Court Opinion

ID: 4482167
Source: CourtListenerOpinion
Date Created: 2020-01-16 21:15:21.041897+00
Date Added: 2024-06-11T13:32:55.976792
License: Public Domain

Simpson, J., dissenting: As a result of the way this case was presented, the Court was tempted to consider irrelevant issues, and it yielded to that temptation and has reached a regrettable decision. Section 165(a) allows a deduction for a loss that is not compensated for by insurance or otherwise. However, section 165(b) limits the deduction to the basis of the destroyed property. If part of the basis has previously been deducted through depreciation or otherwise, the basis must be adjusted, and the amounts previously deducted cannot again be deducted under section 165. Carloate Industries, Inc. v. United States, 354 F. 2d 814, 817 (C.A. 5, 1966); United States v. Koshland, 208 F. 2d 636, 639 (C.A. 9, 1953); Fred Rosenthal, 48 T.C. 515, 527 (1967), affd. 416 F. 2d 491 (C.A. 2, 1969). If the costs of property were deducted when acquired, then the property has no basis that is deductible under section 165. Bessie Knapp, 23 T.C. 716, 720 (1955); J. E. Mergott Co., 11 T.C. 47, 51 (1948), affd. 176 F. 2d 860 (C.A. 3, 1949). A petitioner claiming a deduction under section 165 has the burden of proving that any destroyed property had a basis deductible under such section. I. Hal Millsap, Jr., 46 T.C. 751, 760 (1966), affirmed on other issues 387 F. 2d 420 (C.A. 8, 1968); Samuel Towers, 24 T.C. 199, 239 (1955), affirmed on other issues sub nom. Bonney v. Commissioner, 247 F. 2d 237 (C.A. 2, 1957); cf. Burnet v. Houston, 283 U.S. 223 (1931). The majority relies on Kenosha Auto Transport Corporation, 28 T.C. 421 (1957), but Judge Fisher who decided that case also decided Kaufman’s, Inc., 28 T.C. 1179 (1957), later in the same year. In Kaufman’s, he held that when the basis of property had been previously deducted, albeit erroneously, there was no basis to depreciate in the year before him. In distinguishing Kenosha, he said, 28 T.C. at 1187-1188: The issue here is not the same as in Kenosha Auto Transport Corporation, * * * in which the Commissioner challenged a deduction properly taken by taxpayer in the year before the Court on the ground that it had been erroneously deducted in a prior year. We there held that we must look to the proper treatment of the item in the year before us (and that the respondent must look to sec. 1311, et seq., I.R.C. 1954, for any possible adjustment for prior years). In the instant case, while petitioner is, of course, entitled to a reasonable allowance for depreciation for the year in question, the basis therefor must be limited to unrecovered cost and cannot include a factor of cost already recovered in prior years. In other cases, this Court has held that when the cost of an item has been previously deducted such cost cannot be deducted again, regardless of whether the earlier deduction was erroneous. Thus, in Waldheim Realty & Investment Co., 25 T.C. 1216, 1219 (1956), reversed on other issues 245 F. 2d 823 (C.A. 8, 1957), the Court held that the premiums for insurance covering a period of years could not be deducted when paid but must be prorated over the period of the coverage. However, the Court also held that the premiums which had been previously deducted could not be deducted again in the years before it. Similarly, in Firemen’s Insurance Co., 30 B.T.A. 1004, 1011, 1012 (1934), this Court held that there could be no depreciation for property the costs of which had been erroneously deducted as an expense in prior years. See also Reliable Incubator & Brooder Co., 6 T.C. 919, 929 (1946). The majority attempts to explain away our decision in R. G. Robinson, 12 T.C. 246 (1949), affd. 181 F. 2d 17 (C.A. 5, 1950), by indicating that the earlier allowance may have been proper. However, the Fifth Circuit treated the matter as if the earlier allowance were erroneous and held that a deduction for the year in issue was not allowable because of such earlier erroneous treatment of the item. These cases illustrate the reasons for the regulations providing that if the cost of an item is reflected in inventory, a theft of such an item is not deductible under section 165. Sec. 1.165-8(e), Income Tax Regs. When such costs are taken into consideration in computing the cost of goods sold, the effect is the same as if they had been deducted. See R. G. Robinson, supra at 248. Thus, there is no basis to be deducted again under section 165. In this case, it was money that was stolen by reason of the fictitious purchases, but since the amounts of such fictitious purchases were reflected in the inventory of the petitioner, the tax consequences are the same as if products had in fact been purchased and subsequently stolen from the inventory. In either case, the costs have been taken into consideration in computing taxable income, and there is no remaining basis for the stolen money. Raum and Goffe, JJ., agree with this dissent. Quealy, J., dissenting: I must disagree with the opinion of the majority. It clearly contravenes the intent of the Congress. More important, it is completely lacking in “commonsense,” which in itself should govern our decisions. The opinion of the majority states that “the key to the decision here lies in the fact that the petitioner erroneously deducted nonexistent purchases in computing its cost of goods sold for prior years.” In this respect, the decision fails to recognize that we are not here dealing with, a statutory deduction per se, but with a defalcation or dishonest act on the part of an employee, the effect of which is to produce a shortage in inventory. Such defalcations have become a source of widespread concern, with estimated losses ranging in billions of dollars. No one knows the real amount of the loss or the extent to which it may be attributed to thefts by the employees or to shoplifting by the customers.1 Nonetheless, such losses are automatically reflected in the inventory computation and become a part of the cost of goods sold. There is nothing “erroneous” in this procedure. It is universally followed and accepted for tax purposes. To hold that a taxpayer should be permitted in some later year, when the thief is caught, to again deduct the loss, produces an absurd result. I am unable to agree that the statute must be so construed. Section 165(e) was enacted as a part of the major restructuring of the Internal Revenue laws in the Revenue Act of 1954. In explanation, the report of the Committee on Ways and Means accompanying that Act (H. Rept. No. 1337, 83d Cong., 2d Sess., p. A46) stated: Subsection (e) is a new provision for the treatment of theft losses. There was no comparable statutory provision in the 1939 code. Regulation 118, section 39.43-2 provides that a loss from theft or embezzlement is ordinarily deductible for the year in which sustained. There has been considerable uncertainty and litigation about the application of this rule. Under the new provision, the loss will always be deductible in the year in which the taxpayer discovers the loss. The rule will, of course, also apply to embezzlement, larceny, etc. If the loss is treated as sustained under this subsection, there can be no deduction for the same loss under the 1939 code for a prior year (see sec. 7852). [2] It is clear that section 165(e) was enacted in order to set at rest the uncertainty which had arisen with respect to those losses from theft and the like, which could not be reflected as a deduction from income unless and until discovered by the taxpayer. Where the method of accounting used by a taxpayer is such that a loss is automatically taken into account in computing its taxable income in the year incurred, there is no basis for application of section 165(e). I must disagree with the majority, therefore, in its premise that the fictitious purchases involved in this case were “erroneously” deducted as a part of the cost of goods sold in the year of the defalcation. In the determination of its taxable income, the petitioner resorted to the use of inventories, as required by section 471. The petitioner’s opening inventory plus purchases during the taxable year less the closing inventory for such year was reflected on its books and its income tax returns as the cost of goods sold. By this method of accounting, any loss sustained by the petitioner on account of fictitious purchases was reflected as a part of the cost of goods sold in the year in which such purchase occurred. Whether the petitioner was conscious of the defalcation or not, this method af accounting automatically resulted in the deduction of the loss in the year incurred. The enactment of section 165(e) was not intended to change this procedure.3 On the contrary, for purposes of section 165(e), the deduction of the loss presupposes its “discovery.” There thus remained no undiscovered losses for the petitioner to deduct in its taxable year ended September 30, 1965, other than the amount reflected in the inventory process and credited to the cost of sales for such year. Iiiwin and Gotee, JJ., agree with this dissent.   U.S. News & World Report, vol. 72, No. 7, Feb. 14, 1972, pp. 70-71:    To the same effect, see S. Rept. No. 1622, 83d Cong., 2d Sess., p. 198.    See sec. 1.165-8(e), Income Tax Regs.