The Commissioner has determined, for the calendar year 1955, a deficiency in income tax of $1,813.06 and an addition to tax of $41.82 under section 6654, I.R.C. 1954. The only issue is whether an amount of $8,250, which petitioners claimed on their return as a bad debt deduction, was a nonbusiness bad debt deductible under section 166, I.R.C. 1954, only to the extent of a net capital loss.
FINDINGS OF FACT.
The petitioners are husband and wife and are residents of Mt. Kisco, New York. They filed a joint return for 1955 with the director of internal revenue for the Lower Manhattan District of New York.
After completing a management trainee course with the American Express Company in 1938, petitioner John M. Trent, hereinafter called petitioner, was assigned to various duties as assistant to the executive vice president of the company and served in that capacity until he entered the Navy in November 1940. He served in the Navy until 1945, as communications officer of a destroyer and later as executive officer and commanding officer of a destroyer escort. In October 1945, he returned to his employment with American Express Company on the staff of the executive vice president and remained with that company until 1953, serving for the last 2 years as financial manager for the New York district.
In August 1953, petitioner was employed by Edward F. Caldwell Co., Inc., at a salary of $150 a week. Under this employment he was also to serve as vice president and business manager of Plastic Illuminating Co., Inc., an affiliated company.
Edward F. Caldwell Co., Inc., hereinafter referred to as Caldwell, Inc., engaged in the manufacture and sale of lighting fixtures. The business was begun in 1895 and was incorporated in 1914. Plastic Illuminating Co., Inc., hereinafter referred to as Plastic, was engaged in supplying plastic bowls for lighting fixtures. Prior to petitioner's association with these companies, their stock was owned in equal shares by Edward T. Caldwell, Jr., and Saul Garfunkel. Caldwell was president of both companies.
In his conversation with Caldwell about his employment, petitioner was asked about his finances and was told that he would be expected to lend financial aid to the business. There was no agreement as to when this might take place or as to the amount of aid he might be required to furnish. From his examination of the records of the companies and what he was told by Caldwell, petitioner satisfied himself that the business was sound but in a poor cash position. He was told that the cash shortage was partially due to a loss of $110,000 on a Government contract, which they expected to recover.
As a condition of his employment, petitioner was required to purchase 5 shares of the capital stock of Plastic, a one-third interest, at $1,000 a share. Caldwell and Garfunkel each owned 5 shares for which they had each paid $750.
In February 1954, Caldwell asked petitioner to make an advancement to Caldwell, Inc., of $5,000 with which to pay some old bills of the company. He represented to petitioner that without payment of the bills, supplies would be cut off and the business would have to close down. On February 10, 1954, petitioner gave Caldwell his personal check, made payable to Caldwell, Inc., for $5,000 to be used for the purpose indicated. Caldwell told petitioner that the money would be repaid to him when the finances of the business permitted. Repayment of the loan to petitioner was never made. At the time the loan was made, petitioner's salary was increased from $150 to $250 per week.
In March 1954, Caldwell asked petitioner for an advancement to Plastic of $1,500 with which to pay for a large order of plastic bowls. The supplier would not ship the goods to Plastic's customer until they were paid for, and the company had no funds available. On March 29, 1954, petitioner gave Caldwell his check for $1,500, payable to Plastic. Caldwell promised petitioner that the loan would be repaid when collection was made from the customer. Repayment of this loan to petitioner was never made.
Over the period April 2 to September 21, 1954, petitioner gave his checks, made payable either to Caldwell, Inc., or Plastic, or to Caldwell personally, and received repayment, if any, as follows: Date Company Amount Apr. 2 ................. Caldwell .............. $1,000 repaid. Apr. 20 ................ Caldwell, Inc. ........ 500 repaid. Apr. 30 ................ Caldwell, Inc. ........ 750 repaid. May 21 ................ Caldwell, Inc. ........ 2,400. Aug. 12 ................ Plastic ............... 1,200 repaid. Aug. 19 ................ Caldwell, Inc. ........ 200 repaid. Aug. 24 ................ Caldwell, Inc. ........ 365 repaid. Sept. 10 ............... Caldwell, Inc. ........ 600 repaid. Sept. 21 ............... Caldwell, Inc. ........ 610 repaid.
The May 21, 1954, loan of $2,400, together with the previous $5,000 loan to Caldwell, Inc., and the $1,500 loan to Plastic, left an unpaid balance due petitioner of $8,900.
No notes or other evidence of indebtedness were given to petitioner on any of his loans to Caldwell, Inc., or Plastic. No interest was ever paid or promised to petitioner on any of the loans. None of the loans was in any way secured.
About the last of September 1954, Caldwell asked petitioner for a further advancement to Caldwell, Inc., of $5,000 and told petitioner that without the loan the company would not be able to pay his salary and that he would be fired. Petitioner declined to make the loan and his employment with Caldwell, Inc., was terminated as of September 30, 1954.
Near the end of 1955, petitioner demanded repayment of the three unpaid loans to Caldwell, Inc., and Plastic, but was told that the companies had no funds. Later an agreement was reached between petitioner and Caldwell whereby on December 30, 1955, petitioner assigned to Caldwell by three separate written instruments:
(1) All of his claims against Caldwell, Inc., and loans or moneys advanced to the company for a stated consideration of $100; (2) all of his claims against Plastic for losses or moneys advanced to that company for a stated consideration of $550; and (3) his 5 shares of stock of Plastic for a consideration of $100. At the same time it was agreed in writing that the total consideration of $750 for the assignments would be satisfied by Caldwell, Inc., turning over to petitioner lighting fixtures, of his choice, of a value not in excess of the amount.
In his income tax return of 1955, petitioner claimed a deduction of $8,250 as a business bad debt, representing the unpaid balance of his loans to Caldwell, Inc., and Plastic. This amount was the unpaid balance of the loans amounting to $8,900 reduced by $650, the value of the lighting fixtures received, or to be received, from Caldwell, Inc., in satisfaction of petitioner's claims against Caldwell, Inc., and Plastic, exclusive of the stock. The Commissioner disallowed the deduction as a business bad debt stating in his notice of deficiency:
It has been determined that as a result of the sale by John M. Trent of obligations due from Edward F. Caldwell Co., Inc., and Plastic Illuminating Co., Inc., having a basis of $7,400.00 and $1,500.00, respectively, to Edward T. Caldwell for consideration amounting to $100.00 and $550.00, respectively, you realized a capital loss of $8,250.00, by virtue of Sections 1221 and 165(f) of the Internal Revenue Code of 1954, not previously claimed on your return. Alternatively, in the event it is determined that you realized bad debts totaling $8,250.00 arising from the worthlessness of the obligations due from Edward F. Caldwell Co., Inc., such bad debts are deemed to be non-business bad debts under the provisions of Section 166(d) of the Internal Revenue Code of 1954. Accordingly, the capital gains reported on your return have been decreased by 50% thereof, or $4,125.00, and the deduction for business bad debts totaling $8,250.00 claimed on your return has been disallowed in full.
OPINION.
OPPER, Judge:
It is petitioner's contention that his unpaid loans to Caldwell, Inc., and Plastic in 1954 became worthless in 1955 and that they are business bad debts deductible in full under the statute. Respondent has determined that the debts were nonbusiness bad debts deductible only as capital losses and the case is presented to us on that issue alone.
SEC. 166. BAD DEBTS [I.R.C. 1954].
(a) GENERAL RULE. —
(1) WHOLLY WORTHLESS DEBTS. — There shall be allowed as a deduction any debt which becomes worthless within the taxable year.
* * * * * * *
(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; and
(B) where any nonbusiness debt becomes worthless within the taxable year, the loss resulting therefrom shall be considered a loss from the sale or exchange, during the taxable year, of a capital asset held for not more than 6 months.
(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 taxpayer's trade or business; or
(B) a debt the loss from the worthlessness of which is incurred in the taxpayer's trade or business.
Petitioner's contention is based on his statement that he tentatively agreed at the time of his employment to lend financial aid to his employer's business to an indefinite extent if and when circumstances should require it. He acquired stock in one of the companies at the very outset. We accept petitioner's contention that he was required to advance the funds in dispute to the companies as a condition to his continued employment in the business, as evidenced by the fact that he was discharged when he declined to make further loans. Respondent has determined, that the advances were, in fact, loans as distinguished from capital contributions (as to Plastic), for which petitioner expected to be repaid and that the debts actually became worthless in 1955 to the extent claimed by petitioner.
Counsel for respondent sought at the trial to amend his answer so as to deny that the debts became worthless in 1955 and asked for an increased deficiency, but this motion was denied as untimely.
It by no means follows, however, that the bad debts in question were other than "nonbusiness bad debts" within the meaning of the statute.
The distinction between business bad debts and nonbusiness bad debts for the purpose of the corresponding section 23(k) of the 1939 Code was discussed at length in H. Beale Rollins, 32 T.C. 604, affd. (C.A. 4) 276 F.2d 368. After a careful review of the case, we held that the taxpayer, there, was not engaged in any trade or business within the meaning of the statute, saying (p. 615):
It is clear, however, that the management of a corporation's business, or activity as an officer, director, or stockholder, even of several corporations, cannot be held to constitute the conduct of a separate business by petitioner. Burnet v. Clark, 287 U.S. 410; Commissioner v. Smith, supra; Charles G. Berwind, supra. The business of this group of related corporations is not the business of petitioner, Burnet v. Clark, supra; Jan G. J. Boissevain, 17 T.C. 325; Langdon L. Skarda, 27 T.C. 137, affd. 250 F.2d 429 (C.A. 10), and his activities in regard thereto will not alone serve to establish him in the distinct business of promoting and financing corporations. * * *
The petitioner here is in a much less favorable position than was the taxpayer in the Rollins case. Before his association with Caldwell, Inc., and Plastic, petitioner had had but one employment, that with American Express Company. His managerial experience with that company was limited. His status with Caldwell, Inc., was strictly that of an employee. Although he held the title of "business manager" of Plastic, it is obvious that the affairs of that company as well as of Caldwell, Inc., were dominated by Caldwell. We have no evidence of the services actually performed by petitioner for any of these companies.
Petitioner's contention, however, is not that he was engaged in the business of being an officer or employee of numerous enterprises, or a promoter or moneylender, but that his business was limited to working for the two related corporations which currently employed him and that as a part of that business he made the loans in controversy. The issue presented "is a question of fact in each particular case." But were we to uphold the petitioner's contention that these facts suffice to create a business bad debt, it would be necessary to overrule a large proportion of the cases dealing with this subject.
"* * * The question whether a debt is one, the loss from the worthlessness of which is incurred in the taxpayer's trade or business, is a question of fact in each particular case, and the determination is substantially the same as that which is made for the purpose of ascertaining whether a loss from the type of transaction covered by section 23(e) is 'incurred in trade or business' under paragraph (1) of that section. The character of the debt for this purpose is not controlled by the circumstances attending its creation or its subsequent acquisition by the taxpayer or by the use to which the borrowed funds are put by the recipient, but is to be determined rather by the relation which the loss resulting from the debt's becoming worthless bears to the trade or business of the taxpayer. If that relation is a proximate one in the conduct of the trade or business in which the taxpayer is engaged at the time the debt becomes worthless, the debt is not a nonbusiness debt for the purpose of this amendment." (H. Rept. No. 2333, 77th Cong., 2d Sess. (1942), pp. 76-77; 1942-2 C.B. 431; emphasis added.)
It frequently occurs that an officer or employee of a failing venture is called upon or volunteers to assist in keeping the enterprise afloat by advancing funds by way of capital investments, loans, or guarantees. The compulsion in these instances, as it was here, is that if the employer fails, the employment will fail with it. Yet it has repeatedly been held that this will not be adequate to convert a capital investment or loan or guarantee into a business expense on the one hand, or a business debt on the other. See, e.g., Wheeler v. Commissioner, (C.A. 2) 241 F.2d 883, affirming per curiam T.C. Memo. 1955-138; Charles G. Berwind, 20 T.C. 808, affirmed per curiam (C.A. 3) 211 F.2d 575; H. Beale Rollins, supra. In the Wheeler case, the Court of Appeals said (p. 884):
The Tax Court found that these debts, although they may have been related to some business interests of the taxpayers, were not incurred in the trade or business of the taxpayer in the special sense of § 23(k). * * * The only instance where a shareholder or officer may deduct debts of his corporation to him as business bad debts under § 23(k) is where his business can be considered to be the promoting and financing of business enterprises. See, e.g., Henry E. Sage, 1950, 15 T.C. 299. * * *
In this very situation, petitioner makes no claim to an ordinary loss for the capital he was required to "invest" in his employer's stock. We think the loans he made under similar circumstances and for similar reasons are in no better case.
Decision will be entered for the respondent.
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