AMERICAN DENTAL COMPANY v. Commissioner of Internal Revenue
| Decision Date | 07 May 1941 |
| Docket Number | Docket No. 102977. |
| Citation | 44 BTA 425 |
| Parties | AMERICAN DENTAL COMPANY, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. |
| Court | U.S. Board of Tax Appeals |
John E. Hughes, Esq., for the petitioner.
Jonas M. Smith, Esq., for the respondent.
The Commissioner determined a deficiency in income tax of $6,339.77 and a deficiency in excess profits tax of $404.31 for the calendar year 1937. The issue is whether or not he erred in adding to income $19,234.21, representing canceled indebtedness.
FINDINGS OF FACT.
The petitioner is a corporation engaged in the business of operating a laboratory where it does prosthetic work for the dental profession. It filed its return for the taxable year with the collector of internal revenue for the first district of Illinois.
The petitioner has occupied space in the Mallers Building in Chicago for a number of years. It negotiated a new lease in December 1933, at which time the annual rental was reduced from $15,200 to $8,400. There was then due from the petitioner $15,298.99 in back rent. The president of the petitioner notified the renting agent that the petitioner was unable to pay all of that amount and asked for an adjustment. The renting agent said he would make an adjustment, and, in April 1934, advised the petitioner that he would accept $7,500 in payment of the back rent and would cancel the rest. The petitioner paid the rent required under the lease after 1933 and paid $7,500 in addition in 1937 in discharge of the back rent. The $7,500 was paid as follows: $2,500 on February 26, 1937, at which time it also gave two notes each for $2,500; the one note was paid on April 23, 1937; and the other note was paid on June 25, 1937. The first time that the petitioner made any entry on its books to record the cancellation of the back rent was on February 27, 1937, at which time it made an entry showing that back rent in the amount of $7,798.99 had been forgiven.
The petitioner kept its books and made its returns upon an accrual method of accounting. It had regularly accrued its rent on its books and had taken deductions for that rent on its income tax returns. Those deductions had served to offset income in like amounts.
The Mallers Building Trust, which owned the Mallers Building, credited all payments of rent which it received from the petitioner to the rent account of the petitioner in an open account without applying any particular payment to any particular charge of rent. This account continued without change or interruption at all times material hereto. An entry canceling the back rent in the amount of $7,798.99 was made in that account for the first time in 1937, when the petitioner paid the $7,500 on account of the back rent. The $7,798.99 was then charged to bad and doubtful accounts "To write off the balance of the old account as per agreement." There was then, for the first time since 1933, no balance due in the account.
The petitioner, in November 1936, owed several creditors for merchandise which they had furnished the petitioner over a period of prior years. The petitioner had been a good customer of these creditors for many years. It had given its interest-bearing notes for the amount which it owed to each creditor. It went to three of these creditors in November 1936 and asked for cancellation of interest on the notes on the ground that the creditors had made a similar arrangement with their other customers. Three creditors agreed that they would cancel all interest accruing after January 1, 1932. The petitioner claimed a deduction on its income tax return for 1936 for interest due on the notes held by the three creditors above mentioned. The first entry that the petitioner made on its books recording the forgiveness of interest on these notes was made in December 1937, when the following accounts payable were credited with the following amounts representing interest on the notes accruing after January 1, 1932:
Julius Aderer, Inc _____________________________ $10,546.06
C. L. Frame Dental Supply Co ___________________ 5,314.81
Goldsmith Brothers _____________________________ 1,086.87
The above amounts had been deducted by the petitioner on its income tax returns of previous years as the interest had accrued. Those deductions had offset income on those prior returns to the extent of $11,435.22.
The petitioner had never made any disclosure on its income tax returns showing that the rent and interest above mentioned had been canceled until its return for 1937. It did not report any of the canceled indebtedness as income on that return or on any other return. The cancellation of the indebtedness is shown for the first time on the return for 1937 under schedule B, "Reconciliation of Net Income and Analysis of Earned Surplus and Undivided Profits", as a credit to earned surplus in the amount of $25,219.65, explained "Forgiveness of debts."
The Commissioner, in determining the deficiency, held that the forgiveness of indebtedness in the amount of $25,219.65 represented taxable income for 1937 to the extent that the items represented in that total had served to offset income in prior returns, and upon that theory he included in income for 1937, $19,234.21, consisting of rent in the amount of $7,798.99 and interest in the amount of $11,435.22.
The debts for the rent and for the interest were forgiven in 1937.
The petitioner, near the end of his brief, makes what might be construed as an argument that the forgiveness of this rent and this interest was not income. That point has really not been placed in issue in this case, but, in any event, the forgiveness of indebtedness to a solvent debtor is income to the extent that it frees assets of the debtor from claim. United States v. Kirby Lumber Co., 284 U. S. 1; Lakeland Grocery Co., 36 B. T. A. 289. This rule has been applied to the...
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