Fidelity & Deposit Co. of Maryland v. Magruder

• Decision Date: 23 June 1943
• Docket Number: Civil Action No. 1818.
• Parties: FIDELITY & DEPOSIT CO. OF MARYLAND v. MAGRUDER, Collector of Internal Revenue.
• Court: U.S. District Court — District of Maryland

50 F. Supp. 817

FIDELITY & DEPOSIT CO. OF MARYLAND v. MAGRUDER, Collector of Internal Revenue.

Civil Action No. 1818.

District Court, D. Maryland.

June 23, 1943.

Washington Bowie, Jr., and E. B. McCahan, Jr., both of Baltimore, Md., for plaintiff.

Bernard J. Flynn, U. S. Atty., and T. Barton Harrington, Asst. U. S. Atty., both of Baltimore, Md., and George J. Laikin, Sp. Asst. to Atty. Gen., for defendant.

COLEMAN, District Judge.

This is a suit to recover income taxes paid for the year 1935 by the plaintiff, the Fidelity & Deposit Company of Maryland, an insurance company incorporated under the laws of Maryland, in the amount of $27,500 and interest.

The material facts, as to which there is no dispute, may be summarized as follows:

In September, 1931, the affairs of the Baltimore Trust Company, one of Baltimore's large banking institutions, were in a precarious condition as a result of the financial depression that was spreading over the entire country. In an effort to obviate the closing of this institution, a guaranty fund of $7,700,400 was raised by a group of local persons and corporations interested in preserving the Trust Company's solvency. To this fund the present plaintiff contributed $200,000. Pursuant to the express agreement made by the Trust Company with all contributors to this fund, the latter were subordinated to the rights of depositors and other creditors of the Trust Company, but were entitled to reimbursement out of any assets that might remain to the Trust Company after paying depositors and other creditors. Every contribution to the guaranty fund was evidenced by a certificate of indebtedness issued by the Trust Company which carried interest at 2% per annum, which was paid until 1933, when default occurred. In February of that year, the Governor of Maryland declared a bank holiday and the Trust Company closed. Shortly thereafter, the President of the United States declared a nation-wide bank holiday. Subsequently, the Trust Company was permitted to reopen on a restricted basis, whereby depositors were allowed to withdraw not more than 5% of their deposits. However, by July 1933, liquidation of the Trust Company appeared inevitable, a plan of liquidation was evolved and until January 1935, the Trust Company's affairs continued under the control of the Bank Commissioner of Maryland, and then the Deputy Commissioner was appointed receiver for the Trust Company.

This contribution of $200,000 which the plaintiff had made to the Baltimore Trust Company was carried on its, the plaintiff's, books for the year 1931 as an asset, having a par value equal to its cost, i.e. $200,000. For the year 1932 it was also carried on the books as an asset and was given both book and market value equal to the cost, i.e. $200,000. During that year interest in the amount of $4,666.63 was received on this item, pursuant to the certificate of indebtedness which the Trust Company had issued to the plaintiff. However, during the first half of the year 1933, this $200,000 was transferred on plaintiff's books to so-called "Schedule X", which is a record of the Company's "unlisted assets", and is described as "showing all property owned by the Company in which it had any interest on December 31 of the current year and which is not entered on any other schedule and which is not included in the financial statement for the current year." The $200,000 was given a book value of "nothing", and decrease by adjustment in book value during the year was shown as $200,000. The Company's books also showed that during this same year, 1933, the plaintiff company had received interest on this item in the amount of $666.65. Plaintiff reflected this item in its 1933 tax return as part of its total loss which was indicated in its return as $1,416,160.83. The deduction was not questioned by the Commissioner of Internal Revenue. Entirely apart from the inclusion of this item, plaintiff had no income tax liability for 1933, because of the extent of its other losses, and therefore no tax was paid or assessed.

In the year 1934, the $200,000 was again listed in Schedule X, and its book value was given as $200,000 but its market value as $100. No interest was received on this item in 1934. The plaintiff's income tax return for this year originally indicated a loss and therefore no tax liability, but subsequently, as a result of revision, the plaintiff did pay certain taxes.

Finally, the plaintiff's return for 1935, which was a profitable year, showed net income of $432,875.36, and in this return there was charged off as an "account receivable" this $200,000 item. The Company's books and annual statement for 1935 show that this item was no longer carried at a nominal value in Schedule X, but was completely written off.

The controlling statute is Section 23(k) of the Revenue Act of 1934, Sec. 23(k), 26 U.S.C.A. Internal Revenue Acts, page 673, which reads as follows:

"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 (or, in the discretion of the Commissioner, a reasonable addition to a reserve for bad debts); and when satisfied that a debt is recoverable only in part, the Commissioner may allow such debt, in an amount not in excess of the part charged off within the taxable year, as a deduction."

The applicable Treasury Regulation is the following (Article 23(k)-1, Treasury Regulations No 86):

"Bad Debts. * * *

* * * * * *

"If all the surrounding and attending circumstances indicate that a debt is worthless, either wholly or in part, the amount which is worthless and charged off or written down to a nominal amount on the books of the taxpayer shall be allowed as a deduction in computing net income. There should accompany the return a statement showing the propriety of any deduction claimed for bad debts.

* * * * * *

"Before a taxpayer may charge off and deduct a debt in part, he must ascertain and be able to demonstrate, with a reasonable degree of certainty, the amount thereof which is uncollectible. Any amount subsequently received on account of a bad debt or on account of a part of such debt previously charged off and allowed as a deduction for income tax purposes, must be included in gross income for the taxable year in which received. In determining whether a debt is worthless in whole or in part, the Commissioner will consider all pertinent evidence, including the value of the collateral, if any, securing the debt and the financial condition of the debtor. Partial deductions will be allowed with respect to specific debts only.

"Where the surrounding circumstances indicate that a debt is worthless and uncollectible and that legal action to enforce payment would in all probability not result in the satisfaction of execution on a judgment, a showing of these facts will be sufficient evidence of the worthlessness of the debt for the purpose of deduction. Bankruptcy is generally an indication of the worthlessness of at least a part of an unsecured and unpreferred debt.

* * * * * *

"Federal or State authorities incident to the regulation of banks and certain other corporations may require that debts be charged off in whole or in part. If, in any such case, the basis of the requirement is the worthlessness or partial recoverability of the debt, as the case may be, such charging off will, for income tax purposes, be considered prima facie evidence of worthlessness; but if the charging off is due to market fluctuations, or if no reasonable attempt has been made to determine to what extent recovery may be made, no deduction for income tax purposes of the amount so charged off can be allowed."

It will be noted that before a debt may be deducted from gross income as a bad debt, two conditions must be fulfilled, namely, (1) the debt must be ascertained to be worthless, and (2) it must be charged off within the taxable year. The Government contends that the plaintiff both ascertained that its advance to the guaranty fund was a worthless debt and charged it off in 1933, and that having done so, and having included such deduction in its 1933 income tax return, plaintiff may not, a second time, claim the same deduction in 1935.

On its part, however, the plaintiff company contends that it never, in fact, wrote this item off until 1935, when for the first time its worthlessness was definitely ascertained.

First, let us analyze what the facts disclose with respect to writing off of the debt. As already indicated, Schedule X of the plaintiff's books, to which the item here in issue was transferred in 1933, represented a record of plaintiff's unlisted assets, namely, assets owned by it, or in which it has some interest on December 31st of the current year, and which were not entered on any other schedule or included among its approved assets shown in its financial statement for the current year. It is to be noted that items transferred to this Schedule X were not items necessarily determined to have no value at the time of transfer, but were items which the Company was not permitted to list as approved assets to which its policy holders and stockholders might look as having a definite, fixed value. When such items were sold or definitely ascertained to be worthless, they were taken out of Schedule X and completely charged off the plaintiff's books.

Thus, it appears that for the year 1933 there were six items transferred to Schedule X, in addition to the $200,000 guaranty fund item here in issue, the aggregate of the seven items being $306,754.50. However, the figure shown in plaintiff's 1933 income tax return purporting to reflect its loss on investments during that year was $636,531.65, while plaintiff contends that this item should have been only $329,777.15, that is, only the amount of its losses as to which there was and could have been no dispute, and not such amount plus the...