441 F.2d 999 (D.C. Cir. 1970), 23179, Stahl v. United States
|Citation:||441 F.2d 999|
|Party Name:||Ruby Smith STAHL v. UNITED STATES of America, Appellant.|
|Case Date:||November 23, 1970|
|Court:||United States Courts of Appeals, Court of Appeals for the District of Columbia Circuit|
Argued March 10, 1970.
Mr. David English Carmack, Atty., Department of Justice, of the Bar of the Court of Appeals of Maryland, pro hac vice, by special leave of Court, with whom Asst. Atty. Gen. Frederick B. Ugast, Messrs. Lee A. Jackson, Atty., Department of Justice, and David G. Bress, U.S. Atty., at the time the brief was filed, were on the brief, for appellant. Miss Issie L. Jenkins, Atty., Department of Justice, also entered an appearance for appellant.
Mr. Sidney J. Silver, Washington, D.C., for appellee.
Before BAZELON, Chief Judge, and TAMM and LEVENTHAL, Circuit judges.
LEVENTHAL, Circuit Judge:
This case comes on appeal by the Government from a judgment of the District Court 1 awarding $5, 532 plus interest to a taxpayer in an action for refund of overpayment of federal income tax. Because we hold that on the disputed item taxpayer was entitled to take a deduction, for a loss on a transaction entered into for profit, we affirm.
I. The Facts
On April 12, 1962, Mrs. Ruby Smith Stahl, a widowed musician and music teacher, turned securities with a market value of approximately $210, 000 over to
Balogh & Co., a Washington securities firm. Under an agreement between Mrs. Stahl and the firm, the securities were to be used by the firm as part of its capital so that the firm could satisfy certain SEC requirements. The securities were to be returned to her on May 12, 1963, subject, however, to the claims of all of the firm's creditors, present and future. In return Mrs. Stahl received one percent of the value of the securities per quarter, in addition to the dividend and interest income. She also became a member of the board of directors of the firm but attended only one meeting and never received notice of the others.
A subsequent agreement between the taxpayer and the firm provided that one half of the securities would be returned to her on December 15, 1963, and the other half on September 15, 1964. On October 31, 1963, however, the firm sold the securities for $257, 078.90. In August, 1964, the firm filed a petition in bankruptcy. The petition showed that its liabilities exceeded its assets by more than $300, 000. The bankruptcy proceedings were still pending before the District Court when it entered judgment in the case at bar.
The taxpayer claimed an ordinary loss of $87, 146 (based on the $127, 012 of the securities less an expected 'recovery' in bankruptcy of $39, 866) on her amended tax return for 1963. The Internal Revenue Service disallowed the deduction on the ground that the loss was not an ordinary loss but a capital loss in the nature of a nonbusiness bad debt. Furthermore, treatment of the loss as a nonbusiness bad debt was disallowed for 1963 since the debt was not wholly worthless at the end of that year. 2 The taxpayer paid the additional assessment and brought this suit for refund.
The taxpayer and the Government agree that the loss is deductible in some manner at some point in time; the dispute is over the proper characterization of the loss and hence its proper tax treatment. The District Court, agreeing with the taxpayer, held that the agreement between the taxpayer and the securities firm created not a debtor-creditor relationship but a bailment, and that the loss was consequently deductible under section 165(c) of the Internal Revenue Code, which allows deductions for losses incurred in a trade or business and losses incurred in a transaction entered for profit. 3 The Government adheres to its contention that the loss was deductible under section 166(d) of the Code as a nonbusiness bad debt.
A 166(d) loss, as contended by the Government, is subject to limitations disadvantageous to the taxpayer. A 165(c) loss is deductible from ordinary income. In contrast a 166(d) loss is treated like a short-term capital loss, 4 and as such is first applied so as to reduce low-taxed long-term capital gains (under 1201). Any excess of loss over capital gains is deductible from ordinary income only to the extent of $1000 (under 1211). The limitations of 166 would be applicable even though profits earned from the transaction were taxable at ordinary income rates-- rates actually paid by the taxpayer in the case at bar on profits earned in 1962. The consequence is that a taxpayer with a stand-off-- because an earlier profit of, say, $10, 000 was followed by a loss of equal amount, -- would be subject to an overall increase in taxes. 5 This result
was mandated by Congress where the ensuing deductions fell into the category of nonbusiness bad debts. We must consider whether Congress intended it to apply in a case like the one before us.
II. Inapplicability of bad debt provisions
Section 166 of the Internal Revenue Code is captioned 'Bad Debts.' The section is applicable, -- Whether what is involved are business bad debts governed by (a), or nonbusiness bad debts governed by (d), -- only in case 'of a bona fide debt.' 6 Carrying forward the concept of bona fide debt, Treasury Regulation 1.166-1(c), 26 C.F.R. 1.66-1(c) (1970), provides:
Only a bona fide debt qualifies for purposes of section 166. A bona fide debt is a debt which arises from a debtor-creditor relationship based upon a valid and enforceable obligation to pay a fixed or determinable sum of money. A gift or contribution to capital shall not be considered a debt for purposes of section 166.
A. Debt Not Established by Taxpayer's Loan of Securities to Corporation.
The District Court found no 'debtorcreditor relationship' in this case. The Government leans on the recurrent use of the words 'loan' and 'indebtedness' in the agreement between Mrs. Stahl and Balogh and Company. But 'the decisive factor is not what the payments are called but what, in fact, they are, and that depends upon the real intention of the parties.' Byerlite Corporation v. Williams, 286 F.2d 285, 290 (6th Cir. 1960). This 'real intention' is to be deduced from the 'substance of a transaction, ' upon which the incidence of taxation depends. Comm'r of Internal Revenue v. Court Holding Co., 324 U.S. 331, 334, 65 S.Ct. 707, 89 L.Ed. 981 (1945). Professed intentions and labeling must give way if the court finds on supporting evidence...
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