Hess v. Comm'r of Internal Revenue, Docket No. 6024.

Citation7 T.C. 333
Decision Date08 July 1946
Docket NumberDocket No. 6024.
PartiesCARL HESS, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
CourtUnited States Tax Court

OPINION TEXT STARTS HERE

An amount paid by the petitioner in the taxable year in part satisfaction of a guarantee given to his sister against loss of an investment in stock purchased from him, held deductible under section 23(e)(2), I.R.C. Samuel Tenenbaum, Esq., for the petitioner.

S. Earl. Heilman, Esq., for the respondent.

The respondent determined a deficiency of $400.33 in the income tax of petitioner for the year 1941. The only issue is whether the petitioner is entitled to a deduction of $1,100 under section 23(e)(1) or (2) of the Internal Revenue Code, relating to losses sustained by individuals.

FINDINGS OF FACT.

The petitioner is a resident of Birmingham, Alabama. He reported his income on the cash basis for the taxable year 1941 and for the year 1933. The petitioner was secretary-treasurer of the ‘Parisian Company, Inc.,‘ hereinafter referred to as the Parisian Co., a corporation which conducted a mercantile business in Birmingham until it was adjudicated a bankrupt in 1933. Reta H. Lerner is a sister of the petitioner and is a resident of Memphis, Tennessee.

In 1920 the Parisian Co. had an outstanding capital stock of $45,000, consisting of 450 shares of common stock of the par value of $100 per share. The petitioner and several associates purchased all of this stock on November 17, 1920, for the purpose of engaging in the mercantile business. The petitioner paid $15,000 for 150 shares of the stock and became a director and the secretary-treasurer of the corporation. In November 1922 the Parisian Co. authorized an issue of 550 shares of preferred stock of the par value of $100 per share.

In 1925 the petitioner sold to Reta H. Lerner 50 shares of preferred stock of the Parisian Co. which had been issued to him some time before and were owned by him at the time of the sale. Reta H. Lerner paid the petitioner $5,000 in cash for the stock, which she obtained by mortgaging a small apartment house owned by her and her husband. At the time of the sale the petitioner orally agreed with Reta H. Lerner that he would guarantee her against any loss on the stock for a period of 10 years from the date of the sale, and a few days later he confirmed such guaranty by letter. The petitioner used the proceeds of the sale to purchase a home for himself in Birmingham.

In 1927 the Parisian Co. had outstanding 450 shares of common, 363 shares of class B common, and 550 shares of preferred stock; and it authorized an increase in its capital stock and provided for the issuance of 500 additional shares of class B common and 1,450 additional shares of preferred stock. In August 1929 the petitioner received in a split-up of the class B common stock, 4,460 shares of such stock for 243 1/2 shares then owned by him.

In 1930 the petitioner sold to Reta H. Lerner for cash 200 shares of class B common stock of the Parisian Co., at a price of $5 per share, or a total consideration of $1,000. At the time of the sale the petitioner gave Reta H. Lerner a guaranty similar to the one theretofore given her in connection with the sale to her of the 50 shares of preferred stock in 1925.

On January 4, 1933, when the Parisian Co. was on the verge of bankruptcy, the petitioner, in order to protect Reta H. Lerner in the event of his death, took out a policy of insurance on his life with the Protective Life Insurance Co., for $5,000, naming her as beneficiary therein. Bankruptcy proceedings were instituted against the Parisian Co. early in 1933 and, as a result of those proceedings, its assets were distributed under the direction of the bankruptcy court. The stockholders, including Reta H. Lerner, who owned 50 shares of preferred stock and 200 shares of class B stock when the bankruptcy proceedings were instituted, received nothing in the distribution.

On March 8, 1933, the petitioner filed a voluntary petition in bankruptcy in the United States District Court for the Northern District of Alabama, and he received his discharge in bankruptcy on July 20, 1933. The petitioner did not include Reta H. Lerner in the schedule of his creditors, and Reta H. Lerner did not file any claim in the bankruptcy court.

After filing his petition and prior to his discharge, to wit, in May 1933, the petitioner visited Reta H. Lerner in Memphis and informed her that the Parisian Co. had failed and that its stock was without value. She reminded him of his guaranty, and he told her that, while he would be unable for some time to repay the principal amount of her investment, he would do so when he could afford it, but that he would at once begin payment of interest on the obligation at the rate of 5 per cent, or $300 per year, and would pay such interest in monthly installments of $25 each. He confirmed this oral agreement by a letter dated May 31, 1933. From May 1933 up to and including the year 1940 he paid Reta H. Lerner $25 per month as interest, pursuant to his agreement.

On February 14, 1941, the petitioner sent Reta H. Lerner a letter reading as follows:

Referring to my letter of May 31, 1933 and also the conversation I had with you in Memphis, I have started to pay you $100. towards the principal of this money in question beginning February 1st of this year.

I am writing you this letter so we both will have a record of this transaction. * * *

In February 1941 and in each of the ten following months of 1941 the petitioner, in accordance with his letter of February 14, 1941, paid Reta H. Lerner $100, or a total of $1,100. He did not pay her any amount as interest after 1940. The petitioner was not indebted to Reta H. Lerner, either during 1941 or at any other time, in any amount other than that for which he was obligated by the agreements of guaranty hereinabove mentioned.

In March and April 1942 the petitioner changed the beneficiary of the policy of insurance on his life, substituting his son and two sisters other than Reta H. Lerner as beneficiaries. On May 1, 1942, he assigned the policy to Reta H. Lerner as collateral security for any indebtedness which might be due her at the time of his death. The policy was in force when this proceeding was heard.

In determining the deficiency the respondent held that the amount of $1,100 paid by the petitioner to Reta H. Lerner in 1941 and deducted on his return as a ‘loss of guarantee‘ is not an allowable deduction.

OPINION.

TYSON, Judge:

The sole issue here is whether the petitioner should be allowed to deduct the $1,100 which he paid to Reta H. Lerner in 1941. The petitioner claims the deduction under section 23(e) of the Internal Revenue Code,1 and contends that that amount, having been paid pursuant to the guaranty made in connection with the sale of his own stock, constitutes a loss incurred either in trade or business, or in a transaction entered into for profit though not connected with the trade or business. He relies upon R. W. Hale, 32 B.T.A. 356; affirmed on another point, 85 Fed.(2d) 819; Marjorie Fleming Lloyd-Smith, 40 B.T.A. 214; also affirmed on another point, 116 Fed.(2d) 642; certiorari denied, 313 U.S. 588; and Robert S. Farrell, 44 B.T.A. 238.

The respondent contends that the loss, assuming there was one, was not sustained in trade or business or in a transaction entered into for profit; and he presents two other objections which affect petitioner's right to the deduction.

The first objection is that the petitioner has failed to prove that he sold his shares of stock in the Parisian Co. to Reta H. Lerner at the times and in the amounts alleged by him, or that in making such sales the petitioner contracted to guarantee Reta H. Lerner against the loss of her investment. The petitioner testified that he sold to Reta H. Lerner 50 shares of preferred stock in 1925 and 200 shares of class B stock in 1930; that such shares were shares which were owned by him; and that at the time of the sales he agreed to guarantee her against loss. There is evidence in the record corroborating the petitioner's testimony and some which points the other way. We have carefully considered and weighed all the evidence in connection with this objection of respondent and have found the facts to be as testified to by petitioner and as corroborated by other evidence.

The second objection of the respondent is that, as Reta H. Lerner apparently had knowledge of the bankruptcy proceedings against the petitioner (and there is no evidence that she did not), the petitioner's obligation under the guaranty was a provable debt from which the petitioner was released by virtue of his discharge in bankruptcy, and that, as the petitioner's promise to pay made after the adjudication was not sufficiently clear, distinct, unequivocal, certain, and unambiguous to revive the debt, ‘the guaranties were not valid obligations in 1941, and that the payments made to Mrs. Lerner in that year thus amounted to gifts.‘ We do not think...

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6 cases
  • United States v. Keeler
    • United States
    • U.S. Court of Appeals — Ninth Circuit
    • 26 Octubre 1962
    ...from the investment. In this connection, the situation here differs from the situation in Hale v. Commissioner, 32 B.T.A. 356 and Carl Hess, 7 T.C. 333 and similar cases cited by taxpayer. In those cases the guaranty was made in connection with the sale of stock owned by the taxpayer himsel......
  • Stamos v. Comm'r of Internal Revenue
    • United States
    • U.S. Tax Court
    • 14 Julio 1954
    ...therefore, the guaranty was given in a transaction entered into for profit. See generally Moses Cohen, 44 B. T. A. 709, 713; Carl Hess, 7 T. C. 333. When petitioner paid the legal expenses in connection with the guaranty, the corporation was insolvent and his investment therein was worthles......
  • Fox v. Comm'r of Internal Revenue, Docket No. 18802.
    • United States
    • U.S. Tax Court
    • 15 Junio 1950
    ...and not a bad debt loss under section 23(k)(4), petitioner, among other cases, cites and relies on Abraham Greenspon, 8 T.C. 431; Carl Hess, 7 T.C. 333; and R. W. Hale, supra. The Hale and Hess cases are different and are distinguishable from the instant case in that the payments in those c......
  • Wakelee v. Comm'r of Internal Revenue, Docket No. 28411.
    • United States
    • U.S. Tax Court
    • 31 Octubre 1951
    ...other situations as to be considered unlike recognized business transactions and thus outside the scope of the deduction section. See Carl Hess, 7 T.C. 333 (guarantee against loss); Norbert H. Wiesler, 6 T.C. 1148, affd. (C.A. 6) 161 F.2d 997; Commissioner v. Wilson (C.A. 9), 163 F.2d 680, ......
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