23 T.C. 1105">*1106 Respondent determined deficiencies in the tax of the petitioners and additions to tax as follows:

1955 U.S. Tax Ct. LEXIS 216">*219 23 T.C. 1105">*1107 The foregoing amounts are those set forth in the statutory notices of deficiency. In addition thereto respondent by motion duly made and granted has made claim for increased deficiencies in the case of F. W. Drybrough, Docket No. 40029, and in the case of L. W. Simpson, Docket No. 40030.

The proceedings were consolidated for hearing and opinion. The issues in controversy are as follows:

1. Whether respondent correctly determined that funds taken from the incoming mail basket of the corporate petitioner by its principal stockholders and officers were income to the corporation and that the corporation is not entitled to an offsetting "embezzlement" loss under section 23 (f) of the 1939 Code;

2. Whether respondent correctly determined that the diverted funds were taxable as dividends to the officer-stockholders receiving them;

3. Whether a cash basis corporation may deduct accrued but unpaid Federal taxes in determining the amount of its earnings and profits;

4. Whether the respondent correctly determined that the corporate and individual petitioners were liable for additions to tax because of fraud under section 293 (b) of the 1939 Code;

5. Whether as to any of the petitioners, 1955 U.S. Tax Ct. LEXIS 216">*220 any of the taxable years involved are barred by the statute of limitations;

6. Whether respondent was correct in increasing the corporate petitioner's taxable income because receipts from a mixed aggregate of claims purchased from the liquidators of insolvent banks were first applied to a recovery of cost before reporting any profit; and

7. Whether respondent correctly determined that the corporate petitioner was not entitled in 1945 to a deduction for real estate taxes not actually satisfied until 1947.

FINDINGS OF FACT.

The stipulated facts are so found. United Mercantile Agencies, Incorporated (hereinafter referred to as United), is a Kentucky corporation with its offices in Louisville, Kentucky. F. W. Drybrough (hereinafter referred to as Drybrough), and L. N. Simpson (hereinafter referred to as Simpson), are individuals residing in Louisville, Kentucky. All of the petitioners kept their books and filed their Federal tax returns on a cash receipts and disbursements basis. Their returns in each of the taxable years were filed with the collector of internal revenue for the district of Kentucky.

United was organized in 1917 by Drybrough to engage in the business of conducting1955 U.S. Tax Ct. LEXIS 216">*221 a collection and mercantile agency. The entire capital contribution of $ 1,500 was made by Drybrough. Marion S. McHenry, who married Drybrough in 1919 and is hereinafter referred 23 T.C. 1105">*1108 to as Drybrough's wife, was issued 5 per cent of the original stock. She was elected secretary of the corporation and has continuously held that office. Until 1933 she worked for United as a salaried officer, but thereafter she took no active interest in the management or affairs of the corporation.

During the taxable years involved Simpson, Drybrough, and the latter's wife were the directors of the corporation. The corporate officers were Drybrough, president, Simpson, vice president and treasurer, and Drybrough's wife, secretary. The common stock was held 55 per cent by Drybrough, 25 per cent by Simpson, and 20 per cent by Drybrough's wife. Simpson's stock had all been transferred to him by Drybrough at various times prior to 1941 in recognition of his services to the corporation or had been received as a stock dividend. The stock held by Drybrough's wife represented her original holding, stock received as a dividend, and shares which her husband had given her in 1935. There were also1955 U.S. Tax Ct. LEXIS 216">*222 222 shares of outstanding preferred stock. Drybrough owned 187 shares and Simpson owned 35 shares.

United declared and paid cash dividends on its common stock during the 1930's, but no dividend on common stock was formally declared subsequent to 1938. United paid a small dividend on its preferred stock in 1941 and 1942 and paid a 6 per cent dividend on its preferred stock in 1944, 1945, and 1946.

During the taxable years involved Drybrough managed and conducted all of his wife's business affairs. He had in his possession blank, signed, stock transfer forms which gave him the power to sell her corporate stock. Her corporate stock was kept in a safety-deposit box which was in their joint names. Drybrough collected all income on his wife's business properties. He could draw checks on her business bank account. She took no active part in the management of United and expected her husband to act on her behalf in all matters concerning the corporation. The stock in United owned by Drybrough's wife was controlled by Drybrough.

When mail was received by United in the years involved it was placed in the mail basket of the receptionist. Included among the mail would be checks payable1955 U.S. Tax Ct. LEXIS 216">*223 on claims which the corporation had purchased and checks for fees on collections for others. In each of the taxable years Drybrough and Simpson from time to time removed checks from the mail basket, endorsed them or had them endorsed, and cashed the checks at the bank. Checks in excess of $ 500, which by custom were placed upon the desk of Simpson by the receptionist, were similarly endorsed and cashed. Checks taken by these officers for cashing in the manner stated above were not reflected in any manner upon the accounting records of United nor were they at any 23 T.C. 1105">*1109 time on deposit in the bank to the credit of United. Generally the checks taken represented final collections on purchased assets. The proceeds of the cashed checks were divided in the ratio of 75 per cent to Drybrough and 25 per cent to Simpson.

The aggregate amounts ¹ in checks taken by Drybrough and Simpson, representing collections, fees, and miscellaneous items, were as follows:

1955 U.S. Tax Ct. LEXIS 216">*224 Only Drybrough and Simpson knew of their practice of taking checks from the incoming mail basket and cashing them for their own use. The practice was discovered by an internal revenue agent in 1946. Drybrough's wife learned of what her husband and Simpson had done in the summer of 1947.

The proceeds of the checks were divided between Drybrough and Simpson on the basis of stock ownership. Drybrough received 20 per cent of the diverted funds on behalf of his wife and in respect to her stock. Although she did not know of the distributions, this was not unusual as she had little knowledge of the income she was receiving on her business properties. And the failure to consult her before making the distributions was not abnormal as she had not taken an active part or interest in the affairs of the business for many years and her positions as an officer and director were strictly nominal. Drybrough and Simpson did not intend to embezzle from United.

The accumulated earnings and profits of United at the end of each of the taxable years involved were as follows:

1955 U.S. Tax Ct. LEXIS 216">*225 United, Drybrough, and Simpson were indicted in the United States District Court for the Western District of Kentucky on March 13, 23 T.C. 1105">*1110 1950, and were jointly charged with knowingly and willfully attempting to defeat and evade income, declared value excess-profits, and excess profits taxes due and owing by the corporation to the United States for each of the years 1943 to 1946, inclusive, in violation of section 145 (b) of the Internal Revenue Code of 1939. No indictments were sought against Drybrough and Simpson for evasion of their individual income tax obligations. Each of the defendants entered a plea of nolo contendere and each received a fine. Drybrough and Simpson were each also sentenced to a prison term of 1 year and a day, and were released on parole in November 1950.

In February 1951 Drybrough and Simpson returned to the corporation the full amount taken. At that time the internal revenue agent in charge was demanding from United taxes and addition to tax amounting in the aggregate to $ 342,614.32, exclusive of interest, and in respect to the years 1942 to 1946, inclusive. The taxes demanded in this connection were identical to those set forth in respondent's1955 U.S. Tax Ct. LEXIS 216">*226 90-day letter.

In February 1951, Simpson severed his connection with United and received for his stock in United shares in other corporations having a book value of $ 33,857.14.

The individual petitioners knew that if the diverted funds were included in the gross income of the corporation, the corporation would be liable for a tax of 95 per cent on those funds. They took the funds in order to evade the payment of this corporate tax. They also knew that to the extent of at least 5 per cent of the diverted funds they were taking money which would have been available for the payment of dividends. Each knew that at least part of the diverted funds received was taxable to him as income. In each of the taxable years involved at least part of the deficiency resulting from the failure to include the diverted funds on the respective tax returns of each of the petitioners was due to fraud with intent to evade tax.

In 1939 in order to supplement its income United began to purchase notes, claims, judgments, accounts, mortgages, and other indebtedness from the liquidators of insolvent commercial banks. Through its organization, which had been built up in its business as a collection agency, 1955 U.S. Tax Ct. LEXIS 216">*227 United was able to realize substantial amounts on the purchased claims. A number of years work was necessary, however, in order to collect to the extent possible. At the time the claims were purchased the extent of recovery was not known.

All of the sales were made under the supervision of the State court having charge of receivership proceedings where the assets of the bank were sold in bulk to the highest bidder. While the assets were sometimes offered individually or in small groups, United never purchased except in bulk. The assets or claims purchased in each 23 T.C. 1105">*1111 instance consisted of hundreds or thousands of items. They were purchased at an aggregate or single price from the bank liquidator without any allocation of such price between the various items purchased or even between classes of items. Before making a purchase United would check to see whether the various debtors were listed in the telephone book, would go over a list of the items to be sold with the bank liquidator, and would have the benefit of competitive bids by others for individual items or groups of items. These and other considerations went into arriving at the top bid price which United was willing1955 U.S. Tax Ct. LEXIS 216">*228 to offer.

In 1943 and subsequent years United purchased in bulk assets from the liquidators of the Irish-American Savings and Loan Association, Mechanics Savings and Loan Association, Commercial Trust Company of New Jersey, and East Rutherford Savings, Loan and Building Association. In 1943, 1944, and 1945 all recoveries on assets purchased from the liquidators of the aforementioned banks over and above expenses were applied first to the costs of the assets. Only after the cost of all assets or claims purchased from a particular liquidator had been recovered would United return any of the recoveries on those assets as profits. Respondent determined that all recoveries should be treated as partly a return of cost and partly profit. Accordingly, he determined that the profits on recoveries from the assets purchased from the liquidators of the aforementioned banks should be increased in the amounts of $ 1,000, $ 10,000, and $ 26,000 in 1943, 1944, and 1945, respectively.

United did not attempt to allocate its cost among the various items purchased from a particular liquidator. There was no proper, rational, or reasonably accurate basis for allocating the cost among the individual1955 U.S. Tax Ct. LEXIS 216">*229 items purchased.

United received certain real estate in Illinois as one of the assets purchased from the liquidator of the Kimball Trust and Savings Bank. The property was subject to back taxes and United employed a real estate tax specialist, Simeon K. Markham, to clear its title to the land. At Markham's request United obtained from the National Bank of Louisville, Kentucky, cashier's checks in the amounts of $ 2,000, $ 2,175, and $ 375 for the purpose of paying the accrued taxes on the above described land. The checks were mailed to Markham by an official of United in December 1945. Delays were encountered by Markham in clearing the title and additional taxes accrued. In 1947 new checks were sent to Markham in the correct amounts and the original cashier's checks were returned to United. United surrendered the original cashier's checks and its account was credited in the amount of $ 4,550. United deducted the $ 4,550 as taxes paid on its 1945 return. Respondent disallowed the deduction.

23 T.C. 1105">*1112 Each of the petitioners filed the required tax returns for each of the taxable years involved within the time prescribed by law, and notice of deficiency was mailed to each of1955 U.S. Tax Ct. LEXIS 216">*230 the petitioners on January 15, 1952. Drybrough signed waivers of the statute of limitations for the years 1943 to 1946, inclusive, and Simpson signed waivers of the statute of limitations for the years 1944 to 1946, inclusive, which were in effect on January 15, 1952. No waiver of the statute of limitations was signed by United.

OPINION.

The two individual petitioners, Drybrough and Simpson, owned or controlled all of the outstanding stock of United, the corporate petitioner. During the taxable years involved the individual petitioners took more than $ 200,000 in checks from the corporation's incoming-mail basket. They cashed the checks and divided the proceeds in ratio to the amount of common stock owned or controlled by each. They thus caused the corporate income to be understated by the amount of the withdrawals, and no part of the amounts so received was reported on their individual income tax returns.

We have held time and again under circumstances similar to those here present that the diverted funds are taxable as income to the corporation and are taxable as dividends to the extent of earnings and profits to the officer-stockholders receiving them. Eugene Vassallo, 23 T.C. 656;1955 U.S. Tax Ct. LEXIS 216">*231 Michael Potson, 22 T.C. 912; Bennett E. Meyers, 21 T.C. 331; Auerbach Shoe Co., 21 T.C. 191, affd. (C. A. 1) 216 F.2d 693; Jack M. Chesbro, 21 T.C. 129 (on appeal C. A. 2). See also Currier v. United States, (C. A. 1) 166 F.2d 346. Petitioners argue that the above line of cases is distinguishable because there all of the stockholders participated in the withdrawal of funds from the corporation while here Drybrough's wife, who owned 20 per cent of the outstanding stock, was not even aware of the withdrawals until after the close of the taxable years involved. They argue that this converts the diversion of funds into a wrongful taking amounting to an embezzlement. United contends that, as the checks were taken by Drybrough and Simpson acting as embezzlers rather than as agents of the corporation, the checks were not "received" by the corporation and, therefore, as a cash basis taxpayer, it did not realize any taxable income. In the alternative United contends that, if the checks were "received," 1955 U.S. Tax Ct. LEXIS 216">*232 it sustained an offsetting "embezzlement" loss deductible under section 23 (f) of the 1939 Code, ² citing 23 T.C. 1105">*1113 Summerill Tubing Co., 36 B. T. A. 347. The individual petitioners contend that they are not taxable on "embezzled" funds, citing Commissioner v. Wilcox, 327 U.S. 404">327 U.S. 404.

Petitioners' contentions are without merit. Under the circumstances present in the instant case, the ownership of stock by Drybrough's wife did not convert what would normally be considered a corporate distribution into an embezzlement of funds for tax purposes. The evidence establishes that Drybrough handled all of his wife's business affairs, including the collection of income on her business properties. 1955 U.S. Tax Ct. LEXIS 216">*233 He had in his possession blank, signed, stock transfer forms which gave him the power to sell her corporate stock. He could draw checks on her business bank account. Drybrough's wife took no active interest in the affairs of United and her positions as director and secretary of the corporation were strictly nominal. We are convinced that the individual petitioners were not in the habit of consulting Drybrough's wife concerning corporate affairs and that each was of the opinion that Drybrough had full power to act and receive income on his wife's behalf. It is also evident that a part of the distribution of diverted funds to Drybrough was made on his wife's stock and that neither of the individual petitioners thought that they were infringing upon her rights as a stockholder by making a distribution without her consent or knowledge. Practically speaking the transactions represented the receipt of checks by the corporation (cf. Auerbach Shoe Co., supra), the endorsement and cashing of the checks by the corporation's principal officers, and the distribution of the money to the stockholders in proportion to their stock holdings (cf. Jack M. Chesbro, supra).1955 U.S. Tax Ct. LEXIS 216">*234

Summerill Tubing Co., supra, is clearly distinguishable. There corporate funds were taken by the corporation's president to the exclusion of minority and preferred stockholders. Here United did not sustain a realized loss by the surreptitious, but pro rata, distribution of its corporate funds. Furthermore the individual petitioners certainly had sufficient "claim of right" to their pro rata share of the diverted funds to be taxable thereon. W. L. Kann, 18 T.C. 1032, affd. (C. A. 3) 210 F.2d 247, certiorari denied 347 U.S. 967">347 U.S. 967. Cf. Healy v. Commissioner, 345 U.S. 278">345 U.S. 278; Currier v. United States, supra.

Bearing in mind the principles of corporate entity, the actions of the individual petitioners may possibly, under Kentucky statutes, have technically amounted to embezzlement. So also would the actions of a sole stockholder who pocketed corporate money without the formality of declaring dividends. To allow the corporation and its stockholders to escape taxation under such circumstances because the1955 U.S. Tax Ct. LEXIS 216">*235 distributions are technically illegal would make a mockery of the internal revenue laws. Cf. George M. Still, Inc., 19 T.C. 1072, affd. 23 T.C. 1105">*1114 (C. A. 2) 218 F.2d 639. Under petitioners' theory the stockholders could escape both corporate and individual taxes by the surreptitious diversion of corporate funds to their own use, and then, if discovered, by claiming embezzlement satisfy all civil liability for taxes by returning the funds to the corporation and including them in the income of the corporation in the year of discovery. To borrow the language of the Court of Appeals in W. L. Kann v. Commissioner, (C. A. 3) 210 F.2d 247, at p. 251: "Such local law concept of embezzlement, while it may be useful to deter those in control of a corporation from defrauding creditors and minority stockholders, should not, in our opinion, be used as a vehicle for tax avoidance, absent a clear mandate to the contrary."

The individual petitioners contend that in any event, if we sustain the tax liabilities of United as determined by respondent, the distributions of the diverted funds were not dividends1955 U.S. Tax Ct. LEXIS 216">*236 within the purview of section 115 (a) of the 1939 Code. ³ These tax liabilities, they argue, wipe out all accumulated and current earnings and profits in each of the taxable years involved. Relying on such cases as Wm. J. Lemp Brewing Co., 18 T.C. 586, holding that a cash basis personal holding company may deduct accrued taxes under section 505 (a) (1) of the 1939 Code in computing its "Subchapter A Net Income," and J. Warren Leach, 21 T.C. 70, holding that liability for taxes must be considered in determining insolvency in transferee cases, they assert that accrued but unpaid taxes should be deducted in determining the earnings and profits of a cash basis corporation.

1955 U.S. Tax Ct. LEXIS 216">*237 A similar argument was rejected by this Court in Paulina Dupont Dean, 9 T.C. 256 (appeal dismissed (C. A. 3)). Following Helvering v. Alworth Trust, 136 F.2d 812, certiorari denied 320 U.S. 784">320 U.S. 784, reversing 46 B. T. A. 1045, we held that accrued but unpaid Federal taxes for the current and past years should not be considered in the case of a cash basis corporation in determining the amount of earnings and profits available for the payment of dividends. We distinguished the personal holding company cases which are based upon the premise that section 505 (a) (1) specifically allows the deduction of accrued taxes even by a cash basis taxpayer. Section 102 cases (cf. Harry M. Stevens, Inc. v. Johnson, 115 F. Supp. 310">115 F. Supp. 310) are distinguishable for the same reason. Similarly, the fact that unpaid and even previously unknown tax liabilities are to be considered in determining insolvency 23 T.C. 1105">*1115 in transferee cases, is no authority for considering such liabilities in determining the amount of earnings and profits available for the payment1955 U.S. Tax Ct. LEXIS 216">*238 of dividends. Therefore, as unpaid taxes should be disregarded, both the accumulated and current earnings and profits of United exceeded the amount of the distributions in each of the taxable years involved. Hence, the full amounts of the distributions are taxable as dividends.

Drybrough and Simpson received 75 and 25 per cent of the diverted funds, respectively. Respondent determined that the full amount received by Drybrough was taxable as his dividend income. Drybrough contends that in no event should he be taxable on more than 55 per cent of diverted funds as that was the extent of his stock ownership. With the latter contention we agree. Normally a stockholder is taxable on the amount received regardless of whether the distribution is proportionate to his stock holding. Ben R. Meyer, 45 B. T. A. 228. But in the instant case Drybrough received 20 per cent of the diverted funds on behalf of his wife, and to that extent the amount he received was not his income. A. M. Johnson, 32 B. T. A. 156.

We have found that in each of the taxable years involved at least part of the deficiency of each of the petitioners was1955 U.S. Tax Ct. LEXIS 216">*239 due to fraud with intent to evade tax. We think our finding is supported by clear and convincing evidence.

United does not contest its liability for additions to tax because of fraud in the event we hold that the failure to include the diverted funds in its reported gross income resulted in deficiencies. The individual petitioners contend, however, that even if we hold that the distributions were taxable to them as "constructive dividends," they did not know they had received taxable income. They readily admit that they intended to evade corporate taxes and each entered a plea of nolo contendere when so charged in the prior criminal proceeding. It is their contention that they did not intend to evade their personal income taxes.

We need not decide whether a taxpayer is liable for additions to his individual tax where at least part of his personal deficiency is a result of his fraudulent scheme to evade corporate tax. Nor do we need to determine whether the individual petitioners were aware that the full amount of the distributions in question were taxable as dividends; although Simpson's testimony, that he did not report his share of the diverted funds because he did not 1955 U.S. Tax Ct. LEXIS 216">*240 wish to reveal the wrongful evasion of corporate tax, indicates that he, at least, knew that these funds were taxable to him.

Both of the individual petitioners testified that they did not think the diverted funds were taxable as dividends. The primary reason given was that, if the diverted funds had been included in the corporate income, the corporation would have paid 95 per cent of the 23 T.C. 1105">*1116 funds to the Government in taxes, which would have prevented it from paying a dividend in the amount received. However, it is evident from the petitioners' testimony that, to the extent of at least 5 per cent of the diverted funds, they knew they were taking money which would have been available for the payment of dividends.

Petitioners argue that we cannot attribute to them knowledge of having received a dividend where no dividends were formally declared and when the declaration of a dividend would have endangered the necessary borrowing capacity of the corporation. We do not believe the individual petitioners were so naive as to think that taxability depends upon the wisdom of making the distribution or that stockholders can escape taxation on a corporate distribution by the simple1955 U.S. Tax Ct. LEXIS 216">*241 expedient of failing to formally declare a dividend. Both were successful business men with many years experience. Despite their self-serving denials, we are convinced each knew that at least part of the distributions was taxable as income to him. In order to sustain the additions to tax only part of the deficiency must be due to fraud with intent to evade tax. Bennett E. Meyers, supra.Accordingly, the statute of limitations has not run as to any of the petitioners on any of the years involved, and respondent properly determined that each petitioner was liable for 50 per cent additions to tax under section 293 (b)⁴ of the 1939 Code.

1955 U.S. Tax Ct. LEXIS 216">*242 Petitioners have advanced a number of variations to the arguments set forth herein, with respect to their liability for tax on the diverted funds. In order not to unduly burden this opinion we think it is sufficient to say that these arguments have been carefully considered and in our opinion are without merit.

The next issue for decision is whether United properly reported the proceeds from collections on assets purchased from the liquidators of insolvent commercial banks. The assets in question were acquired in lump-sum purchases from the liquidators of four insolvent banks, and in each instance consisted of hundreds of items of various kinds such as notes, judgments, accounts, mortgages, and other evidences of debt. United did not attempt to allocate its cost among the various items. In each case receipts in excess of expenses were treated as a return of capital until the cost of all of the items purchased from a particular liquidator was recovered. Thereafter, receipts in excess of expenses were treated as profits. Respondent determined that all receipts should be treated as partly a return of cost and partly profit.

In William T. Piper, 5 T.C. 1104, 1109,1955 U.S. Tax Ct. LEXIS 216">*243 we stated the established rule for determining profits in this type of situation. We there said:

23 T.C. 1105">*1117 "where a mixed aggregate of assets is acquired in one transaction, the total purchase price shall be fairly apportioned between each class so as to determine profit or loss on subsequent sale of specific assets in the group. If such apportionment be impractical, no profit shall be realized until the cost shall have been recovered out of the proceeds of sales." Cf. Inaja Land Co., Ltd., 9 T.C. 727; Nathan Blum, 5 T.C. 702; Warren v. Commissioner, (C. A. 1) 193 F.2d 996, reversing on other grounds 16 T.C. 563.

In the instant case apportionment would be wholly impracticable. In each purchase United acquired hundreds of differing items, each having a highly speculative value if any value at all. Only years of attempting to collect on the various items would disclose which were worthless, the amount collectible on others, and whether the over-all purchase would result in a gain or loss.

Respondent argues that as United's bid was influenced by whether1955 U.S. Tax Ct. LEXIS 216">*244 the individual debtors were listed in the telephone book, by competitive bids which were made either on individual items or groups of individual items, and by information furnished by the liquidator concerning various items, there was a practical basis for allocation. We disagree. While this information was useful in determining an aggregate bid price, where the number of items involved would tend to balance out errors in estimates, it would not constitute a proper, rational, or reasonably accurate basis for allocating to each individual item a part of the cost. Under the circumstances, we think United properly recovered its cost before reporting a profit. Webster Atwell, 17 T.C. 1374 (appeal dismissed (C. A. 5)); Inaja Land Co., Ltd., supra;William T. Piper, supra;John D. Fackler, 39 B. T. A. 395.

The final issue is whether United was entitled to a $ 4,550 deduction in 1945 for taxes paid. In December of that year United sent three cashier's checks totaling $ 4,550 to a real estate tax specialist, Markham, whom United had employed to clear its title to certain1955 U.S. Tax Ct. LEXIS 216">*245 land in Illinois. The taxes were paid with other checks in 1947. The original cashier's checks were returned to United by Markham. They were surrendered at the bank on July 23, 1947, and United's account was credited in the amount of $ 4,550.

United as a cash basis taxpayer is entitled to deduct only taxes actually paid. Arthur T. Galt, 31 B. T. A. 930. Obtaining the cashier's checks did not constitute payment. Nor did United make payment by sending the checks to Markham, its agent. Arthur T. Galt, supra.Therefore, as Markham did not turn the checks over to the local tax officials (cf. Lillian Bacon Glassell, 12 T.C. 232), United is not entitled to the claimed deduction.

Decisions will be entered under Rule 50.