1936 BTA LEXIS 658">*658 Decedent, in life, was a stockholder and officer in two corporations and carried on a cattle business individually and in a partnership. He endorsed notes of the corporations, and of an individual who purchased cattle from him. He also paid debts of one of the corporations and endorsed a note of an individual. The estate continued the cattle business conducted by the decedent before his death. In winding up the affairs of the partnership the executors received a note from the surviving partner for his share of the firm's liabilities. In the administration of the estate of the decedent the executors were required to satisfy the endorsed notes, and they ascertained the note of the surviving partner to be worthless. Held, that the losses are not attributable to any trade or business regularly carried on by the executors and the estate, and, the individual not being the same taxpayer the petitioner may not use the losses in computing a net loss of the estate.
34 B.T.A. 715">*715 This proceeding involves the redetermination of a deficiency1936 BTA LEXIS 658">*659 of $19,894.56 in income tax for 1928 determined against the estate of R. R. Russell, deceased. The issue is whether certain losses sustained in 1926 were attributable to the operation of a trade or business regularly carried on by the petitioner. Substantially all of the facts were stipulated.
FINDINGS OF FACT.
All of the property of R. R. Russell, who died June 28, 1922, a resident of San Antonio, Texas, consisted of community property of himself and wife. In his last will and testament he appointed O. H. Judkins, T. P. Russell, and J. L. Borroum independent executors of his estate, directed that all of his debts be paid, and authorized his executors to "borrow monies, make sales of property as in 34 B.T.A. 715">*716 their judgment would be to the best interest of the Estate, and to lease for an unnamed number of years, such real estate as it was not deemed advisable or found necessary to sell in connection with the administration of the estate." The will further provided that in all of such matters the consent of the decedent's wife, Mattie E. Russell, "should first be obtained."
The will was duly probated and ever since the estate has been in the process of administration. At1936 BTA LEXIS 658">*660 the request of the widow, at all times important the executors retained possession and control of her one-half community interest in the community property and managed and operated the entire estate as a unit. The executors kept books of account and filed income tax returns of the estate on the accrual basis.
During his lifetime the decedent was regularly extensively engaged in the business of raising, buying, selling, and exchanging livestock, including horses, cattle, sheep, and goats. At the time of his death he owned several ranches comprising about 145,000 acres of land in Texas, approximately 26,000 head of cattle, and about 8,000 sheep and goats. He was also director of four or five banks and two or three loan companies, including the Stockyards Loan Co. of Kansas City, Kansas, and had an interest in some partnerships engaged in the livestock business. The petitioner continued to operate the ranches which the decedent owned at the time of his death.
Prior to June 28, 1922, the decedent sold some steers to W. J. Rutledge for $304,407. The cattle were paid for by the buyer with money borrowed from the Cassidy Southwestern Commission Co. upon notes bearing the seller's1936 BTA LEXIS 658">*661 endorsement. The notes were further secured by a chattel mortgage on the cattle sold. There was a perceptible drop in the cattle market between the time the cattle were sold and the date of the decedent's death. In the estate tax return filed by the executors of the estate in 1924, the sum of $157,248.74 was claimed as a deduction from gross estate on account of the decedent's liability as an endorser of the Rutledge note. The deduction was allowed by the Commissioner.
In 1924 Rutledge was adjudicated a bankrupt, but neither the petitioner nor the Commission Co. ever filed a claim against the bankrupt estate for the unpaid amount of the note. Thereafter the bankrupt estate surrendered to the Commission Co. such steers covered by the chattel mortgage as were on hand and unsold, and authorized the mortgagee to gather the remaining steers and apply the proceeds of sale of any cattle recovered to discharge the debt.
The bankrupt estate never declared or paid a dividend. The bankrupt was discharged in 1925. Thereafter in 1925 the petitioner was called upon to pay, and did pay, to the Commission Co. the sum of $198,708.11 on account of the decedent's liability as an endorser1936 BTA LEXIS 658">*662 of 34 B.T.A. 715">*717 the Rutledge note. In 1926 the petitioner, upon demand, made the following additional payments to the Commission Co. on account of such liability:
| January 30, 1926, interest | $3,088.89 |
| May 1, 1926 | 818.76 |
| August 10, 1926, note | 35,030.75 |
The note for $35,030.75 was given to satisfy the balance due on the Rutledge note after application of the proceeds derived from the sale of the cattle. The petitioner made no payment on the note until after 1928.
The sum paid on the note in 1925 was charged to profit and loss for that year. On December 31, 1926, it charged to the same account the additional amount of $37,509.59, a figure reached by deducting from the payments made and the note given in 1926, credit allowed for cattle sold, and a refund. It is stipulated that "Neither in 1925 nor in 1926 did W. J. Rutledge have any assets or prospects of paying his debts, and his condition then continued throughout all subsequent years material to this appeal."
On June 1, 1921, the decedent sold to R. H. Martin & Co., a partnership composed of R. H. Martin and the decedent, and engaged in the business of buying, raising, and selling livestock of all kinds, 1936 BTA LEXIS 658">*663 certain livestock for $74,359.62, evidenced by three notes of the buyer executed on June 1, 1921, in the amount of $24,786.54 each. Thereafter the decedent endorsed one of the notes to the City National Bank of San Antonio without recourse. The bank owned and held the note at the time of the decedent's death.
The partnership was dissolved by the death of the decedent. A short time thereafter the petitioner purchased the assets of the partnership for $30,313.70. Martin's unpaid liability on the two partnership notes held by the petitioner, after making allowance for his interest in partnership assets and other liabilities, was $19,904.08, for which on August 12, 1924, he gave petitioner his individual note. The note was ascertained to be worthless and charged off by the petitioner in 1926.
Between August 12, 1924, and the close of 1925 the petitioner paid debts of the partnership in the amount of $3,625.06, of which one-half was chargeable to the surviving partner. These debts were in existence but not ascertained at the time the partnership was dissolved.
In July 1926 the petitioner was required to and did pay the partnership note of $24,786.54 held by the City National1936 BTA LEXIS 658">*664 Bank of San Antonio, plus interest, a total of $35,162.30, by giving the bank its own note. On the same day it was required to and did pay in a like manner an individual note of Martin in the amount of $4,984.28, 34 B.T.A. 715">*718 including accrued interest. The note bore the endorsement of the decedent.
At the time of his death the decedent and his wife owned the following stock in the corporations shown:
| Capitalization | Par value of stock owned | |
| Russell-Coleman Oil Mill Co | $300,000 | $285,000 |
| Beeville Oil Mill Co | 100,000 | 27,000 |
| Winters Oil Mill Co | 150,000 | 37,500 |
| Ballinger Oil Mill Co | 150,000 | 37,500 |
| Runnels County Gins | 150,000 | 37,500 |
| Kennedy Oil Mill Co | 90,500 | 50,000 |
They also had an investment of $9,300 in the San Angelo Cotton Oil Co., a partnership. The Russell-Coleman Oil Mill Co. was organized in 1915 by the decedent and one Coleman, a ranchman.
At the time of his death the decedent was president of the Russell-Coleman Oil Mill Co. and the Beeville Oil Mill Co. and an endorser on and guarantor of notes of "certain" of the organizations listed above. The amount of the notes of the Russell-Coleman Oil Mill Co. which the decedent endorsed1936 BTA LEXIS 658">*665 varied from year to year, and was $300,000 one year. When the decedent died his liability arising out of his endorsement of notes of the Russell-Coleman Oil Mill Co. and the Beeville Oil Mill Co. "was so much greater than the realizable value of the assets of the aforementioned corporations that it was definitely known that the executors would ultimately be forced to pay substantial amounts out of the funds of the Estate in satisfaction of such liability." The executors estimated the probable loss from the decedent's endorsement of notes of the Beeville Oil Mill Co. would be $50,000 and from the Russell-Coleman Oil Mill Co. $70,000. One-half of these amounts was claimed by the executors and allowed by the respondent in the estate tax return as claims against the estate of the decedent.
The executors and the decedent's wife reendorsed notes of the foregoing corporations that had been endorsed by the decedent. The "executors, with R. F. Spencer, who represented them in all matters, attended all annual meetings of the corporations, were consulted in the selection of the local managers and other representatives of the mills, and, generally, by virtue of the stockholdings of the estate1936 BTA LEXIS 658">*666 and of Mrs. Russell, had a dominant voice in the management of the various corporations." Spencer was also president of the Beeville Oil Mill Co. after the decedent's death.
Lacking funds with which to operate them, during the latter part of 1922 the Russell-Coleman Oil Mill Co. leased its properties until June 1, 1923, with an option to buy if a price could be agreed upon. 34 B.T.A. 715">*719 An offer of $125,000 made for the property upon the termination of the lease was declined. The corporation's plant remained idle until 1925, when it was sold for $60,000 and the proceeds of the sale were used to liquidate notes of the corporation held by the City National Bank of San Antonio. In 1926 like disposition was made of the sum of $20,000 received from the sale in that year of all the properties of the Beeville Oil Mill Co., which had been idle since 1922.
In or about July 1926 the principal and accrued interest on notes of the Russell-Coleman Oil Mill Co. and the Beeville Oil Mill Co., originally guaranteed by the decedent and continued by the executors, amounted to $107,208.81 and $101,062.74, respectively. The City National Bank of San Antonio, due to the sale of all of the assets1936 BTA LEXIS 658">*667 of these corporations, with some insignificant exception, was unwilling to continue to hold the notes of the corporations, R. H. Martin, and R. H. Martin & Co., and demanded payment by the petitioner under its liability as guarantor. The petitioner satisfied its liability by giving the bank its note dated July 22, 1926, in the amount of $356,622.93 in full payment of the notes of the corporations, the individual and the partnership, together with "certain other items." The obligations of the two corporations, Martin, and the partnership were worthless in 1926, when the petitioner gave its note to the bank in satisfaction of its endorser liability. The debts were ascertained to be worthless and charged off in 1926. In 1928 the petitioner made a cash payment of $164,967.37 on the note.
In 1926 the petitioner paid the sum of $4,358.29 on behalf of the Beeville Oil Mill Co. in clearing title to the property of the corporation so that it could be sold.
The petitioner sustained a statutory net loss of at least $1,146.97 in 1926 and a like loss of $14,561.57 in 1927. Its taxable net income in 1928 was $71,470 without any deduction for prior net losses.
OPINION.
SEAWELL: 11936 BTA LEXIS 658">*668 The petitioner claims that its 1926 net loss should be increased by the following alleged losses:
| 1. W. J. Rutledge note | $37,509.59 | |
| R. H. Martin note | 19,904.08 | |
| R. H. Martin & Co. note | $24,786.54 | |
| Interest | 10,375.76 | |
| 35,162.30 | ||
| 2. R. H. Martin & Co. debts | 1,812.53 | |
| Russell-Coleman Oil Mill Co. note | 107,208.81 | |
| Beeville Oil Mill Co. note | 101,062.74 | |
| Beeville Oil Mill Co. debts | 4,358.29 | |
| R. H. Martin note | 4,984.28 |
34 B.T.A. 715">*720 The petitioner concedes that the amount of the losses arising out of the decedent's endorsement of notes of the corporations should be decreased by $120,000 on account of deductions taken in the estate tax return, and it is agreed that the remaining amounts of such items, together with the other losses, should be reduced one-half to reflect the widow's community property interest in the estate.
Deductions from gross income, including net losses, are allowable only when clearly provided for by statute. 1936 BTA LEXIS 658">*669 New Colonial Ice Co. v. Helvering,292 U.S. 435">292 U.S. 435. The statutes allow, as deductions in the computation of a net loss, losses "attributable to the operation of a trade or business regularly carried on by the taxpayer." Sec. 206, Revenue Act of 1926; secs. 117 and 169, Revenue Act of 1928. The amount of the several claimed losses is not in controversy.
The petitioner's contention is that all of the losses are attributable to trades or businesses regularly carried on by the decedent during his lifetime, and, having continued such trades or businesses after his death, it is entitled to the benefits of the statute. The respondent's position on the point is that the petitioner was regularly engaged in only the ranching business, and, as none of the losses are attributable to such business, the items form no part of the petitioner's net loss in 1926.
The thing of importance respecting the items in group one is whether they are attributable to a trade or business regularly carried on by the decedent before his death, or his executors, the petitioner. The Rutledge note was endorsed and the note of R. H. Martin & Co. was acquired by the decedent during his lifetime. 1936 BTA LEXIS 658">*670 The Martin note for $19,904.08 was acquired by the petitioner in settling the affairs of R. H. Martin & Co. and the remaining claimed losses in group one resulted from the payment of debts of that partnership after the settlement with Martin, the surviving partner.
During his lifetime the decedent was regularly engaged in the ranching business, including the purchase and sale of livestock, in his individual capacity and as a member of partnerships. He endorsed the Rutledge note and received the partnership note in the ordinary course of operating his individual ranching business, and had the losses occurred prior to his death, undoubtedly the amount thereof would have been available to him in the computation of a net loss. His liability as an endorser existed at the time of his death and the losses resulting from it would have been sustained if the executors had not engaged in any line of business.
The activities of the executors consisted of administering the estate of the individual, including the liquidation of liabilities thereof, and operating the ranches formerly owned and operated by the decedent 34 B.T.A. 715">*721 in his individual capacity. Russell's death worked a dissolution1936 BTA LEXIS 658">*671 of the partnership of R. H. Martin & Co., and the activities of the executors as to it related only to settling its affairs as required by law. The ordinary duties of an executor, such as the executors here were performing in settling the liabilities of the estate on the notes and winding up the affairs of R. H. Martin & Co., do not constitute a trade or business regularly carried on. O. A. Refling, Executor,17 B.T.A. 327">17 B.T.A. 327; affd., 47 Fed.(2d) 859; Charles Lesley Ames, Executor,14 B.T.A. 1067">14 B.T.A. 1067; affd., 49 Fed.(2d) 853; People's Pittsburgh Trust Co. v. United States,6 Fed.Supp. 447; Eli Strouse,24 B.T.A. 748">24 B.T.A. 748; affd., 59 Fed.(2d) 600. Thus the losses referred to were not attributable to any trade or business regularly carried on by the petitioner unless under the statute it and the decedent are one and the same taxpayer. In our opinion they are not.
A new corporation formed to acquire the assets and business of an existing corporation in exchange for its stock may not obtain the benefit of a net loss of the old corporation in the computation of its net income. 1936 BTA LEXIS 658">*672 292 U.S. 435">New Colonial Ice Co. v. Helvering, supra. Under a ruling of the Commissioner of long standing a net loss of an individual may not be carried forward in determining net income of his estate, the theory of the principle being that the two are not a single taxpayer. I.T. 1562, C.B. II-1, p. 33. The statutes classify the estate of a decedent as a taxpayer. Sec. 2, 1926 Revenue Act; sec. 701, 1928 Revenue Act. The taxable net income of an individual and an estate are not computed in the same manner. Certain specified contributions made by an estate pursuant to the terms of the will are deductible from gross income without limitation, whereas in the case of an individual the amount of the deduction is limited. Contributions to a public cemetery may be deducted by an estate, but not by an individual. In the case of an estate, the credit allowed is the same as that for a single person, with no allowance for dependents. Sections 214(a) and 219(b), Revenue Act of 1926, which contain other provisions peculiar to estates. No credit is available to an estate for earned income. Sec. 209, 1926 Revenue Act. A further distinction is that property of the decedent acquired1936 BTA LEXIS 658">*673 a new basis when it was acquired by the estate. Sec. 113(5), 1928 Revenue Act. In Hartley v. Commissioner,295 U.S. 216">295 U.S. 216, the Court, in holding that under the 1924 and 1926 Acts the basis for property in the hands of the executor acquired from the decedent was the fair market value thereof at the time of the decedent's death, rather than the decedent's basis, said: "The revenue acts consistently treat the estate of a decedent in the hands of an administrator or executor as a separate taxpayer."
34 B.T.A. 715">*722 The fact of continuity of the business was stressed by the petitioner in 292 U.S. 435">New Colonial Ice Co. v. Helvering, supra, but the Court did not regard it as controlling, saying:
* * * Besides, the matter of importance here, as will be shown presently, is not continuity of business alone but of ownership and tax liability as well. Had the transfer from one company to the other been effected by an unconditional sale for cash, there would have been continuity of business, but not ownership or tax liability.
The losses contained in group one were not attributable to any trade or business regularly carried on by the petitioner, but to businesses1936 BTA LEXIS 658">*674 regularly carried on by the decedent prior to his death, and, the estate being a taxable entity separate from the individual, the petitioner is not entitled to include the items in the computation of its net loss for 1926.
The decedent and Martin had equal interests in the partnership of R. H. Martin & Co. In closing up the affairs of the firm it was determined that Martin owed the estate the sum of $19,904.08 on the two partnership notes it held, each in the face amount of $24,786.54. Whether the third note of a like sum, held by the City National Bank of San Antonio, was taken into the reckoning is not shown by the record. If the decedent's investment in the partnership resulted in taxable gain or deductible loss, the amount thereof should have been reflected in the return of the estate for 1924, the year in which the settlement was made between Martin and the estate. The loss on the note given by Martin did not result from any partnership activity of the decedent or his executors, but was due to the failure of Martin to pay the obligation. 1936 BTA LEXIS 658">*675 Lewis G. Carpenter,33 B.T.A. 1">33 B.T.A. 1.
The partnership debts of $3,625.06 were paid after the settlement was entered into between the partners but prior to 1926, and can not on any ground be allowed as a deduction in 1926.
The items in group two relate to losses resulting from endorsement of notes of two corporations, debts paid for the account of one of the corporations, and an individual note of R. H. Martin. In Burnet v. Clark,287 U.S. 410">287 U.S. 410, the taxpayer at various times endorsed notes of a corporation of which he was a majority stockholder and president, and to the affairs of which he devoted a large part of his time. He was not regularly engaged in endorsing notes or buying and selling securities. From these basic facts the Court refused to allow, in the computation of net losses, amounts the taxpayer paid out to satisfy his liability as endorser of the corporation's notes.
Neither the decedent nor the petitioner was regularly engaged in the business of endorsing or guaranteeing notes, making advances to, or paying debts of corporations. Under the rule announced in the Clark case, supra, the losses sustained on the corporate notes1936 BTA LEXIS 658">*676 and debts paid for one of them would not have been deductible by the decedent 34 B.T.A. 715">*723 in the computation of a net loss had they occurred during his lifetime. His estate, a separate taxpayer, acquired no greater rights.
The loss sustained on the individual note of R. H. Martin has no relation to any trade or business regularly carried on by the estate or by the decedent prior to his death, and, like the other losses, may not be used in the computation of a net loss of the petitioner for 1926.
Decision will be entered under Rule 50.
Footnotes
1. This decision was prepared during Mr. Seawell's term of office. ↩