1. In 1962 petitioner received notes in the total amount of $ 69,000 from McHenry in satisfaction of business and personal obligations, and in exchange for petitioner's interest in Tomatoes, Inc. Held, petitioner is not entitled to any capital loss on the disposition of his interest in Tomatoes. Held, further, the notes petitioner received from McHenry did not become worthless in 1965.
2. In 1966 petitioner filed a voluntary petition in bankruptcy and his assets were transferred to the trustee in bankruptcy. Held, petitioner is not entitled to a business expense deduction upon transfer of his assets to the trustee. B & L Farms Co. v. United States, 368 F. 2d 571 (C.A. 5, 1966). Held, further, petitioner is not entitled to a deduction for any unused net operating loss of the trustee in bankruptcy at the termination of the bankruptcy proceedings.
3. In 1965 petitioner claimed an investment credit under sec. 46(a), I.R.C. 1954. The property with respect to which petitioner claimed his qualified investment credit passed from petitioner to the trustee in bankruptcy prior to the expiration of its useful life. Held, petitioner must recapture *150 investment credit on such assets.
Robert O. Rogers, for the petitioner.
Richard G. Holloway, for the respondent.
Forrester, Judge. Simpson, J., concurring. Irwin and Hall, JJ., agree with this concurring opinion. Quealy, J., dissenting. Dawson, Featherston, Sterrett, and Goffe, JJ., agree with this dissent.
FORRESTER
*37 Respondent has determined deficiencies in petitioner's Federal income tax as follows:
Petitioner argues that B & L Farms is distinguishable because that decision *165 involved a corporate taxpayer, whereas he is an individual taxpayer. We dismiss petitioner's contention because the decision in B & L Farms was based on the requirement of actual payment by a cash basis taxpayer before a deduction will be permitted under section 162, and is applicable to both individual and corporate taxpayers.
Section 642(h) provides generally that upon termination of an estate or trust, any unused net operating loss carryover under section 172 shall be allowed as a deduction to the beneficiaries succeeding to the property of the estate or trust. *167 Petitioner argues that he should *45 qualify as such a beneficiary because estates of bankrupt individuals are taxed under the same provisions as estates of decedents.
While it is true that income of a bankrupt estate is taxed as income of an estate, Rev. Rul. 68-48, 1 C.B. 301">1968-1 C.B. 301; G.C.M. 24617, 1945 C.B. 237">1945 C.B. 237, it is not clear that a bankrupt estate is an estate for all purposes of taxation. Rev. Rul. 68-48, and its progenitor, G.C.M. 24617, deal solely with the duty of the trustee in bankruptcy to report income and the manner of reporting. Section 642 and the regulations thereunder deal only with estates and trusts, both inter vivos and testamentary, and nowhere describe or designate a bankrupt individual's estate as an estate within the meaning of the statute.
Furthermore, it is unlikely that petitioner is "the beneficiary succeeding to the property of the estate or trust" within the meaning of 642(h). The bankrupt individual taxpayer is not included in the definition of "beneficiaries succeeding to the property of the estate or trust" in section 1.642(h)-3, Income Tax Regs.*168 *169
Moreover, it is apparent that the bankrupt taxpayer was not intended to be covered by the statute. It is evident that the purpose of section 642(h) was to afford some measure of relief to beneficiaries of estates who take diminished interest in the property of an estate as a result of losses by the estate. Greggar P. Sletteland, 43 T.C. 602">43 T.C. 602, 610 (1965). A bankrupt taxpayer does not have a diminished interest in his bankrupt estate because of expenses or losses incurred by the estate, but rather his creditors receive a lesser amount. In fact, through the bankruptcy proceedings, the bankrupt taxpayer is discharged from liabilities which here were (and usually are) greatly in excess of the basis in the property which he turned over, and is also relieved from any income from cancellation of indebtedness as well. Astoria Marine Construction Co., 12 T.C. 798">12 T.C. 798, 801 (1949).
*46 Given the above, and recognizing that the allowance of "deductions depends upon legislative grace; and only as there is clear provision therefor, can any particular deduction be allowed," New Colonial Co. v. Helvering, 292 U.S. 435">292 U.S. 435, 440 (1934), *170 it is clear that petitioner is not entitled to any unused deductions of the bankrupt estate under section 642(h).
Issue 5. Recapture of Investment Credit
FINDINGS OF FACT
In a schedule attached to his 1965 return, petitioner claimed an investment credit under section 46(a) for 1965 in the amount of $ 4,028.95. He also claimed an unused investment credit from 1964 in the amount of $ 1,825.42, for a total of $ 5,854.37.
On July 28, 1967, respondent allowed petitioner a carryback of his unused investment credit from the years 1964 and 1965 to the year 1962 in the amount of $ 5,854.37.
The property with respect to which petitioner claimed his qualified investment credits for 1964 and 1965 was property used in his trade or business of farming in those years. The useful life of such property ranged from 4 to 8 years. This same property passed from the petitioner to the trustee in bankruptcy on September 27, 1966.
OPINION
Petitioner received a carryback investment credit for 1962 based on section 38 property acquired in 1964 and 1965. Respondent contends that petitioner must recapture part of this credit under section 47(a)(1) because the property was transferred to the trustee in bankruptcy *171 in 1966, prior to the end of its useful life. We agree with respondent.
Section 47(a)(1) provides as follows:
SEC. 47. CERTAIN DISPOSITIONS, ETC., OF SECTION 38 PROPERTY.
* * * *
(1) Early disposition, etc. -- If during any taxable year any property is disposed of, or otherwise ceases to be section 38 property with respect to the taxpayer, before the close of the useful life which was taken into account in computing the credit under section 38, then the tax under this chapter for such taxable year shall be increased by an amount equal to the aggregate decrease in the credits allowed under section 38 for all prior taxable years which would have resulted solely from substituting, in determining qualified investment, for such useful life the period beginning with the time such property was placed in service by the taxpayer and ending with the time such property ceased to be section 38 property. [Emphasis supplied.]
The broad language of the statute is easily capable of application to transfers from a bankrupt taxpayer to a trustee in bankruptcy. It *47 should be noted that the trustee and bankrupt taxpayer are two separate taxable entities. Norris Bloomfield, 52 T.C. 745">52 T.C. 745, 750 (1969).
Furthermore, *172 the Senate Finance Committee report in respect of this statute manifests an intention to include within its scope such transfers in bankruptcy. The report includes the following language: "In general, property will be considered disposed of whenever it is sold, exchanged, transferred, distributed, involuntarily converted, or disposed of by gift. [S. Rept. No. 1881, 87th Cong., 2d Sess., 3 C.B. 852">1962-3 C.B. 852-853.]"
Therefore, in view of our finding that the useful life of the assets in question extended beyond 1966, we hold that petitioner is required to recapture investment credit in 1966.
Petitioner argues that recapture is not required because under section 47(b) disposition of section 38 property is exempt from recapture where there is a mere change of the form of conducting the business. *173 This section is obviously inapplicable to petitioner on the facts of this case because it also requires that "the taxpayer retain a substantial interest in such trade or business."
Decision will be entered under Rule 50.
SIMPSON
Simpson, J., concurring: In my judgment, the results in connection with issues 3 and 4 are unfortunate; however, the Court was required to reach the conclusions adopted by the majority, and it will require the creative hand of the legislature to enact new laws that will bring about reasonable results in this situation.
In connection with issue 3, the conclusions are required not only because of the technicality that there has been no payment, but also because it is impossible in 1966 to know whether, or to what extent, the business expenses of the petitioner will ultimately be paid. The assets transferred by him to the trustee in bankruptcy may be used to pay personal obligations, and in any event the business expenses may be paid only in part. To allow a deduction in 1966 for all of the expenses would obviously be unjustifiable.
Similarly, *174 in connection with issue 4, it is clear that the debtor is *48 not a beneficiary of the estate, and when section 642(h) was enacted, there was no consideration of its applicability to a bankrupt estate.
Yet, these conclusions cause a distortion of income. In 1966, the petitioner earned income and incurred expenses in connection with the earning of that income. Eventually, some of those expenses may be paid, but they are never taken into consideration in computing the income of the petitioner which is subject to taxation. The bankrupt estate, when the expenses are paid, is entitled to deductions, but those deductions cannot be offset against the appropriate income and might be of no use to the estate. A legislative solution might be to allow a special carryback of the loss sustained by the bankrupt estate. It is clear that the present tax laws do not bring about appropriate results in connection with a bankruptcy, and that this matter must be dealt with by legislation.
I do not believe that this disparity in result as between a cash basis taxpayer and an accrual *176 basis taxpayer under the internal revenue laws can be allowed to stand. Where an interpretation of the law, whether literal or otherwise, produces an absurd result, I would seek a different answer. For example, see Bongiovanni v. Commissioner, 470 F. 2d 921 (C.A. 2, 1972), reversing a Memorandum Opinion of this Court.
1. Arising out of a claimed carryover loss from 1966.↩
1. Both parties have conceded on brief that the incorporation of Tomatoes was a non-taxable transaction under sec. 351.↩
2. All statutory references are to the 1954 Internal Revenue Code↩ unless otherwise specified.
3. It is at least plausible that petitioner did receive as much as $ 26,000 in mortgage principal payments, since Farms possessed physical assets with a cost basis of $ 30,207.37.↩
4. Compare Homer A. Martin, Jr., 56 T.C. 1294">56 T.C. 1294, 1298et seq↩., dealing with claimed inventory reduction measured by the basis of inventory merchandise turned over to the trustee in bankruptcy.
6. We note that neither the Internal Revenue Code nor the Federal Bankruptcy Act deals specifically with the tax aspects of a voluntary petition in bankruptcy. Norris Bloomfield, 52 T.C. 745">52 T.C. 745, 748. Obviously, allocation of percentage receipts between business and nonbusiness creditors would pose many problems.
See Krause & Kapiloff, "Bankrupt Estate, Taxable Income and the Trustee in Bankruptcy," 34 Ford. L. Rev. 401↩ (1966).
7. SEC. 642(h). Unused Loss Carryovers and Excess Deductions on Termination Available to Beneficiaries. -- If on the termination of an estate or trust, the estate or trust has --
(1) a net operating loss carryover under section 172 or a capital loss carryover under section 1212, or
(2) for the last taxable year of the estate or trust deductions (other than the deductions allowed under subsections (b) or (c)) in excess of gross income for such year,
then such carryover or such excess shall be allowed as a deduction, in accordance with regulations prescribed by the Secretary or his delegate, to the beneficiaries succeeding to the property of the estate or trust.
8. Sec. 1.642(h)-3 Meaning of "beneficiaries succeeding to the property of the estate or trust".
(a) The phrase "beneficiaries succeeding to the property of the estate or trust" means those beneficiaries upon termination of the estate or trust who bear the burden of any loss for which a carryover is allowed, or of any excess of deductions over gross income for which a deduction is allowed, under section 642(h).
(b) With reference to an intestate estate, the phrase means the heirs and next of kin to whom the estate is distributed, or if the estate is insolvent, to whom it would have been distributed if it had not been insolvent. If a decedent's spouse is entitled to a specified dollar amount of property before any distribution to other heirs and next of kin, and if the estate is less than that amount, the spouse is the beneficiary succeeding to the property of the estate or trust to the extent of the deficiency in amount.
(c) In the case of a testate estate, the phrase normally means the residuary beneficiaries (including a residuary trust), and not specific legatees or devisees, pecuniary legatees, or other nonresiduary beneficiaries. However, the phrase does not include the recipient of a specific sum of money even though it is payable out of the residue, except to the extent that it is not payable in full. On the other hand, the phrase includes a beneficiary (including a trust) who is not strictly a residuary beneficiary but whose devise or bequest is determined by the value of the decedent's estate as reduced by the loss or deductions in question. * * *
9. The pertinent language of sec. 47(b) is as follows:
(b) Section Not To Apply in Certain Cases. -- Subsection (a) [requiring recapture] shall not apply to --
* * * *
For purposes of subsection (a), property shall not be treated as ceasing to be section 38 property with respect to the taxpayer by reason of a mere change in the form of conducting the trade or business so long as the property is retained in such trade or business as section 38 property and the taxpayer retains a substantial interest in such trade or business.
1. While I realize that what would be the cost of goods sold for a manufacturer has been termed as an expense for the farmer, such terminology does not change the result.↩