B.B. Rider Corp. v. C.I.R., 82-3585

• Decision Date: 24 January 1984
• Docket Number: No. 82-3585,82-3585
• Citation: 725 F.2d 945
• Parties: 84-1 USTC P 9171 B.B. RIDER CORPORATION, Appellant, v. COMMISSIONER OF INTERNAL REVENUE, Appellee. Benjamin and Helen STRATMORE, Appellants, v. COMMISSIONER OF INTERNAL REVENUE, Appellee. B.B. RIDER CORPORATION, a/k/a General Manufacturing Corporation, Appellant, v. COMMISSIONER OF INTERNAL REVENUE, Appellee.
• Court: U.S. Court of Appeals — Third Circuit

Page 945

725 F.2d 945

84-1 USTC P 9171

B.B. RIDER CORPORATION, Appellant, v. COMMISSIONER OF INTERNAL REVENUE, Appellee.

Benjamin and Helen STRATMORE, Appellants, v. COMMISSIONER OF INTERNAL REVENUE, Appellee.

B.B. RIDER CORPORATION, a/k/a General Manufacturing

Corporation, Appellant, v. COMMISSIONER OF INTERNAL REVENUE, Appellee.

No. 82-3585.

United States Court of Appeals Third Circuit.

Argued Sept. 15, 1983.

Decided Jan. 24, 1984.

James D. Crawford (argued), Barry J. Fleishman, Schnader, Harrison, Segal & Lewis, Philadelphia, Pa., Edwin Fradkin, John J. O'Toole, Starr, Weinberg & Fradkin, Roseland, N.J., for appellants.

Glenn L. Archer, Jr., Asst. Atty. Gen., Michael L. Paup, Chief of Appellate Section, Ann Bellanger Durney, Liza A. Prager (argued), Tax Div., U.S. Dept. of Justice, Washington, D.C., for appellee.

Before SEITZ, Chief Judge, and GIBBONS and ROSENN, Circuit Judges.

OPINION OF THE COURT

SEITZ, Chief Judge.

I.

Taxpayers Benjamin and Helen Stratmore (filing jointly) and B.B. Rider Corporation appeal from the tax court's decision that they had certain deficiencies in their income tax. See B.B. Rider Corporation v. Commissioner, 43 T.C.M. (CCH) 637 (1982). This court has jurisdiction over the appeal pursuant to 26 U.S.C. Sec. 7482(a) (1976).

II.

B.B. Rider Corporation ("Rider") was originally an authorized franchisee for the sale and servicing of Frigidaire refrigerators. Benjamin Stratmore ("Benjamin") began working for Rider in 1932, as its credit manager. About five years later, Benjamin borrowed $15,000, which he contributed to the purchase of Rider.

In the taxable years in question, Benjamin owned 25 percent of the stock in the corporation; Benjamin's wife, Helen Stratmore ("Helen"), owned 8 1/3 percent; and Benjamin's two brothers each owned 33 1/3 percent. At all times in question, Benjamin, as President and Chief Financial Officer, was an active and vital employee of the corporation. Helen also worked for the corporation, as Vice President and Office Manager.

In 1950, the Stratmore brothers formed General Manufacturing Corporation ("General") to manufacture aircraft engine components. The new corporation was not a financial success, and in 1957, Rider and General both filed for bankruptcy reorganization. The plan of reorganization and other relevant documents do not appear to be part of the record. Based on testimony and on the parties' stipulations, the tax court found:

One of the consequences of the 1958 bankruptcy reorganizations of Rider and General was the placement of limitations on the maximum salaries the corporations could pay to [Benjamin] Stratmore and Helen Stratmore.... Rider and General paid their creditors only 25 cents for each dollar owed. In order to accomplish the reorganization the Stratmores agreed to forego their claims as creditors of the corporation[s] and to honor their obligation as guarantors of the remaining 75 percent of the corporate debts.

43 T.C.M. at 651-52, 653. After the reorganization, the two corporations merged. We refer to the merged corporation as "Rider/General."

In 1961-1971, the Stratmores made payments of principal and interest on debts incurred by Rider and General that the Stratmores had guaranteed prior to the reorganization. The Stratmores took ordinary deductions for these payments on their joint tax returns. Upon examination, the Internal Revenue Service (the "IRS") determined that the payments were not deductible in full, but only as nonbusiness bad debts subject to a statutory limitation on deductions for short-term capital losses. Based on these disallowances, the IRS issued a notice of deficiency to the Stratmores in 1974.

The IRS also disallowed deductions by Rider/General for payments made to Benjamin for "travel and entertainment" in the corporation's taxable years 1961, 1964, and 1965. ¹ Based on these disallowances, the IRS issued a notice of deficiency to Rider/General in 1974. In a 1977 notice of deficiency, the IRS disallowed as unreasonable Rider/General's deductions for payments made to Benjamin as "compensation" during the corporation's taxable years 1970, 1972, 1973, and 1974.

The Stratmores and Rider/General filed petitions in the United States Tax Court for review of these three notices of deficiency. The cases were consolidated for trial, and the tax court held that the IRS was correct in its disallowances. The Stratmores and Rider/General appeal.

III. Payments of Principal

In 1961 to 1971, the Stratmores made payments of principal as guarantors ² of debts incurred by Rider and General prior to the reorganization. The Stratmores reported these amounts as miscellaneous deductions or as employee business expenses. They contend that these payments are fully deductible against ordinary income as business bad debts under I.R.C. Sec. 166(a). ³

Section 166(a) sets out the general rule that any debt is deductible in the year in which it becomes worthless. Section 166(d)(1)(A) excludes from this general rule all "nonbusiness debts" of noncorporate taxpayers. A nonbusiness debt is "a debt other than ... a debt created or acquired (as the case may be) in connection with a trade or business of the taxpayer; or ... a debt the loss from the worthlessness of which is incurred in the taxpayer's trade or business." I.R.C. Sec. 166(d)(2).

Under section 166(d)(1)(B), nonbusiness bad debts are deductible as short-term capital losses, but such deductions were limited to $1,000 or less for the taxable years in question, see c. 736, 68A Stat. 321 (1954) (amended in 1969); Pub.L. No. 91-172, Sec. 513(a), 83 Stat. 487 (1969) (amended in 1976 and 1977) (current version of these statutes appears at 26 U.S.C. Sec. 1211 (1976)).

The taxpayer bears the burden of refuting the IRS's determinations. Welch v. Helvering, 290 U.S. 111, 115, 54 S.Ct. 8, 9, 78 L.Ed. 212 (1933). The tax court agreed with the IRS that the Stratmores' payments on the corporate debts created nonbusiness bad debts. Whether a debt is a business bad debt may be a mixed question of law and fact, see Anderson v. United States, 555 F.2d 236, 237 (9th Cir.1977), but the relationship between a debt and the taxpayer's trade or business is a question of fact, Treas.Reg. Sec. 1.66-5(b)(2); see United States v. Generes, 405 U.S. 93, 104, 92 S.Ct. 827, 833, 31 L.Ed.2d 62 (1972). We review the tax court's factual findings and inferences from fact for clear error only. Commissioner v. Duberstein, 363 U.S. 278, 289-91, 80 S.Ct. 1190, 1198-1200, 4 L.Ed.2d 1218 (1960); Imbesi v. Commissioner, 361 F.2d 640, 643 (3d Cir.1966).

There is no distinction between a loss that results from a direct loan to a corporation and one that results from the guarantee of a loan. Putnam v. Commissioner, 352 U.S. 82, 92, 77 S.Ct. 175, 180, 1 L.Ed.2d 144 (1956). If an employee of a corporation lends the corporation money primarily to protect his job, he is entitled to deduct the amounts paid as a business bad debt if the loan becomes worthless. Trent v. Commissioner, 291 F.2d 669 (2d Cir.1961). However, when the guarantor of a corporate debt is both a shareholder and an employee of the corporation, it is difficult to determine whether he executes his guarantee to protect his investment or to protect his job. Mixed motives are not uncommon, and the critical question is which of the taxpayer's motives is dominant. Generes, 405 U.S. at 103, 92 S.Ct. at 833.

The Generes Court sought to determine whether a shareholder/employee's dominant motive in indemnifying the underwriter of the corporation's bid and performance bonds was to protect the shareholder/employee's job or to protect his investment. The Court's decision turned on a comparison of the amount that the shareholder/employee originally invested in the corporation and the amount, after taxes, that he received annually as a salaried employee of the corporation. The Court found it implausible that the shareholder/employee would indemnify the underwriter of the corporation's bonds in order to protect an annual salary of approximately $7,000 (after federal taxes), which was less than one-fifth of his original investment of $38,900.

The shareholder/employee in Generes worked for the construction company only six to eight hours per week and had a full-time job elsewhere. The tax court readily distinguishes Generes if the guarantor of a corporate debt is an older individual who has devoted his life to the industry in question, who has few prospects of equivalent employment ⁴ if he should lose his job, and whose income is primarily his salary from the corporation. See Estate of Allen v. Commissioner, 44 T.C.M. (CCH) 9 (1982); LaStaiti v. Commissioner, 41 T.C.M. (CCH) 511 (1980); see also, e.g., Mann v. Commissioner, 34 T.C.M. (CCH) 377 (1975); Young v. Commissioner, 33 T.C.M. (CCH) 397 (1974). But see also, e.g., Massey v. Commissioner, 43 T.C.M. (CCH) 271 (1982).

Pointing to these and other tax court decisions, the Stratmores argue that Generes is factually distinguishable because Benjamin was close to sixty years old when he executed the guarantees in question, and he had devoted most of his life to running Rider and General, working full time and depending on his salary and his wife's salary as his sole and irreplaceable sources of income. Although we recognize the significance of such considerations, we cannot dispense entirely with the comparison of salary and investment on which the Generes Court specifically relied.

As the tax court noted, there is no evidence in the instant case of what the Stratmores' salaries were when they guaranteed the loans to Rider and General. The Stratmores' combined salaries in the early 1960s were, on the average, just less than $14,000 per year ⁵ before taxes, but there is evidence that these salaries were artificially low due to a salary limitation to which the Stratmores agreed at the time of the reorganization.

The parties disagree over the value of the Stratmores' investment in Rider and General. The...