*1803 DEDUCTION - BAD DEBT. - Held that petitioner was entitled to a deduction of $19,894.60 from gross income for 1922, where evidence establishes that the debt in that amount was ascertained to be worthless and charged off during that year.
*728 The respondent has asserted a deficiency in the amount of $2,570.74 in this petitioner's income tax for the calendar year 1922, and the greater portion of that amount is in controversy in this proceeding.
The petitioner has withdrawn his first assignment of error relative to the disallowance of $2,000.05 of the amount claimed as depreciation on dredges and the only remaining issue is whether petitioner is entitled to deduct $19,894.60 as a debt ascertained to be worthless and charged off during 1922.
*729 FINDINGS OF FACT.
Since 1904 the petitioner, as an individual, has been engaged in the business of building levees and drainage canals under the trade name of Sternberg Dredging Co., with offices in St. Louis, Mo. Most of the petitioner's contracts*1804 have been obtained from the Federal and State Governments which required him to post large surety bonds from reliable surety companies, and therefore it has been imperative that he maintain his financial and credit standing.
In 1920 Edwin J. Brock interested petitioner in an enterprise of manufacturing a water purifier for steam boilers under certain patents issued to James A. Ray. The petitioner and Brock agreed to organize a corporation, the Brock Engineering Co., with an authorized capital stock of $5,000 divided into 50 shares of a par value of $100. They agreed to divide the stock equally and that petitioner would pay $2,500 in cash and that Brock would give his entire time and attention to the business without any salary. It was also agreed that petitioner would loan to the corporation another $2,500 when needed, Brock having estimated that $5,000 cash would be all that would be needed to finance the enterprise. That agreement was carried out, the corporation was organized, a license was obtained from Ray to manufacture the water purifiers, and production was commenced in the latter part of 1920.
The Brock Engineering Co.'s business was not successful from the very*1805 start, but the petitioner felt that the water purifier was a good thing because it helped to eliminate scaling of boilers of steam engines and Brock was very enthusiastic about it, so they continued doing business until October, 1922. Because the said corporation had no capital and no financial standing it was necessary for petitioner to assure its creditors that all of the corporation's obligations would be paid, and, as the various bills and accounts came due, the petitioner loaned money to the corporation, which would issue its checks in payment of its various debts. As each loan was made the amount thereof was entered in the ledger of the Sternberg Dredging Co. in an account under the name of Brock Engineering Co., and such loans amounted to $1,800 during 1920, $5,109.60 during 1921, and $12,985 during 1922, or a total of $19,894.60 by the end of December, 1922. During that period of time Brock had drawn no salary and he gave his time and efforts with the hope of making the business show profits in which he would share equally, but in October, 1922, he came to petitioner, told him that the enterprise was a total failure and that he, Brock, was through.
*730 At the*1806 close of the year 1922, the petitioner thoroughly examined the affairs of the Brock Engineering Co. and found that it had the following assets and liabilities:
| Assets | Liabilities | ||
| Accounts and bills receivable | $5,973.00 | Accounts and bills payable | $4,884.43 |
| Office furniture and fixtures | 462.72 | H. J. Sternberg | 19,894.60 |
| Tools | 711.03 | Capital stock | 2,500.00 |
| Tanks | 700.02 | ||
| Total | 7,846.77 | Total | 27,279.03 |
| Loss | 19,432.26 |
He also found that while he had already made loans totaling $19,894.60, it would be necessary for him to make further advances during 1923 to meet other liabilities of the corporation. Having assured the payment of the corporation's liabilities when credit was extended to it, the petitioner felt obligated to advance sufficient funds to meet them, because it was vital to his own construction besiness that he maintain his own credit. Petitioner further found that during the period of operation only a few water purifiers had been sold; that although a costly advertising campaign had been carried on, there was no demand for such devices; and that, so far as he was able to determine, the enterprise was a complete failure, with no*1807 prospects of being rejuvenated. In his judgment the debt of the Brock Engineering Co. to him in the amount of $19,894.60 was worthless and petitioner ordered his employee to charge it off his books kept under the name of Sternberg Dredging Co. In the ledger the amount of the Brock Engineering Co. shows that $19,894.60 was charged off to profit and loss on December 31, 1922, and the journal also shows a charge-off of the said account on the same date.
In February, 1923, James A. Ray, the owner of the patents for the water purifiers, went to the petitioner and offered to sell his patents for $2,500, but petitioner refused the offer because he thought they were not worth much. Finally Ray said he needed money and would sell the patents for $1,000. Ray and petitioner entered into a contract on February 27, 1923, whereby petitioner acquired the patents in consideration of $1,000 and the petitioner's agreement to protect and indemnify Ray against all claims of the Brock Engineering Co. Petitioner purchased the patents with the hope that in some way and at some time they might help him recoup some of his losses.
During 1923 debts owing the Brock Engineering Co. were collected in*1808 the amount of $5,896.47, which was applied on its obligations. The petitioner loaned the corporation $3,279.29 during the *731 year 1923 and $849.71 during 1924 to clear up all of the obligations of the said corporation, which ceased manufacturing water purifiers in October, 1922.
In the latter part of 1923, Brock and two others, V. C. Sears and C. B. Brockett, offered to purchase the patents and their purpose was to organize a new corporation, sell the stock and use the new capital in an effort to put the water purifier on the market. On November 22, 1923, the petitioner individually and as president of the Brock Engineering Co. entered into a contract with Brock, Sears, and Brockett, whereby the former agreed to sell all of the corporation's assets and the patents to a new corporation to be organized by the latter parties. It was further agreed that upon receipt of such assets and patents the new corporation would pay to petitioner $25,000 as follows: 100 shares of its stock of the par value of $10,000; a note for $5,000 due in 90 days; a note for $5,000 due in 15 months, and a note for $5,000 due in 24 months. The said consideration was based on the amount which petitioner*1809 had loaned to the Brock Engineering Co.
The petitioner reported as income the amounts received on the notes in the years in which paid. No dividends have ever been paid on the 100 shares of stock.
In his income-tax return for the year 1922 petitioner deducted $19,894.60 as a bad debt ascertained to be worthless and charged off during that year. The respondent has disallowed that deduction.
OPINION.
TRUSSELL: The respondent's disallowance of the claimed bad debt deduction was based on his determination that the debt was not totally worthless at the close of the year 1922, and he points to the subsequent events happening at the close of 1923 to sustain his view.
The facts of record show that this petitioner had been engaged in business for many years prior to 1922 and that in his sound business judgment the debt was totally worthless at the close of the year 1922, at which time it was charged off. We are of the opinion that the facts as they existed at that time not only warranted petitioner's judgment as to the worthlessness of the debt, but actually established the worthlessness beyond doubt. The petitioner may not be called upon to look into the future and foretell*1810 events which may never happen. At the close of the year 1922 the petitioner had ample reason, based on facts, to believe that he would never recover any portion of the $19,894.60 loaned to the Brock Engineering Co., and he may not be denied a proper deduction because subsequent events occur in his favor.
*732 We are of the opinion that petitioner was entitled to a deduction of $19,894.60 from his gross income for the year 1922, pursuant to section 214(a)(7) of the Revenue Act of 1921.
Judgment will be entered pursuant to Rule 50.