Jones v. Commissioner , 14 B.T.A. 729 ( 1928 )

ELIZA A. JONES, HOWARD B. JONES, AND MABEL JONES WILKER, EXECUTORS, ESTATE OF ARTHUR B. JONES, PETITIONERS, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

Jones v. Commissioner

Docket Nos. 17186, 26581.

United States Board of Tax Appeals

14 B.T.A. 729; 1928 BTA LEXIS 2926;

December 14, 1928, Promulgated

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Amounts claimed in 1921 and 1922 as deductions for bad debts disallowed for failure to show when such debts were ascertained to be worthless.

William B. Hale, Esq., and Calvin F. Selfridge, Esq., for the petitioners.

R. H. Ritterbush, Esq., and William S. Delany, Esq., for the respondent.

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SIEFKIN

These are proceedings, duly consolidated for hearing and decision, for a redetermination of deficiencies in income tax for the years 1921 and 1922 in the respective amounts of $26,253.57 and $18,496.32.

The petitioners, under Docket No. 17186, relating to the year 1921, allege error of the respondent in disallowing as a deduction the amount of (1) $69,749.80 claimed by the petitioners for a worthless debt from the E. C. Manufacturing Co., which decedent charged off his books in the year 1921, and (2) the amount of $50 claimed as a deduction for a worthless debt from John B. Rees, which decedent charged off in the year 1921.

The petitioners, under Docket No. 26581, relating to the year 1922, allege as error the disallowance by the respondent of a deduction of $51,287.30 claimed by petitioners for a worthless debt of the E. C. Manufacturing Co., determined to be worthless and charged off decedent's books in the year 1922.

FINDINGS OF FACT.

The petitioners in the consolidated cases are the duly qualified executors of the estate of Arthur B. Jones, who died February 21, 1927.

Arthur B. Jones, from 1906 through 1922, was managing trustee of the estate of Marshall Field. In 1913 Hugh J. Ellis visited Jones and asked him to loan money to the E. C. Manufacturing Co., a corporation in which Ellis owned half the stock. Both Jones and Ellis were Welshmen, and because of this, Jones advanced money to the company from time to time and received therefor forty-seven notes. There follows a statement showing the amount and date of each loan made as evidenced by promissory notes:

Statement showing cash invested (notes payable)
Year	Day of loan	Amount
1913	Sept. 26	$6,420.00
1915	Apr. 6	2,000.00
1916	Dec. 6	3,000.00
1917	Jan. 23	1,500.00
	Mar. 14	1,252.47
	Mar. 16	1,577.57
	Mar. 17	161.87
	Mar. 20	7,398.10
	Mar. 23	499.79
	Mar. 26	1,875.46
	Mar. 27	275.00
	Mar. 29	2,627.67
	Apr. 1	1,659.63
	Apr. 23	2,000.00
	Apr. 24	1,000.00
	May 11	1,000.00
	May 25	3,000.00
1917	June 30	$3,500.00
	Aug. 29	1,500.00
	Sept. 26	2,500.00
	Oct. 20	3,000.00
	Dec. 11	500.00
	Dec. 18	500.00
	Dec. 31	2,121.33
1918	Jan. 17	6,000.00
	July 6	1,000.00
	Sept. 3	2,100.00
	Oct. 17	10,000.00
1919	Apr. 21	5,000.00
	June 30	2,900.00
	Aug. 19	1,500.00
	Oct. 28	10,000.00
	Dec. 13	8,000.00
1920	Nov. 10	8,000.00
1921	Mar. 16	$2,000.00
	June 15	3,000.00
	Sept. 3	5,000.00
	Sept. 6	5,000.00
	Sept. 20	5,000.00
	Oct. 24	4,000.00
	Dec. 6	2,000.00
	Dec. 24	500.00
1922	Jan. 18	300.00
	Apr. 18	1,500.00
	June 1	1,000.00
	July 19	6,000.00
	Dec. 5	2,000.00
	May 31, 1923, notes payable	142,248.89

Jones took no security for any of the notes.

The note given September 26, 1913, for $6,420 was payable one year after date and provided for payment of interest of 7 per cent. This note was made by E. C. Manufacturing Co., by Hugh J. Ellis, president.

On its face, the second note, that of December 6, 1916, for $3,000, appears to be Ellis' personal note, but the evidence shows that these amounts were advanced to the E.C. Manufacturing Co. This is a demand note. All the notes given thereafter are payable on demand and carried interest at 7 per cent.

The notes given thereafter up to and including that of April 1, 1917, for $1,659.63, were made by E. C. Manufacturing Co., by Hugh J. Ellis, president. Notes given to Arthur B. Jones thereafter were made by E. C. Manufacturing Co., by Howard B. Jones, president.

The E.C. Manufacturing Co. was in the business of manufacturing nuts, bolts, automatic screw machines, parts for automobiles, parts for typewriters and parts for adding machines. The business was conducted in a small shop and 15 persons were employed. A contract with the English Government had been obtained by Ellis for the manufacture of gun bars for English shells, but the contract had been taken at such a figure that the company operated at a loss. When the United States entered the war more machines were installed and the company continued to fill orders. Arthur B. Jones loaned money to the company to buy these machines. After the war the company did no business for about a year, then it went into the automobile business. Business improved in the latter part of 1919 and early part of 1920. Arthur B. Jones loaned the company more money then, in order to help it succeed. In the fall of 1920 the automobile business suffered a slump and it became apparent to the president of the company in 1921 that the company could not operate at a profit.

In the latter part of 1917 Ellis, at the instance of Arthur B. Jones, turned over his stock in the E.C. Manufacturing Co. to Jones' son, Howard B. Jones, to see if it were possible to keep the business from going into bankruptcy and thereby protect Arthur B. Jones' interest. Howard B. Jones acquiring all the stock of the E.C. Manufacturing Co., except one share held by the secretary of the corporation, he became president of the company and had entire control of it. Arthur B. Jones had previously given his son money to buy a bicycle business which was an off-shoot of a business the son had been in and which had been liquidated. Howard also had an income from some stocks and bonds which his father had given him when he was young. Financial statements of the E.C. Manufacturing Co. were furnished Arthur B. Jones monthly. In 1919 he stated to Richard H. Peel, who helped him prepare his return for 1921 and 1922, that he would never get his money out of the E.C. Manufacturing Co., but gave no reason for thinking so. In 1921 Arthur Jones became concerned about the business and at that time favored liquidation of the company. Efforts were made to combine with other corporations and to sell the business, but all attempts failed. Jones loaned the company more money, the purpose of which was to allow it to stop taking new business and finish up that which it had on hand, and in order to pay rent so that the company could stay long enough to liquidate the plant to the best advantage.

In the latter part of 1922 or in January, 1923, an auction was held, but the assets of the company were selling at such a low figure that the auction was stopped and the assets were sold piece by piece. After the bills were paid the sale of assets netted the company $16,748.26, exclusive of the amounts due to Arthur B. Jones. This money was given by Arthur B. Jones to his son.

The only time the company showed a profit was in November and December, 1918. The loss during each year from 1918 to 1922 was as follows:

1918	$18,667.60
1919	15,420.46
1920	16,487.46
1921	49,444.02
1922	48,805.88

The balance sheet of the E.C. Manufacturing Co. at December 31, 1919, was as follows:

Bank Account		$338.26
Petty Cash		75.00
			$413.26
Accounts rec. ledger current		17,167.69
Accounts rec. ledger claim		1,641.12
			18,808.81
Suspense accts. 1919	$615.50
Suspense accts. old	1,717.57
	2,333.07
Less: Reserve for same	2,547.15
				$214.08
H. B. Jones, per acct			650.00
Consignment acct			300.00
Merchandise acct., Raw		7,956.22
Inventory Work in process		25,954.50
			33,910.72
Machinery acct	45,899.84
Shop Equipment	6,193.18
Tool Acct	11,474.89
		63,567.91
Less: Reserve for dep'n.:
Machinery	14,364.93
Shop equip	754.45
Tool acct	3,130.90
		18,250.28	45,317.63
Office furniture			140.50
Deferred charges:
Advertising		120.50
Stationery		50.00
Insurance				1.44
Shipping cases		340.00
Shop Expense		150.00
			660.50
Notes Payable				96,948.89
Accts. pay. Ledger				21,938.51
Accrued Pay Roll				792.97
Federal taxes				32.02
Interest reserve - Notes pay				9,336.45
Shop Pay Roll - uncalled for				25.12
Capital stock				5,000.00
Profit & loss Dec. 31, 1918			$18,667.50
Loss on steel 1919	$608.13
Loss on claim a/c 1919	487.25
Loss for 11 months	13,298.65
Loss for Dec	826.43
			15,420.46
			134,289.48	134,289.48

The books of the E.C. Manufacturing Co. showed assets and liabilities at December 31, 1920, as follows:

Assets:
(Current assets) -
Cash Bank		$70.92
Cash Drawer		4.70
Accts. rec		7,513.96
			$7,589.58
Working assets -
Mdse., raw		8,859.04
Mdse., in process		34,628.83
Stationery supplies		50.00
			43,537.87
Fixed assets -
Machinery	$43,176,86
Machinery dep'n	16,711.50
		26,465.36
Shop Equipment		6,521.28
Tools		4,212.13
Elec. wiring & Equip		1,247.87
Office furn. & fix		258.84
			38,705.48
Personal - H. B. Jones			1,264.87
Prepaid expense -
Prepaid insurance		734.80
Prepaid shipping expense		420.29
Total prepaid expense			1,155.09
Total assets				$92,252.89
Liabilities:
Notes payable		104,948.89
Accounts pay		14,167.84
Accrued int. pay		16,200.68
Excess tax		50.00
Shop payroll uncalled for		51.77
Shop payroll accrued		113.92
Contingent		2,280.82
Reserve for bad debts		14.49
				137,828.41
Total liabilities				$45,575.52
Represented by:
Loss for year 1918		18,667.60
Loss for year 1919		15,420.46
Loss for year 1920		16,487.46
Total loss			50,575.52
Capital			5,000.00
				45,575.52

The balance sheet of the E.C. Manufacturing Co. at December 31, 1921, was as follows:

Cash:
Bank	$44.64
Petty cash	20.75
Accts. rec.:
A/c Rec	13,525.50
H. B. Jones	1,470.09
Inventories:
Raw material	5,266.25
Fcty. material	14,452.68
Miscellaneous Assets:
Stationery	50.00
Insurance P.P	207.30
Shipping exp. P.P	72.25
Plant:
Office furn. & fix	138.84
Shop equip	6,872.89
Tools	8,689.99
Machinery	41,584.21
Accounts Payable:
A/c payable		$8,400.47
Res. for excise tax		267.10
Notes pay. - A. B. Jones		127,248.89
Reserves:
Res. for interest		24,054.36
Shop pay roll accrued		323.74
Allowance for dep. machinery		20,045.19
Allowance for dep. tools		5,624.30
Allowance for dep. shop equip		1,035.50
Capital:
Capital		5,000.00
P. & L.	99,604.16
	191,999.55	191,999.55

The balance sheet of the E.C. Manufacturing Co. as of December 30, 1922, was as follows:

Cash:
Bank		$195.86
Petty cash		12.73
Accounts Receivable:
Accts. rec.		2,563.33
Howard B. Jones		2,121.00
Inventories:
Raw material		3,027.88
In process		1,793.85
Miscellaneous Assets:
Insurance prepaid		107.10
Office furn. & fix.		100.00
Plant:
Shop equip	$6,847.62
All for depn	1,743.48
		$5,104.14
Tools	8,848.53
All for depn	7,738.85
		1,109.68
Machinery	41,643.66
All for depn	25,040.07
		16,603.59
Accounts Payable:
Accounts payable			$538.36
Notes payable - A. B. Jones			141,948.89
Interest accrued - A. B. Jones			33,566.55
Pay roll accrued			89.01
Capital:
Capital			5,000.00
P. & L		148,403.65
		181,142.81	181,142.81

The profit and loss account of the E.C. Manufacturing Co. as of May 31, 1923, showed the following:

Sales		$2,197.07
Shop pay roll	$634.02
Shop exp	114.90
Insurance	6.29
Light, water, power	54.91
Rent	1,590.00
Taxes	30.05
Advertising	177.10
Cartage	10.41
Exce. & dis	67.60
Commission	842.12
Legal	127.65
Office salaries	1,950.00
Office expense	91.54
Factory mdse	2,216.15
		7,912.74
		5,715.67
Interest earned		4.05
Loss from mfg		5,711.62

BALANCE
Cash	$5,772.77
A/c rec	3,332.25
H. B. Jones	9,083.75
Prepaid insurance	82.30
Notes payable		142,248.89
Interest payable		33,566.55
Capital		5,000.00
P. & L. to December 31, 1922	148,403.65
Loss from mfg. to May 1, 1923	5,711.62
Loss from sale of shop	8,429.10
	180,815.44	180,815.44

Arthur B. Jones was a good business man and made good investments for the Marshall Field Estate over a number of years.

Authur B. Jones kept no books of account except his check book. In the fall of 1921 or in the spring of 1922 Arthur B. Jones expressed his opinion that a part of the notes were worthless. Richard H. Peel assisted Jones in making out his income-tax returns for the years 1921 and 1922. In preparing those returns Peel and Jones had the balance sheets of the E.C. Manufacturing Co. before them and by computation from them they determined that $69,749.80 of the total indebtedness of the E. C. Manufacturing Co. to Jones was not collectible at December 31, 1921, and that $51,287.30 of the remaining indebtedness was uncollectible at December 31, 1922. These amounts were claimed as deductions on the returns for 1921 and 1922, respectively.

These amounts were disallowed as deductions by the respondent.

OPINION.

SIEFKIN: Under docket No. 17186 the petitioner assigned as error the action of the respondent in disallowing as a deduction the amount of $50 claimed by the petitioner as a deduction for a bad debt owing from John B. Rees. However, no evidence was adduced with regard to this assignment of error and it will be decided in favor of the respondent.

The remaining question to be decided is whether the respondent erred in disallowing as a deduction from income for the year 1921, the amount of $69,749.80, and from income for the year 1922 the amount of $51,287.30, which amounts were claimed by the petitioner in his returns for the respective years as deductions for bad debts owing from the E.C. Manufacturing Co.

Section 214(a)(7) of the Revenue Act of 1921 provides:

That in computing net income there shall be allowed as deductions:

* * *

(7) Debts ascertained to be worthless and charged off within the taxable year (or, in the discretion of the Commissioner, a reasonable addition to a reserve for bad debts); and when satisfied that a debt is recoverable only in part, the Commissioner may allow such debt to be charged off in part.

The evidence discloses that A. B. Jones kept no books of account except his check book. During the years 1921 and 1922, and even as early as 1919, he was aware that the E.C. Manufacturing Co. was in poor financial condition. Richard H. Peel testified that he assisted Jones in preparing his returns for the years 1921 and 1922, and that at those times they had before them the balance sheets of the E.C. Manufacturing Co. and that from such sheets the extent of the worthlessness of the obligations of the E.C. Manufacturing Co. to Jones was calculated. But there is no evidence as to when such calculations were made. We can not speculate, for example, as to whether the calculations with regard to the return for 1921 took place in 1921 or in 1922. We have repeatedly held that deductions for bad debts can only be allowed when the worthlessness is ascertained within the year for which the deduction is claimed. We must hold that no deductions are allowable.

Judgment will be entered for the respondent.