*1269 1. Where stockholders make advances to a corporation and the debts to them are subsequently assumed, first, by a partnership of which they are the sole members and, second, by a corporation in succession to such partnership in which they are the principal stockholders, held, that such debts were not worthless in the taxable year.
2. Where petitioner, on the cash basis, as endorser, during the taxable year gave his individual promissory note for $10,000, and paid, in cash, accrued interest amounting to $99.17, in taking up the note of an insolvent maker, only the interest payment will be allowed as a deduction from his income in that year, where payment of the principal left is postponed to a future period. United States v. Whitehall,271 U.S. 9
3. Other bad debt claims and losses made in these proceedings are disallowed for the want of proof to sustain them.
4. Under the facts shown, negligence penalties imposed by the respondent under section 275(a) of the Revenue Act of 1924 are justified and must be sustained.
*1023 The respondent has determined a deficiency in income tax against petitioner Hughes at Docket No. 44113 for the year 1924 in the amount of $7,780.36. At Docket No. 61821 he has determined a deficiency in income tax for the year 1924 against petitioner Little in the amount of $29,914.60, to which has been added a negligence penalty of $1,493.92, and a deficiency in income tax for the year 1925 in the amount of $36.20. Each petitioner alleges that the respondent erred in disallowing certain claims for deductions from his gross income in 1924 as losses from his interest in a group of bad debts owing to them from a coal-mining company which they jointly financed and which it is alleged became worthless in that year. In Docket No. 61821 other bad debt claims and issues which relate to gains, losses and negligence penalties are involved. The two proceedings were consolidated for hearing and report.
FINDINGS OF FACT.
The petitioners are individuals. At all times material here they were engaged in business at Bismarck, North Dakota. Little was president of the First National Bank of Bismarck and connected with a number of other local banks. He was also*1271 president of the Providence Life Insurance Company of Bismarck. Hughes was president and principal stockholder of the Hughes Electrical Company, through which corporation he engaged in the public utility business.
In June 1918, the petitioners organized the Beulah Coal Mining Company, a corporation, hereinafter referred to as the Beulah Company, to which they transferred some coal-mining properties near Beulah, North Dakota, which they had theretofore acquired and partly developed as equal sharing partners. All of the capital stock of the Beulah Company, except nominal holdings, was issued to them in exchange for the partnership assets and money paid in. The Beulah Company functioned until about October 2, 1922, at which date it ceased business and leased its plant and equipment to the petitioners, who then undertook the development of some adjacent coal properties which they individually owned or controlled. The lease of the Beulah Company plant was made to Hughes, but for and in behalf of both petitioners, and through it they took possession of that corporation's assets, all of which they thereafter used in the operation of a coal-mining business, conducted as a copartnership, *1272 and styled "The Knife River Coal Mining Company," hereinafter referred to as the "partnership." On the same date, October 2, 1922, the petitioners formed the Knife River Coal Mining Company, a corporation, hereinafter referred to as the "corporation." This corporation was intended to be employed *1024 by the petitioners in operation of their coal properties as an expedient to shield them from personal liability for debts and the accidental hazards of the mining business; but, for reasons not shown, was not so employed until near the end of 1923, at which time it formally organized and took over the business and assets of the partnership.
Incidental to their operations through the Beulah Company the petitioners personally made advances of money and assumed certain corporate obligations which amounted in the aggregate to $224,375.10. When the petitioners began operating through the partnership they continued physical possession and control of all of the assets of the Beulah Company and used them in the prosecution of their partnership business. In such business they opened up partnership books in which they charged against the Beulah Company the advances they had made in*1273 their operations through it, as well as its unpaid debts which the partnership assumed. About the same time the petitioners brought proceedings in the state courts to foreclose the mortgage underlying the Beulah Company's bonds, which they owned. This action resulted in their acquisition through a judicial sale held July 25, 1923, of title to all of the assets of such company for the sum of $35,000. Such assets were taken into the property accounts of the corporation on December 31, 1923, and thereafter used as its property. In connection with that taking over the corporation entered charges in its books against the Beulah Company which included the advances made by the petitioners in their operations through it, as aforesaid, as well as the unpaid notes and other obligations of the Beulah Company which the petitioners had assumed, which, in gross, amounted to $224,375.10. In the same way and at the same time the corporation credited the Beulah Company with $112,108.54 for the physical assets taken over and then balanced the account by a further credit of the $104,375.69, which it charged against surplus.
The petitioners delivered to the corporation other assets, which were*1274 given a book value of $260,035 as of December 31, 1923. For these and the assets of the Beulah Company the corporation issued to them its capital stock and bonds of par value in the respective amounts of $61,000 and $170,000, and, in addition, assumed Beulah Company debts, which the petitioners were otherwise bound to pay, including interest, etc., amounting to $44,481. Subsequently, on August 9, 1924, the corporation issued additional shares of its capital stock of a par value of $4,000 to the petitioner.
Petitioner Little kept his accounts and reported his income on the cash receipts and disbursements basis. On December 22, 1924, he was called upon by the Merchants National Bank of St. Paul, Minnesota, to pay a note in the sum of $10,000, which he had endorsed at *1025 the request of the maker, who later became insolvent. This the petitioner did by giving his own note for that amount to the bank and paying accrued interest amounting to $99.17. This note was not paid within the year 1924.
At the close of the year 1924 Little owned 250 shares of the capital stock of the Kelly Springfield Motor Truck Company, which he had purchased in parts at different times in 1916, *1275 1917 and 1918 for a total cash consideration of $19,600. He also owned at the close of that period 196 shares of the capital stock of the Goodridge-Call Lumber Company, which he had acquired prior to March 1, 1913, some by purchase for cash at $100 per share and some by way of stock dividends.
In their tax returns for 1924 each of these petitioners claimed a bad debt deduction from his gross income of that year of a sum which he alleges represented his share of a joint loss amounting to $93,382.92, which they allege they sustained in that year when they determined that their advances to the Beulah Company were uncollectible. Other deductions were claimed by petitioner Little from his 1924 income as follows: (1) $5,974.88 as a net loss carried over from 1923; (2) $2,100 representing interest, and $700 taxes paid; (3) $500 as a loss on investment in Barton Gulch Mining stock; (4) $5,000 as loss on note of one Bradley; (5) $1,000 as a loss on investment in Federal Adding Machine Company stock; (6) $10,000 as a bad debt loss on note of one Twitchell; (7) $21,797.16 loss on investment in Goodrich Call Lumber Company stock; and (8) $19,600 as a loss on an investment in Kelly Springfield*1276 Truck Company stock.
The respondent in his audit of their returns denied to each petitioner all of the claims for deductions made by him, and, in addition, added to petitioner Little's income for 1924 taxable items as follows: (1) $3,338.95 representing understated interest; (2) $9,060.79 as understated dividends; (3) $44,982.09 as understated profits; (4) $700 for excessive deduction taken for alleged taxes paid; and (5) $17,435.22 as unreported capital net gain. For failure to report his true income the respondent imposed the statutory penalty provided in section 275(a) of the 1924 Act against Little.
OPINION.
LANSDON: The petitioners contend that their advances in cash and property to the Beulah Coal Mining Company during its operations constituted bad debts which were ascertained to be worthless in 1924. As the basis for his determination in respect of this issue, the respondent contends, first, that the petitioners suffered no deductible loss in their transactions with the Beulah Company; and, second, that, even if that corporation's obligations to them could at any time *1026 have been considered in the category of bad debts, in the circumstances the time of*1277 the ascertainment of worthlessness must have been prior to 1924.
We think the record supports both theories advanced by the respondent. Respecting the first, the petitioners have not adduced proof convincing to us that they ultimately lost the whole, or even part of their outlays made in their operations through the Beulah Company, which they here claim were debts which were ascertained to be worthless in 1924.
The petitioners' advances to the Beulah Company were made prior to October 1922, when they closed it down and began using its plant and equipment in their partnership operations. They did this under a lease which provided for certain compensation to the Beulah Company for the use of the property, but no accounting was made to it for such use and the record shows that they paid nothing on such account. If such use had any value whatever the corporation was entitled to a credit against any indebtedness the petitioners held against it. The fact that the partnership used this plant and other assets for more than a year and thereby was enabled to develop the mining properties and mines which it delivered as a going business to the corporation succeeding it is evidence to*1278 us that such use was valuable. What that value was we are unable to say in the absence of proof. Conceivably to the petitioners it may have exceeded the amount in dispute, inasmuch as by use of the equipment and other assets held over by them from the Beulah Company they were enabled to organize their new corporation without capital expenditures or any interruption of their mining business.
Other facts shown in the record to our mind tend to support either or both of two theories which are fatal to the petitioner's contention, viz: (1) that the petitioners determined these alleged bad debts worthless and lost to them not later than December 31, 1923, and/or (2) that their claims on that date were taken over and assumed by the corporation. An abstract of the account of the Beulah Company with the partnership which was put in evidence shows that on December 31, 1923, the partnership balanced the account with a closing credit entry of $104,375.69, the amount now claimed as a bad debt, which it charged to surplus. These books and all other partnership accounts were taken over by the corporation and adopted by it as its own. Although the exhibit introduced by petitioners showing*1279 the successive transfers of these accounts, first to the partnership and last to the corporation, was not explained, it indicates that the partnership and the corporation in the order stated each assumed the payment of the obligations here in issue and that they were written off as losses of the corporation at the close of the year 1923. In any event the petitioners have not convinced us that the respondent erred *1027 in denying the deductions of the petitioners claimed for them in 1924, and his acts are approved. Since the record fails to disclose that advances made by petitioners to the Beulah Company became worthless debts at any time or that any loss was sustained therefrom, the alternative contention that, if the Board should find the debts worthless in 1922 or 1923, net losses applicable to income tax liability for 1924 resulted, need not be considered.
Other assignments of error urged in the appeal of petitioner Little at Docket No. 61821 remain to be considered. The petitioner gave his individual promissory note for $10,000 and paid $99.17 in interest to a bank in discharge of a note for $10,000 upon which he was bound as indorser for one Twitchell, an insolvent*1280 maker. He claimed the amount of this note as a bad debt deductible from his income in 1924. This Board and the courts have held that the giving of a note in the circumstances shown and where the maker thereof keeps his accounts and makes his income tax return on the cash receipts and disbursements basis does not result in a deductible loss until such note is paid in cash and by such holding we are bound. ; . The payment of $99.17 for interest constitutes a deductible claim and will be allowed; all in excess of such sum will be disallowed.
We are unable to find proved facts in the record to sustain petitioner Little's claims of losses from his investments in the Kelly Springfield Truck Company and Goodridge-Call Lumber Company stocks, which securities he contends became worthless in 1924. Little testified at the hearing that he paid $19,600 for his Kelly Springfield stock, but the only evidence introduced as to the value of such stock in the taxable year consists of copies of correspondence and an unverified copy of an alleged financial statement purporting to show the*1281 condition of that corporation as of December 16, 1922. There is nothing to show that such stock was valueless in 1924 or at any other time. The document or statement if accorded probative value at all would support the theory that the corporation was insolvent in 1922, which facts the petitioner must have known. We hold, therefore, that the petitioner has failed to sustain the burden of showing that the respondent erred in denying the deduction in the year claimed.
Little's stock holdings in the Goodridge-Call Lumber Company were acquired at different times prior to March 1, 1913, part by purchase at par and part through stock dividends to him. He claims that his 196 shares of this stock had a fair market value on March 1, 1913, of $21,797.16 and that they became worthless in 1924. No testimony of witnesses who pretended to know the fair value of this stock on March 1, 1913, or its lack of value in 1924, was introduced at the hearing of these appeals. The petitioner however introduced in evidence a letter received by his agent in October 1928, with a *1028 statement purporting to show the book value of the book value of that stock on March 1, 1913. This letter and*1282 statement are incompetent and without probative force. The same may be said of a great mass of other miscellaneous hearsay memoranda put in evidence which merely reflect the opinions of parties not under oath or present for cross examination before the Board. For lack of proof showing error we sustain the act of the respondent in denying this claim.
Since we are unable to find that petitioner Little sustained any losses in connection with the stock transactions above discussed, it is unnecessary to consider the alternative claim that such losses if sustained in prior years resulted in net losses applicable to income tax liability in 1924.
The remaining assignments of error, which relate to deductions claimed by petitioner Little, were abandoned at the hearing and the acts of the respondent in denying them are therefore approved.
Little has neither denied the items of income which the respondent found were omitted from his income tax return for 1924, nor offered any satisfactory explanation for such omissions. There is ample proof in the record to justify the imposition of the negligence penalty, which, under the facts shown, was mandatory under section 275(a) of the Revenue*1283 Act of 1924. These penalties are therefore affirmed.
No evidence in respect of the deficiency asserted against Little for 1925 was adduced. The determination of the respondent thereto is affirmed.
In Docket No. 44113 decision will be entered for the respondent. In Docket No. 61821 decision will be entered under Rule 50.