Jagels v. Commissioner ( 1931 )

C. H. C. JAGELS, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

Jagels v. Commissioner

Docket No. 32081.

United States Board of Tax Appeals

23 B.T.A. 1041; 1931 BTA LEXIS 1779;

July 3, 1931, Promulgated

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Where the petitioner, while president and director of a bank, joined with six other directors in borrowing money with which to purchase from the bank at their full face value certain notes which were considered questionable by the bank examiner but which the petitioner believed would ultimately be paid in full, and where four directors, including petitioner, paid varying amounts on account of their endorsement of a note given to secure the loan obtained under the circumstances set out, Held, in the absence of evidence of evidence to show what part, if any, of the debts evidenced by the notes so purchased was ascertained to be worthless and charged off in the taxable year, petitioner is not entitled to a deduction for a bad debt and no deductible loss has been sustained.

R. M. O'Hara, Esq., for the petitioner.

Philip M. Clark, Esq., for the respondent.

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MATTHEWS

This is a proceeding for the redetermination of a deficiency in income tax of $8,513.77 for the year 1922. The error assigned is the disallowance by the Commissioner of a deduction claimed by the petitioner from his gross income for 1922 of a loss in the amount of $31,209.97 sustained by him through an alleged investment made in certain notes held by the Second National Bank of Hoboken, which notes were not readily collectible and were purchased by seven of the directors of the bank, including the petitioner, for the purpose of relieving the bank of slow and questionable paper. The petitioner claims that the amount in controversy is deductible as a loss incurred in trade or business, or as a loss incurred in a transaction entered into for profit not connected with his trade or business, or as a bad debt ascertained to be worthless and charged off within the taxable year.

The respondent denied the deduction claimed by the petitioner on the ground that, inasmuch as the directors of the bank who purchased the notes in question were stockholders of the bank, the investment constituted a capital contribution or donation to the bank and therefore is not an item which is properly deductible from income for the year involved herein.

FINDINGS OF FACT.

On February 1, 1919, petitioner was president and a director of the Second National Bank of Hoboken and owned 464 shares of a total outstanding issue of 2,500 shares of the stock of that bank. On December 31, 1922, there was outstanding a total of 7,000 shares of which petitioner owned 1,600 shares.

Early in 1919 the affairs of the Second National Bank of Hoboken were examined by a bank examiner, who raised the question whether certain notes held by the bank constituted satisfactory assets by reason of the fact that they were of a "frozen" character and not readily collectible. Certain directors of the bank, wishing to avoid criticism decided to purchase the notes in question. These notes were not endorsed by the bank and were in the following approximate amounts:

Moskowitz	$5,000
W. K. Grove	14,000
A. Lubash	8,000
Lobell	18,000
Whiteman	18,000

Petitioner believed that these notes were collectible. In order to raise the money to buy the notes at their full face value and to pay cash therefor to the bank there was borrowed from the Irving National Bank the sum of $75,000. A note for $75,000 payable to the Irving National Bank was signed by H. E. Benjamin Company and endorsed by petitioner and the following men, each of whom was a director of the Second National Bank of Hoboken: Messrs. W. G. Keuffel, T. N. Eberhardt, H. Brittain, A. Podesta, A. N. Terbell and H. J. Gordon. The H. E. Benjamin Company was an accommodation maker of this note. Petitioner assured the other directors who endorsed the note that they would never sustain any loss on account of their participation in the transaction. The excess of the loan of $75,000 over the cost of the notes thus purchased was left on deposit with the Irving National Bank in the name of H. E. Benjamin Company.

The H. E. Benjamin Company was organized in 1911 or 1912 with a nominal capital, to take over three farms in South Carolina and Florida which were in financial difficulties and in which the Second National Bank of Hoboken was interested. The H. E. Benjamin Company operated these farms until the bank recovered its investment and went out of business in 1923. The records of the H. E. Benjamin Company are not in existence. The stock of this company was owned by the directors who were all stockholders of the Second National Bank of Hoboken. Petitioner was treasurer of the company in 1919. For the year 1922 the income-tax return of the H. E. Benjamin Company showed a net income of $3,457.05.

Efforts to collect the notes purchased from the Second National Bank of Hoboken resulted in the full payment of the Moskowitz note and partial payments on the notes of Grove, Lobell and Whiteman. Approximately $33,000 was realized on the notes of Lobell and Whiteman, who were in business together, and a large part of Grove's note was paid of when his house was sold. No payment was ever made on the Lubash note. The amounts collected totaled approximately $50,000.

In December, 1922, it was determined that nothing further could be realized on the notes purchased from the Second National Bank of Hoboken and it was decided to liquidate the note held by the Irving National Bank. Equal payments were not made by the various endorsers on the note. Keuffel was financially able to pay his proportionate part but agreed to pay only $1,200. Petitioner was engaged in the coal business and Keuffel was a valued customer whom he did not wish to alienate. Terbell paid $2,400 and Brittain paid $600. Both Terbell and Brittain were in financial difficulties. Eberhardt's estate was also involved. Gordon had made a payment of $10,000 on another note and refused to pay anything on the note involved herein. Podesta refused to make any payment. Payments were made to the H. E. Benjamin Company by petitioner during the year 1922 in the total amount of $31,834.97.

Petitioner deducted from his gross income for 1922 the sum of $31,209.97 and claims that this amount represents the loss resulting from his endorsement of the note for $75,000 payable to the Irving National Bank. This deduction was disallowed in whole by the respondent in determining the deficiency in question.

OPINION.

MATTHEWS: It is contended by petitioner that this case comes within one of the following provisions of section 214(a) of the Revenue Act of 1921, which provides that in computing net income there shall be allowed as deductions:

(4) Losses sustained during the taxable year and not compensated for by insurance or otherwise; if incurred in trade or business;

(5) Losses sustained during the taxable year and not compensated for by insurance or otherwise, if incurred in any transaction entered into for profit, though not connected with the trade or business; * * *

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(7) Debts ascertained to be worthless and charged off within the taxable year * * *.

We are of the opinion that the deduction claimed by the petitioner does not represent a loss sustained during the taxable year in trade or business. The petitioner was engaged in the coal business and was an officer and director of several corporations, including the Second National Bank of Hoboken. We have held that a director of a corporation is not engaged in the business of the corporation. , and cases cited therein. The facts of the instant case clearly demonstrate that whatever loss was sustained was incurred in an isolated undertaking separate and apart from the taxpayer's usual and actual business. See also , in which we held that where directors of a national bank voluntarily replace worthless bonds held by the bank with cash and Liberty bonds, no deductible loss has been sustained by the directors. It may be noted that in the Ward case the notes removed by the directors from the assets of the bank were known to be worthless at the time they agreed to replace the same with good assets, while in the instant case the notes were believed to be collectible and substantial amounts were actually collected on the same; this distinction does not affect the holding that the alleged loss was not incurred in trade or business.

Petitioner's object apparently was to try to save the Second National Bank of Hoboken harmless on account of the loans made by the bank to the makers of the notes. He testified that he believed that the notes would ultimately be paid in full although they were determined by the bank examiner to be not readily collectible. The notes were purchased by the directors at their face value. An unfavorable purchase is not necessarily a realized loss. .

The petitioner contends in substance that his loss may be measured by the amounts which he paid to the H. E. Benjamin Company in 1922. We do not agree with this contention. These payments were made to liquidate the note payable to the Irving National Bank which was endorsed by the petitioner and the other directors of the Second National Bank of Hoboken. Inasmuch as the H. E. Benjamin Company was an accommodation maker of that note we may treat it as the note of the petitioner and the other endorsers. It is clear that no gain or loss resulted from borrowing money from the Irving National Bank under the circumstances described and repaying that loan. The purchase of the questionable paper held by the Second National Bank of Hoboken was a separate transaction. If the petitioner is entitled to any deduction it arises out of the failure to collect in full the purchased notes. To be entitled to a deduction for a bad debt it is essential to show that the debt was ascertained to be worthless and charged off in the taxable year. There is some testimony tending to show that the notes purchased were worthless in part, but the extent of the worthlessness does not appear. We must, therefore, hold that the petitioner has failed to prove any deductible loss. .

Judgment will be entered for the respondent.