Borg v. Comm'r of Internal Revenue, Docket No. 2395-66.
| Decision Date | 07 May 1968 |
| Docket Number | Docket No. 2395-66. |
| Citation | 50 T.C. 257 |
| Parties | JOE E. BORG AND RUTH P. BORG, PETITIONERS v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT |
| Court | U.S. Tax Court |
OPINION TEXT STARTS HERE
Charles A. Whitebook, for the petitioners.
Walter O. Johnson, for the respondent.
1. Held, for purposes of computing the allowance portion of a deductible corporate net operating loss under sec. 1374(c)(2)(B), I.R.C. 1954, petitioners, as cash basis taxpayers, had a zero basis in notes issued by their electing small business corporation, as evidence of indebtedness arising from an employment contract.
2. Held, further, loans to an electing small business corporation by third parties endorsed by its shareholders as sureties are not ‘indebtedness of the corporation to the shareholder(s)‘ under sec. 1374(c)(2)(B), I.R.C. 1954, where the shareholders had not been called upon to satisfy the corporate obligation.
Respondent determined a deficiency in petitioners' 1962 joint Federal income tax of $3,844.18. Both parties having conceded certain issues, the sole issue remaining for decision is whether petitioners' deductible share of the net operating losses incurred by an electing small business corporation exceeds the amounts allowed by the respondent.
Some of the facts have been stipulated and are so found. The stipulations and exhibits thereto are incorporated herein by this reference.
Petitioners Joe E. Borg and Ruth P. Borg are husband and wife and resided at Tulsa, Okla., at the time of the filing of the petition herein. They filed their joint Federal income tax return for 1962 with the district director of internal revenue, Oklahoma City, Okla.
Borg Compressed Steel Corp. (hereinafter referred to as Borg Steel) is an Oklahoma corporation, duly incorporated and existing under the laws of the State of Oklahoma, with its principal place of business at Tulsa, Okla. Its charter was granted on August 1, 1947, and it has remained engaged in the scrap-processing business continuously from its incorporation until the date of trial herein.
Borg Steel had only one class of capital stock during the period involved in this case: common capital stock. As of July 31, 1961, and throughout the year 1962, the corporation had issued and outstanding 3,000 shares of common capital stock, owned by the following persons:
+--------------------------------+
¦ ¦Shares ¦
+-----------------------+--------¦
¦ ¦ ¦
+-----------------------+--------¦
¦Petitioner Joe E. Borg ¦1,347 ¦
+-----------------------+--------¦
¦Petitioner Ruth P. Borg¦1,153 ¦
+-----------------------+--------¦
¦Monroe J. Friedman ¦500 ¦
+--------------------------------+
The petitioners' total basis in their common capital stock of Borg Steel as of July 31, 1961, was $25,000.
Borg Steel duly elected to file its U.S. income tax returns on the basis of a fiscal year ending on July 31, and has so filed its returns. The corporation employs the accrual method of accounting.
On August 10, 1960, Borg Steel elected to be free of tax as a small business corporation within the purview of subchapter S of the Internal Revenue Code of 1954,1 commencing with its taxable year ending July 31, 1961.
For the fiscal year commencing August 1, 1960, and ending July 31, 1961, Borg Steel sustained an operating loss in the amount of $28,630.88. The petitioners claimed and were allowed a combined deduction of $23,859.07 of the corporation's operating loss on their 1961 U.S. income tax return as their share of the loss as electing shareholders of a subchapter S corporation.
On July 31, 1962, there was a balance due petitioner Joe E. Borg from Borg Compressed Steel Corp. on a promissory note of the corporation for cash advanced to it in the sum of $15,153.98.
For the fiscal year commencing August 1, 1961, ending July 31, 1962, Borg Compressed Steel Corp. sustained an operating loss in the amount of $37,564.83. Petitioners claimed a deduction on their 1962 income tax return of $31,304.03 as their share of the loss as electing stockholders of a subchapter S corporation. Respondent disallowed the loss claimed to the extent of $15,009.12. The matter in tabular form is set forth as follows:
+-----------------------------------------------------------------------------+
¦Loss claimed: ¦ ¦ ¦
+-------------------------------------------------------+----------+----------¦
¦1961 return (first year of election) ¦$23,859.07¦ ¦
+-------------------------------------------------------+----------+----------¦
¦1962 return ¦31,304.03 ¦ ¦
+-------------------------------------------------------+----------+----------¦
¦Total losses claimed 1961-62 ¦ ¦$55,163.10¦
+-------------------------------------------------------+----------+----------¦
¦Basis of petitioners' stock (7/31/61) ¦25,000.00 ¦ ¦
+-------------------------------------------------------+----------+----------¦
¦Basis of indebtedness (balance due as of 7/31/62 on ¦ ¦ ¦
+-------------------------------------------------------+----------+----------¦
¦promissory note for cash advanced) ¦15,153.98 ¦ ¦
+-------------------------------------------------------+----------+----------¦
¦ ¦ ¦40,153.98 ¦
+-------------------------------------------------------+----------+----------¦
¦Amount of loss claimed in 1962 disallowed by respondent¦ ¦15,009.12 ¦
+-----------------------------------------------------------------------------+
On September 2, 1958, Borg Steel executed a promissory note to the First National Bank & Trust Co. of Tulsa, Tulsa, Okla. (hereinafter referred to as the bank) in the principal amount of $190,000, payable in installments. The proceeds of the loan as evidenced by this note went to the corporation and were used by the corporation in the operation of its business. As security for the loan the corporation gave the bank a mortgage on substantially all of its equipment and machinery and the life insurance policies of the corporation on its officers.
On September 1, 1961, there was $67,500 due on the note given by Borg Steel to the bank dated September 2, 1958. On that date the corporation executed a new promissory note to the bank in the principal amount of $135,000; $67,500 of the new note was used by Borg Steel to pay the balance due on the note dated September 2, 1958, and the remaining balance was received and used by the corporation in the operation of its business. As security for the loan the corporation gave the bank a mortgage on substantially all of its equipment and machinery and the life insurance policies of the corporation on its officers.
In order for Borg Steel to obtain the loans from the bank, petitioners were required to pledge their personal assets and to endorse the notes. The endorsements were in the following language:
FOR VALUE RECEIVED, the undersigned, jointly and severally, in addition to the obligations imposed by endorsement, hereby unconditionally and absolutely guarantee to the First National Bank and Trust Company of Tulsa the payment of the within note according to its terms and tenor, agreeing to be bound by all the provisions thereof and to assume and to perform all the obligations therein contained in like manner as the makers thereof.
The undersigned further waive notice of the acceptance hereof and presentment for payment, protest and notice of protest and non-payment, of the within note or any installment thereof.
On July 31, 1962, there was a balance due to the bank of $105,000 on the note dated September 1, 1961.
The loans as evidenced by the notes dated September 2, 1958, and September 1, 1961, were paid in full. All payments were made by Borg Steel. The petitioners were not required to make any payments.
The notes executed by Borg Steel to the bank were carried on its books and records as notes payable to the bank. The corporation's balance sheet for its fiscal year ending July 31, 1962, did not show any indebtedness due the petitioners Joe E. Borg or Ruth P. Borg as a result of their endorsements of the notes to the bank.
During the fiscal years ending July 31, 1960, July 31, 1961, and July 31, 1962, the petitioner, Joe E. Borg, was employed by Borg Steel under a written employment contract dated January 17, 1953, on the basis of an annual salary of $36,000 per year, plus a bonus arrangement. This salary arrangement had been in effect since 1955 and in view of the services rendered as the principal officer of the corporation, the salary was reasonable in amount.
Because of the financial condition of Borg Steel, the petitioner, Joe E. Borg, was not paid any salary from the corporation for the fiscal years July 31, 1960, and July 31, 1961. He drew the sum of $24,000 in salary from the corporation for the fiscal year ending July 31, 1962. The salaries paid and unpaid compensation by Borg Steel to Joe E. Borg may be seen in tabular form as follows:
+--------------------------------------------------------------------------+
¦ ¦Salary ¦ ¦ ¦Total ¦
+----------------------------------------+--------+------+-------+---------¦
¦Borg Compressed Steel Corp. FYE July 31—¦paid ¦Bonus ¦Salary ¦unpaid ¦
+----------------------------------------+--------+------+-------+---------¦
¦ ¦under ¦paid ¦unpaid ¦salary ¦
+----------------------------------------+--------+------+-------+---------¦
¦ ¦contract¦ ¦ ¦end of FY¦
+----------------------------------------+--------+------+-------+---------¦
¦ ¦ ¦ ¦ ¦...To continue reading
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