Whipple v. Commissioner of Internal Revenue

• Citation: 83 S.Ct. 1168,10 L.Ed.2d 288,373 U.S. 193
• Decision Date: 13 May 1963
• Docket Number: No. 305,305
• Parties: A. J. WHIPPLE et al., Petitioners, v. COMMISSIONER OF INTERNAL REVENUE
• Court: United States Supreme Court

373 U.S. 193

83 S.Ct. 1168

10 L.Ed.2d 288

A. J. WHIPPLE et al., Petitioners,

v COMMISSIONER OF INTERNAL REVENUE.

No. 305.

Argued March 26, 27, 1963.

Decided May 13, 1963.

Rehearing Denied June 17, 1963.

See 374 U.S. 858, 83 S.Ct. 1863.

Charles Dillingham, Houston, Tex., for petitioners.

Solicitor Gen., Archibald Cox, Washington, D.C., for respondent.

Mr. Justice WHITE delivered the opinion of the Court.

Section 23(k)(1) of the Internal Revenue Code of 1939¹ provides for the deduction in full of worthless debts other than nonbusiness bad debts while § 23(k)(4) restricts nonbusiness bad debts to the treatment accorded losses on the sale of short-term capital assets.² The statute defines a nonbusiness bad debt in part as 'a debt * * * other than a debt the loss from the worthlessness of which is incurred in the taxpayer's trade or busi- ness.' § 23(k)(4). The question before us is whether petitioner's activities in connection with several corporations in which he holds controlling interests can themselves be characterized as a trade or business so as to permit a debt owed by one of the corporations to him to be treated within the general rule of § 23(k)(1) as a 'business' rather than a 'nonbusiness' bad debt.

Prior to 1941 petitioner was a construction superintendent and an estimator for a lumber company but during that year and over the next several ones he was instrumental in forming and was a member of a series of partnerships engaged in the construction or construction supply business. In 1949 and 1950 he was an original incorporator of seven corporations, some of which were successors to the partnerships, and in 1951 he sold his interest in the corporations along with his equity in five others in the rental and construction business, the profit on the sales being reported as long-term capital gains. In 1951 and 1952 he formed eight new corporations, one of which was Mission Orange Bottling Co. of Lubbock, Inc., bought the stock of a corporation known as Mason Root Beer³ and acquired an interest in a related vending machine business. From 1951 to 1953 he also bought and sold land, acquired and disposed of a restaurant and participated in several oil ventures.

On April 25, 1951, petitioner secured a franchise from Mission Dry Corporation entitling him to produce, bottle, distribute and sell Mission beverages in various counties in Texas. Two days later he purchased the assets of a soleproprietorship in the bottling business and conducted that business pursuant to his franchise as a sole pro- prietorship. On July 1, 1951, though retaining the franchise in his own name, he sold the bottling equipment to Mission Orange Bottling Co. of Lubbock, Inc., a corporation organized by petitioner as mentioned, of which he owned approximately 80% of the shares outstanding.⁴ In 1952 he purchased land in Lubbock and erected a bottling plant thereon at a cost of $43,601 and then leased the plant to Mission Orange for a 10-year term at a prescribed rental. Depreciation was taken on the new bottling plant on petitioner's individual tax returns for 1952 and 1953.

Petitioner made sizable cash advances to Mission Orange in 1952 and 1953, and on December 1, 1953, the balance due him, including $25,502.50 still owing from his sale of the bottling assets to the corporation in July 1951, totaled $79,489.76. On December 15, 1953, petitioner advanced to Mission Orange an additional $48,000 to pay general creditors and on the same day received a transfer of the assets of the corporation with a book value of $70,414.66. The net amount owing to petitioner ultimately totaled $56,975.10, which debt became worthless in 1953 and is in issue here. During 1951, 1952 and 1953 Mission Orange made no payments of interest, rent or salary to petitioner although he did receive such income from some of his other corporations.⁵

Petitioner deducted the $56,975.10 debt due from Mission Orange as a business bad debt in computing his 1953 taxable income. The Commissioner, claiming the debt was a nonbusiness bad debt, assessed deficiencies. The Tax Court, after determining that petitioner in 1953 was not in the business of organizing, promoting, managing or financing corporations, of bottling soft drinks or of general financing and money lending, sustained the deficiencies. A divided Court of Appeals affirmed, 5 Cir., 301 F.2d 108, and upon a claim of conflict ⁶ among the Courts of Appeals, we granted certiorari. 371 U.S. 875, 83 S.Ct. 146, 9 L.Ed.2d 113.

I.

The concept of engaging in a trade or business as distinguished from other activities pursued for profit is not new to the tax laws. As early as 1916, Congress, by providing for the deduction of losses incurred in a trade or business separately from those sustained in other transactions entered into for profit, § 5, Revenue Act of 1916, c. 463, 39 Stat. 756, distinguished the broad range of income or profit producing activities from those satisfying the narrow category of trade or business. This pattern has been followed elsewhere in the Code. See, e.g., § 23(a)(1) and (2) (ordinary and necessary expenses); § 23(e) (1) and (2) (losses); § 23(l)(1) and (2) (depreciation); § 122(d)(5) (net operating loss deduction). It is not surprising, therefore, that we approach the problem of applying that term here with much writing upon the slate.

In Burnet v. Clark, 287 U.S. 410, 53 S.Ct. 207, 77 L.Ed. 397 (1932), the long-time president and principal stockholder of a corporation in the dredging business endorsed notes for the company which he was forced to pay. These amounts were deductible by him in the current year under the then existing law, but to carry over the loss to later years it was necessary for it to have resulted from the operation of a trade or busi- ness regularly carried on by the taxpayer. The Board of Tax Appeals denied the carry-over but the Court of Appeals for the District of Columbia held otherwise on the grounds that the taxpayer devoted all of his time and energies to carrying on the business of dredging and that he was compelled by circumstances to endorse the company's notes in order to supply it with operating funds.⁷ This Court in turn reversed and reinstated the judgment of the Board of Tax Appeals, since '(t)he respondent was employed as an officer of the corporation; the business which he conducted for it was not his own. * * * The unfortunate endorsements were no part of his ordinary business, but occasional transactions intended to preserve the value of his investment in capital shares. * * * A corporation and its stockholders are generally to be treated as separate entities.' A similar case, Dalton v. Bowers, 287 U.S. 404, 53 S.Ct. 205, 77 L.Ed. 389, decided the same day, applied the same principles.⁸

A few years later the same problem arose in another context. A taxpayer with large and diversified investment holdings, including a substantial but not controlling interest in the du Pont Company, obtained a block of stock of that corporation for distribution to its officers in order to increase their management efficiency. The taxpayer, as a result, became obligated to refund the annual dividends and taxes thereon and these amounts he sought to deduct as ordinary and necessary expenses paid or incurred in the carrying on of a trade or business pursuant to § 23(a) of the Revenue Act of 1928. The Court, Deputy v. du Pont, 308 U.S. 488, 60 S.Ct. 363, 84 L.Ed. 416 (1940), assuming arguendo that the taxpayer's activities in investing and managing his estate were a trade or business, nevertheless denied the deduction because the transactions 'had their origin in an effort by that company to increase the efficiency of its management' and 'arose out of transactions which were intended to preserve his investment in the corporation * * *. The well established decisions of this Court do not permit any such blending of the corporation's business with the business of its stockholders.' 308 U.S., at 494, 60 S.Ct., at 366, 84 L.Ed. 416. Reliance was placed upon Burnet v. Clark and Dalton v. Bowers, supra.

The question assumed in du Pont was squarely up for decision in Higgins v. Commissioner, 312 U.S. 212, 61 S.Ct. 475, 85 L.Ed. 783 (1941). Here the taxpayer devoted his time and energies to managing a sizable portfolio of securities and sought to deduct his expenses incident thereto as incurred in a trade or business under § 23(a). The Board of Tax Appeals, the Court of Appeals for the Second Circuit and this Court held that the evidence was insufficient to establish taxpayer's activities as those of carrying on a trade or business. 'The petitioner merely kept records and collected interest and dividends from his securities, through managerial attention for his investments. No matter how large the estate or how continuous or extended the work required may be, such facts are not sufficient as a matter of law to permit the courts to reverse the decision of the Board.' 312 U.S., at 218, 61 S.Ct., at 478, 85 L.Ed. 783.

Such was the state of the cases in this Court when Congress, in 1942, amended the Internal Revenue Code in respects crucial to this case. In response to the Higgins case and to give relief to Higgins type taxpayers, see H.R.Rep. No. 2333, 77th Cong., 2d Sess. 46, § 23(a) was amended not by disturbing the Court's definition of 'trade or business' but by following the pattern that had been established since 1916 of '(enlarging) the category of incomes with reference to which expenses were deductible,' McDonald v. Commissioner, 323 U.S. 57, 62, 65 S.Ct. 96, 98, 89 L.Ed. 68; United States v. Gilmore, 372 U.S. 39, 45, 83 S.Ct. 623, 627, 9 L.Ed.2d 570, to include expenses incurred in the production of income.

At the same time, to remedy what it deemed the abuses of permitting any worthless debt to be fully deducted, as was the case prior to this time, see H.R.Rep. No. 2333, 77th Cong., 2d Sess. 45, Congress restricted the full deduction under § 23(k) to bad debts...