Scarlett v. Comm'r of Internal Revenue
| Decision Date | 25 March 1974 |
| Docket Number | 3434-70.,Docket Nos. 3433-70 |
| Citation | 61 T.C. 795 |
| Parties | RAMSAY SCARLETT AND COMPANY, INC., PETITIONER v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENTBALTIMORE STEVEDORING COMPANY, INC., PETITIONER v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT |
| Court | U.S. Tax Court |
OPINION TEXT STARTS HERE
Jacques T. Schlenger, Theodore W. Hirsh, and Harry D. Shapiro, for the petitioners.
John J. Weiler, for the respondent.
In September 1965, petitioners Ramsay Scarlett and Baltimore Stevedoring discovered that their bookkeeper had embezzled approximately $1.5 million of corporate funds. The majority of the embezzlements were accomplished by the use of four different types of corporate checks. As to each of three of such types, some checks were drawn and paid prior to the enactment of the Uniform Commercial Code in Maryland, and some afterwards. Insurance provided only $50,000 of recovery for petitioners in 1965. In 1969, petitioners received $475,000 as a settlement from the bank at which all the checks involved had been cashed, and $25,000 from the accounting firm which worked on the corporate books. On their respective 1965 returns, petitioners claimed theft losses for the full amounts of the embezzlements discovered in 1965 less insurance proceeds received that year. Held, that sec. 1.165-1(d)(3), Income Tax Regs., is a reasonable and valid interpretation of sec. 165(e), I.R.C. 1954. Held, further, that in 1965 Ramsay Scarlett had no reasonable prospect of recovering from either its accountants or from the embezzler, but did have a reasonable prospect of recovering approximately $1 million from the bank at which the checks had been cashed. Thus, this amount of Ramsay's claimed theft loss in 1965 is disallowed. Held, further, that Baltimore Stevedoring, in 1965, had a reasonable prospect of recovering the full amount it claimed as a loss in 1965, and thus is not entitled to any such deduction in that year.
In these consolidated cases respondent has determined the following deficiencies in petitioners' Federal income taxes:
+------------------------------------------------------+
¦Petitioner ¦Taxable year ¦Deficiency ¦
+--------------------------+--------------+------------¦
¦ ¦( ¦1962 ¦$89,796.12 ¦
+--------------------------+--+-----------+------------¦
¦ ¦( ¦1963 ¦71,419.48 ¦
+--------------------------+--+-----------+------------¦
¦ ¦( ¦1964 ¦79,862.26 ¦
+--------------------------+--+-----------+------------¦
¦Ramsay Scarlett & Co., Inc¦( ¦1965 ¦115,652.43 ¦
+--------------------------+--+-----------+------------¦
¦ ¦( ¦1966 ¦80,590.01 ¦
+--------------------------+--+-----------+------------¦
¦ ¦( ¦1967 ¦8,060.83 ¦
+--------------------------+--+-----------+------------¦
¦ ¦( ¦1968 ¦31,684.98 ¦
+--------------------------+--+-----------+------------¦
¦Baltimore Stevedoring Co ¦ ¦1965 ¦202,129.11 ¦
+------------------------------------------------------+
Because of concessions, the only issue remaining for our decision is whether the petitioners are entitled under section 165(e)1 to claim deductions in 1965 for theft losses resulting from embezzlements of corporate funds.
Some of the facts have been stipulated and are so found.
Petitioner Ramsay Scarlett & Co., Inc. (Ramsay), is a Maryland corporation which had its principal office in Baltimore, Md., at the time the petition herein was filed. For each of its taxable years involved in the instant case, Ramsay filed Federal income tax returns on a calendar year basis with the district director of internal revenue, Baltimore, Md.
Petitioner Baltimore Stevedoring Co., Inc. (Stevedoring) is also a Maryland corporation which had its principal office in Baltimore, Md., at the time it filed its petition herein. Stevedoring filed its 1965 calendar Federal income tax return with the district director of internal revenue, Baltimore, Md.
The petitioners are closely affiliated. Charles Scarlett, Jr. (Charles), and his immediate family, and William D. G. Scarlett (William) and his immediate family each own 50 percent of the outstanding shares of both companies. William was the president of both corporations and Charles the executive vice president. In addition the petitioners shared the same office facilities and employees.
During the taxable year 1965, and for many years prior thereto, Ramsay was engaged in the business of acting as a ship's agent for ships docking at the Port of Baltimore. When a ship arrived in the port, it was Ramsay's duty to pay for any ‘arrival expenses' which the ship might incur. Such expenses, which included the fees required in order for the ship to be allowed to enter the port, ranged from less than $100 to several thousand dollars depending on the vessel involved. Ramsay would pay such expenses for the ship by writing a check on Ramsay's agency account with the Equitable Trust Co. (Equitable) in Baltimore. In addition, Ramsay was expected to advance cash to the masters of the vessels for other expenses, such as the salaries of the crew members. In approximately 55 percent of the dockings in which Ramsay was involved between 1962 and 1964, less than $1,500 in cash advances were required by the masters; in approximately 85 percent of the dockings, the amount was less than $5,500, although on a very few occasions, the amount required was in excess of $50,000. The following table summarizes the amounts of arrival expenses and cash advances to masters which Ramsay paid out in the years 1962, 1963, and 1964:2
+-----------------------------------------------+
¦Year¦Cash to masters¦Other arrival¦Total ¦
+----+---------------+-------------+------------¦
¦ ¦ ¦expenses ¦ ¦
+----+---------------+-------------+------------¦
¦ ¦ ¦ ¦ ¦
+----+---------------+-------------+------------¦
¦1962¦$545,273.23 ¦$243,009.56 ¦$788,282.79 ¦
+----+---------------+-------------+------------¦
¦1963¦680,355.30 ¦234,439.61 ¦914,794.91 ¦
+----+---------------+-------------+------------¦
¦1964¦954,504.86 ¦255,264.89 ¦1,209,769.75¦
+-----------------------------------------------+
Except for two occasions between 1962 and 1964, all cash advances in excess of $10,000 were delivered to the masters by Brinks, Inc. (Brinks). For such $10,000 advances, when handled by Brinks, Ramsay would write a check on its agency account and make it payable to Equitable. William L. Lampe (Lampe), the treasurer of both petitioners, or Howard Raley (Raley), one of petitioners' bookkeepers, would call ahead to Equitable to inform it of the Brinks' pickup. On most occasions, it would be Raley who would then deliver the check to a teller at the bank, who would cash the check, and hold the proceeds for the Brinks' representative. The Brinks' representative would then pick up such proceeds from a teller at a special teller's window in the bank. On those occasions when an employee of Ramsay would make the delivery to the master, the cash was obtained from a safe located in one of Ramsay's offices.3 For years it had been standard procedure at Ramsay to replenish the cash contained in such safe by having an employee write a check on the agency account payable to an individual— Lampe in the vast majority of cases, one of the Scarletts or Raley on a few occasions— and having such individual endorse it in blank. The check was then taken to Equitable by a Ramsay employee— normally Raley during the 1962 to 1965 period— where the check was cashed, and the proceeds then returned to the cash drawer in the safe. The largest check of this type which was cashed during the 1962-65 period was one on July 23, 1962, for $18,300, payable to Lampe. The vast majority of such checks, however, were for less than $10,000. The average amount of such checks cashed each month at Equitable was approximately $40,000. As required by Ramsay's insurer, a Ramsay employee was not permitted to carry more than $5,000 on his person at any time. Thus, if a check for more than $5,000, payable to an individual, had to be cashed, two or more Ramsay employees would go to the bank, or else one employee would make several pickups.
In addition to taking care of arrival expenses and cash advances to shipmasters, Ramsay, as ship's agent, also provided funds for expenses a ship might incur while in the Port of Baltimore. Such expenses included charges for fuel and repairs, and for the loading and unloading of the vessel. During the 1962-64 period, Ramsay incurred approximately $4 million of such expenses each year. After performing all of such services for the vessel, Ramsay would proceed to settle its account with the ship owner.
During the taxable year 1965, and for many years prior thereto, Stevedoring was engaged in the business of providing Stevedoring services to ships docking at the Port of Baltimore. During the 1962-65 period, a substantial portion of Stevedoring's business involved those vessels for which Ramsay acted as ship's agent, although Stevedoring also furnished services to other vessels.
+---------------------------------------------------------+
¦ ¦1962 ¦1963 ¦1964 ¦
+---------------------+-----------+-----------+-----------¦
¦ ¦ ¦ ¦ ¦
+---------------------+-----------+-----------+-----------¦
¦Total cash to masters¦$541,273.23¦$680,355.30¦$954,504.86¦
+---------------------+-----------+-----------+-----------¦
¦Delivered by: ¦ ¦ ¦ ¦
+---------------------+-----------+-----------+-----------¦
¦Brinks ¦364,992.96 ¦344,240.00 ¦509,807.18 ¦
+---------------------+-----------+-----------+-----------¦
¦Ramsay employees ¦176,280.27 ¦336,115.30...To continue reading
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