*1725 1. Commissioner's determination of amount of income received by the taxpayer in 1924, in the acquisition of the assets of the Neely Lumber Company, sustained for want of reliable evidence to overthrow the prima facie case.
2. Commissioner's action as to bonuses approved, with slight correction.
*1376 This proceeding is for the redetermination of deficiencies asserted against Thomas McCabe for the years 1924 and 1925 in the respective amounts of $8,196.67 and $15,205.57.
Petitioners assign two errors on the part of the Commissioner, as follows:
For the calendar year 1924 - The Commissioner has erroneously added to the net income shown on the income tax return of Thomas McCabe for the calendar year 1924, the sum of $32,874.25 claimed by the Commissioner to constitute gain realized from the acquisition by the said Thomas McCabe of assets of the Neely Lumber Company.
For the calendar year 1925 - The Commissioner has erroneously added to the net income shown on the income tax return of Thomas McCabe for the calendar year 1925 the sum of $66,326.59 claimed*1726 by the Commissioner to be the amount of bonuses constructively received by the the said Thomas McCabe from various corporations during the calendar year 1925.
FINDINGS OF FACT.
Petitioners are the duly appointed and qualified executors of the last will of Thomas McCabe, who died on March 2, 1929, and reside in the State of New York.
In 1923 the Neely Lumber Company was organized by McCabe, Quigley and Neely, to operate in Memphis, Tenn. Its operations were designed to be the purchase and sale of lumber. Its capital stock was $50,000 par value, and was held by the three organizers. Nothing of value was paid for the stock. The business scheme was that its operating capital should be obtained by borrowing money on notes of the corporation, endorsed by McCabe. It did obtain several thousand dollars on that plan, and Neely was sent to Memphis to open up and carry on the business.
After opening up the business, Meely, without the knowledge of McCabe, bought a sawmill for approximately $22,500, paying therefore *1377 in cash, $7,500, and notes for the balance. McCabe, during the first year's operation of the Neely Lumber Company, had endorsed its notes to the extent*1727 of thirty or forty thousand dollars, and had also given Neely a letter of credit in which he assumed liability on any indebtedness incurred by Neely in operating the Neely Lumber Company.
Sometime in 1924 McCabe obtained knowledge of the purchase of the sawmill by being served with a citation issued in a suit in Mississippi for the balance of the purchase price of the sawmill. Besides the suit for the balance of the purchase price of the sawmill, McCabe was sued on several other obligations incurred by Neely. Some of those suits were compromised by McCabe paying 40 or 50 cents on the dollar. The amount of such claims is not disclosed by the record; neither is the amount sued for as the balance of the purchase price of the mill disclosed.
In the early part of 1924, not later than May 24, 1924, McCabe displaced Neely at Memphis and put J. H. Haralson in charge of the business there. Under McCabe's instructions, Haralson proceeded at once to close up the operations of the Memphis business by collecting outstanding bills and accounts receivable, and paying the company's obligations.
In his tax return for 1924, McCabe claimed a deduction on account of bad debts in connection*1728 with the Neely Lumber Company of $18,500. Upon audit of that return the Commissioner enlarged the bad debt claim to $25,000, but added to income $32,874.25, resulting in a net enlargement of income of $26,374.25, which, after making other adjustments not herein involved, formed the basis of the deficiency determined for 1924.
In 1920, 1921 and 1922, and prior thereto, Thomas McCabe owned stock in and was a director and general manager of a number of corporations. Among those corporations were the Salamanca Furniture Works and the Salamanca Panel Company. McCabe owned 66.7917 per cent of the stock of the Salamanca Furniture Works and 50 per cent of the Salamanca Panel Company, and at least half of the stock in the other companies.
While the minute books of the corporations were not put in evidence, the record shows fairly satisfactorily that sometime in 1920 a written document was executed which stipulated that for 1920 Thomas McCabe should receive, in the nature of a bonus, 20 per cent of the net profits earned by each of the two companies named above; and for 1922 it was agreed that McCabe should receive 2 per cent on the sales of each of those two companies. Accordingly*1729 the following amounts were credited to McCabe:
| For 1920, by the Salamanca Furniture Works | $25,639.23 |
| On January 31, 1921, by the Salamanca Panel Company | 12,871.87 |
| For 1922, by the Salamanca Furniture Works | 18,355.18 |
| On January 6, 1923, by the Salamanca Panel Company | 7,523.02 |
| 64,389.30 |
*1378 Those credits to McCabe were charged to the surplus accounts.
In the latter part of 1924, or early part of 1925, a conclusion was reached by the directors and stockholders of four of the corporations in which McCabe was interested, including the Salamanca Furniture Works and the Salamanca Panel Company, to merge the four companies into one company which was to be organized and named Thomas McCabe Industries. The combined capital stock of the four companies was $348,650, and the surplus was $298,881.16. The Thomas McCabe Industries was capitalized at $1,524,504.85, of which Thomas McCabe received $923,329.20, which was slightly more than 60 per cent of the stock. In arriving at the total value at which the company would be capitalized, there were included:
Capital stock of each of the four companies.
An inflation by appraisal of the properties of $298,881.16*1730 which represented the surplus.
A depreciation reserve of $208,915.07.
The McCabe bonus account to the extent of $43,994.41.
A credit to McCabe of $437.29.
A barn owned by McCabe personally and valued at $3,000.
There were other items included, but it is needless to name them. The aggregate amount was $1,524,504.85. Of that aggregate amount McCabe received as his share, as per the aggregate of his shares in the four old companies plus the $3,000 for the barn, $923,329.20 par value.
OPINION.
LOVE: In this case the Commissioner asserted a deficiency for 1924 based on his determination that McCabe realized a taxable gain in the acquisition by him of the assets of the Neely Lumber Company in the amount of $32,874.25. The petitioners assert that McCabe realized no profit whatever with respect to his dealings in the Neely Lumber Company, but suffered a serious loss.
For the year 1925, the Commissioner asserted a deficiency based on a determination that McCabe constructively received, in 1925, bonuses in the amount of $66,326.59. Petitioners assert that McCabe never at any time actually received such bonuses, and that they were never taxable income to him.
The*1731 record is very unsatisfactory. No books were submitted except a ledger of the Neely Lumber Company, which apparently disclosed *1379 but few items pertinent to the issues involved in this case, and several pages taken from the "Combined Journal, Cash Book and Daily Financial Statement" of the Salamanca Furniture Works and the Salamanca Panel Company, respectively. Nearly all the evidence was oral, and from memory of the witnesses. While the witnesses were stockholders and officers in the several companies involved, they were testifying with reference to another person's business transactions that occurred eight or ten years ago. In several instances, as will be pointed out later, their testimony is either in conflict with the book records which are in evidence, or is not corroborated by such evidence.
With reference to the Neely Lumber Company transactions involving the deficiency for 1924, we may point out that the Commissioner determined that McCabe realized a taxable gain in 1924 by taking over the assets of that company. That determination constitutes a prima facie case in favor of the respondent in this proceeding. It, therefore, devolves upon petitioners to overthrow*1732 that prima facie case by establishing, by competent evidence, that the Commissioner erred in whole or in part in that determination.
It was fairly well established and we have found as a fact that McCabe endorsed notes of the Neely Lumber Company to the extent of thirty or forty thousand dollars and that he gave Neely a letter of credit which rendered him liable on several debts incurred by Neely. The proof also shows that McCabe was sued on a number of claims against the Neely Lumber Company, and that he settled those claims, some at forty cents on the dollar, and some at fifty cents on the dollar. It is also established that McCabe took over the Neely Lumber Company in 1924, dismissed Neely from its management and substituted Haralson. The witness testified that in the liquidation of the Neely Lumber Company, McCabe collected and got about $3,000, but not exceeding $3,500. The ledger pages of the Neely Lumber Company that are in evidence disclose the fact that Haralson, after May, 1924, collected on notes and accounts receivable an aggregate of $14,597.43. The discrepancy here pointed out serves to illustrate the unreliable character of the oral testimony. Not that the witnesses*1733 intentionally misrepresented the facts, but rather in the very nature of things, they did not know or did not remember the facts. Other similar discrepancies might be pointed out. The result is that we can not determine from the record how much McCabe did receive as a result of the liquidation of the Neely Lumber Company. We may not act and decide issues of fact on surmises and guesses. We must have reliable and fairly definite evidence.
*1380 In his return for 1924, McCabe claimed a loss of $18,500, based on bad debts involving the Neely Lumber Company, but reported no income from that source. Upon audit, the Commissioner enlarged the allowance for bad debts to $25,000, but added to income, $32,874.25. Upon the evidence in the record, we can not hold that the Commissioner erred and, hence, we approve his action on the deficiency asserted for 1924.
On January 31, 1921, there was credited to McCabe, on the books of the Salamanca Furniture Works, 2 per cent of its net earnings, $25,639.23, as a bonas. The same company credited to McCabe on January 6, 1923, a sum equal to 20 per cent of its sales in 1922, $18,355.18, as a bonus. That makes a total in bonuses credited*1734 to McCabe by the Salamanca Furniture Works of $43,994.41.
There was credited on the books of the Salamanca Panel Company to McCabe as bonuses, on December 31, 1920, 20 per cent of net earnings, $12,871.87, and on March 6, 1923, 2 per cent on sales, $7,523.02, making a total of $20,394.89. This makes a grand total of bonuses credited of $64,389.30.
The Commissioner charged to McCabe "Bonuses constructively received in 1925, $66,326.59." There were included in the capital account of the Thomas McCabe Industries, McCabe bonuses to the amount of $43,994.41, which is the exact amount of the two bonus items credited by the Salamanca Furniture Works. What became of the two items credited by the Salamanca Panel Company is not disclosed by the record. So far as the evidence discloses, either oral or documentary, those credits remained on the books at the date of the merger in 1925.
It appears, therefore, that McCabe never was paid in cash any of those bonuses. The $43,994.41 that was carried into the capital account of the Thomas McCabe Industries was apportioned among its stockholders, and in that way McCabe got about 60 per cent of it. There is no evidence in the record as to*1735 what the market value of that stock was. Those bonuses were credited to McCabe in 1921 and 1923, respectively.
There is no evidence in the record that shows that the several corporations had the cash at the time or times when the bonuses were credited on their books to McCabe to pay a draft drawn on such credits. Neither is there evidence to show that the corporations had the cash available at any time prior to 1925.
Those credits still remained on the books at the beginning of 1925. The Commissioner has determined that McCabe received them in 1925. We find no evidence in the record justifying us to hold that the Commissioner erred.
It is true that there was testimony to indicate that McCabe authorized the crediting, into the capital account of the corporation organized *1381 in 1925, of the two bonus credits on the books of the Salamanca Furniture Works (at least the amount so credited to the capital account equaled those two bonus credits), but we are unable to determine what became of the two bonus credits on the books of the Salamanca Panel Company.
McCabe received a large part of the stock of the new corporation, the value of which at date of its receipt*1736 is not disclosed.
The Commissioner charged McCabe with constructive receipt of $66,326.59. We think the evidence clearly shows that the aggregate of the four bonus items credited to McCabe was $64,389.30, and no more, hence, the amount should be changed from $66,326.59 to $64,389.30, and with that correction we approve the determination of the Commissioner on that issue.
Judgment will be entered under Rule 50.