1929 BTA LEXIS 2473">*2473 Deductions claimed by the petitioners on account of bad debts, to the extent ascertained to be worthless and charged off in the respective taxable years, allowed under section 214(a)(7) of the Revenue Act of 1921.
16 B.T.A. 996">*996 This is a proceeding for the redetermination of deficiencies in income tax as follows:
| Petitioner | Amount of deficiency | |
| 1922 | 1923 | |
| Samuel L. Lubell | $4,666.89 | $302.81 |
| Morris M. Lubell | 3,209.47 | 282.99 |
| Jacob J. Lubell | 3,507.06 | 275.27 |
| Aaron D. Lubell | 3,479.31 | 274.79 |
| Abraham P. Lubell | 2,961.26 | 265.60 |
16 B.T.A. 996">*997 The only issue raised by the pleadings is whether the respondent erred in disallowing deductions claimed on account of debts alleged to have been ascertained to be worthless and charged off within the respective taxable years.
FINDINGS OF FACT.
The petitioners are, and during the years 1922 and 1923 were, partners in the firm of Lubell Brothers, hereinafter referred to as the partnership, with principal office in New York City. The partnership was composed of the five individuals, 1929 BTA LEXIS 2473">*2474 who are petitioners herein, and each of whom had an equal share in the profits and losses thereof. The partnership was and is engaged in the manufacture and sale of boys' blouses, shirts and pajamas.
The respondent increased the income of the partnership for the year 1922 by $90,000 and for the year 1923 by $10,000, as the result of the disallowance of deductions claimed by the partnership on account of certain notes issued to it by the Rambler Manufacturing Co.
The Rambler Manufacturing Co. was a corporation organized under the laws of the State of New York about 1910 or 1911 and was, during the taxable years, engaged in the business of manufacturing and selling boys' wash suits and novelties. This company, hereinafter referred to as the corporation, had a total issued and outstanding capital stock of $3,000, consisting of 30 shares of the par value of $100 each. The partnership owned 16 shares of the corporation's stock, and a brother of the petitioners herein, who was not a member of the partnership, owned the remaining 14 shares.
In order to finance its business the corporation secured loans from banks and also cash advances from the partnership. The partnership gave1929 BTA LEXIS 2473">*2475 a blanket guarantee to the bank of the corporation's account for $40,000, but neither the partners nor the partnership endorsed any notes for the corporation. The corporation executed notes to the partnership for the cash advanced to it from time to time.
The corporation operated profitably up to and including 1918 or 1919, but thereafter suffered losses, commencing with the fiscal year ended July 31, 1921. The corporation kept its books on the basis of a fiscal year ending July 31. In July, 1922, the partnership took physical inventory of the corporation and found that it had a deficit of about $99,000. Taking into consideration all of its assets and liabilities, the corporation was at that time insolvent to the extent of more than $99,000.
At December 31, 1922, the corporation was indebted to the partnership in the amount of $164,000, and on the same date the partnership determined that said debt was worthless to the extent of $90,000, and charged said latter amount off its books. In 1923 the partnership 16 B.T.A. 996">*998 determined that said debt was worthless in the additional amount of $10,000, and in said year charged off said additional amount. These amounts were claimed1929 BTA LEXIS 2473">*2476 as deductions from gross income of the partnership for the years 1922 and 1923, respectively, under the provisions of section 214(a)(7) of the Revenue Act of 1921. The respondent disallowed the said deductions, added said amounts to the partnership income, and determined the deficiencies here involved. No part of the amounts claimed as deductions was ever recovered by the partnership; in fact, no part of the total indebtedness at December 31, 1922, was ever recovered by the partnership.
The last cash advance made by the partnership to the corporation was on September 8, 1922, in the amount of $1,000. The partnership never recovered any part of the $164,000 advanced by it to the corporation.
In addition to the funds advanced by the partnership to the corporation, the partnership had guaranteed payment of the corporation's obligations to the bank and to commission houses to the extent of $15,000 or $20,000. When the partnership discovered the true financial condition of the corporation in July, 1922, it was decided not to liquidate the corporation immediately, but to continue it for the purpose of paying off its debts to others than the partnership, in order to avoid further1929 BTA LEXIS 2473">*2477 losses to the partnership, if possible. The liquidation of the corporation was effected gradually, and the corporation eventually paid off all of its obligations except that to the partnership, no part of which was ever paid. The liquidation of the corporation was finally completed about the end of the year 1926.
OPINION.
TRAMMELL: The Revenue Act of 1921, in section 214(a), provides that in computing the net income of an individual there shall be allowed as deductions:
(7) Debts ascertained to be worthless and charged off within the taxable year * * *; and when satisfied that a debt is recoverable only in part, the Commissioner may allow such debt to be charged off in part.
It seems clear from a consideration of the uncontroverted evidence that the debtor corporation herein was hopelessly insolvent at December 31, 1922, and that the partnership was justified in ascertaining the debt in question to be worthless, at least to the extent of the amounts claimed as deductions.
The respondent has not filed any brief setting forth his position in the premises, and we are not advised of his reasons for disallowing 16 B.T.A. 996">*999 the claimed deductions, except as disclosed by the1929 BTA LEXIS 2473">*2478 deficiency letters, in which the following statement appears:
Careful consideration has been given the protest to the agent, dated October 22, 1926, against the adjustment of partnership income resulting from the disallowance of $90,000 and $10,000 bad debts for the years 1922 and 1923, respectively.
However, since the corporation is still a going concern and the partnership owns more than one-half of the capital stock of the corporation, the amounts are not deductible losses in 1922 and 1923, and the action of the agent in disallowing the bad debts has been sustained.
When the partnership discovered the insolvent condition of the corporation in 1922, it was faced with the necessity of deciding upon one of two courses of procedure. It might have taken steps to liquidate the corporation at once, in which event there would have been no possibility of reducing the amount of the partnership loss below the aggregate amount of the deductions here claimed. But, on the other hand, the partnership would have been compelled to reimburse the bank and the commission houses on its guarantee, thus materially increasing the amount of its ultimate loss. Or, the partnership might have effected1929 BTA LEXIS 2473">*2479 a gradual liquidation of the corporation's business, using the proceeds from the sale of its assets to discharge its indebtedness to the bank and others, and thus avoid increasing the corporation's debt to the partnership. The latter course was decided upon, and the liquidation of the corporation was completed in 1926. All the obligations of the corporations were discharged during the period of liquidation, except the debt owing to the partnership. It also clearly appears that the business of the corporation was not continued in the hope or expectation of reducing the indebtedness to the partnership below the amounts charged off its books; and, in fact, no part of the indebtedness existing at December 31, 1922, was ever recovered.
Under the circumstances existing in this case, we think it is immaterial that more than 50 per cent of the outstanding capital stock of the corporation was owned by the partnership, and it is further our opinion that the right of the petitioners to the deductions claimed is not defeated by reason of the fact that the operation of the corporation was continued in subsequent years for the purpose of effecting liquidation without further loss to the partnership. 1929 BTA LEXIS 2473">*2480 ; . See, also, .
The amounts claimed constitute lawful deductions for the respective taxable years, and the action of the respondent is reversed.
Judgment will be entered under Rule 50.