*32 Decision will be entered under Rule 50.
Held, a bad debt resulting from loans which the taxpayer made to a California corporation which was organized by him to further and stimulate the sales in the Western States, including California, of a similar business which he had conducted for many years as a sole proprietorship with headquarters in Buffalo, New York, was proximately related to and connected with his business and was deductible as a business bad debt under section 23 (k) (1), I. R. C. 1939. The Commissioner's determination that the debt was deductible only as a nonbusiness bad debt is reversed.
*366 The Commissioner has determined a deficiency in petitioners' income tax for the year 1950 of $ 48,495.30. The deficiency is due to two adjustments made by the Commissioner to the net income reported by Lawrence M. Weil and his wife, Lucille G. Weil, in their joint return for 1950. These adjustments were:
| (a) Bad debts | $ 73,756.25 |
| (b) Dividends | 37.50 |
Petitioners do not contest adjustment (b). Adjustment*33 (a) is explained in the deficiency notice as follows:
(a) It is determined that the loans owing from the Electric City Box Co. of California, Inc., in the total amount of $ 73,756.25, are not deductible as a business bad debt.
To this determination by the Commissioner the petitioners assign error.
FINDINGS OF FACT.
Many of the facts have been stipulated and the stipulation of facts is incorporated herein by reference.
Petitioners are the Estate of Lawrence M. Weil, deceased, and his surviving wife, Lucille G. Weil, with residence in Buffalo, New York. Lawrence M. Weil and Lucille G. Weil filed a joint return for the taxable year 1950 with the collector of internal revenue for the twenty-eighth district of New York. Lawrence M. Weil, sometimes hereinafter referred to as petitioner, died on June 17, 1952. Edward H. Kavinoky and Lucille G. Weil are the executors of his estate.
For many years prior to his death the petitioner was engaged in the manufacture, purchase, and sale of jewelry cases, watch boxes, ring boxes, fine paper boxes, displays, trays, and showcase trims.
*367 The petitioner was a sole proprietor, individually engaged in business under the assumed name of Electric*34 City Box Company, sometimes hereinafter referred to as the Buffalo company. The Buffalo company did a large volume of business throughout the United States, and particularly in California and the Western States where the annual sales amounted to several hundred thousand dollars. Because of the large proportion of the petitioner's trade which was carried on in California and the Western States, the petitioner believed that the retention and expansion of this trade was essential to his business success.
Since 1937, the petitioner's western salesman was Lloyd Kirsch, hereinafter sometimes referred to as Kirsch, a resident of the State of California. Kirsch had entered the petitioner's employ in 1937, when, because of a heart condition, the petitioner was no longer able to travel extensively. At that time the petitioner turned the entire western area over to Kirsch as his selling territory.
On account of Kirsch's ability as a salesman, Weil was anxious to retain Kirsch's services for the Buffalo company. Those services were regarded as vitally important to the petitioner's business since it was largely through Kirsch's efforts that the western trade had been developed so successfully. *35 In 1946, Kirsch was dissatisfied with the compensation which he had been receiving, and the petitioner feared that Kirsch might leave his employ unless the former was given some additional compensation and/or incentive to continue as salesman for the petitioner's business.
The petitioner also had other problems in connection with the retention of his western market. One of these was the high packing and shipping costs incurred in sending his goods across the country. These costs, in some instances, were pricing the petitioner out of competition with western manufacturers.
For these reasons, and others, but primarily in order to satisfy Kirsch and retain his services, the petitioner decided to create a separate business organization to manufacture and sell in California and the other Western States. The petitioner decided to organize a corporation because he would then be able to give Kirsch stock, which would give him a hold on Kirsch and which would also serve as an incentive to work for the growth of the corporation. By using the corporate device, petitioner, as an absentee investor, was also able to avoid acquiring a Buffalo company partner, and to limit his investment and*36 liability in the new enterprise. On February 7, 1946, the petitioner incorporated, under the laws of the State of California, the Electric City Box Company of California, Inc., hereinafter sometimes referred to as the California corporation.
After the formation of the California corporation, it was decided to purchase an established jewelry display manufacturing and sales *368 company to serve as the nucleus of the new western operation. A suitable business was finally located and the corporation purchased the display business of Al Greene in Los Angeles, California. At that point the California corporation became active. At the same time the stock of the corporation was issued.
The petitioner became, and continued to be throughout the life of the corporation, its majority stockholder.
Capitalization of the California corporation was $ 51,800 paid in. This was composed of $ 45,800 paid in on account of preferred stock and $ 6,000 paid in for a total of 300 shares of common stock of a par value of $ 20 per share. All the shares of preferred stock were issued to Weil; 270 shares of the common stock were issued to Weil and 30 shares were issued to Al Greene.
At about the same*37 time, Kirsch was issued 60 shares as a gift from petitioner. These 60 shares of stock were transferred directly from the shares originally purchased by the petitioner. Kirsch also became a vice president of the corporation. The stock issued to Al Greene was in partial consideration for the sale of his business. Later, stock was issued to Ben Jacobs who became the auditor and general manager of the California corporation, and who also served the petitioner individually as the supervisor of the petitioner's lesser salesmen in the West.
The California corporation was not the only corporation which the petitioner organized in the jewelry box and display business. In 1946, the petitioner organized Art Containers, Inc., incorporating a business which he had previously conducted as a sole proprietorship. Art Containers manufactured and sold jewelry cases, and lined and unlined paper and cardboard jewelry boxes. In 1949, the petitioner purchased a going display business in Buffalo, thereafter incorporating it as the Amerco Display Corporation. The Amerco Display Corporation manufactured and sold jewelry display cases, jewelry display platforms, jewelry trays, ring displays, and boxes.
*38 All of the corporations in which the petitioner was interested were economically related to his individual jewelry box and display business. There were business dealings between the petitioner's sole proprietorship and each of the corporations.
The California corporation provided an effective sales outlet for western sales of some of petitioner's individual products manufactured in Buffalo. It was the petitioner's plan to have the California corporation manufacture those items which were costly to ship from the East and those items which the petitioner was then purchasing from outside sources. The petitioner would thus retain in the corporation the profit otherwise lost on such sales, and at the same time would provide himself with a steady source of those items which he was then purchasing from outside manufacturers.
*369 During the period of its operation, the California corporation manufactured and sold jewelry boxes, jewelry cases, jewelry displays, trays, platforms, and showcase trims. These items were all either identical to the petitioner's individual products or went hand in hand with the petitioner's products and had the same trade market.
A course of dealing developed*39 between the California corporation and the sole proprietorship in Buffalo. After the organization of the corporation, Kirsch sold for the California corporation as well as for the petitioner's sole proprietorship. During this period, however, his entire compensation consisting of a salary plus commissions was paid by the petitioner. Kirsch's personal interest in the corporation acted as an incentive to his selling. Having the additional items manufactured by the California corporation, and competitively priced in the West, gave him a more complete "line"; consequently it was easier for him to sell to merchants many of whom preferred to see only one salesman and make all of their purchases at that time. The California corporation not only purchased products manufactured by the petitioner individually, but its salesmen sold all the products manufactured by the petitioner and the corporations in which he was interested. Similarly, the petitioner purchased some of the corporations' products and his salesmen sold others. It was helpful for the salesmen to carry the products of all these organizations because it "filled out their lines" and made it easier to fill all the needs of*40 a prospective customer.
The product lines of the petitioner individually and the California corporation were similar. However, the California corporation did not manufacture plastic boxes, the main product of the proprietorship; those it purchased direct from the proprietorship. It was planned gradually to build up a skilled labor pool in California and eventually to have the corporation manufacture plastic boxes as well as displays and allied items.
As a result of the California operation and the joint sales of the products of both manufacturers, the sale of the products manufactured by the petitioner individually was enhanced and the petitioner retained the services of his salesman Kirsch. However, the California corporation did not prosper in its own right and in 1948 the petitioner made 8 loans to the corporation, totaling $ 64,256.25. These sums were advanced as loans, with the intent that they be repaid, and a demand note in the amount of each loan was given at the time of the loan.
During the year 1950, the California corporation ceased to operate and had no funds with which to repay the loans made to it by the petitioner. Neither the petitioner nor his estate has ever*41 received any portion of the $ 64,256.25, and this sum became a worthless bad *370 debt in 1950. The petitioner and his wife claimed this loss as a business bad debt on their joint 1950 Federal income tax return.
The bad debt was proximately related to the petitioner's Buffalo business conducted by him as a sole proprietorship. It was a business bad debt deductible in full under section 23 (k) (1), I. R. C. 1939. 1
In addition to the loans of $ 64,256.25, evidenced by demand notes, which the petitioner made to the California corporation, the California corporation executed and delivered to the petitioner during the taxable years 1949 and 1950 promissory notes which aggregated the sum of $ 9,500. These latter notes were given by the California corporation to evidence its indebtedness to the Buffalo company arising out of an open account for raw materials and merchandise shipped by the Buffalo company to California, but not paid for*42 by the California corporation.
OPINION.
As noted in our preliminary statement the Commissioner, in his determination of the deficiency, disallowed $ 73,756.25 bad debts which petitioners had deducted in their joint return for 1950. The Commissioner's reason for this disallowance was, as stated in his deficiency notice, that the debt was not deductible because it was not a business bad debt.
The Commissioner at the hearing conceded that he erred in his determination to the extent of $ 9,500. The stipulation of facts which was filed shows that this $ 9,500 was due the petitioner by the California corporation for raw materials and merchandise which the petitioner had shipped to the California corporation during 1949 and 1950 and for which it had never paid the petitioner. This leaves in controversy $ 64,256.25, instead of the $ 73,756.25 originally disallowed by the Commissioner.
The Commissioner concedes that this $ 64,256.25 became entirely worthless in 1950. His only reason for determining its disallowance is that it was a nonbusiness bad debt under the provisions of section 23 (k) (4). Petitioners contend that the debt was a business bad debt within the meaning of section 23*43 (k) (1) and the deduction should be allowed in full.
These respective provisions of the Internal Revenue Code of 1939 have often been before our Court in cases which we have had for adjudication. They are familiar provisions of the statute, and it is not believed necessary to print them here. Suffice it to say that we think petitioners' contention should be sustained under such cases as Robert Cluett, 3rd, 8 T. C. 1178 (1947); Stuart Bart, 21 T. C. 880 (1954); and J. T. Dorminey, 26 T. C. 940 (1956). As said by the Court of Appeals for the Second Circuit in Commissioner v. Smith, *371 203 F. 2d 310, 311 (1953): "Whether a particular loss or expense is incurred in a taxpayer's trade or business is a question of fact in each particular case. [Citing authorities.]" It seems clear to us from the facts embodied in our Findings of Fact that Weil's loans to the California corporation were, as we said in Stuart Bart, supra (p. 881) "proximately related to his business (Robert Cluett, 3rd, 8 T. C. 1178)*44 and he is entitled to a deduction under section 23 (k) (1) rather than under (k) (4)."
The Commissioner clearly recognizes that the $ 9,500 which the California corporation owed Weil for raw materials and merchandise which Weil had sold and shipped to the California corporation was a business bad debt and he now concedes that it should be allowed as such. He continues to contend, however, that the remainder of the debt owed by the California corporation to the taxpayer, $ 64,256.25, should not be allowed as a business bad debt.
As we have already stated at the outset of this Opinion, we think the $ 64,256.25 still in issue was a debt proximately related to or connected with petitioner's Buffalo business. We do not think it would serve any useful purpose to repeat in this Opinion the facts upon which we base this conclusion. We think it is sufficient to say that in our opinion the loans which Weil made to the California corporation aggregating $ 64,256.25 were proximately related to or connected with his Buffalo business, and petitioners are entitled to have them deducted in full under section 23 (k) (1) and not deducted under the limitations prescribed by section 23 (k) (4).
The*45 Commissioner in his brief strongly relies on Commissioner v. Smith, supra, which reversed Weldon D. Smith, 17 T. C. 135 (1951). We think that case is clearly distinguishable on its facts from the instant case. In the Smith case, supra, in holding that the debt which Smith held against Llenroc Farms, Ltd., a Canadian corporation, was a business debt as petitioner claimed and not a nonbusiness debt as the Commissioner contended, we said (17 T. C., p. 146):
Petitioner was engaged in a number of business ventures, not only giving financial assistance, but also personally participating in the varied enterprises. As such, it was a part of his regular business.
In other words, our holding was to the effect that the taxpayer Smith was in the business of organizing and financing business corporations. The Court of Appeals for the Second Circuit did not agree with our holding and reversed us, holding that Smith's activities in organizing and financing other corporations did not constitute a business and he was not in the business of lending money.
In the instant case, petitioners' primary*46 contention is that the loans which Weil made to the California corporation were proximately related to his business and on the facts detailed in our Findings of *372 Fact we have sustained that contention. There were no such facts present in the Smith case, supra, as those in the instant case upon which we have based our decision. For example, in the instant case petitioner sold from his Buffalo company to the California corporation raw materials and merchandise, and at the time the California corporation ceased business it owed the petitioner $ 9,500 for raw materials and merchandise which it purchased from the petitioner. The Commissioner concedes that this $ 9,500 was a business debt and is deductible in full. There were no such facts in the Smith case.
It is true that petitioners contend in the alternative that in the event we do not sustain them in their primary contention, nevertheless the decision should still be in their favor because Weil was in the business of organizing and financing other corporations engaged in similar activities to those of his sole proprietorship, the Buffalo company. In making this contention, petitioners argue that their situation*47 in this respect was different from that which existed in Commissioner v. Smith, supra.
Having already decided in favor of petitioners based on their primary contention, we find it unnecessary to decide their alternative contention and we do not do so.
Decision will be entered under Rule 50.
Footnotes
1. All section references are to the Internal Revenue Code of 1939, as amended.↩