DocketNumber： Docket No. 10060
Judges： Kern
Filed Date： 9/26/1947
Status： Precedential
Modified Date： 11/14/2024
*94
In 1937 petitioner's son, who was at that time unemployed and without resources, went into the retail business. Petitioner furnished to him both credit and capital. Shortly thereafter the son borrowed additional capital from a bank and obtained petitioner's endorsement on notes given for such loans. Petitioner knew nothing of the condition of his son's business except that it was not good. He endorsed the notes only because he wanted to see his son stay in business. In January 1939 the notes became due and the son was unable to pay them. Thereupon petitioner gave his own note to the bank in payment of the son's notes. Later in 1939 the son went into bankruptcy and was discharged. The son did not list any debt owing to petitioner arising by reason of petitioner's payment of the son's notes as part of his liaiblities, nor did the petitioner file any claim on account thereof. In 1941 petitioner paid the note given by him to the bank in 1939, and claimed a bad debt deduction in the amount of such payment in 1941.
*464 The Commissioner determined a deficiency in petitioner's income tax for the taxable year ended December 31, 1941, in the amount of $ 1,972.90. The only question presented is whether the Commissioner erred in disallowing a deduction claimed for a bad debt loss.
FINDINGS OF FACT.
Petitioner is a resident of Raleigh, North Carolina, who filed his income tax return for the year 1941 with the collector of internal revenue for the district of North Carolina. The income of petitioner from his principal business, which is reflected in his return, is computed by use of inventories, while his income from other sources having no relation to that business is reported on a cash receipts and disbursements basis.
Petitioner's business is that of operating a ladies' ready-to-wear store in Raleigh, in which he has been engaged since 1914. The deduction which is involved in this proceeding, however, did not arise from and has no connection with that business.
In 1937 petitioner's son, Bernard, then about 25 years old, decided to open a ladies' ready-to-wear store of his own in Charlottesville, Virginia. At that time*96 he was unemployed. He had studied law, but had given up the practice. Thereafter, and prior to 1937, he had been employed by chain stores and had had other jobs. When he decided to enter business in Charlottesville he had no property and no credit. He borrowed from his father approximately $ 6,700, which he used to prepare and open the store, and he gave his father demand notes therefor. These are not the notes involved here. Bernard's original stock was purchased by him in 1937 upon the credit of his father, the petitioner, who guaranteed, either orally or in writing, Bernard's accounts. A large part of Bernard's later purchases were made either on the strength of petitioner's guarantee of Bernard's accounts or because the vendors knew that Bernard was petitioner's son. Later on he needed additional capital, which he arranged to borrow from the Peoples National Bank in Charlottesville, which agreed to make the loans only if Bernard could secure an acceptable endorser of the notes. He requested his father to endorse his notes and his father *465 did so. Petitioner knew little about Bernard's business during 1937 and 1938 except that Bernard "always needed more money." *97 In the early part of 1939 he withdrew his written guarantees of Bernard's accounts. In January of 1939, when Bernard's notes matured, the bank indicated to petitioner, the endorser, and to his son, the maker, that it would not extend these notes, but would accept notes of petitioner, endorsed by petitioner's wife, in lieu of Bernard's notes, endorsed by petitioner. Otherwise it would require payment of the loans. The amount then due was $ 8,000. Petitioner thereupon gave the bank his note, endorsed by his wife, in the face amount of $ 8,000. On the same date Bernard gave to petitioner herein his note payable on demand for $ 8,000.
Bernard's business declined rapidly during 1939, and in December of that year he filed a voluntary petition in bankruptcy and later received his discharge as a bankrupt. His schedule of assets and liabilities filed in the bankruptcy proceeding listed liabilities in the total amount of $ 38,673.03 and assets in the total amount of $ 17,730.98. The liabilities thus scheduled did not include any liability to petitioner by reason of petitioner's endorsement or payment of Bernard's notes to the bank.
Petitioner knew of the bankruptcy proceeding, but did*98 not file a claim therein for the amounts of money owed him by Bernard. However, petitioner concedes that had he filed such a claim he would have received a dividend amounting to $ 1,641.20 on a claim of $ 8,000. He, therefore, has reduced his claim for a deduction in this case to that extent.
In August 1939 Bernard submitted a financial statement to another Charlottesville bank in connection with his application for a loan. He did not include in his liabilities therein listed any liability to petitioner by reason of petitioner's payment of Bernard's notes.
Petitioner paid $ 7,053.24 on his note to the bank in 1941 and claims a deduction by reason thereof in the amount of $ 6,358.80 ($ 8,000 -- $ 1,641.20).
At the time when petitioner endorsed Bernard's notes in 1937, Bernard was without resources and was likely never to have any. There is no proof that Bernard was ever solvent. Petitioner never endorsed any notes except the notes of Bernard here in question. He endorsed these because Bernard was his son and petitioner wanted to help him stay in business.
OPINION.
The respondent disallowed the deduction of the bad debt involved here from petitioner's 1941 gross income with the*99 explanation *466 attached to the notice of deficiency that the payments made by petitioner on his note in that year "do not represent allowable deductions from your income for the year 1941."
The position of the respondent rests on the fact that the debt of the son to petitioner arising by reason of any payment by petitioner pursuant to his obligation as endorser became worthless prior to 1941. Indeed, all the evidence does establish the fact that it was worthless in 1939, and there is no serious contention on petitioner's part that it was not. However, this fact is not, in itself, fatal to petitioner's case. Petitioner was called upon as endorser of his son's notes to make an involuntary payment on account of his endorsement. He made this payment by executing his own note, which the payee of his son's notes took as payment of the latter notes. Thereupon his son was obligated to him in the sum of petitioner's own note. See ; ; ; ; 11 C. J. 317, § 750, note 97. *100 Since this debt of his son to petitioner arose by reason of petitioner's involuntary payment, as endorser, of his son's notes, he might have a bad debt deduction on account thereof, even though the debt was known to be worthless as soon as it arose. ; see ; ; .
Petitioner proceeds with his contention and argues that, since he reported his income on the cash basis and since his payment as endorser was by the execution of his own note, any deduction as a bad debt of the amount thereupon owed to him by his son would only become available to him when his own note was paid, citing , and .
We are of the opinion that petitioner's case breaks down before he gets to this argument. It is true that, when an endorser is called upon to make a payment of the obligation endorsed, a bad debt deduction (on*101 account of the debt thereupon owed by the primary obligor to the endorser) may be available to the endorser even though the debt deducted as bad was worthless at the time when, technically, it ripened from a conditional obligation into a debt. But when it appears that there is a close relationship between the endorser and the primary obligor, such as that of father and son, that the parties have no reasonable expectation that the primary obligor will pay the obligation when it becomes due, or will be able to reimburse the endorser on account of the latter's payment of the obligation, and that all of the facts present in the transaction show the intention of the parties at the time of the endorsement to be that upon payment of the obligation by the endorser no real and enforceable debt shall result in favor *467 of the endorser, then the intention of the parties will prevail, no debt of the primary obligor to the endorser will be considered as having been created by the endorser's payment, and the entire transaction will be treated as in the nature of a gift. See
In the instant case the principal obligor was the*102 endorser's son. He wished to go into a business requiring credit and capital, neither of which he had. The father loaned or gave to the son both capital and credit. The new business did not prosper. Because the father desired to see the son continue in business, he endorsed the son's notes executed for the purposes of obtaining additional capital. At that time the father made no investigation into the son's business or financial prospects. All he knew was that the business was not prospering and that the son always needed more money. After the father paid the notes thus endorsed, he made no effort to collect against his son the amount of his payment and he filed no claim on account thereof in the bankruptcy proceedings in which his son was later involved, nor did the son ever list such a debt as one of his liabilities or take any step indicating that he acknowledged the existence of this indebtedness.
Under the circumstances disclosed by the record in this case, we are of the opinion that the transaction in question is equivalent to one in which a father borrowed money from a bank and, in effect, made a gift of the proceeds to his son. It will not, in our opinion, justify *103 a bad debt deduction, since, on the facts shown, it is impossible for us to conclude that the petitioner and his son intended a debt to arise from petitioner's payments of his son's notes. See .
In , we permitted the deduction as a bad debt of amounts paid by a father on account of a guarantee of a son's obligation. In that case, however, we pointed out (p. 1265) "that the petitioner's son was solvent by a safe margin at the time of the * * * guarantee," that the petitioner regarded the transaction "as sound from a business standpoint, and this regardless of the personal relationship" between him and his son, and that the evidence in that case pointed "conclusively to the fact that the petitioner intended to hold his son as a debtor in whatever amount he was required to pay on the guarantees." In the instant case the record before us requires a holding on all these points contrary to that reached in the