*2005 1. BAD DEBTS. - Loans made by a bank in the regular course of its business, where it is not shown that the proceeds of the loans went to the president of the bank, who was responsible for making them, and where the loans are evidenced by notes bearing interest and which are carried as assets, are debts and not losses, and must be ascertained to be worthless and charged off during the taxable year in order to be deductible.
2. LOSSES RATHER THAN BAD DEBTS. - Upon the evidence, held, that certain transfers of money to the Olymphia Oil Corporation by the president and minority stockholder of the petitioner, who was, himself, the sole stockholder in the Olymphia Oil Corporation, the latter corporation being insolvent at the time the loans were made and at all times thereafter amounted to a fraudulent appropriation of the petitioner's funds and the losses suffered by the petitioner on account thereof were deductible as losses sustained during the taxable year 1921, instead of as debts ascertained to be worthless and charged off in subsequent years.
*1133 Petitioner seeks redetermination of deficiencies for 1920 of $32.56 and for 1921 of $154.41, and as grounds therefor alleges that respondent erred in not allowing deductions of $48,037 as losses or worthless debts.
FINDINGS OF FACT.
The petitioner is a banking corporation organized and existing under the laws of West Virginia, and during the taxable years was engaged in the banking business at Mullens, W. Va. The capital stock was $50,000 when the bank was organized in 1915, and was increased to $75,000 in 1916, and to $100,000 in 1917. The bank continued in business until 1926, when it was reorganized by the State Banking Commissioner, which involved an assessment against its stockholders of $75,000 to protect its depositors. The reorganized bank is known as the Peoples Bank, and it acquired the assets of petitioner.
The Bank of Wyoming was organized by J. C. Sullivan, who resided at Tralee, just outside the town of Mullens, where the bank was located. Sullivan was president of the bank and also president and general manager of some fifteen other enterprises, including several coal companies, controlled by him, which were operated from*2007 his office at Tralee. From the time of its organization until early in 1923, the petitioner was entirely dominated by Sullivan. As early as 1920, this was a matter of such concern to the Banking Commissioner that he addressed a letter to the Governor concerning the situation. However, Sullivan continued in control of the bank and early in 1921 was left without any inside check upon his activities by the withdrawal of the only remaining independent directors, D. D. Moran and A. J. Mullens, who resigned from the board on February 10 and April 25, 1921, respectively.
*1134 Thereafter, as shown by the record, the board of directors consisted of the following persons in addition to Sullivan, president of the bank:
J. B. Frank, auditor of Sullivan's companies, who had no property except a small interest therein;
A. W. Daubenspeek, cashier of petitioner, directly subject to dictation by Sullivan;
K. S. McClanahan, a brother-in-law of Sullivan and minor employee of Sullivan's companies;
J. A. Wood, a business associate of Sullivan, who was paid salaries by petitioner and other of Sullivan's companies, but did very little work;
Philip Konrad, superintendent*2008 of certain of Sullivan's mines, appointed to take the place of A. J. Mullins, resigned;
Roy Daubenspeek, assistant cashier and brother of A. W. Daubenspeek, appointed to take the place of D. D. Moran, resigned;
Hiram Sizemore, political associate of Sullivan.
In 1921, loans were made by petitioner to the following individuals and corporations in the amounts listed below:
| Raleigh Fire Creek Coal Co | $10,000 |
| K. S. McClanahan | 3,137 |
| J. B. Frank | 2,400 |
| Olymphia Oil Corporation | 9,000 |
| Olymphia Oil Corporation | 8,500 |
| John F. Koerner | 15,000 |
Notes were taken from each borrower in the respective amounts and in some instances were secured by certain purported collateral as hereinafter detailed. Each note was due in four months from the date thereof, and some renewals were afterward taken, but none of the notes was ever paid.
The manner in which these loans were made was as follows: A. W. Daubenspeek, the cashier, Roy Daubenspeek, the assistant cashier, and M. H. Lusk, the bookkeeper, were not consulted prior to or at the time the loans were made. They had no authority as to anything that Sullivan passed upon. A note in the amount of each loan was*2009 made up in Sullivan's office and the employees of the bank were instructed to credit the particular account with the amount of the note. In no instance did the directors pass on any of the above listed loans before they had been made. The notes were carried as assets and reported as such to the Banking Department of West Virginia.
The Kanawha Valley Bank of Charleston, W. Va., a large banking institution, had, from time to time, loaned money to the petitioner. Hayes Picklesimer, its assistant cashier, who had charge of out-of-town banking connections of this character, was brought in contact with the affairs of the petitioner through the examination of *1135 notes forwarded as collateral for loans made by the Kanawha Valley Bank to the petitioner. During the year 1921, this indebtedness of the petitioner to the Kanawha Valley Bank largely increased until on December 31, 1921, it amounted to $60,000. Picklesimer having in this manner secured information as to these questionable loans made during the year 1921, and also information as to similar withdrawals during the year 1922, became cashier of the petitioner in January, 1923. This move was made for the protection of*2010 the Kanawha Valley Bank and at its insistence and also because the interests of the petitioner would be equally well served.
From February, 1923, until December, 1924, Picklesimer managed the bank. There was little money left to loan and his efforts were largely devoted to attempting to collect where collection was possible and otherwise to conserve petitioner's assets. He carefully investigated the financial responsibility of each of the persons and corporations to whom the loans listed above had been made and found that the purported obligations were not collectible. The obligations were, however, permitted to remain on petitioner's books because to have removed them therefrom would have brought the affairs of petitioner to a crisis, with resulting loss to its depositors. This was done with the approval of the Banking Commissioner's office. The loans here in question were still on the books at the time of the reorganization of the bank in January, 1926. Together with similar withdrawals made by Sullivan in 1920 and 1922, they constituted almost the entire amount of worthless claims existing at that date. Following the reorganization in 1926, Central Trust Company of Charleston, *2011 W. Va., was assigned all assets of the petitioner not taken over by the purchasing bank, including the loans which have been listed above. Nothing was ever collected by it upon them and no recoveries were had on the sums so lost from any source.
The financial situation in 1921 of the persons and corporations to which loans listed above were made was, respectively, as follows:
Raleigh Fire Creek Coal Company, which was incorporated December 24, 1920. This corporation was the lessee of a coal property formerly operated at a loss by Hines as Battleship Coal Company. The mines were well equipped and during 1921 its gross sales were $194,969.69. The workings were down a slope with water from this and an adjoining mine, always at the face of the coal, making mining difficult and expensive, and impossible to produce coal at a profit in 1921 and subsequent years. A tax return showing a profit for the year 1921 was filed, but on examination by the Commissioner, it was found that there was no taxable income and the amount of tax paid was refunded. The Raleigh Fire Creek Coal Company had purchased its leasehold in 1920, at what turned out to be an exhorbitant price of $42,500 in*2012 cash, $382,500 in notes secured by a *1136 first lien on the property, and $300,000 in its own stock. There still remained unpaid at the end of the year 1921 the sum of $322,500. A very substantial decline in the value of coal properties took place between 1920 and 1921 on account of the decline in the price of coal. The gross assets of the Raleigh Fire Creek Coal Company were carried on its books during the taxable year at a valuation of $990,666.02. Included in this total were valuations put on leasehold of $211,335.86 and $188,392.19 on mine development. The evidence shows this valuation was greatly exaggerated and that the property could not have been sold as a going concern in 1921 for anything to compare with the amount shown on its balance sheet as its net worth. It turned out as a failure and went into bankruptcy in a later year.
K. S. McClanahan, who was Sullivan's brother-in-law, worked for the latter's companies at a salary of $250 per month. He had no property, real or personal; "no assets"; "no financial standing"; "no credit rating"; "was not entitled to any credit consideration." Loans of $237 and $2,900 were made to him without endorsement and with*2013 no collateral except 50 shares of stock in Little War Creek Coal Company, pledged to secure the larger loan. This company was not in 1921 a going concern. It owed large amounts and had no earnings; subsequently, in 1927, it became bankrupt, owing large sums to creditors.
J. B. Frank was auditor for Sullivan's companies. He received $5,000 salary per annum and was considered a good credit risk by the Kanawha Valley Bank for amounts ranging from $500 to $2,500 at any one time. He owned two lots, one in Mullens and one in Charleston, each encumbered with indebtedness equal to its value. He had no other sound assets, though he had an interest in some of Sullivan's coal enterprises. The purported security for the loan made to him, 25 shares of stock in Steel Products Company, was worthless, this company having become insolvent and gone out of business in 1920. There was no endorsement upon the note given.
Olymphia Oil Corporation, which was a wild-cat oil venture directed by Sullivan, through a corporation in which he owned all the capital stock. The company drilled a dry hole near Olymphia Springs, Ky., completed in April, 1921, and in June was loaned $9,000 without*2014 endorsement or collateral. A second dry hole was completed in October, 1921, and $8,500 was loaned without security of any kind to meet the bills so incurred. The company had no property except these dry holes and a lease that was worthless in 1921 at the time the loans were made.
John F. Koerner, an employee of Sullivan, received a salary of $250 per month. He had no property, real or personal, except the stock which he put up as collateral for the loan. He lived in a company *1137 house, never had any money, and wrote many bad checks. In November, 1921, he was loaned $15,000 without endorsement, pledging as collateral 165 shares of the stock of the Sullivan Land Company. This was a company organized by Sullivan in 1921, with ambitious plans. He was the principal stockholder. It did not begin active operations until in 1922. It showed a loss of $1,291.28, the first year of its operation and never did show anything but losses until it finally wound up bankrupt in later years. Its balance sheet, as shown on its income tax return, at the end of the year 1921, was as follows:
| SULLIVAN LAND COMPANY | ||
| December 31, 1921 | ||
| ASSETS | ||
| Accounts receivable | $281,718.80 | |
| Advanced Royalty | 2,114.00 | |
| Investments | 300,000.00 | |
| Real Estate | 402,338.49 | |
| $986,171.29 | ||
| LIABILITIES | ||
| Notes Payable | 511,953.00 | |
| Accounts payable | 24,218.29 | |
| Capital stock | 450,000.00 | |
| 986,171.29 |
*2015 Petitioner reported net income for 1921 of $24,430.96 and paid a tax thereon of $4,693.81. No deduction for bad debts or losses with respect thereto was taken by petitioner on its 1921 income tax return.
OPINION.
BLACK: In its original petition, petitioner stated that it was appealing from deficiencies determined against it by the Commissioner for the years 1920 and 1921. However, no errors were assigned in the petition against the deficiency for 1920. The amended petition, upon which this proceeding was tried, made no mention of any deficiency for 1920, and at the hearing no evidence was offered by the petitioner concerning petitioner's income for 1920. At the conclusion of the hearing, counsel for the respondent moved that petitioner's appeal for 1920 be dismissed for lack of prosecution, with a finding that there is a deficiency for the calendar year 1920 in the amount of $32.56, as shown by the notice of a deficiency dated March 29, 1926. Said motion is granted and the appeal for 1920 is accordingly dismissed with a finding that there is a deficiency due by petitioner for that year of $32.56. *2016 .
For 1921, petitioner alleges that it is not only not in default of any deficiency, but is entitled to a refund of taxes for that year in the *1138 amount of $4,593.87. In support of such contention petitioner urges the following assignments of error:
1. The Income Tax Unit has erroneously failed to deduct from petitioner's income for the year 1921 the sum of $48,037, on account of accounts incurred during the year 1921 and ascertained to be worthless and uncollectible prior to December 31, 1921.
2. The Income Tax Unit has erroneously failed to deduct from taxpayer's income for the year 1921, the sum of $48,037, representing losses incurred by the Bank of Wyoming as the result of withdrawal of funds from it, through the making of loans known to be worthless and uncollectible when made.
Manifestly, petitioner can not claim its loss under section 234(5) of the Revenue Act of 1921, because that provision not only requires that the debts shall be ascertained to be worthless during the taxable year, but that they shall be actually charged off within the taxable year. Petitioner not only did not charge off the*2017 debts set out in its petition during the taxable year, but carried them as assets on its books until 1926. It, therefore, can not secure a deduction for these several items under section 234(5), Revenue Act of 1921.
Petitioner next claims the deduction under section 234(4) permitting deductions to the taxpayer for losses sustained during the taxable year and not compensated for by insurance or otherwise. The following cases are cited in support of petitioner's contention on this point: ; ; ; . An examination of the facts in each of the cited cases shows that in each instance the losses claimed resulted from embezzlement by employees not discovered until in years subsequent to when the embezzlement took place. We do not think these cases are in point and we believe they are distinguishable on the facts from those in the instant case. Petitioner also cites *2018 . In that case we held that certain transfers of money and properties by the president and minority stockholder of the petitioner to another corporation, in which the said president and minority stockholder was the principal stockholder, the latter corporation being at all times insolvent, amounted to a fraudulent appropriation of the petitioner's goods and that the losses suffered by the petitioner on account thereof were deductible as "losses sustained during the taxable years 1918 and 1919" instead of as "debts ascertained to be worthless and charged off" within the year such losses were discovered. On the authority of the above decision, we hold that the so-called loans made by petitioner at the direction of J. C. Sullivan, president, to the Olymphia Oil Corporation in 1921, represent losses from the very time they were made, and petitioner is entitled to deduct these *1139 amounts as losses in 1921 under section 234(4), Revenue Act of 1921. Stock in the Olymphia Oil Corporation was owned entirely by Sullivan; it was wholly insolvent at the time the loans were made. These so-called loans were made because Sullivan was*2019 the dominating factor in the bank and were losses from the very beginning. They simply represented a raid on the bank to get money for one of Sullivan's enterprises already wholly insolvent. These so-called loans never did represent any real asset of the bank.
Such can not be said of the other loans, which petitioner seeks to treat in the same manner. The loan of $10,000 to the Raleigh Fire Creek Coal Company was made to a corporation which was a going concern at the time the loan was made, with large assets, and although it owed large liabilities at the end of 1921, it was by no means in failing condition and during 1921 had gross sales of $194,969.69. There were other stockholders in this enterprise besides J. C. Sullivan, at whose direction the loan was made. There was no evidence to show that this loan was not made in the regular course of business and we have no reason to treat it differently from any other loan made by a going bank. The loans made to K. S. McClanahan, J. B. Frank, and John F. Koerner, were loans made to individuals in the regular course of the bank's business in 1921, and were represented by notes drawn up and signed in the regular way. The notes were*2020 secured by collateral of very doubtful value, if not indeed worthless. The loans were made at the direction of J. C. Sullivan, president of the bank, but there is nothing to show that he received any of the money or that they were made for his benefit. Evidently these loans were not such as a careful, prudent banker would have made, but this fact alone does not give us authority to allow them as losses during the taxable year under section 234(4), Revenue Act of 1921. We think the situation as to the foregoing items just described is governed by our decision in . In that case the taxpayer made a loan, secured by a fraudulent chattel mortgage, and it was contended by the taxpayer that the loan was in reality a loss as soon as made. In denying his contention we said:
There appears to be no doubt that the petitioner sustained a loss in the amount of the principal of the notes as a result of his loan to the Mollohans. The only question for this Board to determine is whether the loss occurred in 1919, when the loans were made, or in 1922, when the worthlessness of the security was ascertained. The petitioner contends that the loss sustained*2021 is comparable to an embezzlement or theft, and that, therefore, it occurred at the date when he parted with his money. With this view we are unable to agree.
The loan was made to individuals who gave their notes therefor. It is not disputed that the signers of such notes were the identical persons who negotiated the loans. The chattel mortgage was no more than security for the payment of the notes. For all the record discloses, the Mollohans, at the time *1140 they made the notes, may have owned all the cattle enumerated in the mortgage. In any event, the loans were evidenced not by the mortgage, but by the promissory notes of the Mollohans. We are of the opinion that, regardless of the value of the security, the transaction created a debt. Such debt, not having been ascertained to be worthless until 1922, can not, therefore, be deducted from the petitioner's gross income in the taxable year.
To the same effect is ; ; *2022 ; . The amounts of indebtedness due petitioner by the Raleigh Fire Creek Coal Company, K. S. McClanahan, J. B. Frank, and John F. Koerner, did not represent losses during the year 1921, as contemplated by section 234(4), and were not deductible as bad debt losses in 1921 under section 234(5), because they were not charged off in that year, but were carried as assets of petitioner until 1926. Petitioner is not entitled to the deduction of losses claimed by him with respect thereto for the year 1921.
Decision will be entered under Rule 50.