Burnet v. Huff

• Decision Date: 06 February 1933
• Docket Number: No. 58,58
• Citation: 77 L.Ed. 670,288 U.S. 156,53 S.Ct. 330
• Parties: BURNET, Com'r of Internal Revenue, v. HUFF et al
• Court: U.S. Supreme Court

288 U.S. 156

53 S.Ct. 330

77 L.Ed. 670

BURNET, Com'r of Internal Revenue,

v HUFF et al.

No. 58.

Argued Dec. 6, 1932.

Decided Feb. 6, 1933.

The Attorney General and Mr. Paul D. Miller, of Washington, D.C., for petitioner.

Mr. Harry C. Weeks, of Wichita Falls, Tex., for respondents.

Mr. Chief Justice HUGHES delivered the opinion of the Court.

In computing net income for 1920, the respondents, R. E. Huff, and his wife, E. B. Huff (now deceased), sought deduction of a loss alleged to have been sustained in that year, in relation to community property, through the embezzlement of trust funds. The funds were held by a partnership of which R. E. Huff was a member and were embezzled by his copartner. The Commissioner disallowed the deduction, holding that as the funds were not the property of the petitioners, and they were not called upon to make good the amount embezzled until 1921, they sustained no loss in 1920. The Board of Tax Appeals, upon the authority of Farish v. Commissioner (C.C.A.8th) 31 F.(2d) 79, upheld this ruling. An alternative claim, for the deduction of the amount in question as a worthless debt, was also disallowed. 20 B.T.A. 516. The Circuit Court of Appeals, declining to follow the Farish Case, reversed the decision of the Board (56 F.(2d) 788), and this Court granted certiorari, 286 U.S. 541, 52 S.Ct. 645, 76 L.Ed. 1279.

The pertinent facts as found by the Board of Tax Appeals are these: R. E. Huff, a lawyer and banker in Wichita Falls, Texas, and J. S. Mabry were copartners engaged in managing the business of a reciprocal fire insurance association known as Wichita Great Western Underwriters. Under the plan of organization, 25 per cent. of the gross premium income of the association was allotted to expenses and profits, and the remaining 75 per cent. was to be set apart as a reserve to pay fire losses. Any person might become an 'underwriter' by subscribing to the association such amount as he wished to invest, paying one-fourth in cash. Ten per cent. of the cash payment was allowed to the managing attorneys and the rest constituted a reserve or trust fund which was to remain the property of the underwriters and to be used only for the payment of fire losses in excess of the association's reserve. An advisory board was created from safeguarding the interests of the subscribers but undertook no active supervision until about the end of 1920. The board looked to Huff for the proper conduct of the affairs of the association, but the management was left almost entirely to Mabry. Early in 1920, on Mabry's representation that the sum of $25,000 was needed for working capital, Huff advanced this amount to the partnership upon partnership notes payable in six months. The entire amount was repaid to Huff in the autumn of 1920 by checks drawn by Mabry, the money being taken from the trust fund of the association held in reserve for the subscribing underwriters. Huff and Mabry were not the owners of that fund and neither of them had authority to use it for any purpose other than the payment of fire losses. To cover the checks, given to repay Huff, Mabry gave a demand note signed in the firm name in favor of the reserve fund. Mabry had no authority to execute the note and Huff did not know until near the end of 1920 that the note had been given or that the repayment to him had not been made from funds belonging to the firm. The unauthorized use of the trust fund was discovered, in the absence of Mabry, in December, 1920. On Mabry's return in January, 1921, he was removed as one of the managing attorneys and the firm then discontinued business. Mabry promised to pay back the money he had taken but did not do so, and a judgment against him would have been worthless. Huff was unable to determine the amount of the assets of the firm of Huff & Mabry before the close of 1920, and in February, 1921, these assets, amounting to $3,228.65, were turned over by Huff to the association, together with $21,771.35 which he paid personally. He has not been reimbursed. Huff kept no regular books of account and made up his income tax returns upon a cash receipts and disbursements basis.

First. The Revenue Act of 1918 (40 Stat. 1057, 1066, 1067) provided for the deduction of losses incurred 'in trade or business' or 'in any transaction entered into for profit,' or arising from theft of property 'not connected with the trade or business,' when the losses were 'sustained during the taxable year' and were 'not compensated for by insurance or otherwise.' Sections 214(a)(4—6).

The Government concedes that if assets of the taxpayer used in trade or business, or 'in any transaction entered into for profit,' are stolen in any year, the taxpayer sustains the loss in that year and the deduction must then be taken even though the theft is not discovered or the amount ascertained until the following year. This is said to be the import of the regulation adopted by the Treasury Department under the Revenue Act of 1921. Regulations No. 45, art. 111.¹ But the Government contends that a different rule applies (at least where the taxpayer is on a cash basis) when the property stolen is not that of the taxpayer but is held by him in trust, and the theft is not discovered until the following year, as in that case 'the taxpayer, being nothing out of pocket, cannot be said to have 'sustained' the loss in the year of the theft.' The Government also raises the question whether Huff, in the...