NAT AND HAMRICK v. Commissioner
| Decision Date | 29 April 1980 |
| Docket Number | Docket No. 9287-76. |
| Citation | 1980 TC Memo 149,40 TCM (CCH) 276 |
| Parties | J. Nat and Jenice Hamrick v. Commissioner. |
| Court | U.S. Tax Court |
J. Nat Hamrick, pro se, Rutherfordton, N.C. Matthew E. Bates, for the respondent.
Memorandum Findings of Fact and Opinion
Respondent determined a deficiency of $21,775.14 and an addition to tax under section 66511 of $3,266.67 in petitioners' 1973 Federal income tax. The issues presented for our determination are:
(1) whether petitioners are entitled to an interest deduction under section 163 of $53,867.32 for amounts allegedly paid by petitioners as guarantors of a corporate debt.
(2) whether petitioners' claimed deduction of $2,841.90 for State income taxes should be disallowed for failure to properly substantiate these expenses. Petitioners admit that if an underpayment exists, then they are liable for an addition to tax under section 6651.
Some of the facts have been stipulated. These facts, together with the exhibits attached thereto, are incorporated herein by this reference.
Petitioners J. Nat Hamrick and Jenice B. Hamrick, husband and wife, were residents of Rutherfordton, North Carolina, when their petition in this case was filed. Their joint Federal income tax return for 1973 was filed with the Internal Revenue Service Center, Memphis, Tennessee.
During the year in issue petitioners and their son owned the Plantation Land Company, Incorporated (Plantation) which was engaged in real estate development. In April of 1973, Plantation, in need of financing, issued three promissory notes as a result of obtaining the following loans:
Lender Amount
Allan Feldman and Murray Tapper ............ $187,500
First Federal Savings and Loan Association
Charlotte, N.C. .......................... 515,000
First Federal Savings and Loan Association
Charlotte, N.C. .......................... 185,000
Each of the notes was secured by a deed of trust and payment on each note was guaranteed by several individuals2 including petitioners.
In light of financial difficulties experienced by Plantation, the guarantors were shouldered with the responsibility of repayment. Petitioners claim that they then made payments directly to creditors and directed some moneys to Plantation to pay off as much of the loan installments as was possible.
On their 1973 return, petitioners deducted $53,867.32 for interest payments, claiming that they, as guarantors, paid off installments on the notes and are thus entitled to interest deductions.
Additionally, in 1973 petitioner-husband through his partnership Hamrick & Hamrick, Attorneys, paid the North Carolina Department of Revenue a total of $2,400. On his 1973 return he deducted $2,841.90 in State income taxes claiming that all of the above payments were for State income taxes owed by either himself or Mrs. Hamrick.
On his notice of deficiency respondent disallowed the entire interest deduction claimed by petitioners and the deduction for State income taxes.
OpinionSection 163(a) allows a deduction for all interest paid or accrued within the taxable year on indebtedness.
The general rule3 is that a deduction may not be taken for an interest payment unless the interest is owed on an indebtedness of the one seeking the deduction. Payment by one who is secondarily liable on the debt does not qualify for the deduction. Nelson v. Commissioner 60-2 USTC ¶ 9591, 281 F. 2d 1 (5th Cir. 1960); Abdalla v. Commissioner Dec. 34,967, 69 T.C. 697 (1978); Rushing v. Commissioner Dec. 31,545, 58 T.C. 996 (1972); cf. Putnam v. Commissioner 57-1 USTC ¶ 9200, 352 U.S. 82 (1956).
Petitioners argue that under North Carolina law, as a result of their payment guarantee, they had a primary obligation to pay creditors at any time after default by the corproation. Consequently, they assert that any payment made pursuant to the guarantee represents a discharge of the guarantors' own indebtedness.
It is clear that under North Carolina law a guarantee of payment is an absolute promise by the guarantor to pay the debt at maturity if it is not paid by the principal debtor. Stillwell Enterprises Inc. v. Interstate Equipment Company, 41 N.C. App. 204, 254 S.E. 2d 770 (1979); Wachovia Bank and Trust Co.v. Clifton, 203 N.C. 483, 166 S.E. 334 (1932). The obligation of the guarantor is separate and independent of the obligation of the principal debtor, and the creditor's cause of action against the guarantor ripens immediately upon failure of the principal debtor to pay the debt at maturity. EAC Credit Corporation v. Wilson, 281 N.C. 140, 187 S.E. 2d 752 (1972); Arcady Farms Milling Co.v. Wallace, 242 N.C. 686, 89 S.E. 2d 413 (1955); Cameron Brown Capital Corporation v. Spenser, 31 N.C. App. 499, 229 S.E. 2d 711 (1976). However, petitioners overlook the fact that a guaranty contract is collateral to the primary obligation between the debtor and the creditor. EAC Credit Corporation v. Wilson, supra; Wachovia Bank and Trust Co. v. Clifton, supra. Consequently, payment by the guarantors to the creditors entitles the guarantors to maintain an action against the principal obligor. Indeed, N.C. Gen. Stat. sec. 26-3.14 provides that a guarantor who has made payment on the note of the principal debtor is subrogated to the rights that the erstwhile creditor had against the debtor. Therefore, even though petitioners-guarantors were liable to creditors upon the unsatisfied matured obligations, it is abundantly clear that as between petitioners and Plantation, petitioners were secondarily liable on the debts.
The liability of petitioners to the creditors of Plantation is based on their guaranty contract and is absolute. Yet courts have long recognized that the indebtedness upon which interest arises is that of the primary obligor, not the guarantor, and therefore taxpayer-guarantors have been denied interest deductions under section 163. Nelson v. Commissioner, supra; Eskimo Pie Corp. v. Commissioner Dec. 14,348, 4 T.C. 669 (1945). Accordingly, any payments made by petitioners as guarantors of corporate notes cannot qualify for the interest deduction provided by section 163....
To continue reading
Request your trial