Decision will be entered for the respondent.
1. Where stockholder loaned money to the corporation in which he owned shares, creating a bona fide debtor-creditor relationship, later agreed with other shareholder-creditors of the corporation to subordinate their claims as creditors, held, the loss incurred by the shareholder-creditor is deductible, if at all, as a nonbusiness bad debt and the subordinated agreement entered into by all of the shareholder-creditors is not sufficient to convert the loss from the debt into a loss from a transaction entered into for profit within the meaning of section 23 (e) (2) of the Internal Revenue Code.
2. It appearing that the debt in question was not worthless in 1945, held, that it was not deductible in that year.
*130 The *190 respondent determined a deficiency in petitioner's income tax for the taxable year 1945 in the amount of $ 3,584.03. The issue for our decision is whether the petitioner sustained a deductible loss in the amount of $ 7,002 during the taxable year 1945, resulting from his cancellation of a note payable to him by the Sitterding-Carneal-Davis Company, Inc., during the year 1944.
FINDINGS OF FACT.
The facts stipulated by the parties are found accordingly.
The petitioner is an individual residing in Richmond, Virginia, whose Federal income tax return for 1945 was filed with the collector of internal revenue for the district of Virginia.
*131 The petitioner was a stockholder and director of Sitterding-Carneal-Davis Company, Inc. (hereinafter referred to as S-C-D), which was incorporated on July 30, 1930, under the laws of the Commonwealth of Virginia to engage in the lumber and millwork business. The authorized capital stock of S-C-D was 3,500 shares with a par value of $ 50 per share. On August 8, 1944, 2,728.5 shares of S-C-D were issued and outstanding. Of the issued and outstanding stock of S-C-D, 45.21 per cent was owned as follows:
| Name | Per cent |
| F. Will | 4.86 |
| Mrs. F. B. Davis Estate | 3.72 |
| Agnes B. Sitterding | 10.87 |
| W. H. Sitterding | 15.92 |
| F. Sitterding, Jr | 9.84 |
The *191 Sitcarda Finance & Holding Corporation (hereinafter referred to as Sitcarda) was organized on August 1, 1930, under the laws of the Commonwealth of Virginia for the purpose of owning certain lands and buildings. Sitcarda had an authorized capital stock of 1,000 shares of a par value of $ 100 per share. The issued and outstanding shares of capital stock of Sitcarda were owned as follows:
| Name | Per cent |
| F. Will | 5 |
| Mrs. F. B. Davis Estate | 22 |
| Agnes B. Sitterding | 13.4 |
| W. H. Sitterding | 18.9 |
| F. Sitterding, Jr | 13.9 |
| W. C. Carneal, Jr | 24.8 |
| W. Creed Davis | 2 |
During the years 1931 to 1943, inclusive, Sitcarda rented certain lands and buildings to S-C-D. The unpaid rent due Sitcarda from S-C-D on this property during 1931 to 1943, inclusive, totaled $ 38,000. On December 31, 1943, $ 5,500 of this amount was paid in cash to Sitcarda on account. On the balance due, S-C-D issued its note in the face amount of $ 32,500 to Sitcarda.
During the taxable years 1935 to 1945, inclusive, S-C-D realized the following net income and/or sustained the following losses from operations:
| Year | Net income | Net loss |
| 1935 | $ 14,613.29 | |
| 1936 | $ 3,057.74 | |
| 1937 | 3,350.77 | |
| 1938 | 4,823.34 | |
| 1939 | 5,210.44 | |
| 1940 | 19,510.68 | |
| 1941 | 3,137.35 | |
| 1942 | 11,871.13 | |
| 1943 | 88,777.54 | |
| 1944 | 60,348.87 | |
| Jan. 1 to May 31, 1945 | 9,264.74 | |
| June 1, 1945, to May 31, 1946 | 4,198.30 |
*132 *192 On August 8, 1944, S-C-D was indebted to its stockholders or members of their families and/or a corporation owned by members of the Sitterding family as follows:
| Amount | |||
| Face of | of curtailment | ||
| Name | note | Date of note | |
| W. L. Carneal, Jr | $ 10,000 | Apr. 4, 1939 | $ 200.00 |
| Laura E. Carneal Est. 1 | 20,000 | Oct. 21, 1941 | 400.00 |
| W. H. Sitterding | 9,000 | Dec. 31, 1942 | 395.60 |
| Agnes B. Sitterding | 8,000 | Dec. 31, 1942 | 473.60 |
| F. Sitterding, Jr | 8,000 | Dec. 31, 1942 | 375.60 |
| Virginia Baking Co | 15,000 | Dec. 31, 1942 | 300.00 |
| Sitcarda Finance & Holding Corp. 2 | 32,500 | Dec. 31, 1943 | 650.00 |
| Total | $ 102,500 | $ 2,794.80 |
| Unpaid | ||
| Date of curtailment | balance | |
| Name | Aug. 8, | |
| 1944 | ||
| W. L. Carneal, Jr | June 30, 1944 | $ 9,800.00 |
| Laura E. Carneal Est. 1 | June 30, 1944 | 19,600.00 |
| W. H. Sitterding | July 14, 1944 | 8,604.40 |
| Agnes B. Sitterding | July 14, 1944 | 7,526.40 |
| F. Sitterding, Jr | July 14, 1944 | 3 7,624.40 |
| Virginia Baking Co | July 14, 1944 | 14,700.00 |
| Sitcarda Finance & Holding Corp. 2 | July 14, 1944 | 31,850.00 |
| Total | $ 99,705.20 |
All of the noteholders mentioned in the schedule above, except Sitcarda, released the notes involved by written instruments dated *193 August 8, 1944. Sitcarda released its note on October 27, 1944.
Prior to August 8, 1944, and thereafter until March 24, 1945, S-C-D owed the First and Merchants National Bank, Richmond, Virginia, the sum of $ 20,000 which was evidenced by note. Pursuant to a guarantee agreement petitioner, W. H. Sitterding, Agnes B. Sitterding, W. L. Carneal, and John Christian had jointly and severally guaranteed S-C-D's indebtedness to such bank, which guarantee was in effect during 1944 and thereafter until March 24, 1945.
As of August 8, 1944, S-C-D owed the Central National Bank, Richmond, Virginia, the sum of $ 49,000 which was evidenced by notes. Pursuant to a guarantee agreement petitioner, W. H. Sitterding, W. L. Carneal, Jr., and John Christian had jointly and severally guaranteed S-C-D's indebtedness to such bank, which guarantee was in effect during 1944 and thereafter until March 24, 1945.
During 1944 it was decided to sell or liquidate S-C-D due to its continued losses and poor financial condition. As a part of the plan to accomplish this purpose, three agreements were entered into on or about August 3, 1944.
The first contract was entered into between S-C-D and W. H. Sitterding and W. *194 L. Carneal, Jr., as a committee representing the stockholders, and Henry W. Heine. This contract provided that in consideration of Heine selling certain assets of S-C-D the stockholders of that corporation agreed to transfer all of the outstanding stock to Heine and the shareholder-creditors agreed that they would relinquish their claims as creditors against S-C-D in the amount of $ 99,705.20. Heine was to get a 5 per cent commission on all sales of assets and collections. Heine agreed to deposit the net proceeds of such sales and collections in a joint bank account opened in the names of W. L. Carneal, Jr., and Henry W. Heine. It was further *133 agreed that such net proceeds and collections would first be applied to the indebtedness of S-C-D to the First and Merchants National Bank and the Central National Bank totaling $ 69,000, and next to the payment of all other outstanding indebtedness of S-C-D excepting such indebtedness as may be due on real estate owned by S-C-D. Any excess over the amount necessary to pay the debts of S-C-D was to be paid by Heine to W. H. Sitterding and W. L. Carneal, Jr., as a committee representing the stockholders. If the net proceeds of the sales and *195 collections were insufficient to pay such debts then the stockholders of S-C-D were to be personally liable for any deficit.
By the second contract the shareholder-creditors of S-C-D agreed that their claims, supposedly relinquished as stated in the first contract, would be subordinated, and it was further agreed that each $ 50 of indebtedness relinquished by the shareholder-creditors would be treated as a share of S-C-D's stock for purposes of distributing any surplus from the sale of assets and collections.
The third contract provided that S-C-D should purchase the land and buildings owned by Sitcarda for a consideration of $ 100,000.
All of the above mentioned contracts were executed and performed.
The balance sheet of S-C-D as of August 8, 1944, revealed assets of $ 193,821.75 and liabilities, including the $ 99,705.20 owed to the stockholder-creditors of S-C-D, of $ 198,558.02.
By May 31, 1945, Carneal and Heine, as trustees, had paid all of the liabilities of S-C-D except $ 565.49 and except $ 99,705.20 which had been relinquished by the stockholder-creditors of S-C-D.
As of May 31, 1945, the assets of S-C-D which were to be sold under the Heine agreement had been realized upon to *196 the extent of $ 120,591.52, with a loss of $ 28,003.17 on such realization, leaving $ 55,713.28 of unrealized assets, of which $ 24,000 represented a contract of sale of inventory payable in semiannual installments of $ 4,000 each commencing August 1, 1945.
The following distributions were made by the committee for the stockholders of S-C-D on the capital stock and notes of S-C-D previously owned by such individuals:
| Distribution | |||
| Date | Total | ||
| On stock | On notes | ||
| Sitcarda Finance and Holding Corporation: | |||
| Aug. 27, 1946 | $ 567.00 | $ 2,925.00 | $ 3,492.00 |
| July 26, 1948 | 409.50 | 2,112.50 | 2,522.00 |
| W. L. Carneal, Jr.: | |||
| W. L. Carneal, Sr.: | |||
| Laura E. Carneal: | |||
| Aug. 27, 1946 | 1 2,481.75 | 2,700.00 | 5,181.75 |
| July 26, 1948 | 1 1,792.37 | 1,950.00 | 3,742.37 |
| F. Sitterding, Jr.: | |||
| Aug. 27, 1946 | 1,208.25 | 699.42 | 1,907.67 |
| July 26, 1948 | 872.63 | 506.48 | 1,379.11 |
| W. H. Sitterding: | |||
| Aug. 27, 1946 | 1,955.25 | 790.20 | 2,745.45 |
| July 26, 1948 | 1,412.12 | 570.70 | 1,982.82 |
| Agnes B. Sitterding: | |||
| Aug. 27, 1946 | 1,334.25 | 691.20 | 2,025.45 |
| July 26, 1948 | 963.62 | 499.20 | 1,462.82 |
*134 The total amount distributed to the stockholders and noteholders involved herein of S-C-D on August 27, 1946, was $ 19,182.60 and the amount distributed *197 on July 26, 1948, was $ 13,854.10.
The notes of the stockholders of S-C-D which were released by them remained in existence for all purposes relating to the distribution to them as stockholders of S-C-D of the proceeds received by the committee for the stockholders of S-C-D.
The stockholders and noteholders of S-C-D have not received any sums in distribution on their shares of stock or notes since the distribution of July 26, 1948. The committee for the stockholders has no further funds for distribution.
OPINION.
In 1942 the petitioner loaned to S-C-D the sum of $ 7,780. Later in his 1945 income tax return the petitioner determined that the recovery on this debt would be at the rate of 10 per cent, or $ 778, and claimed a deduction as "a partial bad debt connected with his trade or business" the amount of $ 7,002, which respondent disallowed.
The parties disagree as to the nature of the transaction out of which the claimed deduction arose. The respondent contends that the release of the debt due and owing to the petitioner constituted a contribution to the capital of S-C-D, or a nonbusiness bad debt. The petitioner contends that the release of the debt did not result in a bad debt at *198 all but rather a loss resulting from the petitioner's deliberate act of cancellation, which, viewing the transactions occurring in 1944 as a whole, resulted in a loss from a transaction entered into for profit under the provisions of section 23 (e) (2) of the Internal Revenue Code.
That a distinction exists between the deductibility of losses and worthless debts has long been recognized. See Spring City Foundry Co. v. Commissioner, 292 U.S. 182">292 U.S. 182, where it was held that the provisions of the law dealing with deductions for losses and deductions for bad debts are mutually exclusive and hence an amount deductible under one is not deductible under the other.
Section 124 (d) of the Revenue Act of 1942, which is now section 23 (k) (4) of the Internal Revenue Code, dealing with nonbusiness bad debts, has served to bring the distinction between deductions permitted for losses and those permitted for worthless debts into sharp focus, for an examination of sections 23 (e) (2) and 23 (k) (4) indicates that the distinction carries with it radically different tax consequences. It is therefore pertinent to inquire into the true nature of the transaction out of which the deduction argued for by the *199 petitioner grows.
*135 In 1942 S-C-D was experiencing financial difficulty. The petitioner loaned to the corporation $ 7,780, taking the corporation's demand note for that sum, thereby creating a debtor-creditor relationship which existed down to the year 1944. The petitioner argues that the events transpiring in 1944 as the result of the poor financial condition of S-C-D must be viewed as a single transaction, including the petitioner's deliberate act of cancellation, and the agreements entered into by the stockholders of S-C-D, in order to mitigate their losses, were sufficient to convert his relinquishment of his rights as a creditor into a loss incurred in 1945 from a transaction entered into for profit. It is true that the petitioner as a stockholder of S-C-D was motivated in subordinating his claim against S-C-D by the following factors:
(1) S-C-D had on August 3, 1944, agreed by contract to purchase the principal assets of Sitcarda, consisting of land and certain buildings, for the consideration of $ 100,000. The petitioner was one of the principal stockholders of Sitcarda.
(2) The contract with Heine provided for the payment of the debts of S-C-D to the banks, amounting to $ 69,000, *200 which the petitioner, pursuant to guarantee agreements, had jointly and severally guaranteed.
(3) By agreement between the individuals and corporations which had released the debts due and owing to them from S-C-D, it was provided that their claims should be subordinated and each $ 50 of indebtedness released by them would be treated as a share of S-C-D stock for purposes of distributing any surplus from the sale of assets and collections under the Henry W. Heine contract.
However, in 1942 when the petitioner loaned $ 7,780 to S-C-D and took its note in return, a debtor-creditor relationship was created. Any loss arising from that relationship would have been deductible, if at all, under the provisions of section 23 (k) (4) of the Internal Revenue Code, as a nonbusiness bad debt, for the petitioner was not in the business of loaning money to corporations. See Jan G. J. Boissevain, 17 T. C. 325; Estate of William P. Palmer, Jr., 17 T. C. 702. Nor could the subordination agreement, whereby the stockholder-creditors, including the petitioner, agreed to subordinate their claims against S-C-D, convert an otherwise business bad debt into a section 23 (e) (2) loss for purposes of deduction. *201 To permit such a result would emasculate section 23 (k) (4) of the Code. See H. Rept. No. 2333, 77th Cong. 1st Sess., p. 76.
The ingenious argument made by the petitioner in his effort to demonstrate that the cancellation of the notes of the stockholder-creditors of S-C-D was a transaction entered into for profit is interesting but not convincing.
*136 From the above it follows that the loss claimed by the petitioner in 1945 as a deduction is deductible, if at all, as a nonbusiness bad debt. Further, in order to establish deductibility of the item the petitioner must carry the burden of proof in establishing the occurrence during the taxable year 1945 of some identifiable event tending to establish the worthlessness of the debt in that year. The petitioner has been unsuccessful in doing this. Indeed, the balance sheet of S-C-D as of August 8, 1944, the date the petitioner canceled the note, shows assets of $ 193,821.75 and liabilities of $ 198,558.02. Had the petitioner elected to stand on his rights as a creditor, the assets of S-C-D were sufficient to satisfy not only his claim but the claims of the banks, for which he was bound as guarantor, at the rate of approximately 97 cents *202 on the dollar. Further, the record reveals that the petitioner received from the surplus remaining after the liquidation of the assets of S-C-D and the payment of its liabilities, a distribution of $ 1,907.67 in 1946 and a distribution of $ 1,379.11 in 1948. Of the amount distributed in 1946, $ 699.42 was attributable to the note supposedly released by the petitioner in 1944. Of the amount of the distribution in 1948, $ 506.48 was attributable to the note. The fact that the petitioner received distributions attributable to the debt, which he claims was worthless in 1945, in the years 1946 and 1948 is hardly indicative of worthlessness in the year 1945. Therefore, on the record as a whole, we hold that the petitioner has failed to establish the worthlessness in 1945 of the debt due and owing to him from S-C-D.
Decision will be entered for the respondent .