Howard v. Commissioner

HARRY C. HOWARD, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

Howard v. Commissioner

Docket No. 22548.

United States Board of Tax Appeals

20 B.T.A. 207; 1930 BTA LEXIS 2181;

July 8, 1930, Promulgated

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1. An individual who purchases stock as an isolated investment having no relation to any trade or business is not entitled to claim a deduction for an alleged loss under section 214(a)(4) of the Revenue Act of 1921.

2. In 1922 a corporation sold its entire assets to another corporation for a note and the assumption of its debts, purchased, pursuant to an option, shares of stock of the vendee which were paid for with the note, and discontinued business. In 1923 it filed notice of dissolution. One of its stockholders, after litigation over the distribution of the stock purchased, received his portion of such stock in 1928. Held, the stockholder sustained no deductible loss in respect of his original stock in 1922.

3. A mere fluctuation in value of tock, although resulting from a definite change in the character of the corporation's assets, is not a realized gain or loss. Until the stock is sold or disposed of or is demonstrated to be completely and permanently worthless, the holder has neither taxable gain nor deductible loss, and his cost remains the basis for determining gain or loss upon future disposition.

4. Assuming that the new stock may be regarded as having been received in a reorganization so that by section 202(c)(2) the recognition of gain or loss is prohibited, quoere, whether an anticipatory loss in a prior year incident to the reorganization is any more to be recognized?

Harry C. Howard, Esq., pro se.

B. M. Coon, Esq., for the respondent.

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STERNHAGEN

The respondent determined deficiencies in petitioner's income tax of $747.50 for 1922 and $75.60 for 1923. The petitioner attacks only that for 1922, which results from the disallowance by respondent of a deduction taken by petitioner for an alleged loss in respect of stock said to have become partially worthless in 1922. The facts appear from the respondent's admission of allegations in the petition and from petitioner's testimony.

FINDINGS OF FACT.

Petitioner is an individual residing at Kalamazoo, Mich. Prior to 1922 and after March 1, 1913, he purchased at par $5,000 of the preferred capital stock of the Eddy Paper Corporation, a Michigan corporation. Because of the financial depression resulting in the financial embarrassment of the company and the impairment of its capital stock, and in an effort to save some of its assets, on the 25th of November, 1922, the corporation shold all of its assets for $625,000 to the Eddy Paper Corporation, an Illinois corporation, which gave its 90-day note for $625,000, and a further consideration on the part of the Illinois corporation that it would assume and pay, which it did, all the debts of the Michigan corporation, amounting to $2,739,255.71. It also gave an option to the Michigan corporation to purchase from the Illinois corporation all or any part of 31,250 shares of the Illinois corporation at the price of $20 a share. After the sale was completed at $625,000, the Michigan corporation exercised its option and in November, 1922, purchased of the Illinois corporation 31,250 shares of its capital stock, paying therefor with the $625,000 note. This note was surrendered on the same day that the option to purchase was exercised. The assets of the Michigan corporation were transferred to the Illinois corporation during 1922 and deed delivered. The Michigan corporation did no business after November 25, 1922, and under date of March 6, 1923, issued a formal notice of dissolution under sec. 7, ch. 4, Part I, Act No. 84, P.A. 1921.

At the date of the sale, the Michigan corporation had an authorized capital stock of $15,000,000 divided as follows: common stock, $12,000,000, preferred stock, $3,000,000, of which outstanding was, common stock, $7,000,000, preferred stock, $1,766,410. The stock was of a par value of $10 per share.

At a special meeting of the stockholders of the Michigan corporation held in 1923, it was voted to allow the common stockholders to participate in the distribution of the 31,250 shares. Some of the preferred stockholders filed a bill in the Circuit Court for St. Joseph County, Michigan, for an injunction to restrain a distribution of the stock to others than the preferred stockholders in the Michigan corporation. An adverse decree was entered in the Circuit Court and the matter was appealed to the Supreme Court of Michigan, and October 1, 1925, the Supreme Court filed its opinion, ; , holding that the preferred stock was entitled to the entire amount of $625,000 and and that the common stock had no right to any part thereof.

The distribution of the new shares occurred August 8, 1928, and petitioner received 75 shares as his portion.

OPINION.

STERNHAGEN: The petitioner argues that before the end of 1922 the occurrence of "identifiable events" in respect of the stock of the Michigan corporation was such as to establish definitely a loss of $3,250 out of his original investment of $5,000. He claims a deduction under the Revenue Act of 1921, section 214(a)(4) and (5). The petitioner is a practicing lawyer, and, although he was at one time counsel for the corporation, his purchase of the stock was an isolated investment having no relation to any trade or business, and a loss sustained in respect thereof would not be "incurred in trade or business." Subsection (4) is therefore not available to him. See .

In harmony with numerous decisions, we hold that petitioner sustained no deductible loss in respect of such stock in 1922. The stock was not then, nor subsequently, worthless. Even if we treat the notice of dissolution as establishing that the Michigan corporation was dissolved and out of existence, this took place no earlier than 1923, and, notwithstanding it, petitioner's stock ownership remained the indicia of rights having a substantial value which survived at least until the distribution in 1928. No matter how reasonably assured the petitioner felt in 1922 that his investment would yield him less than it had cost, such assurance did not contemplate entire worthlessness nor did it contemplate any actual realization in 1922. The corporation had changed the character of its assets from plant and equipment into a note and again into stock of the new corporation holding the same plant and equipment. The reflection of these transactions of the corporation in the shares, no matter how clear, is potential only, and, like all other fluctuation in value, is not a realized gain or loss. Until the stock is sold or disposed of or is demonstrated to be completely and permanently worthless, the holder has neither taxable gain nor deductible loss and his cost remains the basis for determining the gain or loss upon future disposition. See ; ; affd., ; ; ; ; ; ; .

Were the taxpayer, however, entitled, generally speaking, to deduct as a loss an apparent drop in the value of his investment, so that the foregoing could not be said, it would be necessary to consider whether such loss as might otherwise be recognized must be disallowed under section 202(c) because incidental to an exchange in a reorganization. If in all the circumstances the new stock received in 1928 may be regarded as having been received in a reorganization, as is somewhat indicated in ; , so that be section 202(c)(2) the recognition of gain or loss is prohibited, it may be doubted without deciding whether a preliminary shrinkage or anticipatory loss incident to the reorganization is any more to be recognized.

The petitioner cites . The circumstances of the taxpayer's loss in that case were such as to demonstrate not mere partial shrinkage in value, but substantial worthlessness. The court, after expressly stating that "the statute obviously does not contemplate and the regulations forbid the deduction of losses resulting from the mere fluctuation in value of property owned by the taxpayer," said that losses were allowable if fixed by identifiable events, such as sale, destruction, or physical injury. In the present case, there was no such event as those enumerated by the court, but rather a mere shrinkage in value.

Nor do we find , to compel the allowance of the deduction here claimed. That decision considered a debt due from a debtor whose affairs had been taken over by a receiver. In so far as it discusses the deductibility of partially worthless debts and treats them as losses, there is some analogy to a stock investment which is, when the circumstances are reasonably considered, only partially recoverable. The Court of Appeals did not state or intimate how far the apparent rule of its decision would extend. The present case, in our opinion, is farther from a realized loss, the taxpayer's position being more tentative and speculative. The line of factual distinction between the Sherman case and cases where worthlessness is not legally established could, we think be drawn a good way from the Sherman case and yet not bring the present case within its rule. For if variations in stock values are to be recognized because they reflect the corporation's transactions and condition, it would be difficult to discriminate such losses from those reflected by definite, published stock market quotations.

Judgment will be entered for the respondent.