*3590 In 1920 the petitioner determined that a portion of certain accounts receivable would never be collected and accordingly charged off to profit and loss the portions which it determined would not be collected. Held, that the amounts charged off are not deductible from gross income.
*181 This proceeding is for the redetermination of a deficiency in income and profits tax for 1920 in the amount of $6,063.03. The petitioner assigns two errors in the determination of the deficiency: (1) The disallowance of bad debts in the amount of $12,085.51; and (2) the reduction of invested capital by the tax for the prior year prorated from the respective dates of payment as provided in Treasury Department regulations.
FINDINGS OF FACT.
Petitioner is an Idaho corporation organized in 1902, with principal office at Boise. Ever since organization it has been engaged in the wholesale grocery business.
During the year 1920 and prior thereto the petitioner sold merchandise on open account to customers whose names are given below and *182 at the*3591 close of 1920 these customers owed the amounts set opposite their names:
| W. C. Martin | $7,477.45 |
| Silver Creek Mercantile Co | 4,953.88 |
| E. M. Small | 8,068.50 |
| J. T. Foster | 2,584.08 |
| Byrne Brothers | 7,048.15 |
| D. H. Clare & Son | 1,635.00 |
The first customer named above took bankruptcy in 1920 and all the others made assignments to the Boise Association of Credit Men for the benefit of their creditors.
W. C. Martin was adjudged a bankrupt on November 1, 1920, and the first meeting of creditors was held on November 18, 1920. On final settlement in 1921 or subsequent years his creditors were paid a little over 48 per cent of their claims, the petitioner's claim, which was proven, being $7,423.58. After learning the amount of Martin's assets and the claims which had been proven against him the president of the petitioner determined that at least $3,000 of its claim would never be paid and authorized the bookkeeper to charge off this amount to profit and loss on December 31, 1920. The ultimate loss was greater than the amount charged off.
The Silver Creek Mercantile Co. made an assignment for the benefit of its creditors on November 27, 1920. Petitioner's claim*3592 was $4,953.05, of which it ultimately recovered $2,211.52. After examining the assets and liabilities of this customer the president of the petitioner authorized the bookkeeper to charge $2,500 off at the end of 1920 as a determined loss, no part of which has ever been recovered.
E. M. Small made an assignment for the benefit of his creditors on November 17, 1920. Petitioner's claim was $8,068.50 and up to the present time petitioner has received less than $6,000. After ascertaining the assets and the liabilities of Small, petitioner, on December 31, 1920, charged off $1,000 of this account as being uncollectible.
In the same manner the petitioner determined on or prior to December 31, 1920, that only a portion of the accounts of J. T. Foster, Byrne Brothers, and D. H. Clare & Son would be collected and authorized the bookkeeper to charge off to profit and loss $1,000, $3,000 and $500, respectively. The losses actually sustained on all of these accounts proved to be greater than the amounts charged off in 1920. The determination of the petitioner as to the amount of the losses which would be sustained upon all of these accounts was made by the president of the petitioner*3593 corporation upon the basis of the assets and liabilities of the several debtors.
*183 The Boise Association of Credit Men charges 10 per cent on all collections of claims handled by it, so that the creditor never receives more than 90 per cent of his claim when handled through the Association, and this was known by the petitioner in 1920.
The notice of deficiency upon which this proceeding is based shows that the deficiency for 1920 was computed as follows:
| Net income as shown by revenue agent's report dated | ||
| May 19, 1924 | $129,778.49 | |
| Invested capital as shown by revenue agent's report | 626,933.38 | |
| Add: | ||
| 1919 tax as shown in revenue agent's report, | ||
| $41,398.21 prorated | $17,445.21 | |
| Less: | ||
| 1919 tax as shown in Bureau letter dated Feb. | ||
| 11, 1925, $36,187.03 prorated | 15,249.21 | |
| 2,196.00 | ||
| Invested capital corrected | 629,129.38 | |
| 8% of invested capital | 50,330.35 | |
| Exemption | 3,000.00 | |
| Excess Profits credit | 53,330.35 |
| Excess Profits Tax | |||||
| Per cent of capital | Income | Credit | Taxable | Rate | Tax |
| 20% | $125,825.88 | $53,330.35 | $72,495.53 | 20% | $14,499.11 |
| Balance | 3,952.61 | 3,952.61 | 40% | 1,581.04 | |
| Total | 129,778.49 | 53,330.35 | 76,448.14 | 16,080.15 |
| Income Tax | |||
| Net income | $129,778.49 | ||
| Less: | |||
| Excess Profits Tax | $16,080.15 | ||
| Exemption | 2,000.00 | ||
| 18,080.15 | |||
| Balance taxable at 10% | 111,698.34 | ||
| Income tax at 10% | $11,169.83 | ||
| Total tax assessable | 27,249.98 | ||
| Tax previously assessed: | |||
| Original tax, Form 1120, Account #40349 | 21,186.95 | ||
| Deficiency in tax | 6,063.03 |
OPINION.
SMITH: The first assignment of error is that the respondent has erroneously disallowed the deduction from gross income of 1920 of $12,085.51, debts ascertained to be worthless and charged off during the year. The statement of facts contained in the petition upon this point is as follows:
5. The facts upon which petition relies as the basis of this appeal are as follows:
* * *
*184 (b) Petitioner sold merchandise to the retail trade on open account. During 1920 accounts to the amount of $12,085.51 became worthless and were charged off petitioner's books as bad debts. This amount was deducted from income in petitioner's tax return for 1920 and the disallowance of this deduction by the Commissioner gives rise to the error noted in paragraph 4(a) above.
The answer filed by the respondent "denies*3595 the allegations of fact contained in paragraph 5." Whether the petitioner deducted from gross income in its return for 1920 any amount for bad debts and whether any amount deducted was disallowed by the respondent in the computation of deficiency is not in evidence. Depositions admitted in evidence show that the petitioner charged to profit and loss in 1920 a total of $11,000, representing certain portions of accounts receivable by it at the close of 1920. The record does not show whether these amounts were claimed as a deduction from gross income in the tax return as debts ascertained to be worthless. Upon the assumption, however, that the $11,000 in question was claimed as a deduction from gross income in the tax return, we are of the opinion that the amount is not a legal deduction from gross income. If the amount is a deduction from gross income it must be by virtue of section 234(a) of the Revenue Act of 1918, which provides that in arriving at taxable income there may be deducted from gross income:
(4) Losses sustained during the taxable year and not compensated for by insurance or otherwise;
(5) Debts ascertained to be worthless and charged off within the taxable year.
*3596 In , we stated:
The Revenue Act of 1918 provides for the deduction of both debts ascertained to be worthless and losses sustained. If a debt becomes worthless, it would seem that a loss has been sustained. Debts, however, are deductible in the year in which they are ascertained to be worthless and charged off, which may be other than the year in which they in fact became worthless. Since it can not be assumed that a double deduction was intended, it would appear that, if a debt became worthless in one year, but was not ascertained by the taxpayer to be worthless until the following year, deductions could not be taken for a loss in the first year and for a bad debt in the second. Furthermore, a loss may be sustained upon account of an indebtedness without any ascertainment of worthlessness, as, for example, the embezzlement of negotiable securities. In that case, a loss may be sustained in the year of the embezzlement, although there has been no ascertainment that the debt itself is worthless.
It becomes necessary, therefore, in every case to distinguish between a loss sustained and a debt ascertained to be worthless. * * *
*3597 The two classes of losses are separate and distinct and it is necessary in each instance to determine whether the deduction must meet the requirements of the "loss" provision or the "bad debt" provision. Cf. , and .
*185 We are of the opinion that the amounts owed to the petitioner on open account by W. C. Martin and five other debtors referred to in the findings of fact constitute debts and that if the petitioner is entitled to any deduction from gross income in respect of these accounts for the year 1920 the deduction must be taken under subdivision (5) above referred to as "debts ascertained to be worthless and charged off within the taxable year." The statute does not provide for the deduction of a part of a debt. A part of a debt may not be charged off as worthless and a part retained on books as having value. ; . The petitioner did not ascertain in 1920 that the debts owed to it by these debtors were entirely worthless. The Revenue*3598 Act of 1921 provided for the reduction of a portion of a debt ascertained to be worthless. There is no such provision in the 1918 law under which the petitioner's return for 1920 was made. Upon the record the respondent is sustained upon this point.
The second assignment of error made by the petitioner is that the respondent reduced its invested capital in accordance with the Treasury Department regulations by the tax for the prior year prorated from the respective dates of payment. It is contended that this is contrary to the decision of the Board in , even though in accordance with section 1207 of the Revenue Act of 1926. It is further contended that in so far as section 1207 of the Revenue Act of 1926 purports to interpret a prior law it is unconstitutional. It is apparent, however, that section 1207 of the Revenue Act of 1926 does not purport to interpret a prior law but enacts new legislation determining the manner in which invested capital shall be computed under the Revenue Acts of 1917, 1918, and 1921. We see no merit to the claim of the petitioner upon this point.
Judgment will be entered for the respondent.*3599