Watson v. Commissioner

ARCHIBALD R. WATSON, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

Watson v. Commissioner

Docket Nos. 87873, 88048, 89650.

United States Board of Tax Appeals

42 B.T.A. 52; 1940 BTA LEXIS 1054;

June 13, 1940, Promulgated

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">*1054 1. Where taxpayer owned all the capital stock of two corporations which performed no functions except to hold title to his country estate, it is held that he may deduct taxes and mortgage interest on such real estate which were paid by him.

2. Taxpayer may not deduct net losses suffered by two wholly owned corporations where such corporations carried on businesses of publishing magazines since, under those circumstances, their corporate entities must be respected. Burnet v. Commonwealth Improvement Co.,287 U.S. 415">287 U.S. 415, and Higgins v. Smith,308 U.S. 473">308 U.S. 473, followed.

3. Taxpayer may not deduct amounts as debts ascertained to be worthless or as losses sustained during the taxable years where the factual premise to support either such ascertainment or loss is lacking.

George B. Chandless, Esq., Harold Dudley Greeley, Esq., and William R. Green, Jr., Esq., for the petitioner.

Conway Kitchen, Esq., for the respondent.

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LEECH

">*53 These consolidated proceedings involve deficiencies in income tax as follows:

Calendar year	Amount
1932	$3,727.47
1933	7,319.43
1934	2,476.34

">*1055 The first issue is whether petitioner is entitled to deduct interest and taxes paid by him during the three taxable years on certain real estate, the title to which was held by his wholly owned corporations. The second issue is whether petitioner may individually deduct losses suffered by two wholly owned publishing corporations or whether he may deduct advances to those corporations as bad debts. The last issue is whether petitioner is entitled to a deduction in 1933 of a statutory net loss alleged to have been sustained in 1932.

FINDINGS OF FACT.

Petitioner is County Clerk of New York County, editor of the New York Law Journal, an attorney at law, and engages in a number of business enterprises, each one of which he has incorporated.

Petitioner maintained a country residence at Smithtown, Long Island, consisting of two parcels. Title to one parcel was held by the Nissequogue Realty Corporation and title to the other was held by the Meadow Road Improvement Corporation. Petitioner owned all the capital stock of both corporations. Petitioner had organized these corporations to hold his country estate in order to facilitate transferability of title, because his wife, ">*1056 who would otherwise have to join in the execution of any deed, spent most of her time abroad. Each parcel of realty was mortgaged, and interest on the mortgages, together with taxes on the properties, were paid by petitioner. Neither corporation had a bank account, nor any asset other than the legal title to the properties, nor income, nor kept any books of account. Neither corporation did anything with respect to the properties, petitioner personally undertaking all activities with respect thereto, including proceedings looking to the relocation of a road.

">*54 On October 15, 1930, the Meadow Road Improvement Corporation executed a bond in the sum of $27,500, secured by a purchase money mortgage on the residential property in Smithtown. Petitioner, by a writing endorsed on the bond, guaranteed payments of interest and principal and due performance of all the covenants to be performed by the obligor.

Petitioner paid mortgage interest and taxes on the properties as follows:

	Nissequogue Realty Corporation		Meadow Road Improvement Corporation
Year	Taxes	Interest	Taxes	Interest
1934	$1,418.56	$577.50	$1,145.76	$1,650.00
1933	1,735,80	600.00	1,157.20	1,650.00
1932	1,683.99	600.00	1,122.66	1.650.00

">*1057 Petitioner acquired a magazine known as the American Law Review in 1929 and combined it with another magazine which he was publishing, the New York Law Review. The new magazine was named the United States Law Review. Petitioner organized a corporation on February 5, 1930, known as the United States Review Corporation, to act as the publisher of this magazine. One of the purposes of the incorporation was to relieve petitioner from soliciting and billing subscribers personally. He held all its capital stock. The officers and directors were either close personal friends or members of petitioner's office staff. Neither they nor any one other than petitioner had a financial interest in the corporation nor did they participate in either the financial set-up of the corporation or in the business of publishing the magazine. Petitioner was not an officer of the corporation, but he personally wrote a number of the editorials and supervised everything that was printed. He drafted all letters for solicitation of subscribers and directed the advertising. He consulted with no one as to his exercise of authority or his policies. He personally employed one Joseph Lapidus as editor, fixed">*1058 and changed the latter's compensation, but kept control of all administrative and managerial matters. Lapidus knew no employer other than petitioner, rendered no reports to a board of directors, dealt with no corporate officers as such, and when he resigned he notified only petitioner.

The United States Law Review used space in petitioner's law office. Its name, but not the name of the corporation, was on the door. The magazine carried a statement to the effect that it was published by the United States Review Corporation, but bills were sent out in the name of the United States Law Review. Petitioner personally made its printing contracts, decided upon its typographical arrangement, and selected the paper on which it was printed. ">*55 Petitioner employed, fixed the compensation of, and discharged all employees. Stenographers employed by petitioner for his law practice and stenographers employed by petitioner for the corporation were used interchangeably in both lines of work without any charges being made for such transfers of service. The printer dealt with petitioner personally and did not know that any corporation was involved. The copyright was in the name of">*1059 the corporation.

Petitioner did not offer any stock in United States Review Corporation to outsiders. He supplied all the funds needed by it, paying its obligations and endorsing its notes himself. He never received any note or other evidence for funds so advanced. No bank or other lender ever asked for any financial statement of the corporation, all financing being done on petitioner's personal credit. Meetings of the board of directors were held only when corporate action was required with respect to opening bank accounts, authorization of signatures on checks, or acquisition and disposition of property by the corporation. No compensation was paid either to officers or directors for their services.

The United States Review Corporation had net losses as follows:

1930	$9,995.84
1931	9,461.24
1932	6,777.82
1933	5,375.87
1934	3,277.53
1935	$4,244.62
1936	3,739.32
1937	3,813.63
1938	3,245.89

Petitioner claimed deductions for bad debts as follows:

1932 return	$18,650.30
1933 return	2,804.38
1934 return	3,566.69

These claimed losses were computed by one George B. Chandless, petitioner's accountant and business associate, ">*1060 and were determined as such by petitioner. The method employed for 1932 was to ascertain the liquidating value of petitioner's interest in the corporation and subtract it from the total of previous advances made by petitioner to the corporation. The above figures represent the results of these calculations. For 1933 and 1934 the same method was used, except the total of previous deductions was subtracted in each instance.

Petitioner's advances were set up on the books of United States Review Corporation, together with repayments by the corporation, as follows:

	1930	1931	1932	1933	1934
Cash received by corporation from Archibald R. Watson	$5,450.54	$6,250.00	$4,103.51	$6,386.37	$4,465.00
Cash paid by corporation to Archibald R. Watson		900.00	6,351.88	10,611.25	3,933.00
Excess credits	5,450.54	5,350.00			532.00
Excess debits			2,248.37	4,224.88

">*56 Petitioner continued to make advances to the corporation from 1935 to 1938, inclusive. These advances totaled $66,731.06, and repayments aggregated $41,413.28.

The books of account of the corporation showed deficits as follows:

1930	$9,995.84
1931	19,457.08
1932	26,234.90
1933	31,610.77
1934	34,888.30

">*1061 The estimated value of the corporation's assets on December 31, 1931, was $2,207.79 and on December 31, 1932, was $1,564.63. Its liabilities, exclusive of capital stock, on those dates were $21,665.87 and $27,800.53, respectively.

Petitioner acquired another magazine in 1930, known as the Living Age, from the Living Age Co. of Massachusetts, a subsidiary of the Atlantic Monthly, Co. Here again he organized a corporation, the Living Age Corporation, to act as publisher, and here again one of the purposes of incorporation was to relieve petitioner of soliciting and billing subscribers personally. He held two of the three shares of preferred stock issued by it, the third share being held by Chandless. Chandless endorsed his certificate in blank and left it in the stock book. This stock carried no voting rights. No other stock of any kind was ever issued by this corporation. The officers and directors were either close personal friends or members of petitioner's office staff. Neither they nor any one other than petitioner had any financial interest in the corporation, nor did they participate in the business of publishing the magazine. Petitioner personally directed and supervised">*1062 everything done in connection with the magazine. He rented specific office space for it, made its printing contracts, selected its type, paper, and format, and employed, fixed the compensation of, and discharged its employees. His personal stenographers, stenographers working for the United States Review Corporation, and stenographers hired for the Living Age were used interchangeably and without charge for such transfers of services. The name of the magazine, but not of the corporation, was on the office door. The magazine carried a statement to the effect that it was published by the Living Age Corporation, but its bills were sent out in its own name. The copyright was in the name of the corporation.

Petitioner employed one Quincy Howe as editor of the Living Age, fixed his compensation, and supervised his editorial work without consultation with any officer or director. Petitioner also organized an advisory council for the Living Age, selected the persons who composed it, and handled all correspondence with them. He also ">*57 personally organized and conducted a symposium on neutrality in the columns of the magazine. When the magazine infringed a copyright, he paid">*1063 theh consequent damages.

Howe had nothing to do with the financial policy or management of the magazine. He never attended any directors' meetings, never knew of one being held, had no contacts with any corporate officer, and dealt with petitioner as the person who controlled the magazine.

Petitioner did not offer any stock in Living Age Corporation to outsiders. He supplied all the funds it required, paying its obligations, and endorsing its notes himself. He never received any note or other evidence for funds so advanced. No bank or other lender ever asked for any financial statement of the corporation, all financing being done on petitioner's personal credit. Meetings of the board of directors were held only when corporate action was required with respect to opening bank accounts, authorization of signatures on checks, or acquisition and disposition of property by the corporation. No compensation was paid either to officers or directors for their services.

The Living Age Corporation had net losses as follows:

1930 (profit this year only)	$863.69
1931	8,096.11
1932	5,275.68
1933	6,628.53
1934	$1,996.61
1935	3,069.67
1936	9,293.53
1937	5,843.36
1938	12,225.40

">*1064 Petitioner claimed deductions for losses as follows:

1932	$32,932.99
1933	7,300.10
1934	4,993.74

These claimed losses were computed by George B. Chandless, petitioner's accountant and associate as aforesaid, and were determined as such by petitioner. The method employed for 1932 was used here again to ascertain the liquidating value of petitioner's interest in the corporation and subtract it from the total of previous advances made by petitioner to the corporation. The above figures represent the results of these calculations. For 1933 and 1934 the same method was used, except the total of previous deductions was subtracted in each instance.

Petitioner liquidated the Living Age Corporation in 1938, and in his 1938 return he claimed the total of all the corporation's net losses from the time of its organization to the date of its winding-up. The amount, $51,565.20, was claimed as a deduction in order to protect petitioner's right to deduct such total loss in the event the claimed yearly losses were held to be nondeductible.

">*58 The Living Age Corporation showed deficits on its books as follows:

1931	$7,232.42
1932	12,508.10
1933	19,136.63
1934	21,133.24

">*1065 The estimated value of its assets on December 31, 1931, was $11,648.95, and on December 31, 1932, was $10,907.22. Its liabilities, exclusive of capital stock, on those dates were $44,288.87 and $48,822.82, respectively.

As of August 4, 1931, petitioner assumed a note of the Living Age Corporation to the Irving Trust Co. in the amount of $30,000 and on the same day the note was taken up by a note of the Chain Sales Corporation. The transaction was entered on the books of the Chain Sales Corporation as follows:

Chain Sales Account - Notes Payable
August, 4, 1931	$30,000

Petitioner paid $15,000 on this note in 1932, $7,500 in 1933, and $1,000 in 1934. On June 26, 1934, the note was consolidated with other obligations of the Chain Sales Corporation and a new note negotiated at the Empire Trust Co. in the amount of $15,700.

Petitioner's advances were set up on the books of the Living Age Corporation, together with repayments by the corporation, as follows:

	1930	1931	1932	1933	1934
Cash received by corporation from Archibald R. Watson and corporate obligations assumed by him		$43,448.68	$6,825.00	$6,923.44	$2,500.00
Cash paid byh corporation to Archibald R. Watson	$2,670.42	4,696.40	500.00	2,775.00	500.00
Excess credits		38,752.28	6,325.00	4,148.44	2,000.00
Excess debits	2,670.42

">*1066 Petitioner continued to make advances to the corporation from 1935 to 1938, inclusive. He advanced a total of $22,209.48 and was repaid $19,499.58.

The balance sheet of the Living Age Corporation shows that on December 31, 1931, $38,752.28 was owed petitioner. That amount includes the $30,000 note taken up by note of the Chain Sales Corporation.

Petitioner claimed a net loss of $22,520.29 in 1932 and sought to deduct it as a statutory net loss in computing his income for 1933.

OPINION.

LEECH: That a corporation and its stockholders are separate entities is too well established to require the citation of authorities. Likewise settled is the rule that only in exceptional cases, for tax purposes, will ">*59 those separate entities be disregarded. ; ; ; . One such exceptional case of which the taxpayer may take advantage is where his corporation is merely holding title to real estate, and he has consistently disregarded its separate entity in">*1067 tax matters. ; ; ; affd., .

We do not understand that the recent decision of the Supreme Court in Higgins v. Smith??,, intended to disturb the validity of the rule or that exception. See . Rather, it definitely adds a distinct class of cases to the exceptions. This class includes only certain cases where the Government, and not the taxpayer, may refuse to consider these entities as separate See Valuation Service Co., B.T.A. 811.

The first issue is whether petitioner may deduct taxes and interest on the properties the title to which was held by the Nissequogue Realty Corporation and the Meadow Road Improvement Corporation. These properties constituted his summer residence. Title was so held only to facilitate transfer of title because his wife, who would otherwise have to join in the execution of the deed, spent most of her time abroad. This action was not motivated">*1068 by any intent of the taxpayer to avoid, postpone, or reduce his taxes. He has consistently disregarded their separate entities in income tax matters. All the stock of these corporations was held by petitioner, and they performed no function save that of holding title. They were not doing business. See . The taxes and interest were actually paid by petitioner.

We think that the corporate entities of these two corporations may properly be disregarded, in the light of the recent case of In that case the corporation, whose entity was disregarded, was formed by a bondholders' committee to hold title to property in process of foreclosure. Its only activity was to receive rents from the property and transmit them to the committee to be used to defray expenses of the latter. The instant situation is even more appropriate for disregarding corporate entity in that the two corporations now under consideration received no income at all and had no bank accounts. The case of ">*1069 , contains nothing at variance with our conclusion, for there tax advantages had previously been secured by the taxpayer's treating the corporation and the estate as two separate entities, whereas here, petitioner has always been consistent in his disregard of corporate entities and has never obtained tax advantages by invoking an opposite theory. The Commonwealth Improvement case is also distinguishable ">*60 in that the corporation there had income and bought and sold securities. Accordingly, we hold that petitioner may deduct amounts paid as mortgage interest and taxes on the land held by these two corporations.

The other issues are whether petitioner may deduct losses incurred by his wholly owned corporations, the United States Review Corporation and Living Age Corporation, and whether petitioner is entitled to carry over a 1932 net loss thus determined, so as to deduct it from his 1933 income.

To sustain petitioner in the first of these two issues, requires us to disregard the corporate entities of the United States Review and Living Age corporations. These corporations were doing more than just">*1070 holding title to assets. They were publishing magazines for profit. They were doing business. It may be that the circumstances indicate that, for all practical purposes, the petitioner was the corporation. However, that was so in There, as here, the taxpayer voluntarily assumed the corporate form for carrying on business and then sought to avoid the tax consequences of that status by disregarding it for tax purposes. On the authority of that case, which was reaffirmed in , we must consider these corporations as having entities here separate from those of their stockholder. See also ;

As an alternative contention, petitioner seeks to deduct the difference between the total of his advances to these corporations and the value of his liquidating interest therein as bad debts. Respondent urges that the debts thus sought to be charged off by petitioner and deducted in 1932, 1933, and 1934 were really worthless in 1931. ">*1071 He points to the facts that the Living Age Corporation had a deficit in 1931 of $7,232.42 as compared with $12,508.10 in 1932, that it had net losses of $8,096.11 in 1931 as compared with $5,275.68 in 1932, and that the value of its assets at the close of 1931 was $11,648.95 as compared with $10,907.22 at the close of 1932, whereas its liabilities exclusive of capital stock were, respectively, $44,288.87 and $48,822.82. He emphasizes the similar situation in respect of the United States Review Corporation. He thus contends that petitioner may not "close his eyes to the obvious" and deduct accounts as worthless in a year subsequent to the one in which he must be presumed to have ascertained their worthlessness, citing . Although under all the circumstances, implicit in this record, the validity of this position may be doubted, , we pass the point.

It may be that these contested advances were not loans, but capital investments. It seems unnecessary to decide that question. In any ">*61 event, the action of petitioner in continuing to put money into these corporations year">*1072 after year, in the face of steady losses, deficits, and book insolvencies, the perseverance of these corporations in the magazine publishing business and other evidence negative the existence in the tax years of any factual premise upon which to predicate ; Powers Manufacturing Co. v. Commissioner, they be such, ; ; ; ; , or to identify the occasion of a loss, if they were capital investments. ; .

This conclusion renders unnecessary any decision on the remaining issues.

Reviewed by the Board.

Decision will be entered under Rule 50.

STERNHAGEN, MURDOCK, and MELLOTT dissent on the first issue.