Dobkin v. Comm'r of Internal Revenue
| Decision Date | 27 July 1950 |
| Docket Number | Docket No. 20007. |
| Citation | 15 T.C. 31 |
| Parties | ISIDOR DOBKIN, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. |
| Court | U.S. Tax Court |
OPINION TEXT STARTS HERE
Petitioner and his three associates organized a corporation to hold and manage a parcel of business realty. Approximately $27,000 was required to finance the purchase over and above outstanding first and second mortgages. Petitioner and his associates each paid $7,000 of which $500 was designated capital stock and the remaining $6,500 was set up on the corporation's books as ‘Loans Payable.‘ When additional working capital was required, the equality of investment was maintained by equal contributions. Held: The entire amount paid in by petitioner was intended to be risk capital. His loss upon liquidation of the corporation is not deductible in full as a bad debt but may be deducted as a capital loss subject to the limitations of section 117 of the Internal Revenue Code. Jacob Rabkin, Esq., for the petitioner.
Pershing W. Burgard, Esq., for the respondent.
Respondent determined a deficiency in petitioner's income tax liability for the calendar year 1945 in the amount of $524.41.
The deficiency resulted principally from respondent's disallowance of a bad debt claimed by petitioner in the amount of $3,147.29. Respondent treated the transaction as a long term capital loss and allowed 50 per cent thereof, pursuant to section 117 of the Internal Revenue Code, in his computation of the deficiency. Other adjustments made by respondent in the determination of the deficiency are not contested.
Petitioner is an individual residing at 1085 Anderson Avenue, New York, New York. His income tax return for the period here involved was filed with the collector of internal revenue for the third district of New York.
In November 1940, petitioner and his associates organized Huguenot Estates, Inc. (hereinafter called Huguenot), to acquire a specific parcel of business property located in Mount Vernon, New York. The total purchase price of the apartment building was $72,330.95. Outstanding first and second mortgages, in total amount of $43,750, reduced the amount of capital required of petitioner and his associates to approximately $27,000. To supply this capital, petitioner and his three associated contributed $7,000 each. In consideration of the $7,000 paid in, each received capital stock of Huguenot with an attributed value of $500 and 6 per cent promissory notes of Huguenot, payable on demand, for the remaining $6,500 contributed.
Petitioner's associates in the enterprise were Max Glickin, Ruth Rosen, and a partnership known as J. Schultz & Sons. Petitioner had had business dealings with these associates for a number of years. Their customary method of operation was to organize separate corporations for each of their real estate holdings in order to limit losses to the particular property involved.
Operating deficits of Huguenot required the furnishing of additional capital to it by petitioner and his three associates on three separate occasions in 1942 and 1943. In each instance equal funds were contributed by each of the four stockholders. The funds so paid in were recorded on Huguenot's books as loans payable. Additional funds were paid in to Huguenot by J. Schultz & Sons during 1943, but these advances were repaid by Huguenot within a short period of time so that the net amount that each of the four stockholders paid in to the corporation remained equal. Annual interest was paid by Huguenot through December 31, 1944, on the above amounts designated as loans payable. This interest was recorded on its books as ‘interest on Officers' Loans.‘
In August 1945, Huguenot sold its Mount Vernon property at a substantial loss. One thousand dollars was paid to each of the four stockholders thereafter, and following liquidation of Huguenot on September 30, 1945, they received an additional $3,702.71 each. These total payments of $4,702.71 were recorded in the ‘Loans Payable‘ accounts carried for each of the stockholders, leaving these accounts showing a balance due each stockholder of $3,147.29. Petitioner claimed the latter amount as a bad debt in his 1945 income tax return.
No change in the capital stock account of Huguenot occurred between the date of its organization and the date of its final liquidation, nor was any demand ever made by any of the stockholders for payment of the demand promissory notes issued by Huguenot. Yearly depreciation on the Mount Vernon realty amounted to $881.25 in 1945.
Petitioner's contention that the funds which he paid in to Huguenot should be treated as loans so as to entitle him to a bad debt deduction on the corporation's liquidation runs squarely into our decision in Edward G. Janeway, 2 T.C. 197, affd., 147 Fed.(2d) 602.
Ordinary contributions by stockholders to their corporations are regarded as capital contributions that increase the cost basis of their stock, thus affecting the determination of gain or loss on ultimate dispositions of the stock. Harry Sackstein, 14 T.C. 566. Especially is this true when the capital stock of the corporation is issued for a minimum or nominal amount and the contributions which the stockholders designate as loans are in direct proportion to their shareholdings. Edward G. Janeway, supra.
When the organizers of a new enterprise arbitrarily designate as loans the major portion of the funds they lay out in order to get the business established and under way, a strong inference arises that the entire amount paid in is a contribution to the corporation's capital and is placed at risk in the business. Cohen v. Commissioner, 148 Fed.(2d) 336; Joseph B. Thomas, 2 T.C. 193. The formal characterization as loans on the part of the controlling stockholders may be a relevant factor1 but should not be permitted to obscure the true substance of the transaction. Sam Schnitzer, 13 T.C. 43, 60.
Here petitioner and his three associates designated as capital stock $500 of the $7,000 that each paid in when they organized the...
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