Schoenhut v. Commissioner

GEORGE W. SCHOENHUT, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

OTTO SCHOENHUT AND MINNIE SCHOENHUT, PETITIONERS, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

Schoenhut v. Commissioner

Docket Nos. 100583, 100584.

United States Board of Tax Appeals

45 B.T.A. 812; 1941 BTA LEXIS 1066;

November 25, 1941, Promulgated

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1. The petitioners were owners of common stock of the A. Schoenhut Co., which was declared by the court to be insolvent in 1935. The machinery and substantially all of its assets, except the dismantled plant, were disposed of in 1936. In 1937 the remaining assets of the bankrupt were sold at public sale for the nominal amount of $125, the purchasers thereof being the mortgagees of the property. Held, that the petitioners' shares of common stock became worthless prior to 1937.

2. Petitioners Otto Schoenhut and Minnie Schoenhut filed a joint income tax return for 1937 and the respondent determined a deficiency in income tax upon the joint return. The petitioners have appealed to this Board from a determination of the deficiency, contending that the deficiency should be found against each upon their respective net incomes. Held, that the deficiency must be determined against the petitioners jointly.

Philip Dechert, Esq., for the petitioners.

Paul E. Waring, Esq., for the respondent.

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SMITH

These proceedings, consolidated for hearing, involve deficiencies in Federal income tax for the year 1937 as follows:

Petitioner	Docket No.	Deficiency
George W. Schoenhut	100583	$1,658.08
Otto Schoenhut and Minnie Schoenhut	100584	8,532.27

The petitioners allege that the respondent erred in the determination of the deficiencies by disallowing the deduction of losses on shares of common stock of the A. Schoenhut Co. which they claim became worthless in 1937. The loss claimed in the case of George W. Schoenhut is $35,263 and in the case of Otto Schoenhut and Minnie Schoenhut it is $80,506.

By an amendment to the petition in Docket No. 100584 the petitioners claim that the respondent, since the issuance of the feficiency notice, has made a jeopardy assessment against them and that there are threats of distraint upon the property of both. They seek to show the portion of the net income of the husband separate from that of the wife, contending that the respondent may not distrain upon the property of the wife for the collection of more than her proportionate part of the net income.

FINDINGS OF FACT.

1. The petitioners herein are residents of the city of Philadelphia. They filed their income tax returns for 1937 with the collector at Philadelphia. In the return filed by George W. Schoenhut there was deducted from gross income $35,263 representing a loss upon an investment in shares of stock of the A. Schoenhut Co., which he claims became worthless in that year. In the determination of the deficiency the respondent disallowed claimed loss and also increased the petitioner's interest income by $115, which adjustment is not contested. Whereas the return showed a net loss of $16,417.42, the respondent determined an adjusted net income of $18,960.58, the principal adjustment being the disallowance of the claimed deduction on account of the worthlessness of the stock of the A. Schoenhut Co., which the respondent in his deficiency notice states "became worthless prior to the taxable year 1937."

Otto Schoenhut and Minnie Schoenhut filed a joint income tax return for 1937 which showed a net loss for the year of $30,792.24. In such return there was claimed a deduction of $80,506 representing an investment made by Otto Schoenhut in shares of stock of the A. Schoenhut Co., which he claimed became worthless in 1937. The respondent has disallowed the deduction of the loss and determined an adjusted net income of $49,713.76.

The gross income shown by the return is in the amount of $50,767.51, of which amount $50,123.91 was the gross income of the husband, and $643.60 the gross income of the wife. Of the adjusted net income determined by the respondent, $49,070.16 was the net income of the husband and $643.60 the net income of the wife.

2. The A. Schoenhut Co., hereinafter referred to as the Schoenhut Co., was incorporated under the laws of the Commonwealth of Pennsylvania on February 25, 1897, and was engaged in the manufacture and sale of toys and similar merchandise.

3. During the year 1937 petitioner George W. Schoenhut, Docket No. 100583, was the owner of 47 2/3 shares of the common capital stock of the Schoenhut Co., which had a cost basis to him of $35,263.

4. During the year 1937 petitioner Otto Schoenhut, Docket No. 100584, was the owner of 143 shares of common capital stock of the Schoenhut Co., which had a cost basis to him of $80,506.

5. During the years 1930 to 1935, inclusive, the Schoenhut Co. sustained the following losses from operations:

1930	$92,977.70
1931	90,645.06
1932	111,721.95
1933	$83,750.11
1934	75,034.67
1935	50,474.98

6. Prior to 1932 due to financial reverses, the Schoenhut Co. pledged its current accounts receivable, equipment, and real estate to two banks as collateral security for demand loans totaling $120,000.

7. Due to financial reverses and lack of liquid capital the Schoenhut Co., on March 8, 1932, authorized the issuance of 1,155 shares of preferred stock at $100 per share. Of the shares so issued 635 shares were subscribed and paid for by the members of the Schoenhut family and the balance of 520 shares were subscribed and paid for by friends of the Schoenhut family. With the money so received the company was able to operate and reduce its demand loans at the banks from $120,000 to $80,000.

8. On August 6, 1934, the Schoenhut Co. borrowed $155,000 from the Federal Reserve Bank of Philadelphia. With the funds so received $80,000 was used to cancel the demand loans at the two banks, which loans were then satisfied of record. Now notes were then issued by the Schoenhut Co., the two banks participating with the Federal Reserve Bank of Philadelphia in the new loan of $155,000 as follows:

Federal Reserve Bank of Philadelphia	$55,000
Integrity Trust Co	50,000
Ninth Bank & Trust Co	50,000
Total	155,000

A new bond and warrant in the sum of $155,000 was then delivered by the Schoenhut Co. to the Federal Reserve Bank of Philadelphia, secured by a collateral mortgage of $155,000 on all land, real estate, machinery, tools, and equipment of the company for the payment of these new promissory notes.

9. On January 4, 1935, the Schoenhut Co. became handicapped by lack of liquid capital and was unable to proceed with its business and meet its debts as they matured and, as a result thereof, on January 17, 1935, the Schoenhut Co. filed in the United States District Court for the Eastern District of Pennsylvania a petition to reorganize under section 77B of chapter VIII of Acts of Congress relating to bankruptcy, said cause being captioned "In the Matter of The A. Schoenhut Company, Debtor - In Proceedings for the Reorganization of a Corporation, No. 18421."

10. On February 11, 1935, there was filed with the clerk of the District Court in the above mentioned bankruptcy proceedings a true and correct statement of the assets and liabilities of the Schoenhut Co. as of January 17, 1935, as shown by the company's books of account. Such statement in condensed form is as follows:

ASSETS
Cash	$31.09
Cash in possession of trustees as collateral for bank loans	9,202.17
Receivable from customers (less reserve $1,100) assigned as collateral for bank loans	20,491.58
Suppliers' debit balances	181.71
Inventories at cost	84,276.52
Total current assets	114,183.07
Other assets	9,964.76
Fixed assets	428,682.62
Total	552,830.45
LIABILITIES
Notes payable - banks (secured by bond and mortgage of $155,000 on real estate and plant and by assignment of customers' accounts and cash in possession of trustee)	$109,099.26
Accounts payable	60,205.81
Other current liabilities	10,310.18
Total current liabilities	179,615.25
Capital stock:
Common	100,000.00
Preferred	115,500.00
Surplus	157,715.20
Total	552,830.45

11. In 1935 the Manufacturers' Appraisal Co. was employed by the Schoenhut Co. to make an appraisal of the company's buildings and attached fixtures, machinery, and equipment, and land sites. Under date of March 6, 1935, that company reported its appraisal made as of February 1, 1935, as follows:

The valuations are as follows:

	Cost of Reproduction	Sound Valuation
PLANT - EAST HAGERT & SEPVIVA STREETS.
Buildings and attached fixtures	$535,815.27	$334,651.08
Machinery and equipment	393,286.08	215,410.19
Land sites	34,761.40	34,761.40
Totals	$963,862.75	$584,822.67
PLANT - VENANGO & AMBER STREETS.
Buildings and attached fixtures	$114,515.73	$86,264.88
Machinery and equipment	62,640.81	41,809.00
Land site	47,496.00	47,496.00
Totals	$224,652.54	$175,569.88
Grand totals	$1,188,515.29	$760,392.55

The foregoing valuations are based on our detailed appraisal of the plants made as of October 15, 1926 adjusted to include additions, deductions and changes made in the plant between October 15, 1926 and February 1, 1935. Detailed lists of additions and deductions, by classifications, are included in this report.

The valuations are a disinterested statement of the cost of reproduction of the buildings, machinery and equipment and the sound valuation after deduction of depreciation for considerations of mechanical deterioration and obsolescence and represent the valuation of the property to a going concern at the date of the appraisal. The land sites have been appraised upon the basis of their useful value industrial sites.

12. On October 17, 1935, the court ordered and decreed that Herbert L. Nelke, Joshua Yeager, and Lionel Friedman be appointed appraisers of the assets of the debtor.

13. On December 3, 1935, there was filed with the clerk of the District Court "A Report of the Appraisers" signed by the above named appraisers in which the total inventory of merchandise on hand is shown as $16,658 and the total fair market value of the real estate as $175,047. The total appraised value of merchandise inventory and real estate was shown to be $191,805. The value of the real estate as shown by the appraisers was not accepted by the court.

14. Thereafter, the "Special Master" appointed by the court to determine the solvency or insolvency of the debtor took a large amount of testimony relative to the fair market value of the assets of the debtor for the purpose of determining the solvency or insolvency of the corporation. He had before him valuations of the real properties, other than machinery and equipment, made by appraisers as follows:

Appraiser	Valuation
Lionel Friedman	$175,147
Samuel T. Hall	106,040
J. Solis-Cohen, Jr	113,000

The special master carefully considered the appraisals made by these appraisers, together with their testimony, and with sales of comparable properties made in 1934 and 1935. On December 26, 1935, he filed his report with the District Court. He found as follows:

ASSETS
Raw material, consisting of toys, etc	$12,435.43
Accounts receivable	2,500.00
Cash	$1,852.13
Dodge truck	500.00
Prepaid insurance	773.80
Note of Harry Schoenhut	5,000.00
Shares of stock of Media Drug Co. and Phila. Bourse	28.00
Machinery	27,944.80
	$51,034.16
Real estate	109,040.00
Total	$160,074.16
LIABILITIES
Notes payable bank, secured by mortgage	$84,281.76
Accounts payable prior to 1/17/35	59,318.43
Other liabilities	23,460.63
Total	$167,060.82

I therefore find as a fact that the said Debtor Company is insolvent to the extent of $6,986.66.

On the 18th day of November, 1935, at a meeting of the Board of Directors of the Debtor Company, it was resolved that the proper officers of the corporation were authorized to advise the Referee that the Corporation is unable to meet its obligations as they mature and that the corporation agrees that it may be adjudicated a bankrupt. * * *

15. On December 30, 1935, the District Court of the United States for the Eastern District of Pennsylvania issued an order:

* * * that the report of John M. Hill, Special Master, filed on December 26, 1935, finding A. Schoenhut Company to be insolvent is hereby approved and confirmed and Leon J. Obermayer and Fred C. Schoenhut, Trustees of the said debtor company appointed by this Court on October 14, 1935, are hereby directed to liquidate the said estate pursuant to the provisions of Clauses C and K of Section 77B of the Bankruptcy Act, * * *

16. Pursuant to order of the District Court in the aforementioned bankruptcy proceeding, Associated Auctioneers, Inc., on February 26, 27, and 28, 1936, conducted a public sale of the stock, machinery, and equipment of the Schoenhut Co. at which the aggregate of the highest bids for the separate lots offered amounted to $33,036.16, the said separate lots of machinery having been appraised by the appraisers at $27,944. The net amount actually realized by the Schoenhut Co. from the sale of this machinery and equipment was $21,000, which amount was paid over to the mortgagees in partial satisfaction of their claims against the bankrupt.

17. During the years 1936 and 1937 the trustees of the bankrupt made strenuous efforts to sell the dismantled plant of the petitioner. Their asking price for the property was approximately $300,000, which if it could have been obtained would have enabled them to pay off all of the debts of the bankrupt and have left something over for division among the stockholders. The mortgagees of the property deferred for more than a year any foreclosure action in order to enable the trustees to make such sale, but they were unable to find a purchaser.

18. On June 2, 1937, a judgment in the amount of $72,911.90 was entered against the Schoenhut Co. in the Court of Common Pleas No. 7 of Philadelphia County, Docket No. 7238, March Term, 1937, in favor of theIntegrity Trust Co., Ninth Bank & Trust Co., and Federal Reserve Bank of Philadelphia, on bond and warrant secured by mortgage given by the Schoenhut Co. upon the main plant, lumber yard, boiler house, and power plant of the Schoenhut Co. located in Philadelphia.

19. On July 6, 1937, the said premises were sold at public auction by the sheriff of Philadelphia County and were bought in by the above mentioned banks, as mortgagees, on a nominal bid of $125. Neither the stockholders nor the creditors of the Schoenhut Co. received anything as a result of the final liquidation of the company.

20. The common stock of the Schoenhut Co. was worthless on December 30, 1935, the date on which the District Court of the United States for the Eastern District of Pennsylvania issued an order to the effect that the Schoenhut Co. was insolvent.

OPINION.

SMITH: The principal question presented by this proceeding is whether or not the petitioners sustained deductible losses in 1937 upon their investments in shares of common stock of the Schoenhut Co. The respondent has disallowed the claimed loss deductions upon the ground, as stated in his deficiency notices, that the shares of stock became worthless prior to 1937. The burden of proof is upon the petitioners to show otherwise. They contend that the "identifiable event" which fixed the loss occurred in 1937, at which time the Schoenhut Co. lost all of its properties as a result of the foreclosure sale of the remaining assets of the bankrupt in that year. They further contend that the cost and replacement value of the company's real estate and buildings, which were not sold until 1937, were several times greater than the outstanding liabilities of the company and that if the market for industrial properties had returned to normal during the years 1936 and 1937 they would have been able to receive something upon their investments in the common stock of the company.

It should be noted that the petitioners were owners of the common stock of the Schoenhut Co. and not of the preferred stock. The evidence does not disclose whether the preferred stockholders were preferred as to assets upon any liquidation of the company. The preferred stock was outstanding in the face amount of $115,500.

The question as to whether a loss upon worthlessness of stock is sustained in a taxable year is a question of fact, to be determined from all of the facts in the case. The Board and the courts have many times recognized that the stock of a corporation in financial diffculties may become worthless long prior to the taxable year in which the corporation finally disposes of its assets. Thus in Sterling Morton,38 B.T.A. 1270">38 B.T.A. 1270, 1279; affd., 112 Fed.(2d) 320, the Board said:

There are, however, exceptional cases where the liabilities of a corporation are so greatly in excess of its assets and the nature of its assets and business is such that there is no reasonable hope and expectation that a continuation of the business will result in any profit to its stockholders. In such cases the stock, obviously, has no liquidating value, and since the limits of the corporation's future are fixed, the stock, likewise, can presently be said to have no potential value. Where both these factors are established, the occurrence in a later year of an "identifiable event" in the corporation's life, such as liquidation or receivership, will not, therefore, determine the worthlessness of the stock, for already "its value had become finally extinct." De Loss v. Commissioner, supra, at 803. Cf. Squier v. Commissioner, supra; Monmouth Plumbing Supply Co. v. United States,4 Fed.Supp. 349. In cases where the stock has concededly lost any liquidating value in a certain year, but an event occurs in a subsequent year which the taxpayer claims is "identifiable," and where the Commissioner of Internal Revenue has determined that stock became worthless in the year in which it lost its liquidating value, then the taxpayer, in order to be entitled to the loss deduction in the latter year, has the burden of proving that, although the stock lost its liquidating value in the prior year, it continued to have a potential value until the occurrence of the event. This we consider to be implicit in the rule stated in Mark D. Eagleton,35 B.T.A. 551">35 B.T.A. 551; affd., 97 Fed.(2d) 62, and John J. Flynn,35 B.T.A. 1064">35 B.T.A. 1064. Cf. William E. Steinback,30 B.T.A. 1252">30 B.T.A. 1252.

Applying these principles to the instant case, we find that petitioner's common stock apparently had no present value as early as the spring of 1930. * * *

In our opinion the Schoenhut Co. was insolvent prior to 1936. The court which had jurisdiction of the case so determined and we see nothing in the evidence which would indicate otherwise.

The situation presented by these proceedings is much the same as that which obtained in a case which arose in the United States District Court for the Eastern District of Pennsylvania in In re Hoffman,16 Fed.Supp. 391. The question there was whether Hoffman, a stockholder in the Franklin Trust Co., sustained a loss in 1932 or in 1931, in the earlier of which years the Secretary of Banking for the Commonwealth of Pennsylvania ordered that the Franklin Trust Co. be liquidated. In its opinion the District Court said:

The question is whether the fact that a bank is closed by the authorities (without a finding of insolvency) and liquidation ordered in a given year establishes the worthlessness of the stock as of that year.

What was said by Judge Dawson in Wesch v. Helburn (D.C.) 5 F. Supp. 581">5 F.Supp. 581, is applicable to this situation:

"Taxation is eminently a practical matter, and a reasonable and practical construction should be given to section 23(e). In Lucas v. American Code Company,280 U.S. 445">280 U.S. 445, 50 S. Ct. 202">50 S.Ct. 202, 203, 74 L.Ed. 538 [67 A.L.R. 1010">67 A.L.R. 1010], it is declared: "The general requirement that losses be deducted in the year in which they are sustained calls for a practical, not a legal, test.'

"In discussing a similar provision of the 1918 act, the Supreme Court of the United States, in the case of United States v. S. S. White Dental Manufacturing Company,274 U.S. 398">274 U.S. 398, 47 S. Ct. 598">47 S.Ct. 598, 600, 71 L. Ed. 1120">71 L.Ed. 1120, used this language: "The statute obviously does not contemplate and the regulations (article 144) forbid the deduction of losses resulting from the mere fluctuation in value of property owned by the taxpayer. * * * But with equal certainty they do contemplate the deduction from gross income of losses, which are fixed by identifiable events.'"

To say that stockholders of a bank which has been closed by order of the authorities and ordered liquidated do not sustain a loss upon their stock until some subsequent date when liquidation finally takes place, or until the official appraisement of the bank's assets, seems to me to be losing touch with reality. It is just conceivable that cases might arise in which some realization could be had by the stockholders in the long future. As a practical matter, however, the business world never remotely considers that contingency. To all intents and purposes the stock of a bank becomes unsalable at any price when the bank is taken over and liquidation begins.

The government's position that the loss occurred in the year in which the bank was closed is in accordance with the general practice of the Department. There is no formal regulation, and it would not be controlling if there were, but it is certainly a sensible, practical rule and in accordance with actual facts. I therefore hold that the bankrupt's loss in the Franklin Trust Company stock was sustained in the year 1931 and not in the year 1932.

The decision of the District Court in that case was affirmed per curiam by the United States Circuit Court of Appeals for the Third Circuit, 87 Fed.(2d) 200.

As in that case, so in the instant proceedings, we think that the claim of the petitioners loses "touch with reality." For all practical purposes the common stock of the Schoenhut Co. was worthless in 1935, if not in prior years. The record shows that there had never been any sales of the common or preferred shares of the Schoenhut Co. after 1933, so far as the witnesses knew. The company had not been able to operate after the beginning of 1935. Its liquid capital was all gone. Although the plant represented a large investment, there was no means of realizing upon it. The stock was worthless in 1935 and nothing occurred in later years to give it any value. Cf. Welsh v. Helvering,290 U.S. 111">290 U.S. 111; Burnet v. Houston,283 U.S. 223">283 U.S. 223; Sterling Morton, supra.We approve the action of the respondent in disallowing the claimed deductions.

Petitioners Otto Schoenhut and Minnie Schoenhut claim that they are liable for deficiencies in income tax only in accordance with the net income of each reported in the joint return and that the deficiencies must be determined against each separately. In support of this contention they cite Cole v. Commissioner (C.C.A., 9th Cir.), 81 Fed.(2d) 485; reversing 29 B.T.A. 602">29 B.T.A. 602.

In its opinion in Frida Hellman Cole, Executrix,29 B.T.A. 602">29 B.T.A. 602, the Board held that, where a joint return representing the combined gross income and deductions therefrom of husband and wife is duly filed, the election granted under section 51 of the Revenue Act of 1928 is exhausted and the tax liability thereunder is a joint obligation of husband and wife. In our opinion we stated:

* * * It is now well established that the right of election granted in section 51 of the Revenue Act of 1928 and in similar provisions of prior acts is exhausted when a joint return is filed. McIntosh v. Wilson, 36 Fed.(2d) 807; Herman Einstein,10 B.T.A. 240">10 B.T.A. 240.

As above indicated, the United States Circuit Court of Appeals for the Ninth Circuit reversed our decision in that case. We followed the Ninth Circuit in Frank W. Darling,34 B.T.A. 1062">34 B.T.A. 1062; Ella T. Flaherty, Executrix,35 B.T.A. 1131">35 B.T.A. 1131; and Celia Seder, Executrix,38 B.T.A. 874">38 B.T.A. 874. In the last cited case we said:

On authority of the cited decisions, we hold that the total deficiency tax, the amount of which is not in controversy, should be apportioned between the estate of Abraham Seder, the deceased husband, and his surviving wife, Celia Seder, according to the net income attributable to each, which amounts may be of 1934 the gain from the sale of capital assets by one spouse may be

In Helvering v. Janney,311 U.S. 189">311 U.S. 189, the Supreme Court held that in joint returns for 1934 under section 117(d) of the Revenue Act of 1934 the gain from the sale of capital assets by one spouse may be offset by the loss from the sale of similar assets by the other spouse. In its opinion the Supreme Court cited Solicitor's Opinion 90, Cumulative Bulletin IV (1921), p. 236, in which it was said:

* * * If a single joint return is filed it is treated as the return of a taxable unit and the net income disclosed by the return is subject to both normal and surtax as though the return were that of a single individual. In cases, therefore, in which the husband or wife has allowable deductions in excess of his or her gross income, such excess may, if joint return is filed, be deducted from the net income of the other for the purpose of computing both the normal and surtax.

We think that this opinion requires us to adhere to the position taken by the Board in Frida Hellman Cole, Executrix, supra.Petitioners Otto Schoenhut and Minnie Schoenhut filed a single joint return for 1937. They appealed to this Board from the determination of a deficiency made against them jointly by the respondent upon their joint income tax return for 1937. The respondent did not determine a deficiency due from either of the parties individually but a deficiency due from the two of them. We do not think upon the basis of the opinion of the Supreme Court in Helvering v. Janney, supra, that the Board is authorized to determine a deficiency against each "according to the net income attributable to each." The deficiency was determined by the Commissioner against the two jointly. We approve his determination.

In Moore v. United States,37 Fed.Supp. 136, the United States Court of Claims had before it the question, as stated by the court:

* * * whether, under the Revenue Act of 1932, a wife, having no taxable income of her own but a considerable net loss, is liable for the income tax originally assessed and for a deficiency assessed upon the aggregate taxable income of herself and her husband, she having made no separate income-tax return, and her husband having made a joint return of the incomes and losses of both, with no separation of the items of income and loss as between himself and his wife shown on the return. * * *

The court held, relying upon Helvering v. Janney, supra, and Taft v. Helvering,311 U.S. 195">311 U.S. 195, that the wife was liable for the income tax originally assessed and for a deficiency assessed upon the aggregate taxable income of herself and her husband. The court pointed out that under the Revenue Act of 1938 and later acts, section 51(b) of the Revenue Acts of 1932, 1934, and 1936 was clarified to expressly provide that where a joint return is filed a husband and wife are jointly and severally liable for the tax liability for that year. The court held, in reliance upon the Committee Report of the House recommending the change, that:

* * * It would not be a wise process of construction to treat the action of a legislature in clarifying a statute as an acquiescence in the contention that the statute had a different meaning before the clarifying change was made.

The court therefore held that the Revenue Act of 1932 was to be given the same construction upon the point involved as would be given to the Revenue Act of 1938 and later acts. The Supreme Court denied a writ of certiorari in this case on October 13, 1941.

In view of the opinions of the Supreme Court in the Janney and Taft cases and of its action in denying a writ of certiorari in the Moore case, the rulings made by the Board in the Darling, Flaherty, and Seder cases, supra, will not be followed in the future.

Reviewed by the Board.

Decisions will be entered for the respondent.

ARUNDELL dissents on the second point.