Docket No. 2504-73.
Filed March 3, 1976.
Petitioner was the founder, president, and former sole shareholder of Multipane. He sold his Multipane shares to Gale. He owned a large block of Gale stock during the years in issue. Gale encountered cash difficulties and proposed a sale of Multipane's assets to WGL, another controlled corporation of Gale. Petitioner made loans to Gale in an effort to avert the sale and to ease Gale's financial troubles, both of which he believed would damage Multipane's business. These loans were subsequently discharged at less than face value, resulting in a loss. Held, petitioner's primary motive in making the loans was to protect the business of Multipane and not to preserve or enhance his own employment or business reputation; the loss was incurred with respect to nonbusiness debts and is deductible only as provided in sec. 166(d), I.R.C. 1954.
Leonard Sarner, for the petitioners.
Howard W. Gordon, for the respondent.
Respondent determined the following deficiencies in petitioners' Federal income taxes:
1967 ....................... $56,891.00 1970 ....................... 24,456.80
The only issue presented is whether a bad debt loss suffered in 1970 is deductible in full or is subject to the limitations imposed by section 166(d) on nonbusiness bad debts. The 1967 deficiency results from disallowance of a net operating loss carryback and depends on our resolution of the bad debt issue.
Highs of 25 7/8 and 25 5/8 were reached on 3/4/68 and 10/14/68, respectively.
FINDINGS OF FACT
Some of the facts are stipulated and are found accordingly. The stipulation of facts and attached exhibits are incorporated herein by this reference.
David and Jeanette Shinefeld were husband and wife and resided in Philadelphia, Pa., at the time the petition was filed. They filed joint income tax returns for the periods involved herein with the District Director of Internal Revenue, Philadelphia, Pa. During the pendency of these proceedings, Jeanette Shinefeld died and her estate was substituted as a petitioner. David Shinefeld is hereinafter referred to as petitioner.
Prior to 1950, petitioner worked in the automotive and electronics industries, in both cases rising from the bottom to high executive positions. In 1950 he organized Multipane, Inc. (hereinafter Multipane), to engage in the manufacture of insulating glass. From an initial capital of about $10,000, over a 10-year period he built this business up to the point where it was earning approximately $200,000 annually after taxes. Petitioner at all times prior to July 1960 was the sole shareholder of Multipane.
On July 1, 1960, petitioner sold the stock of Multipane to Blauner's, Inc., a corporation since renamed Gale Industries, Inc. (hereinafter referred to as Gale). The maximum purchase price was $1,500,000, payable as follows: $200,000 on execution of the agreement; $300,000 the following January; $250,000 in equal installments over a 5-year period; and a maximum of $750,000 over 10 years, contingent on Multipane's earnings. At the same time, he agreed to serve as president of Multipane for this period at an annual salary of $50,000. Major factors in petitioner's decision to sell the company were his desire to lock up the value of his interest in Multipane and to limit the exposure of his investment to risks under the 5-year warranty Multipane provided on its products; and his understanding that he would be given a free hand in continuing to manage the company, which would remain as a subsidiary of the purchaser.
In September 1963, differences between petitioner and Gale led to an amendment of the agreement of sale by which petitioner accepted 228,000 restricted shares of Gale in discharge of the latter's liability to the extent of $228,000 then due and payable. A balance of $579,760.25 was to be paid over a 24-month period.
Dropped from American Stock Exchange on 6/12/69.
Philadelphia, Baltimore Washington Exchange.
In April 1965, petitioner accepted $540,000 in cash in full discharge of Gale's obligation under the sale agreement. As part of this arrangement, the contractual restriction on sale of petitioner's Gale stock was lifted. Petitioner also entered into a new 5-year employment agreement under which he was to receive a salary of $40,000 annually for 3 years and $50,000 for each of the remaining 2 years, plus a percentage of Multipane's profits over the entire 5 years.
He was entitled to 3 percent of the first $2 million of net pretax profit, 4 percent of the next $2 million, and 5 percent of any excess over $4 million.
In the early part of 1967, Gale negotiated for the acquisition of Memory Systems of Missouri, Inc. (hereinafter referred to as MSI), a corporation which owned a glass treatment process of indeterminate, but potentially great, value. Rumors concerning the acquisition of MSI resulted in a large increase in the price of Gale stock. Petitioner personally was skeptical of MSI's value. The following table shows the closing price of Gale stock on the indicated dates:
All statutory references are to the Internal Revenue Code of 1954, as amended and in effect during the years in issue.
The share certificates bore a restrictive legend and petitioner agreed not to sell without Gale's consent. The shares were not registered with the Securities and Exchange Commission.
The closing price of Gale stock on the American Stock Exchange was 2 1/8 on Sept. 30, 1963. The parties have stipulated that the stock had a basis to petitioner of $1.50 per share.
As a director of Gale, petitioner attended a board meeting in April 1967, at which acquisition of MSI was discussed. Also discussed at that meeting was the need to improve Gale's financial position. A plan was proposed by which Multipane's, assets would be sold for $3 million to William Gluckin Co., Ltd. (hereinafter referred to as WGL), another company controlled by Gale. WGL was to borrow the purchase price from certain insurance companies. Petitioner opposed such a move because he felt WGL's cash position was so bad that it would create a ruinous drain on Multipane. This in turn would have damaged Multipane's reputation with suppliers and in the industry in general.
On June 20, 1967, petitioner sold 20,000 shares of Gale common stock for $217,031. Having previously transferred 11,400 shares to his attorneys as a legal fee, he was left with 196,600 out of approximately 2,300,000 Gale shares outstanding.
On June 30, 1967, petitioner loaned Gale $300,000 to help meet its current operating expenses and past due obligations. In June and September 1967, three other Gale directors loaned the company a total of $200,000 for the same purposes. By making the loan, petitioner hoped to forestall the transfer of Multipane's assets to WGL. In this he was finally unsuccessful, and the proposed transaction took place in October 1967.
Three of the directors and the wife of the fourth were also shareholders of Gale.
Sometime in 1968 petitioner decided to dissociate himself from Gale's management. He resigned his position as a director and sold 136,100 shares of common stock at a total price of $2,476,394. Petitioner believed that the stock was far overpriced at the time he made the sale.
Gale's cash difficulties continued, and petitioner loaned the company an additional $50,000 on January 1, 1969. At that time he owned 60,500 shares of Gale common stock. The purpose of this loan was to prevent Multipane's customers, who had heard of Gale's troubles, from refusing to deal with it.
Gale's financial position weakened further and on August 25, 1970, petitioner and a number of other creditors accepted a settlement by which they released their claims in exchange for part payment in cash and Gale preferred stock. Petitioner suffered a loss of $293,275 on his loans to Gale as a result of this settlement. He also accepted $40,000 in cash in settlement of a claim for contingent compensation under the 1965 employment agreement.
ULTIMATE FINDING OF FACT
The dominant motive for petitioner's loans to Gale was not proximately related to his trade or business.
On his 1970 income tax return, petitioner claimed a business bad debt deduction under section 166(a)(1) of $293,275, the amount of the loss he suffered on his loans to Gale. Respondent concedes the existence and the amount of the debts but contends that they should not be allowed on the ground that they constituted nonbusiness debts under section 166(d). The parties are in agreement that, in determining whether the debts bore a proximate relationship to petitioner's trade or business, "the proper measure is that of dominant motivation." United States v. Generes, 405 U.S. 93 (1972); Robert E. Imel, 61 T.C. 318, 324 (1973). The issue is one of fact. Oddee Smith, 60 T.C. 316 (1973); sec. 1.166-5(b)(2), Income Tax Regs.
SEC. 166. BAD DEBTS.
(a) GENERAL RULE. —
(1) WHOLLY WORTHLESS DEBTS. — There shall be allowed as a deduction any debt which becomes worthless within the taxable year.
Sec. 166(d) provides:
(d) NONBUSINESS DEBTS. —
(1) GENERAL RULE. — In the case of a taxpayer other than a corporation —
(A) subsections (a) and (c) shall not apply to any nonbusiness debt; * * *
* * *
(2) NONBUSINESS DEBT DEFINED. — For purposes of paragraph (1), the term "nonbusiness debt" means a debt other than —
(A) a debt created or acquired (as the case may be) in connection with a trade or business of the taxpayer; or
(B) a debt the loss from the worthlessness of which is incurred in the taxpayer's trade or business.
Petitioner does not argue that his duties as a director of Gale or Multipane constituted a separate trade or business to which the debts were related or that he was in a separate trade or business of making loans.
Petitioner contends that his dominant motivation in making the loans in question was "to protect and preserve his managerial position and everyday control as the Chief Executive and highly salaried officer of Multipane and his status, reputation and image to the trade as the continued successful operator of the glass business." (Petitioner's brief, pp. 19-20.) Respondent, relying principally on the size of petitioner's Gale stockholdings (about $2 million at the time of the first loan and almost $700,000 at the time of the second) compared with his annual salary from Multipane ($40,000 to $50,000, plus an unknown contingent amount), see United States v. Generes, supra, argues that petitioner's purpose was to preserve the value of his investment in Gale.
While the record permits no specific findings to be made as to the amount of such compensation accrued or anticipated at the relevant dates, consolidated financial statements attached to a March 1968 proxy statement to Gale shareholders indicated that deferred compensation due to petitioner and two others totalled $3,000 as of Oct. 31, 1967. In 1970 petitioner accepted $40,000 in full settlement of his claim for contingent compensation.
The picture of petitioner which emerges from the record is that of a highly competent businessman justifiably proud of his achievements. He had acquired a considerable degree of financial security at a relatively young age. We do not believe he seriously doubted his ability to earn a comfortable living elsewhere should Multipane fail, nor for that matter his ability to steer it through Gale's financial storms. Nor do we believe, considering his low opinion of Gale's management, that he made the loans in question to preserve or enhance the value of his Gale stock. Foremost in his mind at the time he made each loan was the danger which the business adventuresomeness of the Gale group and the attendant financial drain posed to Multipane. Regarding the purpose for the June 1967 loan, petitioner testified to WGL's troubles and continued:
Petitioner was 58 years old at the time of trial in 1975.
A Well, the purpose in my mind was that while he [Gerald Gluckin, chief executive of WGL] was negotiating with these people in Boston and these people in New York were putting pressure on him that if I could help alleviate the pressure from the New York fellows he might not have to go to Boston and take the assets of Multipane and put them into the Gluckin group.
Q Now, in your own mind, will you then tell me why did you prefer not to have the assets of Multipane in the Gluckin subsidiary?
A Because this Gluckin outfit was always running into us for money. And they — and they — and they could have been the cause of Multipane running into cash problems of its own.
Q Would it in any way have affected your managerial capacity?
A It sure would. It would have presented a bad picture both to the industry and to my suppliers. And this would have been bad for Multipane. The word would have spread immediately throughout the entire —
Q Would it have affected —
A — glass industry.
Q — your employment agreement?
A Well, sure, because anything that would have affected Multipane in a detrimental manner would certainly affect me.
As to the $50,000 advanced in January 1969, he testified:
Q Can you tell me the circumstances of the 1969 loan and the purpose for it —
A Well, again —
Q — which took place — let me finish — in January of 1969?
A Again, we were facing that same —
Q When you say "we" —
A "We", I mean Multipane, Gluckin, Gale, everybody that's mixed up in this bit. Again, they — they don't have any money. They're running out of money, and I had already been visiting some of my biggest accounts and trying to calm them down. * * * Then they were worried. They heard that we didn't have any money and why should they continue to do business with us because they heard that we were getting ready to close our doors —
Q Now, I'm talking about the loan —
A But the loan that I — well, that's what I'm saying. That the loan I gave them again was to help them with their cash position so that my customers wouldn't get word that they [sic] were still financial troubles going on. Because had they known it, again they would begin to say, well, jeez, with this warranty I don't want to do business with Multipane. In spite of our good record with them, I certainly wouldn't have blamed them.
It is clear from these excerpts that Multipane's problems, not his own, were petitioner's chief cause of concern. The fact that he did not directly own any of Multipane's stock does not persuade us otherwise; he evidently took a continued fatherly interest in the company's fortunes. Nor can petitioner prevail on the basis that Multipane's business was his business. The fact that a loan or payment is made in furtherance of the employer's trade or business does not mean it is proximately related to that of the employee. Robert E. Imel, supra; James D. Robinson, 45 B.T.A. 39 (1941). Cf. Deputy v. du Pont, 308 U.S. 488 (1940); Tony Martin, 25 T.C. 94 (1955).
Indubitably, petitioner made the loans in question from a complex of motives. He had an annual salary to protect under a multiyear employment contract, along with the possibility of substantial additional contingent compensation. He owned a large block of Gale's stock. Finally, his personal pride in seeing Multipane prosper was at stake. We credit petitioner's testimony that he made the loans principally to protect Multipane. But we cannot accept his contention that he did so out of concern for his own employment security. Continuation of his salary and contingent compensation may have played a role in his decision, but we are unable to conclude that the role was a dominant one. Nor are we convinced that petitioner's status, reputation, and image to the trade were so endangered as to satisfy the dominant motive standard. Cf. James E. Anderson, 56 T.C. 1370, 1373-1374 (1971), revd. on another issue 480 F.2d 1304 (7th Cir. 1973); Laurence M. Marks, 27 T.C. 464, 467 (1956). If one motive must be lifted from its psychic matrix and labeled "dominant," it would be the motive to protect Multipane itself, the business which petitioner had built from a shoestring and still regarded as "his." Cf. Kelson v. United States, 503 F.2d 1291 (10th Cir. 1974).
The Generes opinion, although emphasizing the greater reliability of "objective" evidence, does not preclude us from drawing this inference from petitioner's credible testimony. William G. Young, T.C. Memo. 1974-76; Geraldine R. Mann, T.C. Memo. 1975-74.
We conclude the loans in question were not proximately related to petitioner's trade or business as an employee and were nonbusiness debts subject to the limitation imposed by section 166(d).
Decision will be entered for the respondent.