39 T.C. 772 (1963), 89719, Foster Frosty Foods, Inc. v. C. I. R.

Docket Nº:89719.
Citation:39 T.C. 772
Opinion Judge:MURDOCK, Judge:
Attorney:James E. Carpenter, Esq., for the petitioner. Jack Morton, Esq., for the respondent.
Judge Panel:BRUCE, J., concurs in the result. RAUM, J., concurring: TIETJENS and WITHEY, JJ., agree with this concurring opinion. PIERCE, J., dissenting: FISHER and MULRONEY, JJ., agree with this dissent.
Case Date:February 12, 1963
Court:United States Tax Court

Page 772

39 T.C. 772 (1963)




No. 89719.

United States Tax Court.

February 12, 1963

James E. Carpenter, Esq., for the petitioner.

Jack Morton, Esq., for the respondent.

ADDITION TO RESERVE FOR BAD DEBT- SEC. 166(c), I.R.C. 1954.- The petitioner has no right under sec. 166(c) to deduct an addition to bad debt reserve for notes discounted and not then owned by it.

The Commissioner determined deficiencies in income tax of the petitioner for its fiscal years ending with February in 1956, 1957, and 1958 of $8,525.40, and $6,028.58. The only adjustment challenged herein is a part of the amount disallowed in each year representing the deduction of an addition to the reserve for bad debts.

Page 773

The additions claimed and the portions allowed were as follows:

Fiscal year Claimed Allowed

1956 $16,394.99 None

1957 16,139.70 $7,332.74

1958 43,308.40 31,714.99

FINDINGS OF FACT. The petitioner was incorporated early in 1948 and since then has been engaged in business in Denver, selling food freezers, food, and food memberships. It filed its income tax returns with the district director of internal revenue, Denver, Colo. Petitioner used an accrual method of accounting. Its customers, desiring to buy on credit, were required to execute a promissory note for the balance due on purchases of food, to enter into a food service membership agreement in purchases of food memberships, and to execute a contract note and chattel mortgage in purchases of freezers. There is no showing of the amount, if any,[1] of its creditor obligations disposed of by the petitioner prior to its fiscal year ended February 29, 1956, but in that year and thereafter it discounted portions of such notes or contracts at three local banks, with recourse. The amounts of notes and accounts discounted and not discounted for certain years were as follows:

Fiscal year Not discounted Discounted

1952 $31,795.24 1

1953 55,846.05 1

1954 56,676.74 1

1955 82,043.52 1

1956 191,725.62 $396,010.53

1957 62,100.07 644,007.64

1958 56,495.77 876,494.73

FN1 No showing. The petitioner received credit to its account for the paper discounted with recourse in the face amount of the note or contract less the agreed upon discount and less the amount which was required to be placed in a loss reserve under the governing contracts. The taxpayer included in income all amounts credited to a bank's loss reserve at the time said credits were made. If a purchaser fell behind on payment of a discounted obligation, the bank would notify the petitioner's credit department which would then try to have the account made current. If it failed or if the bank was not satisfied with any delinquent account it would require the petitioner to buy it back. Page 774 The actual losses of the petitioner on reacquired obligations are not shown in this record. The Commissioner in computing a reasonable reserve at the end of each tax year recognized that the petitioner held outstanding installment contracts amounting to $9,018.25 for 1956, $1,939.67 for 1957, and $8,983.48 for 1958. He included 50 percent of those amounts in computing the allowable additions to the reserve. The petitioner reacquired much larger amounts of these obligations during the tax years but the record does not show what became of them. The petitioner established a bad debt reserve computed with reference to its total sales, cash and credit, including sales involving notes discounted with recourse, by taking $25 per freezer sold (average sale price $630), 5 percent of the price of food sold, and 25 percent of the sale price of food memberships, and adding an amount to the reserve each year on that basis. The following taken from the returns shows the results of that method while in use through February 28, 1958 (omitting cents):

Fiscal year Additions Charges Balance

1952 $918

1953 $11,226 $61 12,083

1954 11,547 9,505 14,126

1955 17,664 11,563 20,227

1956 16,394 7,963 28,658

1957 16,139 16,320 30,915

1958 43,308 28,859 45,364

The Commissioner, in determining the deficiencies, held that the total reasonable reserve for bad debts at the end of each year should be the total of 4 percent of outstanding receivables held by the petitioner (excluding those discounted and held by banks) plus 50 percent of all previously discounted items reacquired by the petitioner and held by it at the end of the year and not charged against the reserve, as shown below:

Reserve, Feb. 28, 1955 Balance

Feb. 29, 1956: $20,227.14

Additions allowed None

Charge-offs per return $7,963.76

Balance in reserve 12,263.38

Feb. 28, 1957:

Additions allowed 7,332.74

Charge-offs per return 16,320.01

Balance in reserve 3,276.11

Feb. 28, 1958:

Additions allowed 31,714.99

Charge-offs per return 28,859.14

Balance in reserve 6,131.96

Page 775 Paragraph 11 of the stipulation filed is as follows: Petitioner concedes that for the purposes of this case only, its reserve for bad debts shall be computed in the manner of the schedule representing respondent's computation thereof for statutory notice purposes, hereinabove, paragraph 8, except for the exclusion by respondent of petitioner's notes receivable discounted; accordingly, only the aforesaid exception by respondent as to each adjustment (b) ‘ Reserve for bad debts,‘ for each of the taxable years per statutory notice of deficiency, is at issue, that is, whether the statutory notice of deficiency computation of a reasonable bad debt reserve should take into consideration petitioner's total notes and accounts receivable, including those discounted with banks, or just total notes and accounts receivable, excluding notes receivable discounted. The Commissioner made no concession regarding any narrowing of the issue for decision. All stipulated facts are incorporated herein by this reference. OPINION....

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