1931 BTA LEXIS 2091">*2091 1. Losses sustained on a stock and under a contract of guaranty allowed as deductions.
2. Where on the termination of a partnership agreement the withdrawals of one member of the firm during its existence exceed his capital investment, plus his share of the net profits of the firm during such period, and the resulting indebtedness of the retiring member to the partnership is forgiven by the remaining members, the retiring member does not sustain a loss on his capital investment or, on the facts here present, derive taxable income because of the forgiveness of the indebtedness.
3. Withdrawals made during the year in which the partnership agreement was terminated held to be taxable as compensation for services rendered.
4. Negligence penalty asserted disapproved.
22 B.T.A. 655">*655 Proceeding for the redetermination of deficiencies of $65.59 and $3,017.65 in income tax for 1925 and 1926, respectively, and a negligence penalty of $150.88 for 1926. The issues not settled by stipulation are: (1925) (a) whether losses of $3,125 and $775 were sustained on certain1931 BTA LEXIS 2091">*2092 stock and a contract of guaranty, respectively; (1926) (b) whether a loss of $10,000 was sustained on the termination 22 B.T.A. 655">*656 of a partnership agreement; (c) whether the sum of $35,451.89 included in petitioner's gross income by respondent represents partnership profits; and (d) whether the deficiency is subject to a 5 per cent penalty for negligence.
FINDINGS OF FACT.
The petitioner in 1924 paid the sum of $3,125 for 31 1/4 shares of stock of the Cameo Apparel Stores, Inc., a New York corporation. The corporation dissolved and wound up its affairs in 1925. After paying its creditors the corporation had no funds for the payment of liquidating dividends on its stock. The petitioner has never realized anything on the stock investment.
Each of the four stockholders of the Cameo Apparel Stores, Inc., guaranteed the rent payable under a lease executed by the corporation during its existence. The corporation was unable to pay the amount of rent due under the lease and the guarantors were required to assume and pay the indebtedness. The petitioner's share of the liability was $775, which he paid in 1925.
In 1922 petitioner, Lawrence Silver and Al Hartman formed a partnership1931 BTA LEXIS 2091">*2093 for the manufacture and sale of dresses under the trade name of Lawrence Silver & Company. At the time of its formation the petitioner contributed to the partnership dressmaking equipment and material having a then value of $10,000.
On January 1, 1926, and continuously thereafter until October 19, 1926, when the partnership agreement was terminated, the petitioner owed the partnership the sum of $24,699.73. This sum represents withdrawals of petitioner from the partnership in 1922, 1923, 1924, and 1925 in excess of his investment of $10,000, plus his share of the partnership's net profits during its existence. At the time the partnership agreement was terminated the petitioner was unable to liquidate this indebtedness. In 1926 petitioner received the sum of $10,752.16 from the partnership as compensation for services rendered. The partnership operated at a loss in 1926.
On October 19, 1926, the petitioner executed an instrument releasing and discharging Lawrence Silver and Al Hartman of all claims arising out of the partnership agreement. On the same day Lawrence Silver and Al Hartman executed a like release in favor of petitioner, and, in addition, assumed and agreed to1931 BTA LEXIS 2091">*2094 pay all of the obligations and debts of the partnership.
In his return for 1926 the petitioner reported the sum of $12,200 as compensation received from the partnership and claimed his partnership investment of $10,000 as a loss. The explanation accompanying the deduction reads: "Investment in Lawrence Silver Co. 22 B.T.A. 655">*657 Partnership and upon withdrawal from firm, investment could not be collected." In computing the proposed deficiency for 1926 the respondent reduced the amount of compensation received from the partnership to $10,752.16; disallowed the claimed loss of $10,000, and included the item of $24,699.73 in gross income on the ground that the indebtedness became income to petitioner when he was released of his liability for its payment.
OPINION.
ARUNDELL: It was stipulated at the hearing that there should be allowed as deductions in 1925 contributions to charitable and religious institutions amounting to $145, and that gross income for 1926 should be reduced by allowing as deductions therefrom, the sum of $150 for contributions to religious and charitable institutions, the sum of $420 representing interest paid on indebtedness, and $434 for taxes.
The items1931 BTA LEXIS 2091">*2095 of $3,125 and $775 involved in the other issues raised under the proposed deficiency for 1925 are held to be deductible as losses sustained in that year.
The petitioner contends that the release of his right to partnership assets resulted in a loss of his capital investment of $10,000, and that the sum of $35,451.89, consisting of the petitioner's indebtedness of $24,699.43 to the firm at the time of its dissolution, and the sum of $10,752.16 which he received therefrom in 1926, does not constitute taxable income.
The contribution of property of a value of $10,000 made by petitioner to the partnership was credited to his capital account in the firm's books, and thereafter at the close of each year, entries were made therein for withdrawals made by petitioner during the year and his share of partnership losses and profits. At the close of 1925, and thereafter until the partnership was dissolved, the account had a debit balance of $24,699.73. The mutual releases executed by the partners in October, 1926, relieved petitioner from liability for this indebtedness and settled whatever claim he then had to partnership assets.
It is apparent from these facts that as petitioner's1931 BTA LEXIS 2091">*2096 drawings from the firm by 1926 were considerably in excess of his capital investment and share of partnership profits, he recovered his partnership investment of $10,000 prior to the taxable year. At the beginning of, and throughout, 1926, petitioner was a debtor of the partnership, rather than a creditor, and had no investment in the partnership to lose.
In 1926 petitioner was without means to pay his financial obligations to the partnership. The forgiveness of petitioner's indebtedness of $24,699.73 to the partnership did not add anything to his worth. 22 B.T.A. 655">*658 The only effect the transaction had on his financial standing was to decrease the amount of his liabilities. It has been held under such circumstances that the amount forgiven does not constitute taxable income. ; ; affirming .
The transaction contains none of the elements of a sale, for when it occurred the petitioner had fully recovered his capital investment and had no partnership assets to dispose of. It has been suggested that a large portion of the item of $24,699.731931 BTA LEXIS 2091">*2097 constitutes compensation for services rendered. Even if this be true such sums would not be income in 1926, but in prior years not now before us.
We think the evidence sustains the conclusion of respondent that the drawings made in 1926, amounting to $10,752.16, are taxable as compensation for services rendered. The sums received were not treated in the same manner as withdrawals made in prior years. Instead of entering the total amount withdrawn during the year as a charge to the capital account of petitioner, the partnership charged the sum to "Salaries and Wages" and the petitioner reported it in his return for 1926 as compensation for services rendered.
In determining petitioner's tax liability for 1926 under Rule 50, the claimed loss of $10,000 will be disallowed; the item of $24,699.73 will not be treated as income, and the sum of $10,752.16 will be included in gross income as compensation for services rendered.
We do not think that petitioner was guilty of negligence in the preparation of his return. When, if ever, the petitioner recovered his capital investment, and whether or not the forgiveness of petitioner's indebtedness to the partnership resulted in taxable1931 BTA LEXIS 2091">*2098 income to him, are questions concerning which petitioner had reasonable grounds to differ from the conclusions reached by the respondent. On this issue the petitioner is sustained.
Decision will be entered under Rule 50.