United States v. Keeler

• Decision Date: 26 October 1962
• Docket Number: No. 17359.,17359.
• Parties: UNITED STATES of America, Appellant, v. H. F. KEELER and Alice H. Keeler, his wife, Appellees.
• Court: U.S. Court of Appeals — Ninth Circuit

308 F.2d 424 (1962)

UNITED STATES of America, Appellant, v. H. F. KEELER and Alice H. Keeler, his wife, Appellees.

No. 17359.

United States Court of Appeals Ninth Circuit.

September 20, 1962.

Rehearing Denied October 26, 1962.

Louis F. Oberdorfer, Asst. Atty. Gen., Lee A. Jackson, Joseph Kovner and Myron C. Baum, Attys., Dept. of Justice, Tax Div., Washington, D. C., Brockman Adams, U. S. Atty., and Joseph C. McKinnon, Asst. U. S. Atty., Seattle, Wash., for appellant.

Rosling, Williams, Lanza & Kastner, DeWitt Williams and William D. Cameron, Seattle, Wash., for appellees.

Before MERRILL and BROWNING, Circuit Judges, and MURRAY, District Judge.

MURRAY, District Judge.

H. F. Keeler (hereinafter referred to as the taxpayer) and his wife, Alice H. Keeler,¹ brought this action in the district court to recover income taxes paid by them for the year 1955 as a result of the refusal of the Commissioner of Internal Revenue to allow in full certain losses as deductions in the computation of their income. The case was tried in the district court before a jury, and the district court directed a verdict allowing taxpayer a deduction of $88,588.90 in full as a business bad debt under the provisions of § 166 of Title 26, U.S.C.A. The district court refused to allow taxpayer a further deduction of $13,694.99 in full as a loss sustained in a transaction entered into for profit or a loss related to his business within the meaning of § 165 of Title 26, U.S.C.A. From the allowance of the $88,588.90 deduction in full, the government appealed, and from the refusal to allow the $13,694.99 deduction in full, the taxpayer cross appealed. Jurisdiction of the district court is conferred by 28 U.S.C. § 1346 and § 1402, and jurisdiction of the appeal and cross appeal is conferred on this court by 28 U.S.C. § 1291.

The appeal and cross appeal will be treated separately herein, although the same factual background is relevant to both. This background was presented through an agreed statement of facts supplemented by testimony and exhibits, and the facts which are largely undisputed, are as follows:

Taxpayer was engaged in the industrial laundry business in and around Seattle, Washington. He started in this business on a small scale in 1920, and gradually built a substantial business. At the times material here the business was conducted under the name of Overall Cleaning and Supply Company, a co-partnership of which taxpayer owned and controlled 82.5%, the remaining 17.5 percent being owned by two elderly persons.

In 1953, plaintiff, together with one Joseph W. Smith, who controlled Northwest Laundry Company, a Portland, Oregon, corporation engaged in the industrial laundry business, and one Henry Hoffman, who was also engaged in the industrial laundry business in Milwaukee, Wisconsin, formed Northern Industrial Laundries, Ltd., hereinafter referred to as Northern, a corporation under the laws of Province of Ontario, Canada. Northern was created to, and did, engage in the same type of industrial laundry business in Toronto, Ontario, as taxpayer, Joseph W. Smith's corporation and Henry Hoffman were engaged in their respective locations. Out of a total investment in Northern of $610,000 in common and preferred stock and debentures, taxpayer invested $95,770.00. The other shareholders in Northern, constituting a majority both in numbers and amount invested had no connection with taxpayer's Seattle laundry business.

At about the time of the incorporation of Northern, taxpayer, Hoffman and Smith encouraged a number of persons referred to as the Hooker group to purchase stock and debentures of Northern by orally promising to reimburse such group for any loss they might sustain by reason of their investment. Taxpayer's wife, Alice H. Keeler, was included in the Hooker group. The investment of the Hooker group in Northern amounted to $71,980.00.

Northern commenced operations on January 1, 1954, in Toronto. On January 7, 1954, taxpayer, Smith and Hoffman executed a guaranty securing to the Canadian Bank of Commerce payment by Northern of a line of credit or loan up to the amount of $150,000. Thereafter, taxpayer and Smith released Hoffman from the guaranty to Canadian Bank of Commerce.

From the start, Northern operations were unsuccessful financially, and taxpayer and Smith's Northwest Industrial Laundry Company supplied Northern with additional working capital in the form of cash advances, payment of invoices and credit sale of used equipment. At the time of the compromise settlement hereinafter mentioned, the advances made to Northern by taxpayer totalled $132,336.11, and there is no dispute but that those advances represent loans and credit from taxpayer to Northern and for which Northern was indebted to taxpayer.

In October, 1954, Northern executed a $250,000 mortgage to taxpayer and Smith's Northwest Industrial Laundry Company to secure certain of the advances previously made by them and also their guaranty to the Canadian Bank of Commerce. In order to secure an extension of the Canadian Bank of Commerce's then existing loan to Northern, the mortgage was assigned by taxpayer and Northwest Industrial Laundry Company to the Canadian Bank of Commerce. On the same day the mortgage was issued, Northern executed a demand promissory note to taxpayer in the sum of $205,000, and a like note in the same amount to Northwest Industrial Laundry Company. These two notes represented the total amount of the advances made by taxpayer and Northwest Industrial Laundry Company to Northern and also the amount of the guaranty.

Northern continued to lose money in its operation and was unable to pay the $205,000 notes when demand was made by taxpayer and Northwest Industrial Laundry Company and was likewise unable to pay the $150,000 which it owed the Canadian Bank of Commerce, which was guaranteed by taxpayer and Northwest Industrial Laundry Company. Eventually in March, 1955, a compromise was worked out whereby taxpayer received $43,747.20 of the $132,336.11 which he advanced to Northern, and the difference between the two sums, $88,588.90 is the amount involved in the government's appeal. As a part of the same compromise, taxpayer and others, including the Hooker group sold their stock and debentures in Northern to certain Canadian residents at a substantial loss. Taxpayer, Smith and Hoffman reimbursed the Hooker group for the loss which the Hooker group sustained on the stock and debentures under their oral agreement above referred to. Taxpayer's share of this reimbursement amounted to $13,694.99, and it is this amount which is involved in the cross appeal.

THE GOVERNMENT'S APPEAL

Section 166 of the Internal Revenue Code of 1954 (Title 26, U.S.C. § 166), under which the district court allowed in full the $88,588.90 as a deduction, provides in pertinent part as follows:

"§ 166. Bad debts

"(a) General rule. —

"(1) Wholly worthless debts. — There shall be allowed as a deduction any debt which becomes worthless within the taxable year.

"(2) Partially worthless debts. — When satisfied that a debt is recoverable only in part, the Secretary or his delegate may allow such debt, in an amount not in excess of the part charged off within the taxable year, as a deduction.

* * * * * *

"(d) Nonbusiness debts. —

"(1) General Rule. — In the case of a taxpayer other than a corporation —

"(A) subsections (a) and (c) shall not apply to any nonbusiness debt; and

"(B) where any nonbusiness debt becomes worthless within the taxable year, the loss resulting therefrom shall be considered a loss from the sale or exchange, during the taxable year, of a capital asset held for not more than 6 months.

"(2) Nonbusiness debt defined. — For purposes of paragraph (1), the term `nonbusiness debt\' means a debt other than —

"(A) a debt created or acquired (as the case may be) in connection with a trade or business of the taxpayer;² or

"(B) a debt the loss from the worthlessness of which is incurred in the taxpayer\'s trade or business."

The government contends that the $88,588.90 loss incurred by the taxpayer on his loans and advances should have been treated as a nonbusiness bad debt and deducted as a short term capital loss under § 166(d) (1) (B) rather than as a business debt, wholly deductible, as found by the district court. The district court concluded that the debt was one acquired in connection with the trade or business of the taxpayer, and therefore, was not a nonbusiness debt, as that term is defined in § 166(d) (2) (A).³

Whether a particular loss or expense is incurred in a taxpayer's trade or business is a question of fact in each particular case. Higgins v. C. I. R., 312 U.S. 212, 61 S.Ct. 475, 85 L.Ed. 783; Treas.Reg. 1954 Code, Sec. 1.1665. However, when that determination involves the interpretation of a statute the decision of the tax court or district court is subject to review here. C. I. R. v. Smith, 203 F.2d 310, 311 (C.A.2, 1953). In this conection, a statement made in Washburn v. C. I. R., 51 F.2d 949, 591 (C.A.8, 1931) is relevant and bears repeating here:

"The Board here found certain primary facts. It drew therefrom the ultimate conclusion that petitioner was not regularly engaged in trade or business under section 204 (a). This required a construction of section 204(a) as applied to the facts. The question here is a mixed one of law and fact. Where similar question was raised in Bishoff v. Commissioner of Internal Revenue (C.C.A. 3) 27 F.(2d) 91, 92, the court said: `Even accepting as conclusive the Board\'s findings of primary facts, it sometimes happens that the reviewing court must inquire, as on writ of error, into the ultimate fact finding in order correctly to determine whether the decision is validly supported by evidence and therefore is "in accordance with law".\' * * * that there may be some degree of finality in a finding of fact by an administrative body may be conceded, but such finding cannot take from the courts the power to

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