*2674 1. BAD DEBT. - Debt ascertained to be worthless and charged off during taxable year held deductible.
2. INCOME. - Where petitioner carried in its accounts receivable and payable for 1920 certain items which had been paid or received prior to January 1, 1920, and upon discovery of that fact during 1920 transferred such items to a suspense account and upon closing its books for 1920 transferred the total $2,121.27 into surplus as of January 1, 1920, and, further, where respondent included said amount in gross income for 1920 because it represented income in prior years but not reported in such prior years, held not to be income in 1920.
3. Where no basis existed for respondent to include $1,450 in income for 1920, held, such amount should be eliminated from gross income.
4. Loss. - Upon the evidence, held, petitioner sustained a loss on sale of truck in 1920.
5. DEPRECIATION. - Respondent allowed no depreciation on petitioner's motor truck for 1920. Depreciation determined and allowed.
*2675 *105 Respondent has asserted against this petitioner a deficiency in income and profits taxes in the amount of $9,662.15 for the calendar year 1920, and this proceeding is for a redetermination of said deficiency. For the year 1921 respondent determined an overassessment in the amount of $122.82.
Petitioner alleges that respondent erred: (1) In disallowing for the year 1920 a deduction of $20,000, alleged to be a bad debt ascertained to be worthless and charged off during said year; (2) in increasing gross income by including therein an item of $2,121.27, *106 alleged to be surplus and not income for 1920; and (3) in including in gross income an item of $1,450 on account of an adjustment made by respondent with respect to a motor truck transaction, and further, the disallowance of an alleged loss sustained through the same transaction.
FINDINGS OF FACT.
The Cooper-Brannan Naval Stores Co. was incorporated under the laws of Alabama in 1916, and had its principal place of business at Mobile. On March 26, 1925, said corporation was duly dissolved under the laws of the Alabama. The petition in this proceeding has been verified and filed by the trustees in dissolution*2676 of said corporation, who under the laws of Alabama, are empowered, for a period of five years after the date of such dissolution, to sue in the corporate name.
During the year 1920 petitioner was engaged in the business of trading in naval stores, securing turpentine from pine trees, making naval stores and selling them. Petitioner's capital stock was $150,000, divided into 150 shares par value $100 each. During 1919 petitioner purchased for $200 per share the 30 shares held by one Lane. On June 30, 1920, the stock was held - by G. W. Cooper, vice president and general manager, 85 shares; L. I. Brannan, president, 30 shares; T. J. Caylor, 5 shares; and 30 shares were held by petitioner as treasury stock. The stock was paid for in cash.
G. W. Cooper and C. N. Pooley were sons-in-law of L. I. Brannan. In June, 1920, Pooley went to Brannan and sought to borrow $20,000 in order to enable him, Pooley, to protect certain stocks and bonds in which he had a substantial equity and which he had bought on margin. At that time Pooley was cashier in a bank at Ocean Springs, Miss. Brannan called Cooper in to see him and asked if the loan could be made by the petitioner. Both Brannan*2677 and Cooper were of the opinion that Pooley could repay petitioner the amount of the loan sought when it would come due, plus interest, and petitioner, on June 30, 1920, loaned Pooley $20,000, Pooley receiving the full amount. Pooley executed and delivered to petitioner his notes dated June 30, 1920, one in the amount of $10,000, which matured on October 1, 1920, with interest, and the other in the amount of $10,000 which matured on December 1, 1920, with interest. The $20,000 which petitioner loaned to Pooley was borrowed by petitioner from the Merchants Bank of Mobile, with which institution petitioner had always banked. Petitioner gave to the said bank its note as security endorsed by Cooper and Brannan, which was the usual and regular procedure whenever petitioner borrowed from said bank. Prior to that time petitioner had loaned money at the usual rate of interest.
*107 Within 60 days from June 30, 1920, Pooley was asked to resign his position with the bank and he lost all the property he had. Having nothing left, not even a home, Pooley moved his family, a wife and four children, to Mobile, where they lived with Brannan, his father-in-law, who supported Pooley's*2678 family. Pooley was unable to secure a position, had no earning power, was destitute, and Brannan put him to work on his (Brannan's) farm, 15 or 20 miles from Mobile. When Pooley's notes came due he had no property and no income, and on December 31, 1920, petitioner, having ascertained the debt to be worthless, charged the said $20,000 off its books as a bad debt before closing the books for 1920. To have sued Pooley on his notes would have been a useless additional expense. Petitioner has never collected any portion of Pooley's notes. Petitioner paid its notes for $20,000 to the Merchants Bank in 1921. In its return for 1920, petitioner deducted $20,000 as a bad debt and respondent disallowed the deduction on the ground that the debt had not been properly ascertained to be worthless during 1920.
Prior to 1920, petitioner kept a single entry set of books and, no balances ever having been made, errors in the accounts were not detected. In June, 1920, petitioner employed a public accountant to install a double-entry set of books as of January 1, 1920. The accountant made up from the old books a forced balance sheet as of December 31, 1919, whereon he entered "accounts receivable" *2679 totaling $5,649.49 and "accounts payable" totaling $5,736.40. It was discovered subsequently during 1920 that payment of $97.34 of said accounts receivable had in fact been received by petitioner prior to January 1, 1920, and that $2,218.61 of said accounts payable had actually been paid by petitioner prior to that date, but had not been properly entered on the old set of books. As the erroneous entries were discovered the items were transferred to a suspense account in order to correct petitioner's 1920 accounts. At the end of the year 1920 the suspense account was closed out and $2,121.27 was added to surplus as of January 1, 1920, in closing the books for the calendar year 1920. The respondent increased petitioner's gross income for 1920 by the amount of $2,121.27 as a result of the above corrections made on petitioner's books on the ground that the said amount represented an accumulation of income over prior years which was not reported in such prior years.
Petitioner's business of gathering crude turpentine and hauling it to the distillery subjects its automobile trucks to very hard usage. The trucks, being used on beaten trails through woods, have a useful life of not*2680 to exceed 18 months. It has been petitioner's practice to trade its trucks in at the end of their useful life and petitioner has usually been allowed approximately one-eighth of a truck's cost as the trade-in value on a new truck. On January 1, 1920, petitioner *108 owned a Reo truck which it had purchased on May 15, 1919, at a cost of $1,750. For the year 1919, respondent allowed petitioner $508.33 as depreciation on that Reo truck, leaving an undepreciated cost of $1,241.67 on January 1, 1920. On March 8, 1920, the said Reo truck was traded in at $300 on an International truck which cost $1,825, the balance or $1,525 being paid in cash. The said International truck was used for the balance of the year 1920. The automobile trucks were capitalized, but petitioner did not make proper adjustments in its property accounts every time it sold an automobile; thus the automobile account was understated. Petitioner deducted $1,184 as depreciation on automobiles for 1920. The revenue agent's report which respondent adopted as to this item, shows $1,450 added to gross income for 1920, with the following explanation:
During the year 1920, the corporation purchased a new truck*2681 in exchange for an old truck and cash. This purchase was properly capitalized and the cost of the old truck was charged off. However no adjustment was made in the Depreciation Reserve. Reference to exhibit D will show that an adjustment should have been made in the Reserve Account. Adjustment is not made resulting in the above additional income.
The said exhibit D shows that the revenue agent has deducted $1,450 for years prior to 1920, and has allowed $281 as depreciation at a rate of 33 1/3 per cent on one car purchased in August, 1919. This $281 item is not in dispute. No depreciation was allowed by respondent on the Reo and International trucks for the year 1920. Petitioner's books show that neither the cost of the Reo truck nor the amount of $1,450 was charged off during 1920, nor did petitioner take or claim such deduction on its return for 1920.
OPINION.
TRUSSELL: We are of the opinion that it is not proper for this Board to go into the question of the motive of petitioner's officers in making the $20,000 loan to Pooley nor into the question of whether or not such loan was an Ultra vires act, as the respondent would have us do. The record establishes the*2682 fact that petitioner, on June 30, 1920, made a loan of $20,000 to Pooley, payable prior to the end of that year with interest; that prior to the end of that year petitioner's debtor lost everything he had and was destitute; that the debt was ascertained to be worthless during 1920, and that it was charged off by petitioner during 1920. Petitioner should be allowed a deduction in the amount of $20,000 from its gross income for the year 1920 under section 234(a)(5) of the Revenue Act of 1918.
The amount of $2,121.27 which respondent added to gross income for 1920 for the reason that it represented an accumulation of income for prior years, but not reported in such prior years, is certainly not income for the year 1920 when it was income for prior years and *109 therefore should be eliminated from petitioner's gross income for the year 1920.
Due to the hard usage to which petitioner's trucks were subjected in hauling crude turpentine through the woods, the useful life of its trucks did not exceed 18 months and petitioner is entitled to a deduction for 1920 for depreciation at a rate of 66 2/3 per cent per annum on its trucks. On January 1, 1920, petitioner owned one Reo*2683 truck which on that date had an undepreciated cost of $1,241.67. The said truck was traded in at a value of $300 on a new International truck purchased on March 8, 1920. The said transaction left petitioner with an item of $941.67, representing the undepreciated cost of a capital item which had vanished, but no deduction for such loss has been allowed. Petitioner should be allowed a deduction of $941.67 for the year 1920 under section 234(a)(4) of the Revenue Act of 1918. The International truck purchased on March 8, 1920, at a cost of $1,825 had an approximate useful life of 18 months, at the end of which period it would have an approximate salvage or trade-in value of one-eighth of its cost of $228.12, and we are of the opinion that the difference or $1,596.88 is a fair basis on which to compute the depreciation sustained on that truck for the year 1920. On that basis depreciation on the International truck for 9 1/2 months during 1920 at a rate of 66 2/3 per cent per annum would amount to $842.79, which amount should be allowed petitioner as a deduction for 1920 under section 234(a)(7) of the Revenue Act of 1918. The respondent proposes to increase petitioner's income for*2684 1920 by $1,450 on the ground that that amount represents the cost of the Reo truck charged off in 1920 without an adjustment in the depreciation reserve. The evidence shows that the said amount was not charged off during 1920 and there being no basis for including said $1,450 in income, it should be eliminated.
The net income as asserted by respondent for 1920 should be reduced by:
| Worthless debt | $20,000,00 |
| Suspense account item | 2,121.27 |
| Loss on truck | 941.67 |
| Depreciation on truck for 1920 | 842.79 |
| So-called adjustment on motor truck transaction in 1920 | 1,450.00 |
| Total | 25,355.73 |
Petitioner's tax liability should be recomputed in accordance with the above findings of fact and opinion. Order of redetermination will be entered upon 15 days' notice, pursuant to Rule 50.
Considered by SMITH, LITTLETON, and LOVE.