1946 U.S. Tax Ct. LEXIS 173">*173
Petitioner and X were cotrustees of a trust for C. X withdrew the funds of the trust, agreeing to make repayment, but he became insolvent and was unable to repay the trust. The guardian of C sued petitioner and X, who were jointly and severally liable to C. In 1941 X was insolvent. Petitioner agreed under a settlement approved by the Superior Court of California to repay the trust for the full amount which X had withdrawn, and he made payment of one-half of the sum in 1941. Petitioner did not receive any benefit from the breach of the trust; X received all of the benefit and was the most at fault for the breach of the trust.
6 T.C. 1231">*1231 The respondent determined deficiencies in income tax for the year 1941 as follows: In Docket No. 6086 the deficiency is $ 1,006.48; and in Docket No. 6087 the deficiency is $ 1,033.71. The respondent has 6 T.C. 1231">*1232 disallowed a loss claimed by petitioners in connection with a payment of $ 5,934.07 which was made by Harold Guyon Trimble in 1941, who was cotrustee of a trust, in settlement of a suit against the trustees for defalcation of trust funds. The circumstances under which the payments were made which gave rise to the deduction which is claimed by petitioners are set forth hereinafter.
The petitioners filed separate returns for the year 1941 with the collector for the first district of California, in which they reported income under the community property method of reporting community income, each deducting1946 U.S. Tax Ct. LEXIS 173">*175 one-half of the total sum paid by Harold Guyon Trimble in 1941.
This proceeding has been submitted under a record which consists of a stipulation of facts, exhibits, and oral testimony.
FINDINGS OF FACT.
Harold G. Trimble is a practicing physician in Oakland, California, and was during all of the period which is material. Esther K. Trimble is his wife. Harold G. Trimble is referred to hereinafter as the petitioner.
Sydney R. Jacobs is the son of Barney Jacobs, who died in 1927, and Jule H. Jacobs is the son of Sydney. Jule was born in 1922. Neither Harold Trimble nor Esther Trimble is related to Sydney R. Jacobs.
Under the will of Barney Jacobs, Sydney R. Jacobs inherited property of value. From 1926 to 1929, Sydney Jacobs carried on a jewelry and loan business in Oakland, California, under the name of Syd's Loan & Jewelry Business.
Harold G. Trimble and Sydney Jacobs were named cotrustees in 1927 of a trust created under the will of Barney Jacobs. The trustees were appointed under a decree of distribution of the Superior Court of California. The decedent, Barney Jacobs, bequeathed $ 10,000 in trust for the benefit of his grandson, Jule H. Jacobs. Under the will of Barney 1946 U.S. Tax Ct. LEXIS 173">*176 Jacobs the sum of $ 10,000 was to be held in trust until Jule H. Jacobs, the beneficiary, became 25 years of age, at which time the trust was to terminate and the principal of the trust was to be distributed to the beneficiary. During the term of the trust, income was to be paid to the beneficiary. The trustees were authorized to deposit the sum of $ 10,000 in a savings bank, or to invest the principal amount in first class state or Federal bonds.
When distribution was made to Trimble and Jacobs, as trustees, of $ 10,000 from the estate of Barney Jacobs, the trustees deposited the money in an account in the Oakland Bank of California, in trust for Jule. The deposit was made on May 27, 1927.
From 1927 to 1929 Sydney Jacobs was in financial difficulties. His financial distress caused him to look to the trust fund of his son. 6 T.C. 1231">*1233 In January of 1929 Sydney Jacobs and his wife and their son Jule lived together. Jule was seven years old.
On January 7, 1929, arrangements were made for Sydney Jacobs to withdraw the entire $ 10,000 from the trust bank account. He withdrew that sum without giving any security. Signatures of both trustees were required by the bank, and the petitioner, 1946 U.S. Tax Ct. LEXIS 173">*177 Harold G. Trimble, signed the withdrawal slip as well as Sydney Jacobs. Thus, petitioner consented to the withdrawal. Sydney Jacobs executed an instrument on January 7, 1929, under which he agreed "to restore to the savings account of Jule Jacobs, in the Oakland Bank, the sum of $ 10,000 on demand."
At the time of the withdrawal, Sydney Jacobs was not known to be insolvent. He was the beneficiary of another trust under the will of Barney Jacobs. That trust held a piece of property located in Oakland, subject to a mortgage. Also, Sydney Jacobs had received securities and cash from his father's estate.
No part of the money withdrawn from the trust account was used for the benefit of Harold G. Trimble. The money was used by Sydney Jacobs for the use of himself and his family, including Jule.
On January 7, 1929, a balance remained in the trust account in the sum of $ 646.73, which represented interest earned on the sum deposited in the account from the date of May 27, 1927. During the period February 7, 1929, through October 5, 1931, Sydney R. Jacobs made payments totaling $ 1,600 in the trust account. No further payments have been made by Sydney Jacobs in the account.
In 19321946 U.S. Tax Ct. LEXIS 173">*178 Sydney Jacobs discontinued the loan and jewelry business; the mortgage on the property in the trust for his benefit was foreclosed; and he went into involuntary bankruptcy. He has not been engaged in any business of his own since 1932. After 1932 he worked at various jobs, including W. P. A. projects and driving a taxi. During 1939, 1940, and 1941 he was not steadily employed. During 1941 he drove a taxi for the Yellow Cab Co., earning about $ 100 a month when he was so employed. He had no assets in 1941. At some time in 1942 he worked in a shipyard in Oakland as a timekeeper.
Sydney Jacobs was insolvent in 1940 and 1941.
On February 21, 1940, Clyde K. Evans was appointed guardian of the estate of Jule Jacobs, by an order of the Superior Court of California, in the County of Alameda, and letters of guardianship were issued on March 18, 1940. Evans was not related to the Jacobs family. Prior to the institution of the guardianship proceeding, Sydney R. Jacobs and his wife refused to be parties to the institution of the proceeding.
On March 22, 1940, Evans, as guardian, filed a petition for an accounting from the trustees of the trust for Jule Jacobs. Under an order to file 1946 U.S. Tax Ct. LEXIS 173">*179 an accounting, Sydney R. Jacobs filed an account on May 6 T.C. 1231">*1234 27, 1940, which showed a balance of $ 2,974.38 in the trust account as of January 1, 1940. In the account, Sydney R. Jacobs stated "that the undersigned trustee (Jacobs) realizes his obligations to said trust but is not financially able to repay said trust any sum whatsoever and has no property, real or personal, from which to realize money to repay same."
On October 16, 1940, the Superior Court entered a judgment and decree on the accounting of the trustees. The court found as a fact that the withdrawal of $ 10,000 was taken by Sydney R. Jacobs, one of the trustees, with the knowledge and consent of Harold Trimble, the cotrustee; that the withdrawal and taking was made without any security whatsoever; and that the withdrawal and taking of $ 10,000 by Sydney R. Jacobs was contrary to and in violation of the express terms of the trust. From all of the facts, including those stated above, the court ordered and decreed that, as of the date of the decree, there was "chargeable to and against Dr. Harold Trimble and Sydney R. Jacobs, and each of them, jointly and severally, the sum of $ 8,400 principal and the further 1946 U.S. Tax Ct. LEXIS 173">*180 sum of $ 1,761.04 as interest to October 5, 1931," together with additional simple interest at the rate of 7 percent from October 5, 1931.
Thereafter, on January 14, 1941, an action was instituted in the Superior Court by Evans against Sydney R. Jacobs and Harold G. Trimble, praying for judgment against each of the defendants in the total sum of $ 15,575.54, with interest at the rate of 7 percent per annum. The above stated sum represented the balance due the trust account by the trustees under the decree of October 16, 1940. Concurrently with the filing of the above suit, Evans caused an attachment to be issued against the property of Harold G. Trimble, who was solvent and who owned property which could be attached.
On May 7, 1941, an agreement was reached under which Harold G. Trimble agreed to pay the sum of $ 11,863.13 in settlement of all claims then existing against him by virtue of his fiduciary capacity as a trustee of the trust for Jule Jacobs. Under the settlement, Harold G. Trimble was to pay the sum of $ 5,934.07 on or before June 1, 1941, and a like amount on or before November 1, 1942, with interest on deferred payments at the rate of 2 percent.
The Superior Court 1946 U.S. Tax Ct. LEXIS 173">*181 approved the settlement. Petitioner made payments in 1941 and 1942 in accordance therewith. The action was dismissed on March 18, 1944.
When Evans instituted a suit against the trustees of the Jule Jacobs trust on January 14, 1941, Harold G. Trimble engaged the services of an attorney and left the matter in his hands. Because of general knowledge that Sydney Jacobs was insolvent in 1941, petitioner did not institute any legal action against Jacobs to recover any sums from 6 T.C. 1231">*1235 him. When petitioner made payments under the settlement agreement he believed he could not recover from Jacobs.
Petitioner has not been repaid any part of the payments he has made under the settlement agreement.
Respondent has allowed deductions for interest paid in connection with the payments under the settlement agreement. He has disallowed deductions for the payment made in 1941 on the principal amount of the sum agreed to in the settlement agreement. In 1941, the petitioner, Harold G. Trimble, paid $ 5,934.07 on account of the principal sum which he agreed to pay in settlement of Evans' suit. Petitioners took deductions in their respective returns on account of the above payment on principal1946 U.S. Tax Ct. LEXIS 173">*182 in the respective amounts of $ 2,967.04 and $ 2,967.03. Respondent has included these payments, respectively, in the 1941 income of Harold G. Trimble and Esther K. Trimble.
OPINION.
Petitioner claims that he is entitled to deduct $ 5,934.07, the sum which he paid in 1941 to the guardian of the beneficiary of the trust involved under the settlement which was approved by the Superior Court of California. The deduction is claimed under
1946 U.S. Tax Ct. LEXIS 173">*183 The facts are that Jacobs, who withdrew the trust fund, received all of the benefits from the fund, and that petitioner, the cotrustee, was, at the most, only negligent in placing his confidence in Jacob's ability to repay the trust. Jacobs agreed to restore the funds to the trust, and at the time Trimble believed that Jacobs had property out of 6 T.C. 1231">*1236 which he could realize sufficient to repay the trust. Under such facts, petitioner was not equally at fault with Jacobs in the breach of the trust, and, since Jacobs was substantially more at fault than petitioner and received the full benefit from the breach of the trust, he was obligated to make contributions to petitioner, his cotrustee, to the extent of the benefit which he received, which was equal to the money petitioner paid under his separate liability to the guardian of the beneficiary. See Restatement of the Law of Trusts, vol. 1, pp. 801-804, para. 258 (d) and (f);
It is held that Jacobs was indebted to petitioner for the amount he paid to the guardian of the beneficiary of the trust, and that the indebtedness became worthless in 1941.
1946 U.S. Tax Ct. LEXIS 173">*184
1. See Mertens, Law of Federal Income Taxation, vol. 5, par. 30.11, p. 367, where it is stated, in part, as follows:
"A Deductible Debt Must Have Value When Acquired. A voluntary loan which gives rise to a debt which is worthless when acquired -- in the sense that it has no value -- may not then or subsequently be deducted as a bad debt. Such an advance is equivalent to a gift; in any event, a taxpayer may not create for himself a right to a deduction by making an advance without reasonable expectation of repayment. There must exist a real and not fictitious or disembodied debtor-creditor relationship.
* * * *
"Where the debt is created involuntarily the foregoing rule does not apply and the taxpayer may be allowed a bad debt deduction, the worthlessness of his claim being in fact the element justifying his right to the deduction. This rule finds illustration in the cases of an endorsement or the assumption of the obligation by a surety. In such cases the debt arises only when the endorser or surety pays [citing
