Herder v. Helvering

• Decision Date: 26 June 1939
• Docket Number: 7180.,No. 7179,7179
• Citation: 70 App. DC 287,106 F.2d 153
• Parties: HERDER et al. v. HELVERING, Com'r of Internal Revenue. HERDER v. SAME.
• Court: U.S. Court of Appeals — District of Columbia Circuit

70 App. DC 287, 106 F.2d 153 (1939)

HERDER et al. v. HELVERING, Com'r of Internal Revenue. HERDER v. SAME.

Nos. 7179, 7180.

United States Court of Appeals for the District of Columbia.

Decided June 26, 1939.

Writ of Certiorari Denied December 4, 1939.

COPYRIGHT MATERIAL OMITTED

Camden R. McAtee, of Washington, D. C., for petitioners.

James W. Morris, Asst. Atty. Gen., and Sewall Key, Norman D. Keller and W. Croft Jennings, Assts. to Atty. Gen., for respondent.

Before GRONER, Chief Justice, and MILLER and VINSON, Associate Justices.

Writ of Certiorari Denied December 4, 1939. See 60 S.Ct. 262, 84 L.Ed. ___.

VINSON, Associate Justice.

Two petitions for review of United States Board of Tax Appeals redeterminations of separate income tax liabilities are consolidated herein. The Board determined a deficiency against George Herder, deceased, for the period January 1 to March 29, 1934, the date of his death, (to which we will refer hereinafter as the first period) and a deficiency against his wife, Mary Herder, for the calendar year 1934.

The decedent, George Herder, and his wife Mary Herder, resided in the State of Texas and owned community property located there which produced income during the first period. The applicable Texas statutes vest title to the community property in the husband and wife in equal parts, but, during coverture, the husband has the exclusive power of control over the property as long as he discharges his obligation as the head of the family.¹ The income from the community is divided equally between them; each may make separate returns of one-half of the income, with an equal division of the allowable deductions.²

The questions presented for our consideration are:

1. The disallowance of certain claimed deductions for bad debts.

2. The proper classification of proceeds from an insurance policy.

3. The proper adjusted cost basis of the property destroyed by fire.

We will consider them in the order outlined.

The Bad Debts

George Herder was in complete control of the community property. It is agreed, and so found by the Board, that, during his lifetime, he kept regular books of account for the community; that they were single entry books, kept on a cash receipts and disbursement basis; that, from time to time, bad debts were charged off by entering credits for the amounts thereof; that no reserve for bad debts was set up on the books; and, that the debts in question were never charged off on the books of account by George Herder in his life time.

The bad debts involved originally aggregated $29,975.56. In the hearing before the Board, petitioners abandoned the claim for deduction of the debt of J. W. Gates amounting to $1,861.22 as it had been charged off by George Herder in a prior taxable period. The record shows, and the Board finds, that certain other claimed bad debts, aggregating $2,521.28 became worthless in a prior taxable period and were disallowed as deductions for this reason. We affirm the Board in this respect. Avery v. Com'r, 5 Cir., 22 F.2d 6, 55 A.L.R. 1277. Thus the bad debts we consider total $25,593.06, of which one-half, or $12,796.53, is claimed to be a deductible item to George Herder, deceased, in the first period, and an equal amount claimed to be deductible in the return of Mary Herder for the taxable year 1934. The return of the estate of George Herder, deceased, for the period March 30 to December 31, 1934, is not before us.

The George Herder Return

The Board found that the debts became worthless upon the death of George Herder because of their peculiar nature and the discontinuance of the financing of the debtors due to his death.

Sec. 23 (k) of the Revenue Act of 1934 reads, in part, as follows:

"Sec. § 23. Deductions from gross income. In computing net income there shall be allowed as deductions:

"* * *

"(k) Bad debts. Debts ascertained to be worthless and charged off within the taxable year * * *." 26 U.S.C.A. § 23(k).

Until his death George Herder was on a cash receipts and disbursement basis, and kept books of account. During prior years, from time to time, he charged off worthless debts by entries on the books. In such a case debts must not only be ascertained to be worthless within the taxable year, but they must be charged off within the taxable year.³ The Board found that these essentials were not present in his case; that there was no charge off on the books, and that the debts did not become worthless within that taxable period.

Petitioners however maintain that the enactment of secs. 42 and 43 of the Revenue Act of 1934⁴ eliminates the application of sec. 23 (k) herein; that it removed George Herder from his position as a taxpayer upon a cash receipts and disbursement basis, and placed him upon an accrual basis for the taxable period involved; and, that the books of account actually kept by him are not to be considered.

In considering the contention of petitioners we must consider the legislative history of secs. 42 and 43.

From its very terms, and as is clearly expressed in the reports of the congressional committees⁵ handling the legislation, it is evident that sec. 42 found its way into the tax law for the purpose of preventing ordinary income from escaping taxation. Previously, whenever a taxpayer on a cash receipts and disbursement basis died, income accrued up to his death passed to the estate as a part of the corpus, escaping the income tax mill altogether. Sec. 42, enacted to cover the situation, "includes" in taxable income "for the taxable period in which falls the date of his taxpayer's death, amounts accrued up to the date of his death". Thus the taxable income for such period is the income of the taxpayer actually received, plus the income accrued but not received. The objective of Congress, which must always be kept in mind, is that the net income of the taxpayer, prior to his death, bear the burden of income taxes, regardless of his tax basis, or whether he kept books, and that the income accrued should be added to the income actually received.

On the other hand it is evident that in subjecting such additional income to taxation, Congress intended to permit additional deductions to such taxpayers. Sec. 43 makes allowable "deductions * * * for the taxable period in which falls the date of his taxpayer's death, amounts accrued up to the date of his death * * *." This could only mean such deductions that were not allowable to a taxpayer on a cash basis prior to the enactment of sec. 43. The purpose of Congress was to see reflected in the return of such decedent credits and deductions which had accrued, whether reflected on the books of the taxpayer or not. It required sec. 43 to remove what would be an otherwise unjust burden resulting from sec. 42. There is nothing contained in secs. 42 and 43 indicating that the provisions in sec. 23 (k) relating to the ascertainment of a debt to be worthless within the taxable year and its charge-off are dispensed with. These two requirements are embedded in the tax laws and are necessary to be met before bad debts become deductible items.

In this view, we cannot agree with petitioners that sec. 23 (k) should be eliminated in the computation of the George Herder return, and we cannot follow them in their desire for such elimination, since it is solely through sec. 23 (k) that bad debts are allowed to be deducted from gross income; nor can we conclude that secs. 42 and 43 abolish the books kept by the taxpayer.

However, we can agree that the tax basis of George Herder was modified as a result of his death. In his lifetime he was upon a cash receipts and disbursement basis, keeping books of account. In this position he had until the last day of the taxable year in which to determine the worthlessness of the debts and to charge them off. He died within the taxable year without having done either. Secs. 42 and 43 changed his basis. The change was not of his choosing. He died and the law changed it for him. Sec. 23 (k) applies to a taxpayer regardless of his basis. The debts must become worthless within the taxable year. The worthlessness of the debt is a fact to be determined — not the opinion of the taxpayer.⁶ This essential was met by the personal representatives of George Herder. The correctness of their conclusion as to their worthlessness within the taxable year is here admitted. The Board so found. Thus sec. 23 (k) in this respect has been complied with.

We come to the charge-off. George Herder did not charge these debts off the books which he kept. He could not do so because they were not worthless to him. If the debts had actually become worthless during the first period, his failure to charge them off on the books would not, in our opinion, have precluded their deduction from gross income. In such a situation, they would have become an accrued deduction which sec. 43 permits to be reflected in the taxable income, and the charge-off within his taxable period, required by sec. 23 (k) would be made by operation of law. But the debts involved in the present case were not worthless within the taxable period. It is admitted, and found by the Board that they became worthless only upon the death of George Herder. Consequently, they cannot be accrued as a deduction under sec. 43 and, in our opinion, may not be deducted in the George Herder return. We therefore affirm the Board's determination in this respect.

The Mary Herder Return

Mary Herder made her tax return for the full calendar year 1934. What we have said in respect of the worthless debts in connection with the return of George Herder for the first period equally controls Mary Herder for the same period. The books for the community were kept by George Herder, and throughout the years debts were ascertained to be worthless and charged off. George Herder fixed the basis of the community while it existed and, as there is nothing in the record indicating that Mary Herder had income other than that received from the...