*2616 Deductibility of losses and bad debts determined.
*244 This proceeding is brought to redetermine deficiencies in income taxes in the sums of $6,112.78, $6,948.13, and $2,886.41 for the calendar years 1918, 1919, and 1920, respectively, of which amounts an aggregate of $13,381.52 is in controversy.
The proceeding was originally brought by John A. Cunningham. He died on August 30, 1928, and it appearing that Cornelia Ann Cunningham was duly appointed executrix of the estate of John A. Cunningham, deceased, the said Cornelia Ann Cunningham was substituted as petitioner by order of the Board dated October 26, 1928,
The petitioner asserts that the respondent erred in disallowing deductions of the following items:
(1) A loss in 1918 in the sum of $4,716.59 due from J. J. Ahern, originally on open account for furniture purchased from the decedent, and subsequently covered by a promissory note.
(2) A loss in 1918 on a note of J. J. Ahern in the sum of $4,824.28 representing the decedent's share of the proceeds from the sale of real estate in*2617 which the decedent and the said Ahern were jointly interested.
(3) A loss in 1918 in the sum of $12,623.20 paid by the decedent by reason of his endorsement as guarantor of a note executed by the Kirby Furniture Co. through the Atlantic National Bank.
*245 (4) A loss in 1919 in the sum of $1,346.73 paid by the decedent by reason of the endorsement as guarantor of a promissory note executed by J. J. Ahern to Lee Graham, vice president of the Grand Boulevard Investment Co.
(5) A loss in 1919 in the sum of $21,879.84 representing the net amount due on the renewal of a promissory note given decedent by J. J. Ahern.
(6) A loss in the sum of $206.48 paid by the decedent in 1919 as traveling expenses for business purposes.
(7) A loss in 1020 in the sum of $11,550 representing amounts paid by the decedent by reason of his endorsement as guarantor of certain notes executed by J. J. Ahern to the First National Bank of Gainesville, Fla.
(8) A loss in 1920 in the sum of $1,000, representing the balance due decedent in respect of a note executed by the Florida State Fair Association, which note decedent endorsed as guarantor.
Though the petition denominated the deductions*2618 as losses, excepting item (6) for traveling expenses, they were treated on the books and are now claimed as bad debts charged off in the various taxable years.
FINDINGS OF FACT.
The decedent was engaged in the wholesale and retail furniture business in Jacksonville, Fla., and also was largely interested in real estate and other investments. He had been in business for 36 years and maintained one set of books to reflect all of his operations.
The decedent and J. J. Ahern were interested jointly in numerous ventures prior to 1918. Ahern was the active director of the enterprises and the decedent furnished a portion of the capital. The decedent endorsed notes for Ahern and otherwise became liable on his account to the extent of more than $75,000. Items (1), (2), (4), (5) and (7) have to do with that relationship.
From time to time J. J. Ahern purchased furniture from the dedent. His open account was closed by the execution of a note. On December 30, 1918, the decedent charged off as a bad debt the sum of $4,716.59 representing the amount due on the note at that time. Before taking this action the decedent secured from the local office of the Bradstreet Co. at Jacksonville, *2619 Fla., a report covering Ahern's financial situation and also procured from the Title & Trust Co. of Florida a search of the records setting forth the ownership by Ahern of any real or personal property. The report of the latter company showed also a number of unsatisfied judgments of record against Ahern. As a result of this investigation decedent was satisfied that Ahern owned no property of any kind subject to execution and was unable to pay his indebtedness.
*246 Prior to 1918 the decedent maintained an open account against Ahern in which there were entered profits due on certain real estate transactions and also items of cash advanced to him by the decedent. Ahern closed this account by the execution of a note on which there was due $4,824.28 on December 30, 1918. For the above given reasons this note also was charged off as a bad debt on that date.
Some time prior to 1911 the decedent assisted one W. E. Kirby in establishing a furniture store conducted under the name of The Kirby Furniture Co. The decedent endorsed the firm's notes for many thousands of dollars. The enterprise prospered until 1911 or 1912 when, due to Kirby's personal and domestic situation, *2620 Kirby became indifferent in his management, the company became financially involved and went out of business in the latter year. At that time by reason of payments made by decedent as endorser of a note to the Atlantic National Bank the company owed the decedent $12,623.20, which he charged off on December 30, 1918. The Kirby Furniture Co. was a corporation of which Kirby owned a controlling interest. The decedent also held a considerable portion of the stock. The debt was worthless and uncollectible in 1912 but decedent retained it on his books because of Kirby's promise "to make good." In 1918 Kirby's health became bad and the decedent charged the account off. Kirby died in 1923 or 1924.
J. J. Ahern was vice president of the Grand Boulevard Investment Co. and custodian of its money. He had diverted some of the company's funds to his own use and was compelled to replace them. To raise the funds he induced the decedent to endorse two notes dated January 27, 1917, and April 29, 1917, for $668.14 and $678.59, aggregating $1,346.73. As security to decedent Ahern executed a second mortgage on his home. The decedent was compelled to pay these notes but did not charge off the*2621 amounts thereof as bad debts during 1918 because he considered the security of the mortgage good. In the early part of 1919 he was advised by his attorney that the said second mortgage was not properly executed and hence his security was worthless. On June 30, 1919, he charged off the said sum of $1,346.73.
Previous to 1918 the decedent and Ahern made a number of profitable real estate deals which were managed and consummated through Ahern, who had control of the funds connected therewith. After repeated requests the decedent obtained an accounting from Ahern and it was found that the decedent's share of such profits amounted to $21,879.84. In settlement of this amount Ahern executed to the decedent his note under seal, the date of which was not proved. Attached to this note as collateral security were certain shares of stock of the National Security & Investment Co. Later, the decedent returned the stock to Ahern because he considered it worthless.
*247 No books, vouchers, or other evidence of the nature of the expenditures were submitted to cover the item of $206.48 claimed to represent expenses incurred by decedent in connection with his business.
Some time*2622 prior to the year 1919 J. J. Ahern purchased from Graham Brothers certain capital stock of the Grand Boulevard Investment Co. and executed to them two notes, one for $10,000 and the other for $9,750. The decedent endorsed both these notes and by reason of such endorsement was compelled to pay the following sums:
| June 20, 1919 | $ 1,740.00 |
| Sept. 22, 1919 | 1,710.00 |
| Sept. 23, 1919 | 1,680.00 |
| Mar. 23, 1920 | 1,650.00 |
| June 22, 1920 | 1,620.00 |
| Sept. 23, 1920 | $1,590.00 |
| Dec. 23, 1920 | 1,560.00 |
| Total | 11,550.00 |
The notes were secured by stock of the Grand Boulevard Investment Co. which was sold at public auction during 1920 and bought in by Sandy Graham. Upon liquidation of the obligation the stock was transferred to the Cities Securities Co., a concern owned by decedent and two others.
In a transaction with the Florida State Fair Association the decedent received a bond of that association of the par value of $1,000. On March 27, 1920, the decedent charged off the sum of $1,017.31, representing the face of the bond together with interest thereon. The decedent made no effort to enforce collection of the bond and never attempted to dispose of it. The bonds were*2623 first mortgage obligations of the association, secured by land and the buildings thereon.
OPINION.
VAN FOSSAN: The depositions on which petitioner relies leave much to be desired in the matter of proof. They are replete with indistinct recollections and unsatisfactory explanations of many of the items in issue. So far as the record justifies, the facts have been set forth above.
With the exception of the sixth allegation of error, the points at issue in this proceeding all involve the right of the decedent to deduct from income debts charged off during the taxable years under the provisions of section 214(a)(7) of the Revenue Act of 1918. During the year 1918 the decedent determined that the unsecured debts owing to him directly by J. J. Ahern or indirectly by reason of endorsements and payments made for the benefit of the said Ahern were worthless and uncollectible. Before so doing the decedent ascertained that the financial status of Ahern was such that it would be useless to reduce his claims to judgment. We believe his action *248 in charging off during the year 1918 the sum of $4,716.59, representing the note of Ahern given in settlement of his furniture account, *2624 was warranted and the deduction should be allowed.
As to the note for $4,824.28 given to close an account for advances and profits on various deals, we encounter a failure of proof of an essential fact. The advances obviously would be a proper basis for a deduction. The profits would be such only if previously taken into income. We have no evidence of the separate amount of each item and are unadvised whether the profits had been accounted for by decedent. We mustTherefore, disallow the entire item.
We find from the evidence that the item of $12,623.20, representing a debt due from the Kirby Furniture Co. apparently became worthless and uncollectible prior to 1918. The indefinite promise of Kirby, joint endorser of the company's note to the Atlantic National Bank, "to make good" at some later date did not justify the decedent in carrying the account on his books as a good asset. In , the court said:
The Revenue Act of 1918, which applies to this case, permits a taxpayer in computing net income to deduct debts ascertained to be worthless and charged off within the taxable year. The reasonable interpretation of the*2625 law is that in order to secure a deduction of worthless debts they must be charged off in the year they are ascertained to be worthless. A man is presumed to know what a reasonable person ought to know from facts brought to his attention. A taxpayer should not be permitted to close his eyes to the obvious and to carry accounts on his books as good when in fact they are worthless and then deduct them in a year subsequent to the one in which he must be presumed to have ascertained their worthlessness. To do so would enable him to withhold deductions in his less prosperous years, when they would have little effect in reducing his taxes, and then to apply the accumulation to another time to the detriment of the fisc. This would defeat the intent and purpose of the law.
Honesty of belief in the taxpayer is not conclusive nor binding on the Board. It is the province of the Board to determine on a review of all the facts and circumstances surrounding the particular debt sought to be deducted whether the taxpayer knew or ought to have known its worthlessness in a prior year. If knowledge of the worthlessness of a debt sought to be deducted can thus be brought home to the taxpayer*2626 it can not be said that the worthlessness was ascertained in the subsequent year when it is actually charged off.
In view of the above it is not necessary to consider the legal effect of decedent's ownership of part of the stock of the company whose note he endorsed and paid.
We are of the opinion that the sum of $12,623.20 due to the decedent from the Kirby Furniture Co. and claimed by him as a bad debt could not properly be charged off during the year 1918.
In 1917 J. J. Ahern induced the decedent to endorse two notes aggregating $1,346.73 and executed as security for the payment of such notes a second mortgage on his home. While the decedent *249 determined definitely that other obligations of Ahern became worthless in 1918, he did not charge off the above debt because it was secured by the mortgage. However, during 1919 the decedent was advised by his attorney that the mortgage was defective and could not be enforced. Upon this information and the general knowledge of Ahern's financial condition, the decedent charged off the said sum of $1,346.73. Under all the facts we are of the opinion that the deduction should be allowed.
As to the item of $21,879.84*2627 representing a settlement of account between Ahern and the decedent, the evidence is insufficient to indicate that Ahern's note became worthless in 1919, the year in which it was charged off, rather than in 1918. There is no evidence that the stock pledged as security and subsequently returned to Ahern ever had any value or that it justified the year's delay in charging off the same. The debt which is sought to be deducted must have been ascertained to be worthless and charged off in the year in which the deduction is claimed. Furthermore, there is no evidence that the decedent had ever taken this account into income. Therefore, we hold that this item is not deductible from the decedent's income for 1919.
No evidence was introduced to show that the item of $206.48 represented ordinary and necessary business expenses of the decedent. This amount is not deductible for the year 1919.
The evidence discloses that the decedent paid the sum of $11,550 as endorser of two notes of J. J. Ahern given in payment for capital stock of the Grand Boulevard Investment Co. Although Ahern himself was ascertained to be insolvent in 1918 the account was not charged off in that year because*2628 there was attached to such notes as collateral security certain stock of the Investment Co. The stock was sold in 1920 and decedent paid the balance due on the notes above the sale price of the stock. Upon payment of said amount the stock was turned over to a company which decedent controlled. By this transfer decedent virtually came into possession of the very stock for which the notes had originally been given. We are unadvised as to the value of the stock and in this state of facts are unable to say that decedent suffered an actual loss. Certainly if the stock had a substantial value in excess of the amount paid at the forced sale petitioner could not be heard to claim that decedent sustained a loss, on one hand, while coming into practical possession of the very securities in question, on the other. The item is disallowed.
The bond of the Florida State Fair Association of the par value of $1,000, which the decedent charged off on March 27, 1920, was not shown to have been ascertained to be worthless on that date. Decedent *250 made no attempt to enforce its payment, to dispose of it or to ascertain its market value. *2629 The mere conjecture on the part of the decedent that the bond was worthless did not constitute an ascertainment of such worthlessness within the meaning of the statute. The deductibility of a debt or loss against income must be based on something more than mere supposition. See , and . The action of the respondent in disallowing this deduction is approved.
Judgment will be entered under Rule 50.