Cole v. COMMISSIONER OF INTERNAL REVENUE

• Citation: 42 BTA 1110
• Decision Date: 30 October 1940
• Docket Number: Docket No. 96589.
• Parties: RUFUS S. COLE, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
• Court: U.S. Board of Tax Appeals

42 B.T.A. 1110 (1940)

RUFUS S. COLE, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

Docket No. 96589.

Board of Tax Appeals.

Promulgated October 30, 1940.

Benjamin P. DeWitt, Esq., and Sidney Pepper, Esq., for the petitioner.

Allen T. Akin, Esq., for the respondent.

Respondent determined a deficiency of $13,701.55 in income tax for the year 1935. The sole question is whether respondent erred in adding to petitioner's income the amount of certain indebtedness which was canceled by one of petitioner's creditors in the taxable year. Other adjustments made by respondent to petitioner's income are not in issue.

FINDINGS OF FACT.

Petitioner is a resident of New York. From January 1, 1924, to January 23, 1935, petitioner was employed in various executive capacities by the Hupp Motor Car Corporation, a Virginia corporation, hereinafter referred to as Hupp.

In November 1929 petitioner became heavily indebted to brokers, and Hupp advanced $101,830 to him to enable him to satisfy these debts. Petitioner delivered to Hupp his demand note for $101,830, dated November 18, 1929, and bearing interest at 6 percent, and also deposited with Hupp certain securities as collateral. Petitioner made regular monthly payments to Hupp to reduce the amount of his note, and after several years Hupp waived any further interest. On December 31, 1931, the note was renewed for $76,770.32. On January 30, 1935, the balance due on this note was $62,487.12.

In August 1934 petitioner was elected a director of Hupp. On August 23, 1934, petitioner and Hupp entered into an agreement under the terms of which Hupp agreed to employ petitioner for a period of at least eighteen months as general sales manager at a salary of $25,000 per year and to pay him a percentage of net profits of Hupp in excess of $1,000,000 and also granted him an option to purchase 25,000 shares of Hupp common capital stock at $2.50 per share.

On January 23, 1935, petitioner was discharged by Hupp.

On January 30, 1935, Hupp agreed to cancel petitioner's note if petitioner would resign as director and sever all connections with the corporation. On that date Hupp, as first party, and petitioner, as second party, entered into an agreement which provided in part as follows:

In consideration of the mutual covenants of the parties hereto, it is hereby agreed as follows:

First Party cancels and delivers the note of Second Party, dated December 31, 1931, in the sum of Seventy-six Thousand Seven Hundred Seventy and 32/100 Dollars ($76,770.32), on which there is now due a balance of approximately Sixty-three Thousand Dollars ($63,000.00), and in addition thereto delivers to Second Party the collateral which was deposited with First Party at the time of the execution of said note.

Second Party hereby cancels his agreement with First Party, dated the 23rd day of August, 1934, by the terms of which Second Party was granted certain options and rights in the net profits of First Party.

Second Party hereby releases First Party from any and all claims and demands of any nature or description whatsoever, and First Party hereby releases Second Party from any claims and demands of any nature or description whatsoever, it being the intention of the parties hereto that each is hereby giving to the other a general acquittance of any and all claims which either may have against the other.

Thereupon, petitioner executed a written resignation as director and delivered it to Hupp, and Hupp delivered to petitioner his canceled note and the securities which he had deposited with Hupp as collateral.

Immediately prior to the delivery to him of his canceled note petitioner had the following assets: Cash in bank, $2,044.93; Hupp stock, $4,506.02; securities deposited as collateral, $2,700; equity in a house, $793. Petitioner owned, on January 30, 1935, a net equity of $19,515.62 in ten life insurance policies in the aggregate face amount of $133,745.71. The wife of petitioner, Edna L. Cole, was the named beneficiary of all the policies. Petitioner had the right reserved to change the named beneficiary in each policy. In April of 1939 the Bankers Trust Co. held all the policies as assignee and at the date of the hearing in this case it had possession of all of the policies as assignee. The above ten policies represent all the insurance on petitioner's life existing on January 30, 1935. None of the policies were effected and none of the premiums were paid with intent to defraud creditors.

Immediately prior to the delivery to him of his canceled note petitioner had the following liabilities: Note owing to Hupp, $62,487.12; miscellaneous, $5,526.38; total, $68,013.50.

Immediately prior to January 30, 1935, the date of petitioner's receipt of his canceled note, petitioner's assets aggregated $10,043.95; and his liabilities aggregated $68,013.50. Immediately after the receipt of his canceled note petitioner was solvent with an excess of total assets over total liabilities in the amount of $4,517.57 (assets of $10,043.95 less liabilities of $5,526.38).

OPINION.

HARRON:

The sole question is whether the cancellation of petitioner's indebtedness to Hupp resulted in taxable income under section 22 (a) of the Revenue Act of 1934, the pertinent provisions of which are set forth in the margin.¹

Respondent determined that the entire amount of the indebtedness canceled was taxable income under section 22 (a). In his brief petitioner contends that, since he was insolvent immediately prior to the cancellation of the indebtedness, the cancellation did not result in taxable income, and relies on Dallas Transfer & Terminal Warehouse Co. v. Commissioner, 70 Fed. (2d) 95, and Burnet v. Campbell Co., 50 Fed. (2d) 488.

In our opinion the Board's decision in Lakeland Grocery Co., 36 B. T. A. 289, is controlling here. In the Lakeland case the taxpayer was insolvent immediately prior to the cancellation of his indebtedness by his creditors but solvent immediately after the cancellation, with an excess of total assets over total liabilities. After considering, inter alia, the same cases relied on by petitioner in his brief here, the Board held that the cancellation of the indebtedness resulted in taxable income to the extent of the excess of total assets over total liabilities immediately after the cancellation. The Board stated in part as follows:

* * * The petitioner's net assets were increased from zero to $39,596.93 as a result of the cancellation of indebtedness by its creditors, and to that extent it had assets which ceased to be offset by any liability. The decisions that the increase in clear assets so brought about constitutes taxable "gain" or "income" (United States v. Kirby Lumber Co., supra, and Helvering v. American Chicle Co., 291 U. S. 426) are applicable to the facts of the instant case, as the cancellation of the petitioner's debts had the effect of making its assets greater than they were before that transaction occurred. It is true that "gain" or "profit" is essential to the existence of taxable "in...