*135 Decision will be entered for the respondent.
Held: 1. Bad debt deduction claimed under section 23 (k) ( 1) of the Internal Revenue Code by petitioners, the majority stockholders and officers of the corporate debtor, disallowed because debt did not "become worthless" within the taxable year.
2. Issue not raised by assignment of error in petition is not before the Court for consideration.
3. Deduction for medical expenses disallowed because those expenses did not exceed 5 per centum of petitioners' adjusted gross income as increased by other adjustments herein. Sec. 23 (x), I. R. C.
*968 The Commissioner has determined a deficiency of $ 4,817.60 in petitioners' *136 income tax for the calendar year 1949. The deficiency results from adjustments to petitioners' reported net income which were explained in the deficiency notice as follows:
*969 (a) Your cancellation of an obligation [$ 20,000] owed you by the Perry Flower Shops, Inc. an existing corporation which you control, is held not to constitute an allowable deduction as a business bad debt in the taxable year.
(b) A net profit of $ 882.68 is held to be reportable from your rental of property in the taxable year instead of a loss of $ 438.61 as claimed in your return.
(c) The above increases in adjusted gross income eliminate the medical expense deduction [$ 723.42] claimed in your return.
The petitioners by appropriate assignments of error have placed in issue adjustments (a) and (c). Although their petition contains a statement that the whole amount of the deficiency is in dispute, it contains no assignment of error to adjustment (b).
FINDINGS OF FACT.
Some of the facts were stipulated and are so found.
Petitioners Earl V. Perry and Ethel M. Perry (sometimes hereinafter referred to as Earl and Ethel, respectively) are husband and wife. They reside in Rochester, New York, and filed*137 a joint income tax return for the calendar year 1949 with the collector of internal revenue for the twenty-eighth district of New York.
In 1929 Ethel, individually, began operation of a retail florist business. Earl joined her in the business in 1930; prior to that time he had been employed by the General Railway Signal Company in Rochester, New York. On June 2, 1944, petitioners and Julius Snyder incorporated the florist business under the laws of New York State as Perry's Flower Shops, Inc.The corporation's operations commenced on July 1, 1944, and it has since maintained its books and filed its income tax returns on the basis of a fiscal year ending June 30.
The corporation began business with 100 shares of fully paid-in capital stock valued at $ 30,639.97, which stock has been owned as follows:
| Number of shares | ||
| Owner | Prior to 1947 | Since 1947 |
| Petitioners jointly | 60 | 66 2/3 |
| Julius Snyder | 30 | 33 1/3 |
| Antoinnette Scheff | 10 |
At all times Ethel has been the president and a director of the corporation, Earl its treasurer and a director, and Julius Snyder its vice president and a director. Antoinnette Scheff was the corporation's secretary for its fiscal years*138 ended June 30, 1946 and 1947.
The corporation prospered and, on June 30, 1947, had an earned surplus of $ 21,360.30. It then operated five retail stores. However, for the fiscal years ended June 30, 1948, and June 30, 1949, it suffered losses of $ 4,867.49 and $ 31,349.07, respectively. Its earned surplus equaled $ 16,493.81 on June 30, 1948, but, on June 30, 1949, it showed a $ 15,139.61 deficit in earned surplus. Four retail stores were in operation in 1949. The corporation was still in business at the date of the hearing of this case in 1953 and then operated two retail stores.
*970 In order to provide the corporation with cash to meet current obligations petitioners lent it sums totaling $ 20,000 during the calendar years 1948 and 1949. The corporation gave petitioners two non-interest-bearing demand notes in return: One for $ 15,000, dated January 25, 1949, the other for $ 5,000, dated September 6, 1949. With respect to these loans petitioners testified that the notes were made non-interest-bearing because they believed the corporation "was commercially insolvent and unable to pay interest" but that they believed "the Thanksgiving and Christmas Holiday trade in 1949*139 would be sufficient to permit the repayment of the loans."
On December 27, 1949, a special meeting of the corporation's board of directors (composed of petitioners and Julius Snyder) was held. The following is an excerpt from the minutes of that meeting:
Mr. Snyder reported that the company's auditor had indicated that for the fiscal year ending June 30th, 1949 the company had lost over $ 31,000.00; that as of that date, its current liabilities exceeded its current assets, viz., $ 77,500.00 against $ 65,000.00; that since July 1st of 1949, its operations have been carried on at a loss.
The directors discussed the details which had been undertaken to remedy the situation and particularly the matter of closing the Park Avenue store. However, the Secretary reported and all of the directors confirmed the fact that the future outlook is not at all certain.
The Secretary reported that the auditor had asked whether, in view of the status of the company, Mr. and Mrs. Perry, who had advanced $ 20,000.00 in loans to the corporation, ought not to cancel the obligation as a bad debt.
Mr. Snyder reported that it is clear that such obligations cannot be repaid and unless they are cancelled, it*140 will be extremely difficult to do business and, as a matter of fact, it might be necessary if such loans are not cancelled to liquidate completely.
Thereupon Mr. Perry and Mrs. Perry indicated that they were prepared to cancel the obligations of the corporation to them for the loans hereinbefore referred to and presented a written memorandum accordingly.
On motion duly made, seconded and unanimously carried, it was
Resolved that the thanks of the corporation be extended to Mr. and Mrs. Perry for having acted accordingly.
The petitioners on December 28, 1949, sent the following signed memorandum to the corporation:
In view of the report made to us by [the corporation's auditor] indicating that Perry Flower Shops, Inc. lost over $ 31,000.00 for the fiscal year ending June 30th, 1949; that its current assets exceeded its liabilities * by approximately $ 12,500.00 as of that date; that since July 1st, 1949, the company has operated at a loss; that the company has no working capital and cannot pay its bills or take advantage of discounts and that an analysis discloses that its accounts payable, in large part, are more than 6 months old, and in view of the fact that from such circumstances*141 it is impossible to collect the indebtedness owing to us from you in the sum of $ 20,000.00, WE DO HEREBY CANCEL our claims against the corporation as a bad debt.
*971 The corporation's journal entries relative to the cancellation of the $ 20,000 debt are as follows:
| Dr. | Cr. | |
| December 1949 | ||
| E. & E. Perry -- Note Account | $ 20,000.00 | |
| Surplus | $ 20,000.00 | |
| To cancel loans made by Ethel and Earl Perry in 1948 | ||
| and 1949 per resolution approved at meeting of Board | ||
| of Directors dated 12/28/49. | ||
| June 30, 1950 | ||
| Surplus Account | 20,000.00 | |
| Capital Surplus | 20,000.00 | |
| To transfer canceled notes of Earl and Ethel Perry | ||
| entered to Surplus Account. | ||
| Capital Surplus | 2,735.80 | |
| Earl V. Perry [account receivable] | 1,037.92 | |
| Ethel M. Perry [account receivable] | 1,697.88 | |
| To transfer Debit balances of December 31, 1949, | ||
| left on books in error. [This entry constituted a | ||
| set-off, against the $ 20,000, of debts owed the | ||
| corporation by petitioners.] |
Petitioners deducted the $ 20,000 as a bad debt loss on their joint income tax return for the calendar year 1949. They characterized this*142 loss on their return as "Bad Debts Loss -- Write Off of loan to Perry Flower Shop, Inc. $ 20,000.00." Petitioners never made any demand to the corporation for payment of that $ 20,000 or took action in an attempt to secure payment thereof.
The corporation's balance sheet on December 28, 1949, the date petitioners canceled their $ 20,000 claim against the corporation, was as follows:
| Assets. | ||
| Cash | $ 575.99 | |
| Accounts receivable -- Trade | $ 32,608.80 | |
| Accounts receivable -- F. T. D. and T. D. S. | 335.07 | |
| 32,943.87 | ||
| Inventories -- July 1, 1949 | 34,446.51 | |
| Refund due -- Collector of internal revenue | 1,163.72 | |
| Mortgage receivable | 1,324.30 | |
| Ethel M. Perry | 1,697.88 | |
| Earl V. Perry | 1,037.92 | |
| Julius Snyder | 80.61 | |
| Furnitures and fixtures | 33,071.98 | |
| Less reserve for depreciation | 19,839.31 | |
| 13,232.67 | ||
| Autos and trucks | 14,437.90 | |
| Less reserve for depreciation | 6,025.11 | |
| 8,412.79 | ||
| Prepaid insurance | 1,584.42 | |
| Total | $ 96,500.68 | |
| Liabilities and Capital. | ||
| Accounts payable -- Trade | $ 28,576.39 | |
| Withholding tax -- Deducted | 2,737.11 | |
| Notes payable: | ||
| Estate of Anna M. Perry | $ 2,500.00 | |
| Hebrew Credit Union | 2,470.81 | |
| Genesee Valley Trust Co | 15,565.93 | |
| National Cash Register Co | 685.35 | |
| Cooney and Co | 1,250.00 | |
| Ethel and Earl Perry | 20,000.00 | |
| 42,472.09 | ||
| Accrued payroll taxes | 422.01 | |
| Hospital insurance -- Deducted | 41.80 | |
| Due Julius Snyder | 100.00 | |
| Deferred profit -- Sale of property | 799.55 | |
| Loans payable -- Berkshire Life Ins | 257.00 | |
| Capital stock | 30,659.97 | |
| Earned surplus | (11,804.09) | |
| Profit for six months to date | 2,238.85 | |
| (9,565.24) | ||
| Total | $ 96,500.68 |
*143 *972 The values ascribed to the corporation's assets in the above balance sheet are the correct values thereof as of December 28, 1949.
Between June 30, 1949, and December 28, 1949, the corporation showed net earnings of $ 2,238.85. Those earnings, plus certain other adjustments (notably a refund of income taxes and adjustments in depreciation and capital asset accounts) caused a reduction in the earned surplus deficit from $ 15,139.61, on June 30, 1949, to $ 9,565.24, on December 28, 1949. In this same period the corporation incurred $ 81,302.98 in trade accounts payable but paid $ 84,964.93 of such accounts, thereby reducing the balance owed from $ 32,238.34 to $ 28,576.39. Moreover, the corporation's net income for its fiscal year ended June 30, 1950, was $ 2,716.29 and its earned surplus deficit was reduced to $ 8,421.67 as of that date.
Although the corporation never has declared or paid any dividends, Earl, Ethel, and Julius Snyder each received a salary as an officer of the corporation. As annual corporate income increased, those salaries in turn increased from $ 5,200 per annum each (totaling $ 15,600) for the first fiscal year of the corporation's operations, to*144 $ 11,700 per annum each (totaling $ 35,100) for the fiscal years ended June 30, 1948, 1949, and 1950. Petitioners devoted their full time to the management of the corporation's affairs. They were not, however, in the business of lending money to, or financing, corporations. They also derived some income from inherited rental properties.
In 1951, Ethel lent the corporation an additional $ 2,995.75 and, in 1953, an additional $ 5,400.
*973 The $ 20,000 debt owed petitioners by the corporation did not become worthless in the calendar year 1949.
Petitioners deducted medical expenses of $ 723.42 in their tax return for 1949.
OPINION.
The major issue we are called upon to decide is whether petitioners are entitled to a $ 20,000 bad debt deduction in 1949 for money lent to Perry's Flower Shops, Inc., a corporation of which they were majority stockholders, officers, and directors. Respondent makes three contentions:
(1) A business bad debt deduction is not allowable under section 23 (k) (1) of the Code 1 because the debt did not become worthless in 1949. The debt was gratuitously forgiven by petitioners and, therefore, constitutes a capital contribution under section 29.22 (a)-13*145 of Regulations 111.
(2) If the debt did become worthless, then it is deductible only as a nonbusiness bad debt under section 23 (k) (4), rather than as a business bad debt under section 23 (k) (1).
(3) If the debt did become worthless, no more than $ 17,264.20 may be deducted by petitioners, since the remainder was offset by the corporation's cancellation of $ 2,735.80 owed it by petitioners.
In view of our decision it will not be necessary to consider respondent's second and third contentions.
As used in section 23 (k) (1), "worthless" refers to actual worthlessness as determined by objective standards. Whether or not a debt has become actually worthless within a particular taxable year is a question of fact, the burden of proving which rests upon petitioners. Redman v. Commissioner, (C. A. 1) 155 F. 2d 319.*146 After carefully considering all the facts of record we think it abundantly clear that petitioners have failed to prove that the $ 20,000 debt owed them by the corporation became worthless in 1949.
The corporation's balance sheet as of December 28, 1949, the date petitioners canceled the $ 20,000 debt, reveals that there were considerably more than enough assets on hand to pay both petitioners' claim and the claims of all other creditors. In arriving at this conclusion we have eliminated the capital stock account of $ 30,659.97 from the liabilities listed on the balance sheet, since creditors' claims are superior to those of stockholders. After doing so it is evident that the assets as valued on the balance sheet (which values we have, in the absence of any contrary evidence, found to be correct, see B. F. *974 , 39 B. T. A. 735) were sufficient to cover all the corporation's liabilities including the $ 20,000 debt, to completely wipe out the earned surplus deficit of $ 9,565.24 as of that date, and to have remaining for the stockholders $ 21,094.73. We can, therefore, see no distinction between this case and Mills Bennett, 20 B. T. A. 171,*147 the pertinent part of the Opinion in which we herewith quote:
The evidence shows that in 1922 the credit of the Bennett Petroleum Corporation was not good and that it did not have sufficient cash or other quick assets to pay its debts to the petitioner. But it had other assets of sufficient value which, so far as we are informed, could have been disposed of for an amount sufficient to satisfy the debt in question. However, the petitioner did not desire to enforce collection for the reason that to do so would compel the Bennett Petroleum Corporation to dispose of its assets, in part at least, which the petitioner feared would eventually result in a loss to him on his stock of the Bennett Petroleum Corporation greater than the amount of the debt. While this course may have been expedient from the petitioner's business standpoint, it did not render the debt worthless. The petitioner's relations to the Bennett Petroleum Corporation were as a creditor and as a stockholder, and the rights of the former status were superior to the rights of the latter. As a creditor he was entitled to have the entire assets of the corporation subject to the payment of his claim before he could participate*148 in these assets as a stockholder, and under these circumstances we are of the opinion that he should not be permitted to charge off as worthless and deduct from income his superior claim and retain the inferior one.
The minutes of the December 27, 1949, meeting of the corporation's board of directors and the petitioners' memorandum of December 28, 1949, canceling the $ 20,000 debt, both of which are quoted in the Findings of Fact, reveal that petitioners took no action whatever to secure payment of the debt. Those documents also indicate, and such indication is supported by the tenor of petitioners' argument in their reply brief, that petitioners failed to enforce collection because to have done so would have necessitated liquidation of the business and the consequent termination of their stockholder and officer interests therein. Mere nonpayment of a debt does not prove its worthlessness and petitioners' failure to take reasonable steps to enforce collection of the debt, despite their motive for such failure, does not justify a bad debt deduction unless there is proof that those steps would be futile. New York Water Service Corporation, 12 T. C. 780;*149 Thom v. Burnet, (C. A., D. C. Cir.) 55 F. 2d 1039; George F. Thompson, 6 T. C. 285, affirmed per curiam (C. A. 2) 161 F. 2d 185; A. Finkenberg's Sons, Inc., 17 T. C. 973; H. D. Lee Mercantile Co. v. Commissioner, (C. A. 10) 79 F. 2d 391, 393. As we have shown, the corporation had assets from which the $ 20,000 debt could have been satisfied. The fact that its capital was impaired is, by itself, of no moment. See James M. Hawkins, 20 T. C. 1069. In short, where, as here, the debtor corporation was solvent, in the sense that its assets exceeded its liabilities exclusive of proprietorship, no bad debt deduction is allowable. *975 Mills Bennett, supra;Irving L. Ernst, 18 B. T. A. 928; First National Bank of Los Angeles et al., 6 B. T. A. 850.
We conclude that the $ 20,000 debt did not in 1949 become "worthless" within the meaning of section 23 (k) (1) of the Code. Petitioners, consequently, are not entitled*150 to a bad debt deduction. The Commissioner's disallowance of the claimed bad debt deduction is sustained. In view of this holding it is unnecessary for us to consider respondent's additional contention that petitioners' cancellation of the debt constituted a capital contribution under section 29.22(a)-13 of Regulations 111.
Petitioners, in their 1949 return, reported a loss of $ 438.61 from rental of property. Respondent determined that they actually realized a net profit of $ 882.68 from that activity and, consequently, increased their reported net income for 1949 by $ 1,321.29. Although the petition contains the general statement that "the whole of this amount [the deficiency] is in dispute" it does not, as is required by Rule 7 (c) (4) (D), (E), Tax Court Rules of Practice, include an assignment of error or any facts applicable to the respondent's determination regarding the rental income. That determination is not, therefore, in issue before this Court since the question of its validity was not appropriately raised in the pleadings. Camp Wolters Enterprises, Inc., 22 T. C. 737.
Section 23 (x) of the Code, as applicable to the taxable year 1949, *151 permits deduction of medical expenses only "to the extent that such expenses exceed 5 per centum of the adjusted gross income." Petitioners deducted medical expenses of $ 723.42 in their 1949 return. Respondent disallowed that deduction on the ground that it did not represent expenses in excess of 5 per centum of petitioners' adjusted gross income as increased by the disallowance of the $ 20,000 bad debt deduction and the aforementioned adjustment of rental income. It is evident, in view of our opinion relative to the bad debt and rental income adjustments, that respondent's determination in this respect is correct.
Decision will be entered for the respondent.