Taxpayers Benjamin and Helen Stratmore (filing jointly) and B.B. Rider Corporation appeal from the tax court's decision that they had certain deficiencies in their income tax. See B.B. Rider Corporation v. Commissioner, 43 T.C.M. (CCH) 637 (1982). This court has jurisdiction over the appeal pursuant to 26 U.S.C. Sec. 7482(a) (1976).

B.B. Rider Corporation ("Rider") was originally an authorized franchisee for the sale and servicing of Frigidaire refrigerators. Benjamin Stratmore ("Benjamin") began working for Rider in 1932, as its credit manager. About five years later, Benjamin borrowed $15,000, which he contributed to the purchase of Rider.

In the taxable years in question, Benjamin owned 25 percent of the stock in the corporation; Benjamin's wife, Helen Stratmore ("Helen"), owned 8 1/3 percent; and Benjamin's two brothers each owned 33 1/3 percent. At all times in question, Benjamin, as President and Chief Financial Officer, was an active and vital employee of the corporation. Helen also worked for the corporation, as Vice President and Office Manager.

In 1950, the Stratmore brothers formed General Manufacturing Corporation ("General") to manufacture aircraft engine components. The new corporation was not a financial success, and in 1957, Rider and General both filed for bankruptcy reorganization. The plan of reorganization and other relevant documents do not appear to be part of the record. Based on testimony and on the parties' stipulations, the tax court found:

One of the consequences of the 1958 bankruptcy reorganizations of Rider and General was the placement of limitations on the maximum salaries the corporations could pay to [Benjamin] Stratmore and Helen Stratmore.... Rider and General paid their creditors only 25 cents for each dollar owed. In order to accomplish the reorganization the Stratmores agreed to forego their claims as creditors of the corporation[s] and to honor their obligation as guarantors of the remaining 75 percent of the corporate debts.

43 T.C.M. at 651-52, 653. After the reorganization, the two corporations merged. We refer to the merged corporation as "Rider/General."

In 1961-1971, the Stratmores made payments of principal and interest on debts incurred by Rider and General that the Stratmores had guaranteed prior to the reorganization. The Stratmores took ordinary deductions for these payments on their joint tax returns. Upon examination, the Internal Revenue Service (the "IRS") determined that the payments were not deductible in full, but only as nonbusiness bad debts subject to a statutory limitation on deductions for short-term capital losses. Based on these disallowances, the IRS issued a notice of deficiency to the Stratmores in 1974.

The IRS also disallowed deductions by Rider/General for payments made to Benjamin for "travel and entertainment" in the corporation's taxable years 1961, 1964, and 1965.1 Based on these disallowances, the IRS issued a notice of deficiency to Rider/General in 1974. In a 1977 notice of deficiency, the IRS disallowed as unreasonable Rider/General's deductions for payments made to Benjamin as "compensation" during the corporation's taxable years 1970, 1972, 1973, and 1974.

The Stratmores and Rider/General filed petitions in the United States Tax Court for review of these three notices of deficiency. The cases were consolidated for trial, and the tax court held that the IRS was correct in its disallowances. The Stratmores and Rider/General appeal.

In 1961 to 1971, the Stratmores made payments of principal as guarantors2 of debts incurred by Rider and General prior to the reorganization. The Stratmores reported these amounts as miscellaneous deductions or as employee business expenses. They contend that these payments are fully deductible against ordinary income as business bad debts under I.R.C. Sec. 166(a).3

Section 166(a) sets out the general rule that any debt is deductible in the year in which it becomes worthless. Section 166(d)(1)(A) excludes from this general rule all "nonbusiness debts" of noncorporate taxpayers. A nonbusiness debt is "a debt other than ... a debt created or acquired (as the case may be) in connection with a trade or business of the taxpayer; or ... a debt the loss from the worthlessness of which is incurred in the taxpayer's trade or business." I.R.C. Sec. 166(d)(2).

Under section 166(d)(1)(B), nonbusiness bad debts are deductible as short-term capital losses, but such deductions were limited to $1,000 or less for the taxable years in question, see c. 736, 68A Stat. 321 (1954) (amended in 1969); Pub.L. No. 91-172, Sec. 513(a), 83 Stat. 487 (1969) (amended in 1976 and 1977) (current version of these statutes appears at 26 U.S.C. Sec. 1211 (1976)).

The taxpayer bears the burden of refuting the IRS's determinations. Welch v. Helvering, 290 U.S. 111, 115, 54 S. Ct. 8, 9, 78 L. Ed. 212 (1933). The tax court agreed with the IRS that the Stratmores' payments on the corporate debts created nonbusiness bad debts. Whether a debt is a business bad debt may be a mixed question of law and fact, see Anderson v. United States, 555 F.2d 236, 237 (9th Cir.1977), but the relationship between a debt and the taxpayer's trade or business is a question of fact, Treas.Reg. Sec. 1.66-5(b)(2); see United States v. Generes, 405 U.S. 93, 104, 92 S. Ct. 827, 833, 31 L. Ed. 2d 62 (1972). We review the tax court's factual findings and inferences from fact for clear error only. Commissioner v. Duberstein, 363 U.S. 278, 289-91, 80 S. Ct. 1190, 1198-1200, 4 L. Ed. 2d 1218 (1960); Imbesi v. Commissioner, 361 F.2d 640, 643 (3d Cir.1966).

There is no distinction between a loss that results from a direct loan to a corporation and one that results from the guarantee of a loan. Putnam v. Commissioner, 352 U.S. 82, 92, 77 S. Ct. 175, 180, 1 L. Ed. 2d 144 (1956). If an employee of a corporation lends the corporation money primarily to protect his job, he is entitled to deduct the amounts paid as a business bad debt if the loan becomes worthless. Trent v. Commissioner, 291 F.2d 669 (2d Cir.1961). However, when the guarantor of a corporate debt is both a shareholder and an employee of the corporation, it is difficult to determine whether he executes his guarantee to protect his investment or to protect his job. Mixed motives are not uncommon, and the critical question is which of the taxpayer's motives is dominant. Generes, 405 U.S. at 103, 92 S.Ct. at 833.

The Generes Court sought to determine whether a shareholder/employee's dominant motive in indemnifying the underwriter of the corporation's bid and performance bonds was to protect the shareholder/employee's job or to protect his investment. The Court's decision turned on a comparison of the amount that the shareholder/employee originally invested in the corporation and the amount, after taxes, that he received annually as a salaried employee of the corporation. The Court found it implausible that the shareholder/employee would indemnify the underwriter of the corporation's bonds in order to protect an annual salary of approximately $7,000 (after federal taxes), which was less than one-fifth of his original investment of $38,900.

The shareholder/employee in Generes worked for the construction company only six to eight hours per week and had a full-time job elsewhere. The tax court readily distinguishes Generes if the guarantor of a corporate debt is an older individual who has devoted his life to the industry in question, who has few prospects of equivalent employment4 if he should lose his job, and whose income is primarily his salary from the corporation. See Estate of Allen v. Commissioner, 44 T.C.M. (CCH) 9 (1982); LaStaiti v. Commissioner, 41 T.C.M. (CCH) 511 (1980); see also, e.g., Mann v. Commissioner, 34 T.C.M. (CCH) 377 (1975); Young v. Commissioner, 33 T.C.M. (CCH) 397 (1974). But see also, e.g., Massey v. Commissioner, 43 T.C.M. (CCH) 271 (1982).

Pointing to these and other tax court decisions, the Stratmores argue that Generes is factually distinguishable because Benjamin was close to sixty years old when he executed the guarantees in question, and he had devoted most of his life to running Rider and General, working full time and depending on his salary and his wife's salary as his sole and irreplaceable sources of income. Although we recognize the significance of such considerations, we cannot dispense entirely with the comparison of salary and investment on which the Generes Court specifically relied.

As the tax court noted, there is no evidence in the instant case of what the Stratmores' salaries were when they guaranteed the loans to Rider and General. The Stratmores' combined salaries in the early 1960s were, on the average, just less than $14,000 per year5 before taxes, but there is evidence that these salaries were artificially low due to a salary limitation to which the Stratmores agreed at the time of the reorganization.

The parties disagree over the value of the Stratmores' investment in Rider and General. The Stratmores contend that their sole investment was the $15,000 with which Benjamin purchased the Stratmores' interest in Rider in the late 1930s. The Commissioner argues that this initial investment had appreciated considerably by the 1950s, when the Stratmores guaranteed the loans in question.

Benjamin's salary when he executed the guarantees was probably not much less than his original investment of $15,000 and may have been much greater. In such a case, the degree to which the original investment has appreciated by the time the guarantees are executed may determine the tax consequences under Generes.6 The question under Generes is whether the guarantor's dominant motivation in executing his guarantee was to protect his salary or to protect his investment. We must therefore compare the value of the guarantor's salary and of his investment at the time at which he executed his guarantee. See, e.g., Alsobrook v. United States, 431 F. Supp. 1122, 1128 (D.C.Ark.1977); Estate of Allen, 44 T.C.M. (CCH) at 16; Young, 33 T.C.M. (CCH) at ---.

On the basis of evidence that Rider/General's machine shop was worth approximately $500,000 in 1966 and 1967, see 43 T.C.M. (CCH) at 641 & n. 7, the Commissioner argues that the value of the Stratmores' investment was their one-third interest in this $500,000. The Stratmores protest that the value of the corporation's assets should be offset by the corporation's debts, and they point to evidence that the corporation had debts in excess of $1,100,000 in 1961.

We will not attempt to offset assets valued in 1966 by debts estimated in 1961, in order to guess at the corporation's actual worth in the 1950s, when the guarantees were executed. The Stratmores did not produce evidence of the value of their salaries or their investment at the time they executed their guarantees. They therefore did not carry their burden of proving that their payments of principal as guarantors of the corporations' debts were sufficiently related to their trade or business to give rise to business bad debts. See Stratmore v. United States, 420 F.2d 461 (3d Cir.1970), cert. denied, 398 U.S. 951, 90 S. Ct. 1870, 26 L. Ed. 2d 291 (1970).7 We will affirm the tax court's decision that these payments gave rise to nonbusiness bad debts.8

The Stratmores also paid interest on debts incurred by Rider and General. The IRS disallowed these interest deductions and determined that the payments gave rise to nonbusiness bad debts. The tax court agreed.

Under I.R.C. Sec. 163(a), a taxpayer may deduct against ordinary income all interest paid or accrued in the taxable year. The general rule9 is that the interest must pertain to a debt of the taxpayer who claims the deduction and not to the debt of another. Under Putnam v. Commissioner, 352 U.S. 82, 85, 77 S. Ct. 175, 176, 1 L. Ed. 2d 144 (1956), when a guarantor honors his guarantee of a corporate debt, he is making payments on the corporate debt and is subrogated to the creditor's rights against the corporation. See also Stratmore, 420 F.2d at 465. Applying Putnam, interest payments by the guarantor are payments of interest on the corporation's indebtedness, and the guarantor may not deduct such payments under section 163(a). E.g., Abdalla v. Commissioner, 647 F.2d 487, 503 (5th Cir.1981); Golder v. Commissioner, 604 F.2d 34, 35 (9th Cir.1979); Nelson v. Commissioner, 281 F.2d 1, 4-6 (5th Cir.1960).

The tax court held that because the Stratmores paid interest on the indebtedness of Rider and General, they were not entitled to a deduction under section 163(a). The Stratmores argue that the interest they paid accrued solely as a result of agreements that they made with the creditors of Rider and General during the reorganization, which permitted the Stratmores to extend their payments as guarantors into the 1960s and 1970s. Because neither these agreements nor the original guarantee appear to be part of the record, we cannot determine the effect, if any, of the agreements on the guarantee.

The Stratmores' primary contention is that they did not pay interest on the indebtedness of another. They contend that Rider and General were discharged from their debts as part of the bankruptcy reorganization in the late 1950s, when the corporations paid their creditors twenty-five cents on the dollar and the Stratmores executed agreements acknowledging their liability for the balance of the debt. The Stratmores also agreed not to file claims in the bankruptcy proceedings as creditors of the corporations.

The Stratmores argue that these events transformed the corporations' debts into their own. They rely on the recent case of Tolzman v. Commissioner, 43 T.C.M. (CCH) 1 (1981). The Commissioner protests that the Stratmores presented no arguments based on Tolzman in the tax court. Because the briefs to the tax court are not in the record, we cannot determine what the Stratmores argued to the tax court.

Although a court of appeals will generally refuse to hear arguments not heard by the trial court, we have discretion to consider such arguments if necessary to avoid a clear injustice. Singleton v. Wulff, 428 U.S. 106, 120-21, 96 S. Ct. 2868, 2877, 49 L. Ed. 2d 826 (1976); see Hormel v. Helvering, 312 U.S. 552, 556-59, 61 S. Ct. 719, 721-722, 85 L. Ed. 1037 (1941). The Stratmores seem to be in circumstances that strongly resemble the guarantors' situation in Tolzman, and if Tolzman controls, it might dictate a reversal of the tax court's decision with respect to the Stratmores' interest deductions.

In Tolzman, the tax court held that the guarantors of a corporate debt could take an interest deduction under section 163(a) for payments made on interest that accrued subsequent to the corporation's insolvency. The tax court reasoned that when the corporation became insolvent, the guarantors became primarily liable for the erstwhile corporate debt. Cf. Baker v. Commissioner, 41 T.C.M. (CCH) 1142, 1148 (1981) (payment of insolvent corporation's liability does not create a bona fide debt). The Commissioner distinguishes Tolzman by arguing that the record does not show whether the interest that the Stratmores paid accrued after the reorganization.10 The tax court made no finding on this point.

We are without the benefit of the tax court's opinion on whether Tolzman applies to this case. Nor are we aware of any other cases in which the tax court followed the Tolzman rule. In the interest of justice, we will vacate the tax court's decision with respect to the interest deductions and remand the case to the tax court to determine whether Tolzman applies.

Rider/General reported the following amounts paid to Benjamin and took a deduction under I.R.C. Sec. 162(a) for the amounts listed as travel and entertainment expenses. See 43 T.C.M. (CCH) at 652.

       Taxable                                            "Travel and
        Year                   Salary                   Entertainment"
        1961                 $ 8,160.00                $ 59,615.76*
        1964                   8,300.00                    70,103.82
        1965                   8,180.00                  52,316.39*