Crown v. Comm'r of Internal Revenue

Decision Date17 September 1981
Docket NumberDocket No. 1588-77.
Citation77 T.C. 582
PartiesHENRY CROWN and GLADYS K. CROWN, PETITIONERS v. COMMISSIONER of INTERNAL REVENUE, RESPONDENT
CourtU.S. Tax Court

OPINION TEXT STARTS HERE

Petitioner was called upon in 1965 to satisfy his guaranty of certain indebtedness to bank 1. Petitioner responded by delivering his personal note (appropriately collateralized) which was renewed at various times through 1966. On Dec. 30, 1966, petitioner satisfied his obligation ($2,697,131.31) to bank 1, with funds borrowed from bank 2 with which petitioner had a line of credit, the unused portion of which exceeded $39 million. The collateral securing the note at bank 1 was released into petitioner's control. On Mar. 1, 1967, petitioner borrowed sufficient funds from bank 1 to pay off the Dec. 30, 1966, loan from bank 2. Neither petitioner nor bank 1 was required to enter into this final arrangement. Held, petitioner made “payment” of his original note to bank 1 in 1966 sufficient to support a deduction. Held, further, the deduction for a bad debt under sec. 166, I.R.C. 1954, is nevertheless postponed until 1969 in which year the underlying claim became worthless. Byron S. Miller, Alan L. Reinstein, and Geoffrey F. Grossman, for the petitioners.

Seymour I. Sherman, for the respondent.

WILBUR , Judge:

Respondent issued a statutory notice of deficiency on December 16, 1976, in which he determined deficiencies in petitioners' Federal income tax for their taxable years 1966 through 1969, as follows:

+--------------------+
                ¦Year  ¦Deficiency   ¦
                +------+-------------¦
                ¦      ¦             ¦
                +------+-------------¦
                ¦1966  ¦$696,272.30  ¦
                +------+-------------¦
                ¦1967  ¦255.74       ¦
                +------+-------------¦
                ¦1968  ¦35,563.96    ¦
                +------+-------------¦
                ¦1969  ¦2,022.87     ¦
                +--------------------+
                

The only issues remaining for our decision relate to the proper tax treatment of various transactions arising from petitioner Henry Crown's guarantee of an obligation of United Equity Corp. Specifically, petitioners allege that:

(1) Respondent erroneously failed to allow a nonbusiness bad debt deduction in the amount of $2,697,131.31 for calendar year 1966, as reported on petitioners' return for such year by reason of the worthlessness of the claim of Henry Crown against United Equity Corp. arising from petitioner's satisfaction, as coguarantor, of United Equity's indebtedness;

(2) Respondent erroneously included in petitioners' income as a short-term capital gain for calendar year 1968 the amount of $70,000 received by Henry Crown in satisfaction of his claim against his coguarantors of the United Equity indebtedness—-such inclusion being impermissible without the allowance of the foregoing bad debt deduction; and

(3) Alternatively, respondent erroneously failed to allow petitioners for calendar year 1969 either a nonbusiness bad debt deduction with respect to the United Equity indebtedness in the amount of $2,627,131.31 or a long-term capital loss in such amount by reason of Henry Crown's sale of all of his interests in claims and collateral assets connected with such indebtedness.

FINDINGS OF FACT

Some of the facts have been stipulated. The stipulation of facts and the attached exhibits are incorporated herein by this reference.

Petitioners Henry and Gladys K. Crown, husband and wife, resided in Evanston, Ill., at the time the petition herein was filed. Petitioners are cash basis, calendar year taxpayers. They filed joint Federal income tax returns for the taxable years 1966 to 1969, inclusive, with the District Director of Internal Revenue at Chicago, Ill. Henry Crown was the actual participant in the transactions giving rise to the taxes and issues in controversy and, accordingly, he will hereinafter be referred to as petitioner.

During 1963 and thereafter, petitioner and his family were substantial stockholders of General Dynamics Corp. (hereinafter General Dynamics). General Dynamics had previously acquired Material Service Corp. from petitioner and his family. During 1963, petitioner was a director of General Dynamics; Patrick H. Hoy (hereinafter Hoy) was president of the Material Service Division of General Dynamics. Hoy was a principal shareholder of United Equity Corp. (hereinafter United Equity) which was, at all times here pertinent, a holding company whose only significant asset was a controlling interest in the stock of Insurance City Life Co. (hereinafter ICL), an insurance company organized under Connecticut law.

Prior to 1963, United Equity borrowed $1.6 million on a secured basis from the American National Bank & Trust Co. of Chicago (hereinafter American National). Such loan was guaranteed jointly and severally by Hoy and five other principal shareholders of United Equity: Jerome S. Garland, Frank W. Chesrow, Charles E. St. Louis, Barton A. Scheidt, and John B. Huarisa (hereinafter Huarisa).

On May 20, 1963, petitioner became a guarantor of the United Equity indebtedness owed to American National, then outstanding in the amount of $1,674,486 including accrued interest. Thereafter, from time to time, American National renewed, extended, and increased its loan to United Equity. Petitioner, Hoy, and all of the other guarantors except Huarisa renewed, extended, and increased their guarantees correspondingly. Beginning in December 1963, Hoy and all of the other guarantors except Huarisa agreed in writing to indemnify petitioner against loss by reason of his guaranty. These indemnity agreements were renewed and extended from time to time as petitioner renewed or extended his guaranty of the United Equity indebtedness to American National.

On November 18, 1965, the Commissioner of Insurance of the State of Connecticut commenced proceedings seeking to prevent ICL from conducting further business. On November 19, 1965, American National requested that petitioner satisfy his guaranty of the United Equity indebtedness. Petitioner accordingly executed and delivered to American National his own 90-day note dated November 19, 1965, and due February 17, 1966, in favor of American National, in the amount of $2,697,131.31, the then-existing balance of the United Equity indebtedness, together with accrued interest. American National then transferred to petitioner its position as creditor of United Equity and as holder of the collateral securing the United Equity indebtedness (hereinafter the United Equity collateral). Such collateral consisted principally of 1,227,103 shares of ICL and shares of stock in two wholly owned ICL subsidiaries.

Petitioner executed renewal notes evidencing his American National indebtedness at 3-month intervals during 1966. The last renewal note executed in 1966 was a 90-day note dated November 14, 1966, and evidenced petitioner's promise to pay American National $2,697,131.31 with interest at the rate of 6 percent per annum, on February 13, 1967.

At first, petitioner's indebtedness to American National was unsecured; however, in September 1966, petitioner delivered to American National collateral consisting of stock in negotiable form, as security. American National valued this collateral at $2,967,422 in November 1966.

Petitioner was a personal friend of the two men who were the president and the chairman of the board of directors of American National during this period. While American National had substantial trust account business from petitioner and his family, it eagerly sought to acquire part of the Crown family loan business.

During the period in question, the principal lending institution for the Crown family was the First National Bank of Chicago (hereinafter First National). Petitioner, various members of his family, and their enterprises had an informal line of credit at First National, in the amount of $50 million, supported by collateral and cross-guarantees. The credit was available generally to any one or more members of the related group of which petitioner was the acknowledged leader, with the collateral and guarantees of each member being applied by agreement to the loans of the other members. During 1965 and 1966, the balances reflecting petitioner's personal borrowing at First National ranged between a high of $7,250,000 on July 2, 1965, and a low of $3 million on June 29, 1966. For the period September 27, 1966, to December 30, 1966, petitioner's personal debt to First National was $3,296,252.96.

On December 30, 1966, petitioner borrowed an additional $2,697,131.31 from First National. This loan brought petitioner's indebtedness to First National to $5,993,384.27 and the entire family indebtedness, including petitioner's, owed to First National up to $11 million. The loan was evidenced by petitioner's note dated December 30, 1966, due March 1, 1967, in the amount of $2,697,131.31 with interest at the rate of 6 percent per annum.

Both American National and First National routinely prepare memoranda with respect to loans, and maintain such memoranda as part of their permanent loan files of record. A memorandum prepared by one of the bank officers at First National on January 3, 1967, concerning the loan transaction of December 30, 1966, reads as follows:

Robert Crown [petitioner's son] called on December 30 and presented a secured note of Henry Crown in the amount of $2,697.131.30 [sic] which we entered and then wired the proceeds through the Fed to the American National Bank, Chicago, with instructions to that bank to use the funds in full payment of Henry Crown's note due 12-30-66.

Bob advised me that arrangements for this loan were made by Henry over the telephone with Mr. Livingston [then chairman of the board of directors of First National]. Bob said that the note being paid at the American National Bank was the indebtedness Mr. Crown assumed at that bank under his guaranty of the Pat Hoy indebtedness there. He also said that the collateral lodged at the American National Bank included a substantial amount of First National Bank stock and thus, he was not delivering the...

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