Pollak v. Commissioner of Internal Revenue, 11166.

• Decision Date: 06 January 1954
• Docket Number: No. 11166.,11166.
• Citation: 209 F.2d 57
• Parties: POLLAK et al. v. COMMISSIONER OF INTERNAL REVENUE.
• Court: U.S. Court of Appeals — Third Circuit

209 F.2d 57 (1954)

POLLAK et al. v. COMMISSIONER OF INTERNAL REVENUE.

No. 11166.

United States Court of Appeals Third Circuit.

Argued December 14, 1953.

Decided January 6, 1954.

Mason G. Kassel, New York City, for petitioner.

S. Dee Hanson, Washington, D. C. (H. Brian Holland, Assistant Atty. Gen., Ellis N. Slack, Sp. Assts. to Atty. Gen., on the brief), for respondent.

Before MARIS, GOODRICH and McLAUGHLIN, Circuit Judges.

MARIS, Circuit Judge.

This is a petition by the taxpayers to review a decision of the Tax Court as to their income tax liability for the taxable year 1949. The sole question involved is whether the court erred in holding that a loss sustained by the taxpayers in that year was a non-business bad debt deductible as a short-term capital loss only to the limited extent permitted by Section 23(k) (4) of the Internal Revenue Code, 26 U.S.C., rather than an ordinary loss resulting from a transaction entered into for profit and deductible in full under Section 23(e) (2) of the Code, as the taxpayers contend. The facts as found by the Tax Court are as follows:

The taxpayers, Leo L. and Virginia M. Pollak, husband and wife, filed joint returns for the year 1949 with the Collector of Internal Revenue for the Fifth District of New Jersey. The taxpayers each purchased 200 shares of stock of the Pollak Engineering and Manufacturing Corporation for $20,000 at its inception in January, 1947. Leo L. Pollak was an officer and employee of the corporation.

Leo L. Pollak and another stockholder joined on January 12, 1949, in a guarantee to a bank of loans by the bank to the corporation up to $200,000. They had endorsed notes of the corporation to the bank for $200,000 during the period from October 4, 1948, to December 13, 1948, Leo L. Pollak believing that the corporation would prosper and he would not lose as a result of the endorsements. The corporation, on April 6, 1949, filed a petition for reorganization under the Bankruptcy Act, 11 U.S. C.A. § 1 et seq. Leo L. Pollak paid the bank $100,000 under his guaranty. The first payment was made on March 14, 1949, and the last on June 23, 1949.

The assets of the corporation were sold during the last six months of 1949 pursuant to the plan of reorganization under which the general creditors, including Leo L. Pollak, received 3.59% of their claims. The corporation was indebted to Leo L. Pollak, at the date of the consummation of the plan, in the total amount of $141,928.33 and he received, on or about December 15, 1949, $5,095.24, representing 3.59% of the total amount due him as a general creditor. The affairs of the corporation became progressively worse after it began to be apparent late in 1948 and early in 1949 that it would not be able to perfect an electrical cigarette vending machine on which it was working and spending large amounts for tools, parts, raw materials and other items. Leo L. Pollak knew, when he made the payments to the bank under his guaranty, that he would eventually recover only a small part of the amount which the corporation would owe him.

The taxpayers, on their joint return for 1949, claimed, under the item "Miscellaneous", a deduction of $94,904.76 for Leo L. Pollak's "Payment as Guarantor on Note." The Commissioner, in determining the deficiency for 1949, disallowed the entire deduction claimed in the return under "Miscellaneous." On the basis of these facts, the Tax Court, affirming the Commissioner's determination, held that Leo L. Pollak's payment to the bank in the taxable year, as guarantor of the corporation's notes endorsed by him, constituted a loss sustained from a statutory non-business bad debt deductible only to the limited extent permissible under the statute as a short-term capital loss, and not in full as an ordinary loss. 20 T.C. 376. The Tax Court thereupon entered its decision accordingly from which the taxpayers petitioned this court for review.

We are satisfied that in so holding the Tax Court erred. It is doubtless true, as the Commissioner says, that under the doctrine of subrogation the corporation became indebted to Leo L. Pollak for the payments made by him on his endorsements and guaranty as and when he made them. But these payments were made under a legal obligation of endorsement and guaranty which he had entered into previously at a time when he believed that the corporation would prosper and that he would not lose as a result of his action. It is utterly unrealistic to suggest, as the Tax Court does in its opinion in this case, that Leo L. Pollak when he entered into this transaction "fully intended and expected to be repaid by the then existing solvent corporation if he was ever called upon to make good his endorsement or guaranty". On the contrary we all know that a stockholder who thus loans his credit to his corporation does so in the hope and expectation that the corporation, with the additional credit thus made available to it, will succeed in preserving or adding to the value of his stock. He hopes and expects not to have to make good on his guaranty but knows that if the venture fails and he must pay, his chances of reimbursement from the defaulting corporation are likely to be very remote. And so here it is obvious that Leo L. Pollak expected, when he made his endorsements and guaranty, to realize...