Loewi v. Ryan, 100

• Decision Date: 25 January 1956
• Docket Number: 101,23708.,Dockets 23707,No. 100,100
• Citation: 229 F.2d 627
• Parties: Mortimer W. LOEWI and Lillian B. Loewi, Appellants, v. Raymond F. RYAN and Rea Forhan Pedrick, Administratrix of William J. Pedrick, deceased, Appellees. Mortimer W. LOEWI and Lillian B. Loewi, Appellants, v. Denis J. McMAHON, Appellee.
• Court: U.S. Court of Appeals — Second Circuit

229 F.2d 627 (1956)

Mortimer W. LOEWI and Lillian B. Loewi, Appellants, v. Raymond F. RYAN and Rea Forhan Pedrick, Administratrix of William J. Pedrick, deceased, Appellees.

Mortimer W. LOEWI and Lillian B. Loewi, Appellants, v. Denis J. McMAHON, Appellee.

Nos. 100, 101, Dockets 23707, 23708.

United States Court of Appeals Second Circuit.

Argued November 17, 1955.

Decided January 25, 1956.

Willkie, Owen, Farr, Gallagher & Walton, Mark F. Hughes, Sandow Holman, H. Bartow Farr, Jr., New York City, for appellants.

Arthur S. Ecker, Paul W. Williams, U. S. Atty. for the Southern Dist. of New York, New York City, for appellees.

Before HAND, FRANK and MEDINA, Circuit Judges.

HAND, Circuit Judge.

These are appeals in two actions tried together, and brought to recover income taxes erroneously collected. The result turns on whether the plaintiffs were entitled to the deduction of a "non-business debt" from their joint income tax for the year 1944; and, if they were, there was an excess deduction remaining after 1944, to which they were also entitled in 1945 and 1946. Two issues were raised: (1) whether the deduction made from the plaintiffs' joint income tax in 1944, was of a debt that had survived until that year; and (2) assuming that the debt was still in existence whether it had not become "entirely worthless" before 1944, or if it had not, whether the plaintiffs were justified under the statute — § 23(k) (4), Title 26 U.S.C.A. — in postponing until 1944 the liquidation of collateral pledged to secure it, which left the remainder "entirely worthless." The evidence upon the first issue was contradictory, and concededly was not so preponderant that the judge should have directed a verdict in the defendants' favor: indeed, they do not say that it was. As to the second issue, which assumes that the debt still existed in 1944, the defendants do not dispute that the plaintiffs in 1944 had possession of property of substantial value that had been given as security for the debt, that they liquidated the security in that year; and that the debtor, at least as early as 1943 and probably for some years before, had no other assets with which to pay the debt. On these facts the defendants argue that the plaintiffs knew that the unsecured part of the debt — by far the greater part — was "entirely worthless in 1943 or earlier, and that they forbore until 1944 to liquidate the security in order to take a larger deduction from their taxable joint income than they could have taken in 1943 or earlier. This the defendants say they had no privilege to do.

The first question is whether the passages in the charge that the plaintiffs challenge were directed to whether the debt survived transactions between the plaintiffs and the debtor before 1944. There can be no doubt we think that they were not so directed, but to the privilege of postponement. The colloquial charge was as follows:

"And in connection, as I say, with whether the debt became worthless in 1944 I charge you that the postponement of a bad debt deduction until the collateral is applied to the debt cannot be permitted solely because of the existence of this collateral. Such postponement must be shown to have been in good faith and bona fide for a taxpayer.

"Under all the circumstances you should satisfy yourselves that a claim of deduction for this debt in 1944 is consistent with reason, common sense and economic reality, and it was made in good faith and in all respects bona fide."

The court did not define the phrases, "good faith and bona fide for a taxpayer," or "consistent with reason, common sense and economic reality"; but, if there could be any doubt that this passage was meant to impose a condition upon the privilege of postponement, the requests that he refused lay it:

(1) "the indebtedness has not become worthless within the meaning of the Internal Revenue Code unless and until all of the collateral securing the indebtedness has been completely realized upon and credited against the indebtedness."

(2) "if the jury found that the indebtedness was secured by collateral and that that collateral was not completely realized upon until the year 1944 the indebtedness could not have become worthless until that year."

Again after the jury was recalled the judge said the following:

"If you find that in any year the Loewis held collateral and that collateral had value you are instructed that postponement of a bad debt deduction until the collateral is applied to the debt cannot be permitted solely because of the existence of that collateral. Such postponement must be shown to have been in good faith and bona fide for a taxpayer."

This language could only have been on the hypothesis that the plaintiffs had not released the debt, and that they had continued to hold partial, though inadequate, security for it until 1944. The upshot of all these passages was therefore that, although they might postpone liquidation, it was only in the exercise of good faith, bona fides, reason, common sense or economic reality, whatever these terms should mean.

We cannot agree that this instruction was correct, or that a taxpayer is not privileged to liquidate his security for whatever purposes he thinks most profitable, among them the reduction of his taxes. It is so abundantly settled in decisions of the Supreme Court¹ that a taxpayer's motive is irrelevant in determining his liability that we need not cite the very numerous decisions of the lower courts. It has at times been said that Gregory v. Helvering, 293 U.S. 465, 55 S.Ct. 266, 79 L.Ed. 596, is at war with this doctrine, because it was only the purpose of the taxpayer to escape taxation that made futile the elaborate web of legal transactions which she wove in entire accord with the letter of the Act. We do not say that in that case the resulting legal transactions would not under the law of the state have created a corporation, or that the transfers and distributions would not have been recognized. Nevertheless, we hold that the Act is to be interpreted against its own background, and in deciding how far it adopted all legal transactions that the state law may have covered, it was proper to exclude those that had no other result than to evade taxation. The purpose of the Act was to exempt from tax only such legal transactions as arose out of an enterprise or venture that had some other authentic object of its own, and were neither alien and hostile to the raising of revenue, nor designed to effect no change in legal interests except to defeat a tax. The sale of property pledged, mortgaged or otherwise transferred to secure a debt does change the legal interest of the creditor, for it then determines how much of the debt shall become unsecured. It is the creditor's privilege to decide when that shall be done, and to cumber the privilege with such conditions as "good faith," "common-sense" or "economic reality" is to deny its full measure, quite aside from any uncertainty in the meaning of the words used.

In what we say we do not wish to be understood as meaning that a taxpayer's decision as to when his security has lost all value is subject to no review. No doubt he takes his chances that that may have happened before he acts; and we do not say that he will be protected if a reasonable person in his place would have thought that it had happened earlier. But, so long as he passes that test he is free to choose his time, whatever his purpose. No other conclusion is possible in the case of a secured debt under a regulation that limits any deduction whatever to occasions when the debt has become "entirely worthless." We are not in accord with the decision of the Tax Court in In re Leopold Spingarn, 7 T.C.M. 498, 501, "that a taxpayer cannot be permitted to hold collateral indefinitely and take a deduction as it suits his fancy when the debt in excess of the collateral was hoplessly bad in prior years." If that is desired, there must be some change in the Act or at least in the Regulations. Nor can we see any relevance in what we said in Scovill Manufacturing Co. v. Fitzpatrick, 2 Cir., 215 F.2d 567, 570, quoting from Belser v. Commissioner, 4 Cir., 174 F.2d 386, 390. The instruction which the judge there gave to the jury was to test whether any debt existed at all, and...