Docket No. 16254.
Joseph J. Seamen, Esq., for the petitioner. Stanley B. Herzfeld, Esq., for the respondent.
Petitioner, president and majority stockholder of Wigton-Abbott Corporation, in 1931 directed its treasurer to purchase for the corporation 200 shares of stock in Columbia Gas & Electric Co. Petitioner's authority as an officer and majority stockholder of the corporation was such that the purchase would have been unquestioned by the directors, but petitioner nevertheless promised the treasurer in writing prior to the ensuing directors' meeting to indemnify the corporation against any loss on the stock. The stock was purchased and held by the corporation until 1941, when the stock was sold at a loss of $6,456.02. In 1943 petitioner paid the Wigton-Abbott Corporation the amount of this loss, pursuant to his promise of indemnity. Held:
(1) The indemnity agreement was merely a gratuitous gesture of petitioner, made for other purposes than the procuring of profit, and petitioner's payment thereunder was not deductible under section 23 (e), I.R.C.
(2) The possibility of petitioner obtaining profit through increased dividends in Wigton-Abbott Corporation was too remote to support a loss deduction under section 23(e)(2). Joseph J. Seamen, Esq., for the petitioner. Stanley B. Herzfeld, Esq., for the respondent.
Respondent determined a deficiency in income tax for the taxable year 1943 in the amount of $1,209.03. The sole issue presented is whether petitioner is entitled to a deduction for $6,456.02 paid by petitioner to the Wigton-Abbott Corporation in 1943, pursuant to a written promise to indemnify the corporation for any loss resulting from its purchase of 200 shares of stock of Columbia Gas & Electric Co. in 1931.
FINDINGS OF FACT.
Petitioner is an individual who filed his income tax return for the taxable year 1943 with the collector of internal revenue for the fifth collection district of New Jersey.
Petitioner is, and at all times material herein was, the president of the Wigton-Abbott Corporation, which specializes in the design and construction of industrial plants, and is its principal stockholder, owing approximately 65 per cent of the corporation's stock. There are other stockholders who are not members of petitioner's family. Petitioner devoted practically all of his working hours to the affairs of Wigton-Abbott Corporation and received a substantial salary therefor. During the taxable year this salary amounted to $40,000 per year.
On April 22, 1931, the petitioner orally directed the treasurer of the corporation to buy 200 shares of stock of Columbia Gas & Electric Co., and informed the treasurer that he would later authorize the purchase for inclusion in the corporate records. The treasurer transmitted the order to the Chase National Bank by telephone and received a quotation which he communicated to the petitioner, who instructed him to buy. Later that day petitioner gave the treasurer a written authorization for the purchase of the stock, including a promise to indemnify the corporation for any loss on the transaction. The text was as follows:
Please buy two hundred (200) shares of Columbia Gas and Electric stock for the account of the Wigton-Abbott Corporation, using a portion of the money which we have on deposit with the Plainfield Trust Company.
I am quite sure that even though it may go lower we should make a substantial profit on it and inasmuch as we have a fair amount of cash on hand at the banks which is not brining in any return I think it good business to do this. I feel so strongly about it that I am guaranteeing the Wigton-Abbott Corporation against any loss in connection with this transaction.
The stock was purchased pursuant to these instructions on April 24, 1931, for a total of $6,630. On May 8, 1931, the board of directors of the Wigton-Abbott Corporation at its regular monthly meeting ratified the purchase. The portion of the minutes dealing with this purchase was as follows:
Mr. Wigton reported that he had instructed the Treasurer to purchase for the account of the Wigton-Abbott Corporation 200 Shares of the Stock of the Columbia Gas and Electric Corp. and the Treasurer reported that on April 24th he had purchased 200 Shares of said stock at 33.00 per share.
Mr. Abbott moved that the action of the President & Treasurer in the purchase of said stock be and hereby is ratified. Mr. Scott seconded the motion and it was so ordered.
There had been two earlier occasions when petitioner had directed the investment of corporate funds in bank stocks prior to authorization by the board of directors, but petitioner on those occasions had made no promise to indemnify the corporation against loss. Petitioner's authority over the affairs of the corporation was such that his directive to purchase Columbia Gas & Electric stock would have been made and approved without any guarantee. The guarantee was a gratuitous gesture by the petitioner.
The stock was held by the Wigton-Abbott Corporation until 1941, when it was sold for $173.98, at a loss of $6,456.02. The corporation claimed this amount as a capital loss in its return for 1941. The internal revenue agent in charge, Newark, New Jersey, disallowed the loss. There were other disallowances— in particular a portion of a deduction for officers' salaries. Following protest by the corporation on the adjustment, there was a settlement of the corporation's 1941 tax liability, with the Government receding to some extent on the salary question. In the settlement the capital loss claimed by the corporation on the sale of the Columbia Gas & Electric stock was still disallowed.
In 1943 petitioner paid the Wigton-Abbott Corporation the amount of the loss, in the sum of $6,456.02, and deducted this sum in his 1943 income tax return. Respondent disallowed the deduction.
Petitioner argues that he was legally obligated to indemnify the Wigton-Abbott Corporation against loss and that he paid $6,456.02 to the corporation pursuant to that obligation. He further argues that the loss was incurred in his trade or business, or in a transaction entered into for profit, and that it was accordingly deductible by him under section 23(e) of the Internal Revenue Code.
SEC. 23. DEDUCTIONS FROM GROSS INCOME.In computing net income there shall be allowed as deductions:(e) LOSSES BY INDIVIDUALS.— In the case of an individual, losses sustained during the taxable year and not compensated for by insurance or otherwise—(1) if incurred in trade or business; or(2) If incurred in any transaction entered into for profit, thought not connected with the trade or business;
Respondent's position is that petitioner's written promise of indemnify to the corporation lacked consideration and, therefore, was not binding. Furthermore, he maintains, even if the promise was binding, the payment by petitioner was not a deductible loss under section 23 (e), or any other section of the Internal Revenue Code.
Obviously, the payment was made pursuant to a legal obligation. The consideration for petitioner's promise of indemnity was the purchase by the corporation of the shares of Columbia Gas & Electric Co. stock. Respondent argues that the performance of a preexisting legal duty is not consideration. But there was clearly no legal duty on the part of the corporation, an engineering concern, to speculate in stocks upon the orders of its president. Hence, the consideration for petitioner's promise of indemnity was the corporation's purchase of the stock, later ratified by the board of directors.
Although the activity of an executive of a corporation has been recognized as a trade or business, George S. Groves, 38 B.T.A. 727, and Ralph C. Holmes, 37 B.T.A. 865, it would only be under most exceptional circumstances, which do not exist in the case at bar, that the guaranteeing of the investments of a corporation of which a taxpayer is president would be considered as a part of the president's trade or business. Therefore, petitioner's loss can not be deducted under section 23 (e) (1) of the Internal Revenue Code.
In considering whether or not petitioner's loss may be deducted under section 23 (e) (2) of the code, providing for losses incurred ‘in any transaction entered into for profit, though not connected with the trade or business,‘ our first problem is to determine whether petitioner hoped to received a profit through the issuing of the guarantee. If we assume for the argument that he hoped that Wigton-Abbott Corporation would realize either capital gains or dividends from its purchase of Columbia Gas & Electric stock that he would thereby profit from increased dividends on his stock in Wigton-Abbott Corporation, under the facts in this case we still have no basis to conclude that petitioner's guarantee of the investment had anything to do with his anticipation of profit.
In our factual finding that the petitioner's authority was such that the purchase would have been made and approved by the corporation without any guarantee and that the guarantee was merely a gratuitous gesture on his part, we have closely paraphrased his own words. Since he was the majority stockholder and the corporation itself would have acted without the guarantee, his gratuitous gesture was evidently made to protect himself from any possible criticism from the minority stockholders for an investment which was somewhat speculative. The avoidance of such criticism from the minority stockholders would have supplied petitioner with an understandable motive for making the guarantee and, when the guarantee was once made to the corporation and thereafter acted upon by the board of directors in approving the purchase, it became a consideration moving from the petitioner to the corporation upon which an enforceable obligation could be based, as we have held above.
However, all such factors have little to do with increasing petitioner's hope for future profit from the corporation's investment in Columbia Gas & Electric Co. stock when petitioner admits that the corporation would have made the stock purchase without any guarantee at all. It is therefore our conclusion that the guarantee was made for purposes other than to procure profit and that the loss resulting from the guarantee is not a deductible one.
The second objection to the allowance of petitioner's loss deduction is that, even if we overlook the absence of any connection between petitioner's guarantee and his hope of profit, there is still an insufficiently direct connection between the purchase of stock in Columbia Gas & Electric Co. by Wigton-Abbott Corporation and the possibility of profit inuring to petitioner on which to base a loss deduction in petitioner's taxable income arising from losses growing out of the Wigton-Abbott Corporation investment.
The purchase of Columbia Gas & Electric stock was made by the Wigton-Abbott Corporation, not by petitioner. Thus, no gain or loss on the sale of the stock could be directly made or incurred by him. Petitioner maintains that as majority stockholder in the corporation he stood to gain if the corporation profited from the purchase of Columbia Gas & Electric stock. A single, relatively small investment, however, on the part of a corporation would not necessarily inure to the benefit of a stockholder in the form of increased value for his stock or of dividends, even if profit resulted. The profit would go to the corporation, not to the stockholder, and the stockholder could only benefit indirectly, if at all. It would be a far cry from the purpose of the statute to hold that an investment of a corporation was a transaction entered into for profit as to an individual stockholder simply because he might indirectly benefit from the investment, or because he agreed to indemnify the corporation against loss.
In Goldsborough v. Burnet, 46 Fed.(2d) 432 (CCA-4, 1931), the taxpayer's mother-in-law, who received most of her support from him, purchased in 1922 certain corporate securities solely at the taxpayer's instance, and at that time of the purchase the taxpayer stated to his mother-in-law that should she sustain a loss by reason of such purchase he would reimburse her for the amount so lost. She did sustain a loss in 1922 as a result of the purchase, and the taxpayer, in accordance with his promise, paid her the sum of $5,757.25. The taxpayer deducted this sum as a loss in his 1922 return and the Commissioner disallowed the loss. Both the Board of Tax Appeals (18 B.T.A. 181) and the Circuit Court upheld the disallowance by the Commissioner.
In its opinion in that case the Circuit Court said (p. 433):
It is contended on behalf of petitioner that he entered into the transaction for profit, because of the fact that if his mother-in-law had gained from the transaction he (the petitioner) would have been correspondingly benefited, because, as his mother-in-law's income increased, the amount he would have to contribute to her maintenance and support would decrease. However commendable we may feel was petitioner's course in reimbursing his mother-in-law for her loss, we cannot but reach the conclusion that the benefit that would have accrued to him had his mother-in-law gained in the transaction is too vague and indefinite to amount to a profit. The profit in the transaction, if there had been any profit, would have gone directly to petitioner's mother-in-law and not to the petitioner, and the petitioner would have benefited only in an indirect way.
As stated in Read v. Tidewater Coal Exchange, Inc., 13 Del.Ch. 195, 210, 116 A. 898, 904, profit ‘must be something of a tangible or pecuniary nature. Intangible benefits not capable of measurement in definite terms, though of value to the recipients, cannot be called profits.‘
Petitioner relies primarily upon Ernest E. Lloyd, 8 B.T.A. 1029, and Marjorie Fleming Lloyd-Smith, 40 B.T.A. 214. In the former case the taxpayer advanced his own money to develop a secret formula which he contemplated to have exploited commercially by a corporation of which the taxpayer was the president. The development of the formula was a failure and the taxpayer deducted the expenses incurred thereby from his taxable income, which deduction was approved by the Board of Tax Appeals.
It is at once apparent that in the Lloyd case the corporation's president was investing his own funds to increase the manufacturing capacity of his own corporation and such increase, if it had occurred, would have had a direct connection with his occupation as a corporation president and would have materially affected his dividend income as a stockholder. In the case at bar the petitioner did not invest his own funds in any attempted promotion of corporate business. Instead, he induced the corporation to deplete its operating funds by investing in corporate stock entirely outside of its own field of activity.
In the Lloyd-Smith case the taxpayer, in order to induce investors to buy bonds necessary to keep a corporation in which she was a heavy stockholder in operation, personally guaranteed the repayment of the bonds. The corporation defaulted and the taxpayer sought a loss deduction. The Board of Tax Appeals permitted such a deduction for the money paid by her in settlement of her guarantee obligations. Here again, as in the Lloyd case, the loss was sustained by the taxpayer in promoting the regular business of the corporation in which the taxpayer was heavily involved. It was the business for which the corporation was organized and out of which the taxpayer's stockholders might reasonably anticipate direct profits. There was a direct connection between the anticipation of such profits and the expenditure of the funds of the taxpayer. In the case at bar the petitioner's hope of profit was indirect from the expenditure of the funds of the corporation and the hope of profit was not connected with the corporation's established activities.
Therefore, because petitioner's guarantee did not cause the investment out of which petitioner claimed he hoped to receive profit, and also because the profit which petitioner claims to have anticipated was too remote from the investment by Wigton-Abbott Corporation to form the basis for a loss deduction to petitioner, it is our conclusion that the respondent was correct in refusing to recognize petitioner's loss deduction.
Reviewed by the court.
Decision will be entered for the respondent.