*1846 A reasonable addition to a reserve for bad debts for 1921 determined.
*439 By this proceeding the petitioner seeks a redetermination of a deficiency in income and profits tax for 1921 of $7,559.15, only $6,398.46 of which is in controversy. The only point in issue is a reasonable addition to a reserve for bad debts deductible from the gross income of 1921.
FINDINGS OF FACT.
The petitioner is a Maine corporation, with its principal office at Lewiston. For 1921 it adopted the reserve method of treating bad debts, whereas prior to that it had deducted from gross income debts ascertained to be worthless and charged off within the year. In its return for 1921 it deducted from gross income $44,989.87 as a reasonable addition to a reserve for bad debts. This amount was computed as follows:
| Bad debts charged off | $30,596.08 |
| Bad debts - reserve on accounts receivable | 10,000.00 |
| Bad debts - reserve on notes discounted | 4,393.79 |
| 44,989.87 |
The respondent in his deficiency notice determined*1847 the addition to the reserve for bad debts in the following manner:
| Balance set up as at December 31, 1920 | $27,225.00 |
| Reasonable addition to reserve (deductible) | 30,596.08 |
| 57,821.08 | |
| Charges | 43,427.29 |
| Balance December 31, 1921 | 14,393.79 |
*440 The balance sheet of the petitioner at December 31, 1921, showed a reserve for loss on notes and accounts receivable of $14,393.79. The balance sheet as at December 31, 1920, showed no amount as a reserve for loss on notes and accounts receivable.
The books of account of the petitioner show as follows:
| Year | Sales | Bad debts |
| charged off | ||
| 1919 | $642,982.89 | $1,158.05 |
| 1920 | 782,301.41 | 2,090.14 |
| 1921 | 813,663.31 | 30,596.08 |
| 1922 | 321,867.92 | 17,378.36 |
| Year ended | Notes | Amounts |
| December 31 | receivable | receivable |
| 1918 | $10,508.38 | $82,077.91 |
| 1919 | 7,948.33 | 99,879.51 |
| 1920 | 5,880.17 | 95,879.51 |
| 1921 | 7,904.21 | 132,284.38 |
The petitioner made and sold carriages, trucks, automobiles, and bodies. The Wade & Dunton Motor Co., a subsidiary of the Carriage Co., was formed in October, 1921, to take over the Ford business theretofore conducted by the petitioner.
*1848 The largest portion of the petitioner's business is done during the first six months of the year. It had a good year in 1919, and for the best part of 1920. In October, 1920, the business depression, which was general throughout the country, began to affect the mills in Lewiston, which was a textile town with five textile mills and a population of approximately 32.000. The mills began to lay off help and business was bad throughout the year 1921. The depression, which was worst in 1921, lasted until 1925.
The petitioner had a very liberal credit policy, which was an outgrowth of the extensive credit of its carriage business of earlier years when the credit risks were less. It carried into the automobile business the liberal credit policies of its carriage business, but suffered many losses thereby. During 1921 the petitioner borrowed over $100,000 from the Manufacturers National Bank of Lewiston, indirectly, by discounting its trade paper 6 per cent in advance, which was a large sum to be handled by that bank. Petitioner was increasing its indebtedness in 1921 to such an extent that the bank believed it would affect its own well-being as well as the petitioner's, unless*1849 curbed. In 1921 the bank determined that from one-fourth to one-third of the trade paper of the petitioner was doubtful. The petitioner was therefore asked to reduce its indirect line of credit (represented by the notes of purchasers of automobiles).
*441 OPINION.
SMITH: Section 234(a)(5) of the Revenue Act of 1921 permits a corporation in computing its net income to deduct from gross income:
Debts ascertained to be worthless and charged off within the taxable year (or in the discretion of the Commissioner, a reasonable addition to a reserve for bad debts); and when satisfied that a debt is recoverable only in part, the Commissioner may allow such debt to be charged off in part.
Although the petitioner, prior to 1921, had not maintained any reserve for bad debts, it elected to set up a reserve for bad debts at the close of 1921 and to deduct from gross income in its annual tax return for that year, as permitted by the regulations, a reasonable addition to a reserve for bad debts in lieu of the amount of debts ascertained to be worthless and charged off within the taxable year. The method by which it arrived at the addition to its reserve for bad debts in the amount*1850 of $44,989.87 is set forth in our findings. The respondent, upon an audit of the petitioner's books of account, determined that the amount claimed in its return as a reasonable addition to a reserve for bad debts was excessive and reduced the amount deductible to $30,596.08, which is the amount of the debts ascertained to be worthless and charged off within the taxable year. In his computation (set forh in our findings), the respondent determined that for the purpose of arriving at a reasonable addition to a reserve for bad debts it should be assumed that $27,225 represented a reasonable amount as a reserve for bad debts at December 31, 1920. The basis for this assumption is not shown by the record. The respondent determined that a reasonable reserve for bad debts at the close of 1921 was $14,393.79, which is the amount shown on the petitioner's books. Why the respondent should have assumed that a proper reserve at December 31, 1920, was nearly twice the amount of a proper reserve at December 31, 1921, when the notes and accounts receivable at the end of 1920 were $101,759.68, and at the end of 1921 were $140,188.63, is not apparent.
*1851 The only question for our determination is whether the amount deducted by the petitioner was a reasonable addition to a reserve for bad debts. What constitutes a reasonable addition must be determined from a consideration of all of the facts in the case. ; . A taxpayer is not entitled to deduct both a reasonable addition to a reserve for bad debts and also debts ascertained to be worthless and charged off within the year. .
*442 The petitioner argues that if it may not in all the circumstances of the case be entitled to deduct from gross income as a reasonable addition to a reserve for bad debts both the amounts ascertained to be worthless and charged off its books of account, namely, $30,596.08, and an amount which it set up as a reserve for bad debts at December 31, 1921, in the amount of $14,393.79, nevertheless, the respondent is in error in assuming that a reasonable reserve for bad debts at the end of 1920 was $27,225. The petitioner submits that if it is*1852 to be assumed that there should be a reserve for bad debts at the close of 1920, for the purpose of computing a reasonable addition to it in obtaining an amount deductible from the gross income of 1921, that reserve should be based upon its prior experience in the years 1919 and 1920; that it should be based upon the percentage of bad debts to sales; and that such a computation shows as follows:
| Year | Sales | Bad debts | Percentage of bad |
| debts to sales | |||
| 1919 | $642,989.89 | $1,158.05 | 0.0018 |
| 1920 | 783,166.49 | 2,090.14 | .0027 |
| Total | 1,426,156.38 | (average) 3,248.19 | (average) .0023 |
| Total sales for 1920 | $783,166.49 |
| Average percentage of loss on bad accounts for the years 1919 | |
| and 1920 | 0.0023 |
| Reasonable reserve for bad debts as of December 31, 1920, based | |
| upon sales | 1,801.28 |
We can not doubt from the entire record that the business depression, which affected some communities in 1920, affected the petitioner principally in 1921. Conditions during 1921 were recognized in the case of *1853 , wherein it is stated:
The general conditions, especially in New England, were very bad. Textiles are a very large part of the business of the company. The textile business was very bad. Almost all the cotton mills and textile mills had overbuilt during the war. Business dropped off. Some paid off too much money in dividends, spent too much money in their plants, and there was a frozen condition. The mills could not collect the receivables themselves, and they could not pay the banks. The banks through the whole country practically carried business along for quite a period. If they had not, there would have been some very bad business, and as it was, a good many of the weaker mills failed, and it was a rather anxious time for banks.
The outlook at the time when the addition to the reserve for the fiscal year 1921 was ordered, justified the sum of $200,000 as a reasonable figure.
Upon the record we determine that a reasonable addition to a reserve for bad debts deductible from gross income for the year 1921 was $43,188.59 determined as follows:
| Debts ascertained to be worthless and charged off in 1921 | $30,596.08 |
| Bad debts - reserve on accounts receivable (Dec. 31, 1921) | 10,000.00 |
| Bad debts - reserve on notes discounted (Dec. 31, 1921) | 4,393.79 |
| Total | 44,989.87 |
| Less estimated reserve for bad debts (Dec. 31, 1920) | 1,801.28 |
| Net addition to reserve for bad debts | 43,188.59 |
*1854 *443 Judgment will be entered under Rule 50.