood Diner. About $15,000 or $20,000 of the petitioner's money was used to renovate the restaurant. The petitioner's wife became ill and was unable to operate the business. The venture soon failed and the petitioner sustained a loss.

The petitioner, in 1936, was interested in a gun shop in a town near Hartford. A mechanic had started a gun repairing and trading business in his cellar and was doing rather well. The petitioner believed he could do much better if he had a place of business on the main highway. A corporation was formed to carry on the business and equipment was purchased. The petitioner took an active part in the business. The mechanic left the business to go into more attractive work and the business of the corporation was terminated. A friend of this mechanic was working on a submachine gun in the cellar of the mechanic's house. The petitioner investigated the possibility of manufacturing the gun. Later a fire arms company manufactured it but the petitioner went no farther than his investigation.

The Union Manufacturing Co. is an old organization engaged in the manufacture of machine chucks. The petitioner thought that the management did not seem to be alert so he decided in 1939 to buy some stock in the corporation in the hope that he could get on the board of directors and improve the business. He also though that this corporation would furnish an outlet for products of Modern Tools. The petitioner invested $5,000 of his own funds and a larger amount of the funds of Oakstone in the stock of that corporation. Dividends were received on the stock and the investment turned out to be satisfactory. It does not appear that the petitioner ever took any part in the management or operation of that corporation.

Whitelock Company was a small corporation. It had about a half a million dollars invested in real estate and equipment for the manufacture of heat exchangers and pressure styles. There were not many shares of its outstanding stock and the petitioner believed he could acquire some of those shares cheaply. He was familiar with the plant and hoped that he might have a part in the management of it. He invested about $6,000 or $7,000 of his own funds in the stock of that company but he never became active in its management.

The petitioner decided in the latter part of 1941 to go into the Air Corps. He left Hartford in May 1942 to take a commission in the Air Corps. He spent most of the time between December 1941 and May 1942 working on affairs of Modern Tools, conferring with Neilson, and making plans for the future of the business while the petitioner would be away in the military service. He was stationed at Wright Field, Dayton, Ohio, during the last 8 months of 1942. Neilson visited him once there on business matters. They communicated by letter and the petitioner frequently conferred with Neilson in Hartford where he went in the course of his military duties and on leave. He stayed with Neilson while he was in Hartford on a number of occasions during 1942.

Associates of the petitioner invited him in 1942, while he was in the military service, to go along with them in an investment in some real estate. He invested some money with them but does not recall how much. A small profit was made but the amount is now shown in the record.

The petitioner helped to an extent not shown by the record to finance two men who started a chrome plating business in 1945, and to finance a chemist who had a formula for plastic coating. The latter enterprise failed.

The Commissioner, in determining the deficiency, explained that the net operating loss deduction in the amount of $19,452.46 deducted on the 1942 return on account of an alleged net operating loss carry-over from 1941, was disallowed for the reason that there was no net operating loss for the year 1941 because there was deducted, in computing the loss, bad debts in the amount of $70,750 representing loans to the Revenue Development Corporation of which the petitioner was a stockholder, which had bad debts do not constitute deductions attributable to the operation of a trade or business regularly carried on by the petitioner and must be disregarded under section 122(d)(5) in computing a net operating loss. He also explained that the earned net income of the taxpayer for 1942 under section 25 of the Internal Revenue Code was $3,000 instead of $12,983.81 and the earned income credit was $300 instead of $1,298.38.

The deduction of $70,750 for 1941 for bad debts was attributable to the operation of a business regularly carried on by the petitioner.

The petitioner had earned net income of at least $12,983.81 during 1942.



No question about the amount of income and deductions of the petitioner for 1941 is involved in this proceeding. The Commissioner concedes that the petitioner was entitled for that year to a deduction of $70,750 for worthless debts and that a net loss resulted. The only question for decision is whether that deduction was attributable to the operation of a trade or business regularly carried on by the taxpayer in 1941. Section 122(d)(5). If it was, then the petitioner is entitled to the net operating loss carry-over for which he contends.

The petitioner has outlined many separate activities in which he participated from the time he was graduated from college until about 1946. There is testimony that he considered additional proposals which were brought to him during that time and that he was known as a person to whom such proposals might be brought profitably. Some of his activities may appear trivial and it may be inappropriate to fit some of the uses to which he put his time or money or both into the pattern of any business regularly carried by him. But even if some are disregarded, enough are left to show that he was regularly carrying on a business. There may be difficulty or difference of opinion in defining that business properly, but it existed and was apparent.

The petitioner was constantly looking for opportunities for the use of his money and time. Those which he found were many and varied. Some proved to be profitable, but most did not. Still the petitioner persisted and a consistent course of action appears. The loans to Revenue Development Corporation were like his aid to or investment in a number of other business ventures— each was accompanied by activity of the petitioner in the venture. This is not a case, like Higgins v. Commissioner, 312 U.S. 212, of a wealthy man claiming that the investing and reinvesting of a large fortune in marketable securities constitutes carrying on a business. The petitioner, no doubt, did some investing and reinvesting of his funds in marketable securities but he does not refer to that part of his activities as a basis for his claim here. He mentions only ventures of a different character in which he assumed greater risks and in which he actually participated, or hoped to participate through personal services. He was not a salaried officer as was the petitioner in Samuel Lanski, 34 B.T.A. 1019. He did not merely invest his money but used his time and energy to make the venture succeed. He did that sort of thing with such frequency and regularity that it amount to a regular business carried on by him. The working assets of his business were his money and his personal services. He used them consistently and repeatedly. If one venture was successful, he continued with it, but if it failed, he dropped it. He continued to look for other opportunities. His business was not merely that of a particular venture. Cf. Burnet v. Clark, 287 U.S. 410. He was not a passive investor. The Revenue Development Corporation venture was not an isolated transaction but was a part of his regular business and the loss from that venture was incurred in the operation of a business regularly carried on by him. Cf. Washburn v. Commissioner, 51 Fed.(2d) 949; T. I. Crane, 17 B.T.A. 720.

Counsel for the respondent, at the beginning of the hearing, said that the issue in regard to the earned income credit is ‘whether the petitioner actually did render his services during the year 1942 to the Modern Tools Corporation such as would entitle him to an earned income credit under Section (24(a)(3) and (4)(A)) of the Internal Revenue Code.‘ The evidence shows that the petitioner actually rendered services to the Modern Tools partnership during 1942 sufficient to entitle him to the earned income credit which he claims. He devoted more time than usual to the affairs of that business during the first four months of 1942, and event after he went into the Air Corps in May 1942 he continued to keep in touch with and to render valuable services to that business. He conferred with his partner on a number of occasions, he corresponded with him, and in other ways continued to serve the business during the last 8 months of 1942.

Decision will be entered under Rule 50.