Court Opinion

ID: 4633795
Source: CourtListenerOpinion
Date Created: 2020-11-21 03:14:40.583162+00
Date Added: 2024-06-11T07:58:07.272263
License: Public Domain

Eugene M. Alexander, Lillian G. Alexander, Petitioners, v. Commissioner of Internal Revenue, RespondentAlexander v. CommissionerDocket No. 52565United States Tax Court26 T.C. 856; 1956 U.S. Tax Ct. LEXIS 120; July 20, 1956, Filed *120 Decision will be entered under Rule 50.  1. Held, petitioner did not make a sale of 10 notes for $ 1,000 each in 1950, in which he alleged he incurred a capital loss of $ 9,500.  He is not entitled to deduct $ 1,000 as a capital loss in 1950, and is not entitled to deduct in 1951 and 1952 a carryover capital loss of $ 1,000 in each of those years.  The Commissioner is sustained in disallowing such claimed losses.2. Held, petitioner did not, in 1950, receive $ 500 in payment for his testifying in a suit which he was to subsequently bring against the debtor on 10 promissory notes which he owned and held against the debtor.  The Commissioner's action in including this $ 500 in petitioner's income for 1950 is not sustained.3. Petitioner, in 1951, secured a judgment on 6 of the notes described above, which judgment was affirmed by the United States Court of Appeals for the Sixth Circuit in 1952.  Petitioner was unable to collect his judgment after effort made.  Held, petitioner incurred a nonbusiness bad debt loss of $ 5,500 in 1952 on account of such debt becoming worthless in that year.  The amount of such loss allowable as a deduction is governed by section 23 (k) (4), *121  Internal Revenue Code of 1939.  Arnold Lefkovits, Esq., for the petitioners.Lester R. Uretz, Esq., for the respondent.  Black, Judge.  BLACK *856  The Commissioner has determined deficiencies in petitioners' income tax of $ 253.76, $ 186.76, and $ 221.40, respectively, for the years 1950, 1951, and 1952.  The deficiency for 1950 is due to the addition to the adjusted gross income reported on the joint return filed by petitioners of the following amounts:Disallowance of a claimed bad debt loss$ 1,000Additional income from Henry Badham for servicesrendered500Error in subtraction100Total additions to income$ 1,600The above adjustments are explained in the deficiency notice as follows:Reference is made to the informal conference in this office on June 4, 1953, regarding the bad debt loss of $ 10,000.00, of which *122  you claim $ 1,000.00 on your 1950 income tax return.Section 23 (K) (1) (b) of Internal Revenue Regulations states in part, "Bankruptcy is generally an indication of the worthlessness of at least a part of an unsecured and unpreferred debt.  In bankruptcy cases a debt may become worthless before settlement in some instances, and in others only when a settlement in bankruptcy shall have been had.  In either case the mere fact that bankruptcy proceedings instituted against the debtor are terminated in a later year, confirming *857  the conclusion that the debt is worthless, will not authorize shifting the deductions to such later year."It is the opinion of this office that your bad debt loss occurred in 1933 and not in 1950, and this office proposes to disallow the bad debt loss of $ 10,000.00 shown on your 1950 income tax return under the provisions of Section 23 (K) (1) (b) of Internal Revenue Regulations.This office further proposes to include the $ 500.00 received from Henry Badham for appearance as a witness on your 1950 return, in accordance with Section 22 of Internal Revenue Regulations.The above proposed disallowances, and inclusion of additional income, and the recomputation*123  of your 1950 income tax result in a balance due this office of $ 253.76, plus interest of $ 36.16, or a total of $ 289.92, as shown on the attached Forms 885-B and 885-C.The deficiencies for 1951 and 1952 are due to the disallowance by the Commissioner of a carryover capital loss of $ 1,000, which petitioners claimed as a deduction for each of those years.  This claimed carryover capital loss of $ 1,000 for each of the years 1951 and 1952 was based on petitioners' claimed capital loss in 1950 and which, as already stated, the Commissioner disallowed.The petitioners, by appropriate assignments of error, contest the correctness of each of these adjustments for 1950, 1951, and 1952, except they do not contest the adjustment which the Commissioner designated "Error in subtraction * * * $ 100.00." In an amendment to the petition petitioners set forth an alternative assignment of error which reads:A. In the alternative, petitioners show * * *1. That the petitioners incurred a bad debt loss of $ 9,500.00 in the year 1952.FINDINGS OF FACT.Petitioners are husband and wife residing in Birmingham, Alabama.  Their joint income tax returns for the calendar years 1950, 1951, and 1952 were*124  filed with the then collector of internal revenue at Birmingham.  Eugene M. Alexander will sometimes hereinafter be referred to as petitioner.In the autumn of 1929, petitioner paid $ 15,000 to Percy Badham for the purchase of one-half of the capital stock in Badham and Company, a corporation engaged in the operation of a men's clothing store in Birmingham.  Percy Badham, sometimes hereinafter referred to as Percy, was president of the corporation.  At the time petitioner advanced the money, Percy fraudulently represented that Badham and Company was in sound financial condition when, in fact, the company was insolvent.  There was never any delivery of stock to petitioner.After payment of the $ 15,000 to Percy, petitioner began working in the store operated by Badham and Company.  Sometime thereafter petitioner realized that the representations made to him by Percy *858  concerning the financial condition of Badham and Company were untrue.  He requested that Percy return the $ 15,000 and after some negotiation Percy agreed to give petitioner $ 5,000 in cash and his personal note for $ 10,000.  The $ 5,000 in cash was never paid, but, on February 24, 1931, Percy executed ten $ *125  1,000 notes payable to petitioner.  The first note was due in February 1932, and the remaining notes were payable at the rate of one a year for 9 successive years.  Nothing was ever paid on the notes by Percy except a small amount of interest in 1931.On August 26, 1933, Percy and his wife filed a petition in bankruptcy in the United States District Court for the Southern Division of the Northern District of Alabama.  The petition listed debts totaling $ 78,051.10 and assets in the amount of $ 210.  Among the debts scheduled in the petition was the $ 10,000 in unsecured notes executed by Percy in favor of petitioner.  Percy and his wife were duly adjudged bankrupt and on December 14, 1934, were discharged from all debts scheduled in their petition.Petitioner was advised by counsel, whom he consulted in 1933 at the time the bankruptcy proceeding of Percy was pending, that his debt against Percy would not be discharged by the bankruptcy proceeding because it grew out of fraud which Percy had committed against petitioner.  It was for this reason that petitioner did not file proof of his claim against Percy in the bankruptcy proceeding.Petitioner did not charge off or deduct any part*126  of the indebtedness of $ 10,000 owed to him by Percy on any of his income tax returns prior to 1950, nor did he make any effort to collect the indebtedness from Percy during the years 1932 to 1950.  He, however, retained the notes and had the expectation that sometime he would be able to collect, at least in part, his indebtedness against Percy.Percy left Birmingham in 1931.  He first went to New York City where he was employed as a salesman in a department store. He remained in New York City for 3 or 4 months and then went to Louisville, Kentucky, where he was employed by Stewart's Dry Goods Company, one of the largest department stores in Louisville.  In the next 15 years he rose to the position of vice president and general manager of that store at an annual salary of $ 20,000.In 1950, Henry L. Badham, a brother of Percy, had a suit pending against Percy in a State court of Kentucky on a series of notes totaling $ 10,000, executed by Percy to the estate of their deceased father.  Henry L. Badham, sometimes hereinafter referred to as Henry, was suing in his capacity as executor of his father's estate.In connection with his suit against Percy, Henry conducted an investigation*127  into the financial affairs of Percy.  Sometime in 1950, as a result of the investigation, Henry learned that Percy had given ten $ 1,000 notes to the petitioner in 1931.  He authorized his attorney, *859  Richard Hall Brown, to purchase the notes, if possible, from the petitioner.  Attorney Brown went to see petitioner and advised him that he represented Henry.  He told petitioner that Henry desired to buy Percy's notes.  The petitioner advised Brown that he was not interested in selling them but, after a second visit from Brown, he told Brown that he would think it over and contact him if he did decide to sell the notes.  Petitioner had no further contact with Brown.Several days after his last conversation with Brown, petitioner contacted an attorney named James W. Aird.  Aird advised petitioner that, in his opinion, the discharge in bankruptcy obtained by Percy in 1933 would not relieve Percy of his personal liability on the notes which he had given petitioner because Percy had fraudulently induced petitioner to invest his money in Badham and Company.  However, Aird told petitioner that the possibility of recovering on the notes was remote, that it would entail some tedious, *128  drawn-out litigation, and that unless a prompt compromise or settlement could be had, it was almost a hopeless proposition.  The petitioner told Aird that he did not have sufficient funds with which to bring suit and for that reason he preferred to sell the notes for whatever he could get for them.  After some discussion between Henry and Aird, Henry orally agreed that if petitioner would bring suit on the notes he would pay the expenses of litigation and, in addition, would pay petitioner $ 1,000 on the notes.  Petitioner was to receive $ 500 before the suit was instituted and the remaining $ 500 when the suit was concluded.  There was no discussion between Aird and Henry or between Aird and petitioner regarding the distribution of proceeds in the event petitioner recovered a judgment on the notes.  In accordance with the terms of the agreement petitioner was paid $ 500 in 1950 by Aird, acting as attorney for Henry, and sometime in 1950, petitioner brought a suit on the notes in the United States District Court for the Western District of Kentucky sitting in Louisville.  The suit as originally instituted was on the 10 notes which were in petitioner's possession.  However, a nonsuit*129  was later taken on 4 of the notes which were barred under the 15-year statute of limitations in the State of Kentucky.As a defense to the suit Percy maintained that the notes were discharged in the 1933 bankruptcy proceeding. Petitioner contended that the notes were not discharged in the bankruptcy proceeding because there was fraud in the inducement of the investment which led to the issuance of the notes.  In connection with his suit against Percy petitioner made two trips to Louisville, once for the purpose of giving his deposition and the second time to testify at the trial.  His expenses on these two trips were paid by Henry.On April 13, 1951, a jury verdict was returned in favor of the petitioner and against Percy for the full amount of the 6 notes, plus *860  interest, and judgment was entered in the approximate amount of $ 13,800.  The judgment of the District Court was affirmed on appeal by the United States Court of Appeals for the Sixth Circuit in February 1952.Petitioner was never paid the additional $ 500 which was to be paid him on the notes after the suit was concluded.In 1952, within 30 days after the affirmance of the United States District Court's judgment*130  by the United States Court of Appeals for the Sixth Circuit, garnishment proceedings were begun in Louisville against Percy Badham.  Percy quit his job in Louisville and moved to Houston, Texas.  Further efforts to collect the judgment proved futile and it became worthless in 1952.OPINION.The pleadings and evidence raise the following issues in this proceeding:1. Did petitioner make a completed sale to Henry in 1950, for a consideration of $ 1,000 paid and agreed to be paid, of the 10 notes for $ 1,000 each which he held against Percy Badham?  If this question is answered in the affirmative, then is petitioner entitled to a long-term capital loss of $ 9,500 in 1950, of which he claims a deduction of $ 1,000 in 1950 and a deduction of $ 1,000 in each of the years 1951 and 1952 as a capital loss carryover from 1950?2. Was the $ 500 which was paid petitioner by Henry in 1950 paid to him for his appearance as a witness in the suit which petitioner, sometime in 1950, brought against Percy and was it income to petitioner as determined by the Commissioner?3. If issue 1 is decided against petitioner, then, in the alternative, is petitioner entitled to a nonbusiness bad debt loss of $ *131  9,500 in 1952?Issue 1.We shall take up and decide issue 1 first.  If it is decided in petitioner's favor, then he does not press issue 3.There is no dispute but that in 1950 petitioner was the owner and holder of 10 promissory notes of $ 1,000 each executed February 24, 1931, by Percy and due, respectively, from 1 to 10 years after date.  Nothing had ever been paid petitioner on these notes except a small amount of interest.  In 1933, Percy was adjudged a bankrupt and was discharged as a bankrupt December 14, 1934.Petitioner was advised by his attorney that because his indebtedness against Percy was occasioned by Percy's fraud, Percy would not be discharged in bankruptcy from the indebtedness which he owed petitioner.  *861  Petitioner, therefore, did not prove up his claim against Percy on the 10 notes for $ 1,000 each which he owed petitioner.  Petitioner still owned these notes in 1950.  In that year Henry Badham, a brother of Percy and the executor of their father's estate, was bringing a suit in his fiduciary capacity against Percy.  He was, for reasons which do not appear too clear in the record, anxious for petitioner to bring suit against Percy in the United States*132  District Court at Louisville, Kentucky, on the 10 notes which he owned.  He had his lawyer agree to pay petitioner $ 500 immediately on the notes and $ 500 additional at the conclusion of the suit.  Henry paid the $ 500 in 1950 which, under the agreement, he was to pay immediately but he never paid the remaining $ 500 which was to be paid at the conclusion of the suit.  Petitioner claims that under the arrangements which were made with Henry concerning the notes, he sold the notes to Henry in 1950.  In fact, he testified at the hearing that he sold the notes to Henry in 1950.  Regardless of what petitioner may have thought he did, the facts in the record do not convince us that petitioner sold the notes to Henry.  The record shows that the suit against Percy was brought by petitioner and the judgment which was obtained against Percy was in petitioner's favor.  Petitioner's pleadings in the case are not in evidence but they must have alleged that petitioner was the legal owner and holder of the notes or else the judgment would not have been rendered in his favor.  Therefore, we think the facts fail to sustain petitioner's contention that he sold the 10 notes to Henry in 1950 and suffered*133  a long-term capital loss of $ 9,500 by reason of such sale, of which he was entitled to take a capital loss deduction of $ 1,000 in 1950 and a carryover capital loss of $ 1,000 in each of the taxable years 1951 and 1952.The Commissioner's action in disallowing the $ 1,000 capital loss claimed by petitioner in each of the taxable years, including the carryover losses into 1951 and 1952, is sustained.Issue 2.We next take up petitioner's assignment of error that the Commissioner erred in his determination that "This office further proposes to include the $ 500.00 received from Henry Badham for appearance as a witness on your 1950 return, in accordance with Section 22 of Internal Revenue Regulations." The evidence shows that all that petitioner received for his appearance as a witness was his actual expenses as a witness in traveling to and from Louisville, Kentucky, in attending the trial of the suit brought in his name against Percy.  Just how much these expenses were is not shown in the record.  It is clear from the evidence, however, that these expenses had nothing to do *862  with the $ 500 which Henry paid petitioner in 1950.  None of that $ 500 was paid petitioner for*134  his attendance as a witness.  Petitioner treated it as a return of capital on his $ 10,000 notes and, while for reasons we have already explained we cannot hold under the evidence that petitioner made a completed sale of the notes to Henry in 1950 so as to entitle him to a capital loss in that year, nevertheless, we do hold that this $ 500 was a return of capital to petitioner and was not income to petitioner in 1950, as the Commissioner has determined.The action of the Commissioner in adding this $ 500 to petitioner's income in 1950 is not sustained.Issue 3.We next take up petitioner's alternative assignment of error which is that petitioner incurred a bad debt loss of $ 9,500 in the year 1952.  Petitioner concedes that his debt against Percy was a nonbusiness debt.  The testimony of petitioner was to the effect that while he realized that after Percy's bankruptcy in 1933 and his discharge in bankruptcy in 1934 his notes had but little value, nevertheless, he was advised by his attorney that on account of Percy's indebtedness to petitioner being based on Percy's fraudulent representations to him, Percy's discharge in bankruptcy did not free him from liability on the notes. *135  That this was true is attested by the fact that in 1951 petitioner secured judgment against Percy on the 6 notes which had not been previously barred by the statute of limitations.Did petitioner's indebtedness against Percy become worthless in 1952?  Petitioner has the burden of showing that his debt against Percy became worthless in 1952.  Cf.  Redman v. Commissioner, 155 F.2d 319">155 F. 2d 319. Respondent contends that the indebtedness became worthless in 1933 when Percy filed his petition in bankruptcy.  Ordinarily bankruptcy of the debtor is an identifiable event to prove the debt of the creditor worthless if nothing is collectible.  But here the situation is somewhat different from the ordinary bankruptcy proceeding. Here the debt against the bankrupt was tainted with fraud against the creditor and the bankrupt was not discharged from the indebtedness.It is undoubtedly true that, following Percy's bankruptcy, the notes had but small value but petitioner testified that at all times he regarded them as having some value and that he expected at some time in the future to collect them, at least in part.  He made no attempt to take any tax deduction, because*136  of the worthlessness of the notes, in any year prior to the taxable years here involved.  By the time petitioner brought suit on the notes in 1950, Percy had become the general manager of a large department store in Louisville, Kentucky, at a salary of *863  $ 20,000 per annum.  Petitioner had good grounds to believe he could collect his judgment if one was procured.  After petitioner secured the judgment against Percy, either Percy was discharged from the position which he held or he voluntarily resigned from it and moved to Houston, Texas.  Petitioner endeavored to collect on his judgment by legal process, but failed.  On the evidence, we have made a finding that "Further efforts to collect the judgmeint proved futile and it became worthless in 1952." But it must be remembered that the judgment of $ 13,266 in petitioner's favor consisted of $ 6,000 as principal and the balance was interest.  Petitioner does not contend that any of this interest had ever been taken into income and was a part of his loss.  Therefore, it is clear that it was not deductible as a part of the debt.Petitioner agrees that the $ 500 which he received in 1950 from Henry was a return of capital and should*137  be used to reduce the principal of his notes.  Petitioner, in his alternative assignment of error, alleges that he incurred a bad debt loss of $ 9,500 in 1952.  In his allegation of facts in support of his alternative assignment of error, petitioner alleges:2. Petitioners have not been compensated by insurance or otherwise for or on account of said bad debt loss in the amount of $ 10,000.00 except that petitioners admit Eugene Alexander was paid the sum of $ 500.00 by the brother of said Percy Badham in the year 1950. * * *Notwithstanding petitioner's claim that he suffered a nonbusiness bad debt loss of $ 9,500 in 1952, it seems clear that he did not suffer a loss of $ 4,000 of this amount in 1952.  This $ 4,000 is represented by 4 notes of $ 1,000 each against which the statute of limitations had run when petitioner brought his suit against Percy in 1950.  Petitioner took a nonsuit on these 4 notes after his suit was instituted. Petitioner was given judgment on only the 6 remaining notes for $ 1,000 each.  Therefore, we hold that petitioner has not proved that the 4 notes for $ 1,000 each, which were barred by the statute of limitations when petitioner brought his suit against*138  Percy in 1950 and on which later in that year he took a nonsuit, had any value at the beginning of the taxable year 1952.  These notes had become worthless in some prior year.  What year it is unnecessary for us to decide.Therefore, we hold that the amount of petitioner's debt against Percy which became worthless in 1952 was $ 5,500, instead of the $ 9,500 which petitioner claims in his alternative assignment of error. As already stated, petitioner concedes that this debt was a nonbusiness debt.  Therefore, the statute which is applicable to the deduction claimed is section 23 (k) (4), Internal Revenue Code of 1939.Decision will be entered under Rule 50.