Gertz v. Comm'r of Internal Revenue, Docket No. 307-73.

• Citation: 64 T.C. 598
• Decision Date: 21 July 1975
• Docket Number: Docket No. 307-73.
• Parties: ROBERT L. GERTZ AND J. KAY GERTZ, PETITIONERS v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT
• Court: United States Tax Court

64 T.C. 598

ROBERT L. GERTZ AND J. KAY GERTZ, PETITIONERS

v.COMMISSIONER OF INTERNAL REVENUE, RESPONDENT

Docket No. 307-73.

United States Tax Court

Filed July 21, 1975.

Robert L. Gertz, pro se.

Willard N. Timm, Jr., for the respondent.

Petitioner claimed a bad debt deduction under sec. 166 for wages never paid. Held, respondent did not err is disallowing the bad debt deduction since petitioner had never reported the amount claimed in income, as required by sec. 1.166-1(e), Income Tax Regs. Held, further, petitioner is not entitled to claim a tax credit for wages his employer was never liable to withhold.

IRWIN, Judge:

Respondent determined a deficiency in petitioner's income tax for the calendar year 1969 in the amount of $1,209.87. Various concessions having been made, the only issue remaining for our determination is whether respondent erred in disallowing a claimed bad debt deduction for wages which were never paid.

FINDINGS OF FACT

Some of the facts have been stipulated and these facts are found accordingly.

Petitioners are husband and wife and resided in Laguna Hills, Calif., at the time of the filing of their petition in this case. For the calendar year 1969 they filed their joint Federal income tax return with the Internal Revenue Service Center, Ogden, Utah. In reporting their income for Federal income tax purposes petitioners used the cash receipts and disbursements method of accounting.

In July 1963 Robert Gertz (hereinafter referred to as petitioner) entered into an oral 2-year employment agreement with Edward E. Gurian & Co., Inc. (hereinafter Gurian), an Illinois corporation. Pursuant to this agreement petitioner was employed as an engineer designing products. On August 16, 1964, Gurian ceased doing business and petitioner's employment was terminated. At that time he was receiving a salary of $185 per week. Petitioner was paid in full for all services rendered.

Sometime after August 16, 1964, Gurian filed a petition for an adjudication of bankruptcy in the United States District Court for the Northern District of Illinois. Petitioner filed a wage claim in this bankruptcy proceeding in the amount of $8,918. This amount was claimed to be due under the oral employment agreement. The bankruptcy court allowed petitioner a $600 priority claim and an $8,318 unsecured claim. The priority claim was paid in full and the trustee withheld income tax on that amount. The unsecured claim was never satisfied.

Petitioner determined that the entire wage claim became uncollectible in 1969 and accordingly claimed a bad debt deduction in the amount of $8,917¹ on his income tax return for that year. No portion of this amount had ever been included in petitioner's income for Federal income tax purposes.

In the notice of deficiency the Commissioner of Internal Revenue disallowed petitioner's bad debt deduction in the amount of $8,917, stating that this amount ‘has never been included as income on any Federal income tax return’ as required by section 166² and the regulations thereunder. The Commissioner did allow petitioner a deduction of $100 for legal fees incurred in attempting to recover the unpaid wages.

OPINION

Petitioner claimed on his 1969 tax return a bad debt deduction under the provisions of section 166(a)(1)³ in the amount of $8,917. $8,317 of this amount represents the unsatisfied portion of his wage claim allowed in the bankruptcy action.

Respondent argues that petitioner has failed to prove the existence of a bona fide debt, as required by section 1.166-1(c),⁴ Income Tax Regs. In the alternative, respondent argues that if in fact a bona fide debt does exist, section 1.166-1(e),⁵ Income Tax Regs., and the cases decided thereunder bar the petitioner from claiming such a deduction when he has failed to report any of the amount so claimed as income in any taxable year.

We do not find it necessary to our determination of this issue to reach a finding concerning the validity of petitioner's debt; for assuming, without deciding, the bona fide character of the debt, it has long been settled that a taxpayer is not entitled to a bad debt deduction under section 166 for the value of unpaid wages or other income items if such an item has never been reported as income. Charles A. Collin, 1 B.T.A. 305, 309 (1925); Howard J. Simons, 1 B.T.A. 351, 353 (1925); J. Noble Hayes, 7 B.T.A. 936, 944 (1927); Bush Terminal Buildings Co., 7 T.C. 793, 812 (1946). It follows that since the $8,317 of unpaid wages was never reported as income, petitioner is not entitled to a bad debt deduction under section 166.

Petitioner at the trial and on brief argues that he more appropriately should be permitted to amend his tax return and be given a tax credit on his allowed wage claim that will reduce the income tax deficiency assessed against him.

Petitioner maintains that because the bankruptcy court allowed his wage claim against Gurian, the existence of a liability on Gurian's books showing $8,917 in wages payable to petitioner has been established. Once such a debt is established, petitioner claims that the Internal Revenue Service is responsible for collecting a percentage of the debt from the employer for withholding tax purposes. The employee should then be entitled to claim a tax credit on his income tax return for that amount.

Section 3402(a)⁶ imposes a duty on employers paying wages to employee-taxpayers to withhold a percentage of those wages for income tax purposes. Section 31(a)(1)⁷ provides that the wages so withheld will be credited by the Internal Revenue Service to the income tax account of the employee-taxpayer. The effect of these provisions is to reduce the employee's income tax bill for the year in which the tax on wages is withheld.

It is clear that the duty imposed by section 3402 does not arise unless and until the employer actually or constructively pays wages to his employee. ⁸ The essence of petitioner's argument is that the bankruptcy court's allowance of his wage claim is tantamount to such a constructive payment of wages within the meaning of section 31.3402(a)-1(b), Employment Tax Regs. With this we cannot agree. The allowance of an employee's unpaid wage claim in a bankruptcy action against his former employer is merely a judicial determination which authorizes the employee to participate with the other creditors of the bankrupt in the pro rata distribution of the assets of the bankrupt's estate. By the very nature of the proceeding it is rare that any creditor's claim is satisfied in full. To the extent an employee's claim is satisfied, withholding taxes accrue and the trustee in bankruptcy is required by section 3402 to deduct the appropriate amount from the payment made to the employee. United States v. Fogarty, 164 F.2d 26, 33 (8th Cir. 1947); In re Freedomland, Inc., 341...