Niblock v. CIR

• Decision Date: 31 October 1969
• Docket Number: No. 17624.,17624.
• Parties: Donald C. NIBLOCK, Jr., and Marilyn Niblock, Petitioners-Appellants, v. COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellee.
• Court: U.S. Court of Appeals — Seventh Circuit

417 F.2d 1185 (1969)

Donald C. NIBLOCK, Jr., and Marilyn Niblock, Petitioners-Appellants, v. COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellee.

No. 17624.

United States Court of Appeals Seventh Circuit.

October 31, 1969.

Stephen A. Seall, John L. Carey, South Bend, Ind., William A. Thorne, Elkhart, Ind., for appellants.

Johnnie M. Walters, Asst. Atty. Gen., Stanley L. Ruby, Attorney, Tax Division, U. S. Department of Justice, Washington, D. C., Lee A. Jackson, Thomas L. Stapleton, Attorneys, Department of Justice, Washington, D. C., for appellee.

Before DUFFY, Senior Circuit Judge, KILEY and FAIRCHILD, Circuit Judges.

DUFFY, Senior Circuit Judge.

This is an appeal from a judgment of the Tax Court which upheld the decision of the Commissioner of Internal Revenue in determining deficiencies in taxpayer's federal income taxes. These deficiencies resulted from a redetermination by the Commissioner that losses sustained by taxpayer in 1963 constituted nonbusiness bad debts and were erroneously carried back against ordinary income for the years 1960 and 1961. Donald C. and Marilyn Niblock, husband and wife, filed joint federal income tax returns for the years in issue.

Donald C. Niblock, Jr. (taxpayer) started his business career as an employee of Niblock Nash Sales, Inc., a family-owned business which had been started by his father. He resigned his position and sold his stock in the Company when he was unable to agree with his father over business policy.

Taxpayer and one Merlin Alson subsequently formed Niblock Flying Service, Inc. Taxpayer owned 50% of the stock and was a salaried employee. He eventually sold his interest to Alson and purchased a business which he operated under the name of Hart Mobile Homes Corporation. He was both a stockholder and an employee.

In 1960 taxpayer sold his stock in Hart Mobile Homes but entered into a contract with the purchasers whereby he was to serve as president of the corporation for a five-year period.

Taxpayer claims that after eight or nine months, he discovered he could not work for anyone other than himself or in a business in which he had a substantial proprietary interest. Thereafter, he negotiated a termination of his employment agreement with Hart Mobile Homes.

Approximately October 10, 1961, taxpayer and Alson organized Aero-Marine Development Corporation. He and Alson each owned 50% of the stock and each paid $2,500 therefor.

Aero-Marine initially sold low-priced airplanes and later began the manufacture and sale of small fiberglass boats. Taxpayer was an officer and employee of Aero-Marine from the date of incorporation until his resignation on August 26, 1963. During this period he received a salary for the services which he rendered. As salary, taxpayer was paid at the weekly rate of $150 or $7,800 annually.

From October 25, 1961 to December 31, 1961, Aero-Marine sustained operating losses in the amount of $17,439.13. As a result of these losses, Aero-Marine borrowed $60,000 from a bank. Taxpayer and Alson were guarantors on this loan. The loan was to defray operating expenses necessary to remain in business. In August 1963, taxpayer and Alson were guarantors of Aero-Marine's obligations in the respective amounts of $48,000 and $21,000.

Taxpayer turned over to the Company his personal airplane valued at $16,000 for which he took a demand promissory note. The Company sold the plane for $16,408.13 and used all the proceeds therefrom to pay its creditors.

Both taxpayer and Alson had made advances to the corporation. In August 1963, the taxpayer's advances totaled $16,408.13, while advances from Alson totaled $3,215.77. Neither the advances nor the guarantees altered the voting power or proportionate equity interests of taxpayer and Alson.

The operating history of Aero-Marine shows a net operating loss for 1961 in the amount of $17,439.13; in 1962, the taxable income before deducting its net operating loss carry-forward from 1961 was $8,028.97. The net operating loss in 1963 was $71,605.99.

In October 1963, as a result of his guarantee, taxpayer paid the bank $28,000. In all, taxpayer paid a total of $48,000 to discharge corporate obligations which he previously had guaranteed. Taxpayer had received $4,820 in assets from Aero-Marine and therefore deducted $43,720 as an ordinary loss. He also claimed the $16,408.13 advance as a capital loss since it had become worthless in 1963. The Internal Revenue Service granted taxpayer the right to carry back his net operating losses for 1963 and 1964 to his 1960 and 1961 returns.

In his notice of deficiencies dated September 26, 1966, the Commissioner determined that taxpayer's loss in the amount of $43,720 was a capital loss. Accordingly he determined that the tentative carryback adjustments were erroneously allowed thus resulting in the deficiencies determined for the years 1960 and 1961.

In the Tax Court, taxpayer amended his petition to claim the direct advance of $16,408.13 to the corporation as an ordinary loss.

Section 166(a), Internal Revenue Code of 1954, provides that a taxpayer may deduct a bad debt in full in the year that it becomes worthless. This is limited by the language in Section 166(d), Internal Revenue Code of 1954, which indicates that nonbusiness bad debts are to be treated as short term capital losses. Under Section 1.166-5(b) (2), Income Tax Regs., the character of a bad debt is determined by the relationship it bears to the...