Decisions will be entered for the respondent in docket Nos. 3210-67 and 6468-67.
Petitioners were the principal stockholders and directors of Gillespie Equipment, Inc. Robert E. Gillespie was also a salaried executive of that company. Advances made to the company, and the payment, as guarantors, of corporate debt gave rise to bad debts. Held, the losses were nonbusiness bad debts inasmuch as such losses were not proximately related to a trade or business of the petitioners.
*1025 The respondent determined deficiencies in income taxes from the petitioners as follows:
| Taxable | Tax | |
| Docket No. | year | deficiency |
| 6468-67 | 1 1962 | $ 6,782.61 |
| 3210-67 | 1963 | 3,415.55 |
| 3210-67 | 1964 | 5,423.30 |
| 6468-67 | 1965 | 10,257.40 |
*1026 The deficiencies result from the disallowance by the respondent of certain deductions claimed by the petitioners as a result of advances to, or the payment of obligations of, Gillespie Equipment, Inc.
The respondent contends that the deductions in question resulted from the worthlessness *142 of nonbusiness bad debts as defined in section 166(d). 2
The petitioner claims that:
these deductions are business bad debts and/or losses of these petitioners (officers-stockholders) and are job related as opposed to investor related and were made for the purpose of protecting petitioners' jobs, earned income, their business prestige and credit standing in the community, and deductible under Section 162 and Section 166(a); or in the alternative, are then deductible under Section 165(c)(2) relating to transactions entered into for profit, or Section 212, relating to expenses for the production of income.
FINDINGS OF FACT
The parties submitted stipulation of facts, supplemented by oral testimony. The facts as stipulated are incorporated herein.
The petitioners are husband and wife. At the time of the filing of the petitions, the petitioners resided at 3030 S.E. 45th Avenue, Portland, Oreg. For the taxable years here in question, the petitioners jointly filed their income tax returns with the district director of internal revenue, Portland, Oreg.
At all times material herein, the petitioners were the principal *143 stockholders, directors, and officers of Gillespie Decals, Inc., Gillespie Properties, Inc., and Gillespie Equipment, Inc.
Gillespie Decals, Inc., was engaged in the manufacturing and sale of industrial decals. During the taxable years in question, petitioner Robert E. Gillespie was its principal executive officer. He had been controlling stockholder and principal officer for more than 10 years previously and as such received a substantial annual salary from Gillespie Decals, Inc.
Gillespie Properties, Inc., was a corporation organized in 1961 to hold the real property from which Gillespie Decals, Inc., conducted its business. The petitioners owned all of the stock of Gillespie Properties, Inc.
For a period of years prior to 1961, Robert E. Gillespie became concerned over the fact that the sales of Gillespie Decals, Inc., had reached a plateau and approximately 50 percent of its business depended on a single customer, the U-Haul Co. As a result, he sought to obtain other sources of business. He purchased the business of the Douglas Hood Co., which was engaged in the distribution of trailers and truck bodies. He thereupon caused Gillespie Equipment, Inc., to be organized, to which *144 this business was transferred in February 1961. *1027 The business of Gillespie Equipment, Inc., was then expanded to include a truck and trailer parts repair business and the distribution and sale of additional products such as hydraulic loaders, telephone company trucks, and related equipment. Mr. Gillespie was the president of Gillespie Equipment, Inc. In 1961 he drew a salary of approximately $ 13,500 from Gillespie Equipment, Inc. In subsequent years, however, he never drew more than $ 3,400 per year as a salary from Gillespie Equipment, Inc. Mrs. Gillespie was not actively engaged in the business, and she received no salary from Gillespie Equipment, Inc.
On May 11, 1962 Gillespie Equipment, Inc., entered into an agreement with Trans-America Equity, a small business investment company, pursuant to which the latter purchased $ 60,000 face amount of convertible debentures issued by Gillespie Equipment, Inc. In order to induce Trans-America Equity to make such purchase, Robert E. Gillespie and Dorothy B. Gillespie, individually, and as guardians for their children, deposited in escrow as security for the payment of the convertible debentures all of the stock of Gillespie Properties, *145 Inc., all of the stock of Gillespie Decals, Inc., all of the stock of Gillespie Equipment, Inc., and a second mortgage on certain property at Lake Oswego, Oreg. The escrow agreement provided that repayment of the debentures "would be guaranteed by the undersigned [the petitioners] to the extent of the value of the items herein placed in escrow." At all times material herein, the value of the collateral was substantially in excess of $ 60,000.
On March 22, 1963, Robert E. Gillespie, individually, and Gillespie Equipment, Inc., entered into an agreement to lease a building to be erected by Gunderson Bros. Investment, Inc., an Oregon corporation, at 4350 Northwest Front Avenue, Portland, Oreg. Pursuant to that agreement, on July 26, 1963, Robert E. Gillespie, individually, and Gillespie Equipment, Inc., entered into a lease of said building for a term of 10 years, beginning August 1, 1963, at a monthly rental of $ 2,055.90. The building was used in the business of Gillespie Equipment, Inc. However, in view of the limited capital of Gillespie Equipment, Inc., Gunderson Bros. Investment, Inc., required Robert E. Gillespie, individually, to assume liability for the payment of the rent. *146 After a period of 3 years, Robert E. Gillespie could obtain a release from this personal guarantee upon presentation of evidence the Gillespie Equipment, Inc., had net worth sufficient to justify his release.
At about the same time, an agreement was entered into between Gillespie Equipment, Inc., and Gunderson Bros. Engineering Corp. (an affiliate of Gunderson Bros. Investment, Inc.) whereby Gunderson would finance the inventory of Gillespie Equipment, Inc., under a "flooring plan" form of financing, which provided that a specified *1028 percentage of the amount received from any sales out of such inventory would be paid over to Gunderson. Robert E. Gillespie agreed personally to guarantee the repayment of the sums so advanced if Gillespie Equipment, Inc., did not pay.
On July 31, 1963, Robert E. Gillespie and Dorothy B. Gillespie executed a guaranty agreement with the United States National Bank of Portland, a national banking association, pursuant to which the guarantors assumed liability for any indebtedness owing by Gillespie Equipment, Inc., to the bank.
Between September 10, 1961, and February 10, 1962, Gillespie Equipment, Inc., entered into several agreements with Vernstrom-Robertson *147 Leasing Corp. for the lease of personal property consisting of office furniture and equipment and machine shop equipment. In order to secure said leases, Robert E. Gillespie, individually, was required to execute a form of guaranty pursuant to which he guaranteed the payment of all rentals due under the leases.
In February 1963 Gillespie Equipment, Inc., ordered a bookkeeping machine from the Burroughs Co. in order to keep up with the large number of transactions being made by the firm at that time. Purchase of this equipment was financed by agreement with C.I.T. Corp., a national financing concern. Robert E. Gillespie, individually, guaranteed payment of the purchase price pursuant to the terms of this financing.
At various times, Dorothy B. Gillespie made loans or advances to Gillespie Equipment, Inc., out of her individual funds aggregating $ 20,421.00. Gillespie Equipment, Inc., issued its notes, as evidence of such advances, on the dates and in the amounts set forth below:
| Date | Amount |
| July 29, 1963 | $ 11,821 |
| Nov. 7, 1963 | 6,000 |
| Dec. 20, 1963 | 2,600 |
| 20,421 |
In addition, Gillespie Equipment, Inc., issued a note dated December 3, 1963, to Robert E. Gillespie in the amount of $ 8,149.00. There *148 is no evidence showing the purpose for which such note was issued.
Beginning in the fall of 1962 and continuing throughout the year 1963, Gillespie Equipment, Inc., suffered from the lack of adequate personnel and was unable to properly account for its business transactions. Delivery of the accounting machine was delayed and interim statements were not available. In December 1963, however, an unaudited statement of the financial condition of Gillespie Equipment, Inc., disclosed that the company had suffered a substantial loss and was unable to meet its obligations. At the same time, it was *1029 discovered that Gillespie Equipment, Inc., had not paid over to Gunderson Bros. Engineering Corp. the amounts due under the "flooring plan" of financing. In the trade, the failure to pay such funds over to the lender is deemed a payment "out of trust" and constitutes the serious breach of the borrower's obligation.
The stockholders of Gillespie Equipment, Inc., thereupon executed a common law assignment transferring the assets of Gillespie Equipment, Inc., to the Oregon Association of Credit Management, which organization thereupon took over the assets and proceeded to liquidate Gillespie Equipment, *149 Inc. Since it was apparent that the indebtedness of Gillespie Equipment, Inc., would not be satisfied as a result of such liquidation, Robert E. Gillespie undertook to satisfy his liability as guarantor of its various obligations.
Gillespie Equipment, Inc., was in default under the terms of the convertible debentures issued to Trans-America Equity on account of the failure to pay the interest due January 1, 1964. Robert E. Gillespie thereupon initiated negotiations with Trans-America Equity as a result of which it was agreed that Trans-America Equity would release the collateral held to secure the debentures in consideration of the payment of $ 20,400 in cash and the transfer of all of the stock of Gillespie Properties, Inc., at an agreed valuation of $ 40,000. As a part of this agreement, Gillespie Decals, Inc., agreed to lease the property from Gillespie Properties, Inc., for a specified rental and the petitioners were given the option to repurchase the stock of Gillespie Properties, Inc., for the sum of $ 41,000 together with a penalty or interest charge. Such stock was subsequently repurchased from Trans-America for $ 41,800. As a result of the foregoing, petitioners sustained *150 a loss on account of the guaranty of the indebtedness of Gillespie Equipment, Inc., in the amount of $ 60,400.
On or about May 9, 1964, the liability of Robert E. Gillespie to Gunderson Bros. Investment, Inc., and Gunderson Bros. Engineering Corp., both on account of the liability under the lease and the failure to pay over funds received "in trust" under the financing agreement, was satisfied by the payment of the sum of $ 3,000 and the transfer by petitioners to Gunderson Bros. Engineering Corp. of certain property owned by the petitioners, making up a total consideration of $ 21,357.33.
During the year 1965, the liability of petitioners on account of the guaranty of the indebtedness of Gillespie Equipment, Inc., to the United States National Bank of Oregon was satisfied by the payment of Robert E. Gillespie of the sum of $ 6,971.12. The liability of Robert E. Gillespie on account of the guaranty of the purchase of the business machine financed through C.I.T. was satisfied by the payment of the balance of $ 4,421.84. The liability of Robert E. Gillespie on *1030 account of the guaranty on the lease of certain personal property by Gillespie Equipment, Inc., was satisfied by the payment *151 of $ 996.76.
As a result of the foregoing transactions, the petitioners in their income tax returns claimed the following:
| Docket No. | Docket No. | ||
| 3210-67 | 6468-67 | ||
| 1963 | 1964 | 1965 | |
| 1. Notes issued 11/7/63 and 12/20/63 | $ 8,600 | ||
| 2. Transfer of property and cash to Gunderson | |||
| Bros. Investment, Inc., and Gunderson Bros. | |||
| Engineering Corp | $ 21,357.33 | ||
| 3. Note issued 7/29/63 | $ 11,821.00 | ||
| 4. Note issued 12/3/63 | 8,149.00 | ||
| 5. U.S. bank loan paid per demand | 6,971.12 | ||
| 6. Guaranty of C.I.T. conditional sales | |||
| contract | 4,421.84 | ||
| 7. Guaranty of Vernstrom-Robertson lease | 996.76 | ||
| 8. Guaranty of debenture bonds | 60,200.00 | ||
| Total bad debts or losses claimed | 8,600 | 21,357.33 | 92,559.72 |
The respondent concedes and the Court finds that the advances made by the petitioners to Gillespie Equipment, Inc., were not collectible and became worthless. It further appears that the petitioners were not aware of the financial condition of Gillespie Equipment, Inc., until December 1963. At the time that the petitioners satisfied or discharged their obligations to the creditors of Gillespie Equipment, Inc., that corporation was hopelessly insolvent and any resulting obligation or indebtedness from Gillespie Equipment, Inc., to the petitioners was worthless.
OPINION
The *152 petitioners owned or controlled all of the stock of Gillespie Equipment, Inc. That corporation obtained a loan of $ 60,000 from Trans-America Equity for which it issued $ 60,000 face amount of convertible debentures, secured by the guaranty of the petitioners to the extent of the value of certain collateral. The collateral consisted of all of the stock of Gillespie Decals, Inc., all of the stock of Gillespie Properties, Inc., all of the stock of Gillespie Equipment, Inc., and a second mortgage on certain real property owned by the petitioners. The value of the collateral was substantially in excess of $ 60,000.
When Gillespie Equipment, Inc., went into receivership, the debentures were in default. It was incumbent on the petitioners either to satisfy the indebtedness or to risk the loss of the collateral. After some negotiation, petitioners entered into an agreement with Trans-America Equity pursuant to which petitioners paid Trans-America $ 20,400 in cash and transferred to Trans-America all of the stock of Gillespie Properties, Inc., at an agreed valuation of $ 40,000 subject to an option to repurchase such stock at a later date. Petitioners thereupon obtained release of the *153 stock of Gillespie Decals, Inc.
*1031 At the outset it must be recognized that as a result of the discharge of the debentures there arose an obligation running from Gillespie Equipment, Inc., to the petitioners. It is immaterial whether that obligation arose by operation of the law of subrogation or whether there was only an implied obligation on the part of the debtor to make whole the petitioners for the loss sustained on account of the debtor's default. In either case, there was a "debt" within the meaning of section 166 of the Code. Putnam v. Commissioner, 352 U.S. 82 (1956); Bert W. Martin, 52 T.C. 140">52 T.C. 140 (1969); Stratmore v. United States, 420 F. 2d 461 (C.A. 3, 1970); United States v. Hoffman, 423 F. 2d 1217 (C.A. 9, 1970).
Although in the Putnam case the Supreme Court found that the guarantor took over the worthless obligation by operation of the law of subrogation, that decision has been given a broad interpretation by this Court. Bert W. Martin, supra. In this, we have been joined by the Court of Appeals for the Third Circuit in the Stratmore case and the Court of Appeals for the Ninth Circuit in the Hoffman case. In Stratmore, the court said:
It is not meaningful to emphasize unduly *154 the common law principle of subrogation in analyzing the substantial realities upon which federal taxation is based. When the creditor turns to the guarantor for payment, the debt is already uncollectible. In both Putnam and the present case the claims against the debtors were at all relevant times no more collectible in the hands of the guarantors than in those of the original lender. To allow the tax result to turn on the presence or absence of this technical right of subrogation under state law would be to undermine the Putnam doctrine: taxpayers could change capital losses to ordinary losses almost at will. For example, every guarantor could obtain an ordinary loss simply by reaching an agreement with the creditor for payment of less than the full amount of the guarantor's liability, and thus avoiding any subrogation. We hold that taxpayers' payment pursuant to the guarantees was not a loss under section 165(c)(2) but rather a non-business bad debt under section 166(d).
Respondent does not question that petitioners sustained a loss on account of payment of the debt of Gillespie Equipment, Inc. Gillespie Equipment, Inc., was hopelessly insolvent at the time. Respondent contends, *155 however, that the transaction resulted in a loss on account of a nonbusiness bad debt subject to the limitations of section 166(d).
The petitioners argue that in obtaining the release of the stock of Gillespie Decals, Inc., Robert E. Gillespie incurred a loss which was connected with his employment as the principal executive officer of that company. While this may be have a consequential benefit of having discharged the indebtedness for which the stock was held as collateral security, we must also look to the initial transaction pursuant to which the petitioners pledged that stock. Serino v. United States, 252 F. Supp. 717">252 F. Supp. 717 (D. S.C. 1966); cf. George P. Weddle, 39 T.C. 493">39 T.C. 493 (1962), affd. 325 F. 2d 849 (C.A. 2, 1963).
*1032 The petitioners' pledge was made in connection with their guaranty of the debentures issued by Gillespie Equipment, Inc. Petitioners contend that the loss resulting from this guaranty was proximately related to their positions as corporate officers, rather than to their interests as investors in the corporation.
It is clear from the record that in obtaining financing through Trans-America Equity, the petitioners were acting as stockholders and not for the purpose of providing *156 additional income to Robert E. Gillespie, individually. The collateral was not the sole property of Robert E. Gillespie. It was the property of all the stockholders. In determining the nature of the loss, we must look to that transaction and not to the fact that the subsequent default may have jeopardized Robert E. Gillespie's employment with Gillespie Decals, Inc.
In this case, while Robert E. Gillespie was the principal officer of Gillespie Equipment, Inc., and undoubtedly intended to profit from his services for the corporation, the true nature of the transaction with Trans-America was that of a stockholder furnishing collateral in order to obtain additional working capital for the corporation. Applying either the primary-motivation test of Niblock v. Commissioner, 417 F. 2d 1185 (C.A. 7, 1969), affirming a Memorandum Opinion of this Court, or the significant-motivation test of Weedle v. Commissioner, 325 F. 2d 849 (C.A. 2, 1963), affirming 39 T.C. 493">39 T.C. 493 (1962), it is clear that the petitioners have not met their burden of showing that Robert E. Gillespie's interest as an employee was the motivation for guaranteeing the corporate notes. See Stratmore v. United States, supra.
Dorothy *157 B. Gillespie was not in the trade or business of being a corporate officer. She received no salary from Gillespie Equipment, Inc., and there is no indication that her time, attention, or services were devoted to the business conducted by Gillespie Equipment, Inc. Compare Weddle v. Commissioner, supra. Her status was that of an investor. See Whipple v. Commissioner, 373 U.S. 193 (1963).
Petitioners' reliance on those cases which hold that working as a corporate executive for a salary may be a trade or business, e.g., Trent v. Commissioner, 291 F. 2d 669 (C.A. 2, 1961), reversing 34 T.C. 910">34 T.C. 910 (1960), is misplaced. See Eugene H. Rietzke, 40 T.C. 443">40 T.C. 443 (1963). Though Robert E. Gillespie was a salaried executive of Gillespie Equipment, Inc., and Gillespie Decals, Inc., the petitioners have not demonstrated that Mr. Gillespie's bad debt loss as guarantor of the obligations of Gillespie Equipment, Inc., was proximately related to his business of being a corporate executive. See Stratmore v. United States, supra.Since the debt arose out of a "capital" or "nonbusiness" transaction, it must be regarded as a nonbusiness bad debt subject to the limitations of section 166(d). Whipple v. Commissioner, supra;*158 George P. Weddle, supra.
*1033 The same rule would apply with respect to the loss sustained by the petitioners on account of the guaranty of the indebtedness of Gillespie Equipment, Inc., to the United States National Bank of Oregon. This was the joint and several liability of the petitioners and while the petitioners personally guaranteed payment of the indebtedness, there is no evidence that they did so other than in their role as stockholders or investors in the corporation.
In order to provide sufficient space for the business of Gillespie Equipment, Inc., Robert E. Gillespie negotiated an agreement with Gunderson Bros. Investment, Inc., for the lease of a building to be erected by Gunderson. In view of the limited capital of Gillespie Equipment, Inc., it was required that the lease be executed in the name of Robert E. Gillespie, individually, and in the name of Gillespie Equipment, Inc., as joint lessee. However, the lease referred to Robert E. Gillespie's obligation as being a personal guaranty. At about the same time, Gunderson Bros. Engineering Corp. (an affiliate of Gunderson Bros. Investment, Inc.) agreed to provide financing for the inventory of Gillespie Equipment, Inc., under *159 a "flooring plan" of financing. As a condition for such financing, Robert E. Gillespie, individually, guaranteed the payment of any amounts due from Gillespie Equipment, Inc.
In the settlement with the Gunderson companies, the amount paid on account of the liability under the lease and the amount paid on account of the breach of the terms of the "flooring plan" of financing were not stated separately. All claims by the Gunderson companies were released and discharged upon the payment by Robert E. Gillespie of $ 3,000 in cash and the transfer of property making up a total payment of cash or its equivalent of $ 21,357.33.
We believe that the loss sustained by Robert E. Gillespie on account of the settlement of his liability under the lease with Gunderson Bros. Investment, Inc., cannot be distinguished from the loss incurred on account of the guaranty of the loan from Trans-America Equity. The one difference between the guaranty of the rental payments to Gunderson Bros. Investment, Inc., and the guaranty of the repayment of the loan from Trans-America Equity was that the guaranty to Gunderson Bros. Investment, Inc., was not required of the other stockholders, but represented the separate *160 liability of Robert E. Gillespie. The record does not justify a finding that there was even significant employee motivation on the part of Robert E. Gillespie in providing the guaranty.
In the year prior to the execution of the lease, 1962, and in the year the lease was executed, 1963, Robert E. Gillespie's salary from Gillespie Equipment, Inc., did not exceed $ 3,400 per year. On the other hand he had a considerable proprietary interest in Gillespie Equipment, Inc. *1034 that would be both protected and enhanced as a result of the additional space that was to be made available under the lease. Further, the lease provided that when Gillespie Equipment, Inc.'s net worth increased, Robert E. Gillespie could be released from his personal guaranty. This provision indicates to us that Robert E. Gillespie was dealing with Gunderson Bros. Investment, Inc., in his capacity as the controlling shareholder of Gillespie Equipment, Inc.
Since the amounts paid by Robert E. Gillespie under the "flooring plan" of financing and under the lease were not stated separately, the Court is unable to distinguish between Mr. Gillespie's loss under the financing agreement with Gunderson Bros. Engineering Corp. and *161 his loss under the lease with Gunderson Bros. Investment, Inc. The record does not justify the application of a different rule to the loss suffered under the financing agreement. It also must be presumed that, as in the transaction with Gunderson Bros. Investment, Inc., Robert E. Gillespie was dealing with Gunderson Bros. Engineering Corp. in his capacity as the controlling shareholder of Gillespie Equipment, Inc.
In our opinion, the amount of $ 21,357.33 paid by Robert E. Gillespie to the Gunderson companies constituted a nonbusiness bad debt subject to the limitations of section 166(d). See Stratmore v. United States, supra.
The same rule should also apply with respect to the losses sustained by Robert E. Gillespie as a result of his guaranty on the lease or purchase of business equipment by Gillespie Equipment, Inc. Accordingly, the payments which he made in the year 1965 to satisfy that liability amounting to $ 996.76 and $ 4,421.84 are properly deducted only as nonbusiness bad debts.
Finally, the petitioners claimed deductions of $ 8,600 for the year 1963 and $ 11,821 for the year 1965 on account of advances made to Gillespie Equipment, Inc., by Dorothy B. Gillespie. Respondent *162 does not question the "worthlessness" of the resulting indebtedness, but has disallowed the deductions on the ground that the loss arose on account of worthlessness of a nonbusiness bad debt subject to the limitations of section 166(d).
It is clear from the record that Dorothy B. Gillespie was not in the trade or business of being a corporate officer. She could derive no income from Gillespie Equipment, Inc., other than as a stockholder. With respect to these advances, she was acting as an "investor" or "stockholder." Whipple v. Commissioner, supra.Loans by investors to a corporation must be treated as nonbusiness bad debts within the meaning of section 166(d). Whipple v. Commissioner, supra.
With respect to the advances made by Dorothy B. Gillespie, any resulting loss falls squarely within the definition of a nonbusiness bad debt under section 166(d).
*1035 An additional deduction of $ 8,149 was claimed for the year 1965 on account of a note in the amount of $ 8,149 issued on December 3, 1963, by Gillespie Equipment, Inc., and payable to Robert E. Gillespie. Respondent questions in his brief whether the note, in fact, represented an indebtedness to Robert E. Gillespie. However, this *163 issue was not raised at the time of the trial. In his opening statement, counsel for the respondent said:
It is the contention of the Respondent that in each of the eight items which your Honor has before you in that guide sheet, in each case it will be exposed at the trial that the facts indicate that there's a bad debt in every case, and that the nature of that bad debt is a non-business bad debt, so that the income tax deductions treatment would be limited to the short-term capital gain treatment.
The respondent's belated attempt to rely on the petitioner's failure to prove that there was a debt must be rejected. However, for the reasons expressed above, we hold that the transaction gave rise to a nonbusiness bad debt subject to the limitations of section 166(d).
Decisions will be entered for the respondent in docket Nos. 3210-67 and 6468-67.