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

Decision Date24 January 1984
Docket NumberNo. 82-3585,82-3585
Parties84-1 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.
CourtU.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.

Page 946

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

Page 947

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

Page 948

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...

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