Henry v. United States

• Court: U.S. Claims Court
• Writing for the Court: Elden McFarland, Washington, D. C., for plaintiff
• Citation: Henry v. United States, 180 F.Supp. 597 (Fed. Cl. 1960)
• Decision Date: 03 February 1960
• Docket Number: No. 581-57.,581-57.
• Parties: Josephine W. D. HENRY v. UNITED STATES.

180 F. Supp. 597

Josephine W. D. HENRY v. UNITED STATES.

No. 581-57.

United States Court of Claims.

February 3, 1960.

Elden McFarland, Washington, D. C., for plaintiff.

Robert Livingston, Washington, D. C., with whom was Asst. Atty. Gen. Charles K. Rice, for defendant. James P. Garland and Lyle M. Turner, Washington, D. C., were on the brief.

LITTLETON, Judge (Retired).

Plaintiff sues for a refund of income tax for the year 1948. The tax was paid pursuant to a determination by the Commissioner of Internal Revenue that a loss of $27,873.50, claimed by plaintiff as an ordinary loss, fully deductible as such under section 23(e) (2) of the Internal Revenue Code of 1939, 26 U.S.C. (1952 ed.), § 23(e) (2), was a short-term capital loss arising from a non-business bad debt, under section 23(k) (4) of the 1939 Code, 26 U.S.C. (1952 ed.), § 23(k) (4), and therefore subject to the $1,000 limitation on deductions for capital losses (§ 117(d) (2), Int.Rev.Code of 1939, as amended, 26 U.S.C. (1952 ed.), § 117(d) (2)). We are of the opinion that the opinion that the Commissioner was correct in his determination that plaintiff's loss resulted from a non-business bad debt.

On April 9, 1948, plaintiff was owed a total amount of $40,768.11 by one Irene Specht. This amount included sums which plaintiff paid for and advanced upon certain mortgages on property owned by Irene Specht, real estate taxes on the property which had been paid by plaintiff, and unpaid interest on the mortgage indebtedness. On that date, Irene Specht was financially unable to pay the amount she owed to plaintiff, and the parties entered into an agreement whereby Irene Specht transferred the mortgaged property to plaintiff and plaintiff accepted it in full satisfaction of the indebtedness. On June 25, 1948, plaintiff sold the property for $15,000, but incurred expenses of $2,105.39, realizing a net amount of $12,894.61. Plaintiff claimed $27,873.50, the difference between the amount of the debt and the net amount realized from the sale of the property, as a fully deductible loss for the taxable year 1948. The Commissioner disallowed that amount as a fully deductible loss, determined that plaintiff was entitled to treat it as a short-term capital loss, limited plaintiff's deduction to $1,000, and assessed a deficiency tax on the additional $26,873.50. Plaintiff paid the assessed deficiency and interest thereon and filed a claim for refund. No part of the tax paid has been refunded, and plaintiff instituted this action to recover the amounts paid, plus interest according to law.

Plaintiff claims that the loss she incurred as a result of the transaction described above was a loss incurred in a transaction entered into for profit. Such a loss would be fully deductible under section 23(e) (2) of the Internal Revenue Code of 1939, supra, which provides:

"§ 23. Deductions from gross income. In computing net income there shall be allowed as deductions:

* * * * * *

"(e) Losses by individuals. In the case of an individual, losses sustained during the taxable year and not compensated for by insurance or otherwise—

* * * * * *

"(2) if incurred in any transaction entered into for profit, though not connected with the trade or business;"

Defendant asserts that plaintiff's loss resulted from a non-business bad debt, so that its deductibility is governed by section 23(k) (4) of the Internal Revenue Code of 1939, supra, which provides:

"§ 23(k). Bad debts.

* * * * * *

"(4) Non-business debts. In the case of a taxpayer, other than a corporation, if a non-business debt becomes worthless within the taxable year, the loss resulting therefrom shall be considered a loss from the sale or exchange, during the taxable year, of a capital asset held for not more than 6 months. The term `non-business debt' means a debt other than a debt evidenced by a security as defined in paragraph (3) and other than a debt the loss from the worthlessness of which is incurred in the taxpayer's trade or business."

Subsections (e) and (k) are mutually exclusive, and an amount deductible under one is not deductible under the other. A loss attributable to the worthlessness of a debt must be regarded as a bad debt loss, deductible as such or not at all. Putnam v. Commissioner, 352 U.S. 82, 87, 77 S.Ct. 175, 1 L.Ed.2d 144; Spring City Foundry Co. v. Commissioner, 292 U.S. 182, 54 S.Ct. 644, 78 L.Ed. 1200.

Plaintiff asserts that Bowles Lunch, Inc. v. United States, 33 F.Supp. 235, 91 Ct.Cl. 292, requires the conclusion that, because she had released the debt, so that there was no longer any debt in existence, there was no debt which had become worthless within the taxable year requiring treatment under section 23(k) (4).

We do not think this is so.

In Raffold Process Corp. v. Commissioner, 1 Cir., 153 F.2d 168, the taxpayers had entered into a composition agreement with their debtor whereby they agreed to release the debtor from its obligation in return for its payment to them of ten percent of the amount owed. They claimed a deduction for the difference between the amount owed and the amount received under the agreement as a bad debt under section 23(k). The court held that the agreement in itself did not establish the taxpayers' right to deductions for a bad debt, but that the question was whether during the year in which the deduction was claimed the debt became worthless irrespective of the composition agreement. The court went on to find that the Tax Court in its decision there under review had substantial basis for concluding as a matter of fact that the debt had not become worthless. See also American Felt Co. v. Burnet, 61 App. D.C. 125, 58 F.2d 530 and Sitterding v. Commissioner, 20 T.C. 130.

We think that this reasoning is a proper interpretation of the statutory language. Section 23(k) requires short-term capital loss treatment for a nonbusiness debt which "becomes worthless" within the taxable year. Whether the debt is released or not, if it becomes worthless, that is all the statute requires. In this case, the parties have agreed that the debtor was, in 1948 (the taxable year in question), financially unable to repay the money owed to plaintiff-taxpayer. Plaintiff's non-business debt therefore became worthless during the taxable year, and must be treated as a short-term capital loss, under section 23(k) (4).

Plaintiff's principal reliance is on the case of Bowles Lunch, Inc. v. United States, supra. In that case plaintiff had sold certain real estate for a consideration part of which was secured by mortgages on the property. It later repossessed the property, which was reconveyed to it, and in consideration for the reconveyance it released the parties who were personally liable on the mortgages from their obligations. By its repossession, plaintiff acquired an equity of some $94,000, but the amount due on the mortgages had been more than $176,000, so plaintiff claimed a tax deduction of almost $82,000 either as a bad debt under section 23(j) of the Revenue Act of 1928, 45 Stat. 791, 800, 26 U.S.C.A.Int.Rev. Acts, page 357, or as a loss under section 23(f) of that Act. The court held that the loss was deductible as a loss in connection with the repossession of property in consideration for the cancellation of all or a part of the indebtedness against it, under section 23(f), supra, but not as a bad debt. As the basis for its conclusion that the loss was not deductible as a bad debt, the court said, 33 F.Supp. at page 239, 91 Ct.Cl. at pages 298-299:

"Since the parties personally liable were released from liability and the property was reconveyed to the mortgagee, the liability was extinguished, the debt was wiped out. Since there was no longer a debt, the plaintiff is not entitled to a deduction under section 23(j)."

This language does not have the force of a positive holding, since the issue before the court was whether there was a loss deductible under either of the subsections, not under which of the two the loss was deductible. It does lend some support to plaintiff's position, but we think it is not controlling. It should be noted that the language of section 23(j) of the 1928 Revenue Act, with which the court was concerned in Bowles Lunch, was entirely different from that of section 23(k) (4) of the 1939 Code with which we are here concerned. Section 23(j) by its terms applied to "debts ascertained to be worthless and charged off within the taxable year" (italics supplied), whereas section 23(k) (4) applies when "a non-business debt becomes worthless within the taxable year." While the language of section 23(j) might suggest the conclusion that a debt which had been wiped out by a release of liability had not been "charged off" and therefore did not come within the terms of the section, it is difficult to see how such a debt could be considered not to have "become worthless within the taxable year," as required by section 23(k) (4). To the extent that Bowles Lunch might imply that, under the circumstances of this case, plaintiff's debt had not become worthless within the meaning of section 23(k) (4), it is hereby overruled.

The Bowles Lunch case is inconsistent with the decisions of the Courts of Appeals in Commissioner of Internal Revenue v. National Bank of Commerce of San Antonio, 5 Cir., 112 F.2d 946, and Commissioner of Internal Revenue v. Spreckels, 9 Cir., 120 F.2d 517. The National Bank of Commerce of San Antonio case held that there was a bad debt loss under section 23(k) of the Revenue Act of 1934, 48 Stat. 680, 689, 26 U.S.C.A. Int.Rev.Acts, page 673, when a taxpayer received property which had secured an indebtedness and cancelled the debt. The court said, 112 F.2d at page 947, that "everything that...