*265 Decisions will be entered under Rule 50.
1. In April 1947, petitioner Phil Kalech exercised an option to purchase 60 shares of stock of The Toni Company for $ 333.33 per share. The option contained severe restrictions on his right to sell the shares for the next 5 1/2 years. The book value of the shares on March 31, 1947, was $ 557.12 each, and was the highest price at which he could have resold the shares to the vendors at the time he exercised the option. Petitioner sold the shares in January 1948 at a substantial profit. He concedes that the difference in the option price and the fair market value of the shares on the date the option was exercised was additional compensation to him in 1947, but contends that such fair market value was $ 2,000 a share -- the value originally determined by respondent. By amended answer, respondent alleged that the fair market value was only $ 557.12 per share on the option-exercise date. Held, because respondent claims no lesser amount, they are deemed to have had a value of $ 557.12 on that date; and such value will be the basis for computing the amount of long-term gain which petitioner realized from their sale in 1948, and for determining*266 the amount of compensation which he realized upon exercise of the option in 1947.
2. From May 3 to November 30, 1948, petitioner advanced sums to or made payments totaling $ 163,146.59 in behalf of a corporation organized by him to develop a scalp tonic. The corporation returned $ 57,423.43 to him during the same period. It had no other paid-in capital. The corporation steadily lost money and, on December 22, its liabilities (not including amounts advanced by petitioner) exceeded its assets. On that date it decided to dissolve at the end of the year. Held, net advances by petitioner to the corporation in the amount of $ 105,723.16 were his capital investment in it, which became worthless in 1948. Held, further, amounts returned by the corporation to petitioner must be applied against the earliest payments and advances made by him to it to determine whether the capital loss on his investment will be a short-term loss or, in part, a long-term loss, since no indication was made by the corporation as to which specific advances the returns by it were to apply.
3. On December 23, 1948, petitioner advanced $ 100,000 to the corporation. He received all of its assets upon its*267 dissolution at the end of December, including $ 88,624.95 in cash. Held, the $ 100,000 payment by petitioner immediately prior to the corporation's dissolution was to secure its assets intact and to be able to carry on its business without interruption. As such, no loss is recognized in 1948 on such payment.
4. In 1948, petitioner loaned $ 10,000 to a corporation in which he had no stock interest. The loan was not repaid and became totally worthless in that year. Held, the loss is deductible as a nonbusiness bad debt in 1948.
*673 *268 These consolidated proceedings involve the following income tax deficiencies determined against Phil Kalech (hereinafter referred to as the petitioner) for the year 1947, and against him and his wife, Zipporah Kalech, for the year 1948:
| Docket No. | Year | Amount |
| 42376 | 1947 | $ 41,784.78 |
| 42377 | 1948 | 75,645.81 |
The issues to be determined are: (1) Whether 60 shares of Toni stock purchased by petitioner, pursuant to an option, in 1947 for $ 20,000 had a fair market value at the time of purchase of not more than $ 557.12 per share rather than $ 2,000 per share as respondent originally determined; (2) whether petitioner is entitled to a net loss carry-back to the year 1947 from the year 1949 of $ 73,228.40 from the operation of the Korvo Company; (3) whether petitioner is entitled to a short-term capital loss deduction in 1948 of $ 168,196.83; and (4) whether petitioner is entitled to a nonbusiness bad-debt deduction in 1948 of $ 10,000 arising out of a loan in that amount to Lowe Radio Features, Inc. Petitioner claims an overpayment of tax for both years.
Respondent concedes that, if we find the value of the Toni stock at the time it was purchased to be $ 557.12 per share, there*269 will be a substantial reduction of the amount of income which he originally determined petitioner received in 1947, and that adjustment therefor will be taken into account under a Rule 50 computation. Both parties agree that if we so find, the second issue raised with respect to a carry-back loss to the year 1947 becomes moot.
*674 Other issues originally raised have been conceded or are deemed to be admitted, and will be taken into account under a Rule 50 computation.
Some of the facts were stipulated.
FINDINGS OF FACT.
The stipulated facts are so found, and are incorporated herein by this reference.
Petitioner and his wife were residents of Chicago, Illinois, during the years in question. Petitioner filed an individual return for 1947, and he and his wife filed joint returns for 1948 and 1949. All such returns were filed with the collector of internal revenue for the first district of Illinois.
The Toni Stock.
For many years prior to 1947, petitioner was actively engaged in the sales promotion of drug and cosmetic products. Until 1941, he was employed by the Palmolive Company; from 1941 to 1946, he was merchandising and sales manager of the Pepsodent Company. In December*270 1946, he became sales manager of The Toni Company (hereinafter referred to as Toni), manufacturer of the Toni Home Permanent. Incident to his employment by Toni (formerly Noma, Inc.), petitioner purchased 60 shares of its stock for $ 20,000 on April 19, 1947. The option under which petitioner purchased the stock contained the following restrictions as to its sale during the subsequent 5 1/2 years: Petitioner could not sell or pledge the shares without the written consent of the vendors; the vendors could reacquire the shares upon the termination of petitioner's employment, his death, or bankruptcy, at their book value on the last day of the month immediately preceding such event, or $ 333.33, whichever was greater; and the vendors held a proxy to vote the shares. On March 31, 1947, there were 1,600 shares of Toni stock outstanding having a book value of $ 557.12 per share. The balance sheet of the company on that date was as follows:
| Assets | Liabilities | ||
| Assets | $ 1,602,216.89 | Current liabilities | $ 451,841.86 |
| Reserves for taxes | 258,986.41 | ||
| $ 1,602,216.89 | Net worth | 891,388.62 | |
| $ 1,602,216.89 |
On January 2, 1948, petitioner and Toni's other stockholders*271 sold their shares to the Gillette Safety Razor Company. Petitioner received $ 744,029.63 for his shares. On May 1, 1948, he terminated his employment with Toni.
*675 On his return for 1947, petitioner reported no additional compensation because of the exercise of the option and the receipt of the Toni stock.
On his return for 1948, petitioner reported a long-term capital gain from the sale of the Toni stock as follows:
| Sales price | $ 744,029.63 | |
| Cost | $ 20,000.00 | |
| Expense of sale | 5,717.19 | 25,717.19 |
| $ 718,312.44 |
In the deficiency notice for the year 1947, respondent determined that the fair market value of the Toni stock on the date petitioner exercised the option was $ 120,000 ($ 2,000 per share) and, consequently, that petitioner received additional compensation in the amount of $ 100,000 in that year. In the deficiency notice for the year 1948, respondent reduced the amount of long-term capital gain reported by the petitioner on his return by raising the basis of the stock from $ 20,000 to $ 120,000.
At the hearing, petitioner conceded the correctness of the respondent's determination that the difference in the fair market value of the Toni stock and the *272 option price was additional compensation to him, and that the fair market value was $ 120,000. However, by amended answer to the petition in Docket No. 42377, for the year 1948, respondent alleges that the fair market value of the stock on the option-exercise date was not more than $ 557.12 per share -- its book value on March 31, 1947.
The value of the Toni stock at the time petitioner exercised the option was not more than $ 557.12 per share.
Petitioner filed his return for 1947 on March 15, 1948, and paid tax thereon of $ 10,338.71. On February 15, 1951, an agreement was executed extending to June 30, 1952, the time for the assessment of any additional tax. Petitioner overpaid his income tax for 1947.
The Development of "Korvo."
After petitioner terminated his employment with Toni in 1948, he became interested in a scalp tonic known as "Korvo" created by a Dr. Joseph C. Urkov (hereinafter referred to as Urkov) of Chicago. Petitioner believed that Korvo had great potential commercial appeal, and he and Urkov decided to develop the product.
For that purpose, petitioner, on June 9, 1948, organized a Delaware corporation -- Phil Kalech, Inc. (hereinafter referred to as the corporation) *273 -- whose principal office was in Chicago. He was at all times its president and dominant personality. The corporation was authorized to issue 400,000 shares of $ 1 par value common stock and *676 6,000 shares of no-par-value preferred stock. At a meeting of the board of directors on July 9, 1948, petitioner was given 150,000 common shares "in consideration of the use by the Corporation of his name in its title and in further consideration of his services in the organization and operation of the Corporation." It was the directors' opinion that the value of the shares was "at least equal to the par value of the stock."
At the same meeting, the directors gave Urkov 45,000 shares, having, in their opinion, a value at least equal to the par value of the stock, in consideration of Urkov's assignment of the Korvo formula to the corporation. On August 28, 1948, the directors gave Urkov an additional 15,000 shares of stock in consideration of his becoming personally liable for any claims successfully asserted by anyone claiming to have an interest in the formula. The certificates for the shares were issued to petitioner and Urkov on November 4, 1948. Neither petitioner nor Urkov*274 purchased any of the shares for cash, nor did anyone else. Petitioner and Urkov were the sole stockholders of the corporation.
The books and records of the corporation show that, between May 3, 1948, and November 30, 1948, petitioner made payments to or in behalf of it, and that the corporation returned a part of such payments to him as follows:
| Payments to the Corporation | |||
| May 12 | Check of Phil Kalech to the corporation | $ 50,000.00 | |
| May 3-August 30 | Payments by Phil Kalech on behalf of the | 18,103.18 | |
| corporation. | |||
| August 30 | Check of Phil Kalech to the corporation | 25,000.00 | |
| August 30 | Check of Phil Kalech Sales Corp. to the | 25,000.00 | |
| corporation on behalf of Phil Kalech. | |||
| September 29 | Check of Phil Kalech to the corporation | 10,000.00 | |
| October 8 | Check of Phil Kalech to the corporation | 10,000.00 | |
| November 30 | Assumption of liability of Phil Kalech Sales | 24,950.00 | |
| Corporation to Phil Kalech. | |||
| Miscellaneous items | 93.41 | ||
| $ 163,146.59 | |||
| Returns by the Corporation | |||
| September 17 | $ 36,223.30 | ||
| November 30 | 21,200.13 | 57,423.43 | |
| $ 105,723.16 |
Petitioner had hoped that other directors of the corporation would invest in it, and the remaining *275 unissued shares of stock were held for that purpose. By December 1948, however, petitioner knew that no additional sums would be invested, and that the business was steadily losing money. Prior to December 23, 1948, the corporation's liabilities, *677 exclusive of any sums owed to petitioner, greatly exceeded its assets.
Petitioner believed that Korvo could still be developed successfully. He did not wish to see the corporation go into bankruptcy because he believed the formula would be lost to him.
At a directors' meeting on December 22, 1948, it was decided that a dissolution of the corporation would be effected, that petitioner would assume all of its assets and liabilities, and after dissolution would continue to develop Korvo as a sole proprietorship.
At that time, Urkov agreed to the cancellation of his shares on petitioner's promise that if the development of Korvo was successful eventually, he would be paid something and would act as a consulting director to the business.
On December 23, 1948, petitioner paid the sum of $ 100,000 to the corporation.
Immediately prior to its dissolution, its balance sheet reflected assets and liabilities (exclusive of sums owed to petitioner) *276 as follows:
| Assets | ||
| Accounts receivable: | ||
| Trade accounts | $ 64,806.24 | |
| Phil Kalech Sales Corporation | 4,927.43 | |
| Due from Weiss and Geller | 1,021.98 | |
| Due from Corporation Trust Co | 559.95 | |
| $ 71,315.60 | ||
| Cash | 88,624.95 | |
| Inventories | 18,712.97 | |
| Prepaid insurance | 93.03 | |
| Equipment | 1,660.92 | |
| Total assets | $ 180,407.47 | |
| Liabilities | ||
| Accounts payable | 27,066.98 | |
| Accrued liabilities: | ||
| Co-op advertising | $ 90,129.08 | |
| Other advertising | 18,274.84 | |
| Other expenses | 7,410.24 | 115,814.16 |
| Total liabilities | $ 142,881.14 |
On December 31, 1948, the corporation assigned all of its assets to petitioner, who thereupon assumed its liabilities, and a certificate of dissolution was filed with the secretary of state of Delaware.
Petitioner continued the development of Korvo as an individual, doing business as the Korvo Company, beginning January 1, 1949. The books on that date showed the following assets and liabilities, which are identical with those shown on the balance sheet set out above, except for the item of cash in the amount of $ 88,624.95. *678
| Assets | Liabilities | ||
| Accounts receivable | $ 64,806.24 | Accounts payable | $ 27,066.98 |
| Due from Phil Kalech | Accrued expenses | 115,814.16 | |
| Sales Corporation | 4,927.43 | ||
| Due from Weiss & Geller | 1,021.98 | $ 142,881.14 | |
| Due from Corporation | |||
| Trust Co | 559.95 | ||
| Inventories | 18,712.97 | ||
| Prepaid insurance | 93.03 | ||
| Equipment | 1,660.92 | ||
| $ 91,782.52 |
*277 On his income tax return for 1948, petitioner claimed a bad-debt loss on loans to Phil Kalech, Inc., in the amount of $ 168,196.83. This sum represented the amount of the advances by him to the corporation less the amounts returned to him and less the excess of assets over liabilities received by him on dissolution.
In the deficiency notice for that year, respondent disallowed $ 143,196.83 of such claimed loss "for lack of substantiation that this amount constitutes an allowable deduction for 1948 under the provisions of sections 23 (k), 23 (g) and 117 of the Internal Revenue Code." He determined that the initial $ 50,000 advanced by petitioner to the corporation was a capital investment, and allowed a long-term capital loss in the amount of $ 25,000.
The total amount ($ 163,146.59) advanced to or on behalf of the corporation by petitioner during 1948, prior to the decision to dissolve it, constituted a capital investment. A part of such investment in the amount of $ 57,423.43 was returned to him in that year; the balance of such investment, in the amount of $ 105,723.16, became worthless in that year.
Loan to Lowe Radio Features, Inc.
In March 1948, petitioner was approached*278 by an acquaintance, one Joseph Lowe (hereinafter referred to as Lowe), who wished to borrow money to produce a radio show. Lowe operated through a corporation, Lowe Radio Features, Inc. (hereinafter referred to as the Radio Company).
From March to June 1948, petitioner loaned a total of $ 10,000 to the Radio Company. Lowe's venture was a failure. Petitioner made repeated efforts to collect the amount of the loan. By November 1948, Lowe had abandoned the venture, and had taken a job with a radio station. At that time, petitioner went over the books of the Radio Company with his auditor and discovered it had no assets. Shortly thereafter in 1948, it gave up its office and ceased operations.
Petitioner's loan to the Radio Company became totally worthless in 1948.
*679 OPINION.
The Toni Stock.
The effect of the respondent's allegation that the fair market value of the Toni shares on the date they were purchased was $ 557.12 each, rather than $ 2,000 as originally determined in the deficiency notice, is to reduce the amount taxable to petitioner as compensation in 1947 and also to reduce the basis of such shares and thereby increase the amount of gain which petitioner realized*279 in 1948 on the sale of the shares.
The underlying theory of respondent's allegation that the fair market value of the shares was $ 557.12 each, their book value on March 31, 1947, is that the provisions of the option under which petitioner purchased the shares were so restrictive as to preclude any higher fair market value on that date. Petitioner conceded the correctness of respondent's original determination, and argues that the lower fair market value has not been proved.
We agree with the respondent that the value of the shares on the date they were purchased could not have exceeded $ 557.12. The shares for a period of 5 1/2 years could not have been sold or pledged without the written consent of the vendors. Should petitioner have terminated his employment with Toni, or died, or become bankrupt, or tried to dispose of the shares, the vendors had the right to repurchase them at their book value on the last day of the month immediately preceding such an event or for $ 333.33, whichever was greater. Since the respondent claims no lesser amount but alleges that $ 557.12 per share should be used, we conclude that such amount is the basis for computing the long-term gain which *280 petitioner realized in 1948, and for computing the amount of compensation which he realized upon exercise of the option in 1947.
Since the reduction of the amount of compensation which respondent originally determined petitioner received in 1947 will eliminate all taxable income for that year, the parties have agreed that our holding with respect to the Toni shares makes unnecessary consideration of the second issue raised herein with respect to a net loss carry-back of $ 73,228.40 from the year 1949 to the year 1947.
The Development of "Korvo."
The petitioners claimed a deduction of $ 168,196.83 on their return for 1948 on the theory that the advances by petitioner to Phil Kalech, Inc., were loans which became worthless in that year. They pursue that argument here. While they dispute the respondent's allowance of a long-term loss of $ 25,000 based on his determination that the initial $ 50,000 advance to the corporation was a capital investment, they *680 argue that should we find that all advances to the corporation were capital investments therein, the net result would be the same as if we held the advances to be loans. This, they say, is true because the return by the*281 corporation to petitioner of a part of his capital investment during 1948 should be applied to the first sums advanced by him which would mean that all unreturned advances were made within 6 months of the time when they became worthless; and, hence, any loss would be a short-term capital loss.
We have found that $ 105,723.16, which was the net amount advanced by petitioner from the inception of the corporation through November 30, 1948, was his net capital investment therein. The facts here differ in no material respect from those before us in a number of similar cases wherein we have held advances to newly formed corporations in the guise of loans, where there was little or no paid-in capital, were, in fact, capital contributions. Hilbert L. Bair, 16 T. C. 90 (1951), affd. 199 F. 2d 589 (C. A. 2, 1952); Erard A. Matthiessen, 16 T. C. 781 (1951), affd. 194 F. 2d 659 (C. A. 2, 1952); Isidor Dobkin, 15 T. C. 31 (1950), affd. 192 F. 2d 392 (C. A. 2, 1951); Sam Schnitzer, 13 T. C. 43 (1949),*282 affd. 183 F. 2d 70 (C. A. 9, 1950), certiorari denied 340 U.S. 911">340 U.S. 911 (1951); Joseph B. Thomas, 2 T. C. 193 (1943); and Edward G. Janeway, 2 T. C. 197 (1943), affd. 147 F. 2d 602 (C. A. 2, 1945).
We further found that such capital investment became worthless in 1948. That fact is evident even though petitioner received assets in excess of liabilities upon the corporation's final dissolution. Assets exceeded liabilities at that time only because of the $ 100,000 advance which petitioner made on December 23 after dissolution had been agreed upon.
Petitioner claimed, first, that that advance, like all others, was a loan and, in the alternative, that it was a further capital investment. We agree with the respondent that the advance was not a loan because petitioner knew at the time that the corporation was insolvent, was going out of business, and that repayment would never be made. Ray Crowder, 19 T. C. 329 (1952).
We are further satisfied that this payment, unlike all other sums advanced, was not a capital contribution*283 on which loss may be recognized. The purpose which motivated petitioner's advance was his desire to receive the assets of the corporation intact, and to continue, as an individual, the business of developing Korvo.
The net amount which petitioner paid, in order to receive the assets, was actually $ 11,375.05. This is obvious from an examination of the balance sheet of the corporation immediately prior to its dissolution and an examination of the books of the Korvo Company on January 1, 1949. The assets and the liabilities shown in both instances are identical except that the books of the Korvo Company do not *681 show the $ 88,624.95 in cash which petitioner received along with the other assets of the corporation. The effect of the $ 100,000 payment was to enable the corporation to show an excess of assets over liabilities, exclusive of any advances by petitioner, immediately prior to dissolution. Thus, only the amount of $ 11,375.05 was actually paid by petitioner; and being a payment for the assets and right to operate the business as a sole proprietorship, it is not one on which loss may be recognized in 1948. Ruth M. Cullen, 14 T. C. 368 (1950).*284 See Kimbell-Diamond Milling Co., 14 T. C. 74 (1950), affd. 187 F. 2d 718 (C. A. 5, 1951), certiorari denied 342 U.S. 827">342 U.S. 827 (1951).
In holding that petitioner is entitled to a capital loss in the amount of $ 105,723.16, we have not overlooked respondent's argument that the books of the corporation do not show the Korvo formula as an asset, nor does petitioner assign any value to it. We agree with respondent that the formula had a value. He contends that such value was at least $ 45,000. Even if this were true, it would not result in the corporation having an excess of assets over liabilities on the date it was dissolved, because the real assets of the corporation totaled only $ 91,782.52 on that date, whereas the liabilities were $ 142,881.14; and the corporation would still have been insolvent even if the formula had been included among its assets at $ 45,000.
Recognizing that petitioner made a capital contribution to the corporation of $ 163,146.59, of which $ 57,423.43 was returned to him and that he sustained a capital loss of $ 105,723.16 in 1948, raises the question of whether the full amount*285 of such loss is a short-term capital loss or whether some part thereof is a long-term capital loss. Section 23 (g) of the 1939 Code 1 provides a capital loss allowance for securities becoming worthless during the taxable year and such loss is considered as one arising from the sale or exchange of such securities on the last day of the taxable year.
*286 Securities, as defined by that section, include not only actual shares of a corporation but the "rights to subscribe for or to receive such shares," which is what petitioner here had by virtue of his advances to the corporation. Joseph B. Thomas, supra;Edward G. Janeway, supra. The loss on his capital investment is deemed, by statute, to have occurred on December 31, 1948. Since that loss is also considered *682 to have arisen from the sale or exchange of the "securities," we think the so-called "first-in, first-out" rule, 2 pertaining to the sale or exchange of unidentified lots of shares, must be invoked here. See Courtenay D. Allington, 31 B. T. A. 421 (1934).
*287 In applying the first-in, first-out rule in a computation to determine the amount of the short- or long-term loss sustained by petitioner, the amounts returned by the corporation to him aggregating $ 57,423.43 must be applied against the initial advances made by petitioner to the corporation in order to determine what portion of his total advances were made on or after July 1, 1948. We know that the initial $ 50,000 advanced by him on May 12 of that year, which the respondent concedes is a capital contribution, will be eliminated in the computation of the loss under the first-in, first-out rule. With respect to the remaining $ 7,423.43 returned to the petitioner by the corporation, we do not know whether that or a larger amount was advanced to the corporation prior to July 1. The record shows only that between May 3 and August 30, 1948, petitioner made payments of $ 18,103.18 in behalf of the corporation. If the remaining $ 7,423.43 of the amount returned by the corporation exactly equaled the sums advanced prior to July 1, the total loss of $ 105,723.16 would be a short-term capital loss. In any event, the parties can make the necessary adjustment, pursuant to our holding here, *288 in a Rule 50 computation.
Loan to Lowe Radio Features, Inc.
The respondent based his disallowance of the $ 10,000 nonbusiness bad-debt loss claimed by petitioner with respect to advances to Lowe Radio Features, Inc., on the ground that petitioner had not proved the loan to be worthless. We have found as a fact that the loan was worthless in 1948, and petitioner is entitled to a nonbusiness bad-debt deduction therefor on his return for that year.
Decisions will be entered under Rule 50.
Footnotes
1. SEC. 23. DEDUCTIONS FROM GROSS INCOME.
In computing net income there shall be allowed as deductions:
* * * *
(g) Capital Losses. --
(1) Limitation. -- Losses from sales or exchanges of capital assets shall be allowed only to the extent provided in section 117.
(2) Securities becoming worthless. -- If any securities (as defined in paragraph (3) of this subsection) become worthless during the taxable year and are capital assets, the loss resulting therefrom shall, for the purposes of this chapter, be considered as a loss from the sale or exchange, on the last day of such taxable year, of capital assets.
(3) Definition of securities. -- As used in this paragraph (2) of subsection the term "securities" means (A) shares of stock in a corporation, and (B) rights to subscribe for or to receive such shares.↩
2. Regulations 111.
SEC. 29.22 (a)-8. Sale of Stock and Rights. -- If shares of stock in a corporation are sold from lots purchased at different dates or at different prices and the identity of the lots cannot be determined, the stock sold shall be charged against the earliest purchases of such stock. * * *↩