T, as a stockholder and guarantor of certain corporate notes of X Corp., made partial payments in discharge of his obligation as guarantor. At the time of his payments X Corp., which was insolvent, had been dissolved.
52 T.C. 140">*140 OPINION
The Commissioner determined a deficiency in petitioners' 1964 income tax of $ 6,793.66. We must decide whether a $ 425,000 loss claimed by petitioner Bert W. Martin in 1964 is deductible under
The 1969 U.S. Tax Ct. LEXIS 144">*145 facts have been fully stipulated and are so found. The stipulation and the exhibits attached thereto are incorporated herein by this reference.
Bert W. Martin (hereinafter referred to as Martin) and Ada L. Martin, husband and wife, resided at San Marino, Calif., at the time 52 T.C. 140">*141 they filed their petition herein. Their 1964 joint income tax return was filed with the district director of internal revenue, Los Angeles, Calif.
On June 1, 1958, Douglas S. Baird (hereinafter referred to as Baird) entered into a lease covering extensive lands near Lampoc, Calif. As lessee, Baird was granted the right to extract and process all kinds of stone, rock, sand, and gravel except diatomaceous earth and petroleum substances, from these lands. Baird and Martin became interested in a joint undertaking to exploit commercially the mineral deposits subject to Baird's lease. They believed at this time that there were large deposits of limestone which could be extracted, processed, and sold profitably for use as concrete aggregate. Other anticipated commercial uses for the product included use as riprap, building stone, and road-base material.
On June 2, 1958, Missile City Rock Corp. (hereinafter referred 1969 U.S. Tax Ct. LEXIS 144">*146 to as Missile City) was incorporated by Baird and others for the principal purpose of extracting, crushing, and screening rock and selling such gravel and other rock products for construction purposes.
Missile City's authorized capital at all times has consisted of 20,000 shares of $ 10 par value common stock. On December 2, 1958, Missile City issued 1,275 of its shares of common stock to Martin for cash at par. Baird was issued 1,225 shares. At all times thereafter, Missile City's outstanding stock has consisted of 2,500 shares of which Martin has owned 1,275, or 51 percent. On December 2, 1958, Martin was elected as a director and president of Missile City. He continued to occupy these positions at all material times.
On December 2, 1958, Baird sold his entire interest in the mineral lease to Missile City for $ 12,250. In early 1959, Missile City commenced to develop a quarry on the leased lands. A crushing plant and related facilities were installed. Starting-up costs by the close of March 1959, exceeded $ 213,000. These costs far exceeded the original estimates. The capital expenditures budget for the fiscal year ending May 31, 1959, exceeded $ 384,000. The cost of fixed 1969 U.S. Tax Ct. LEXIS 144">*147 assets plus the leasehold and development costs exceeded $ 600,000 by July 31, 1959. The plant did not become operative until September 1959. When quarrying operations commenced, it was discovered that the limestone deposits occurred in layered and lenslike deposits interspersed with other material rather than in solid formation. Extraction and processing costs exceeded the selling price of the products.
Prior to the development of quarrying and processing facilities Martin, as president of Missile City, was authorized to borrow up 52 T.C. 140">*142 to $ 400,000 on its behalf. Missile City's borrowing exceeded the original authorized amount:
Missile City's taxable year or period | Amount borrowed |
6/2/58 to 5/31/59 | $ 350,000 |
FYE 5/31/60 | 750,000 |
FYE 5/31/61 | 500,000 |
FYE 5/31/62 | 1,300,000 |
FYE 5/31/63 | 250,000 |
FYE 6/1/63 to 5/19/64 | 0 |
Total | 3,150,000 |
The foregoing loans, from Northern Trust Co. of Chicago, Ill., were guaranteed by Martin. Martin's guaranty was secured by his pledge of sufficient readily marketable securities. All the loans were made with the knowledge and approval of the corporation.
By August 1963, Missile City has sustained large operating losses and had exhausted any hope of finding deposits which would 1969 U.S. Tax Ct. LEXIS 144">*148 support a profitable operation. Its assets were turned over to a receiver for the benefit of creditors who thereafter liquidated the assets and applied the entire net proceeds in partial satisfaction of creditors' claims, the final distribution to creditors being made in April 1964. None of these proceeds were paid to the Northern Trust Co. which had, with Martin's consent, subordinated its claim to the claims of other creditors. Missile City was dissolved in May of 1964. Thereafter, Martin paid $ 425,000 to the Northern Trust Co. in partial payment of his obligation as guarantor.
Martin guaranteed the bank loans to Missile City with the reasonable expectation that he would profit thereby through his 51 percent shareholder's interest in Missile City.
On his 1964 income tax return, Martin claimed a $ 425,000 deduction under
There is no claim that Martin's payment gives rise to a deduction either as a trade or business loss under
The Commissioner 1969 U.S. Tax Ct. LEXIS 144">*149 concedes that Martin is entitled to a short-term capital loss deduction. Consequently, the only question we must decide is whether Martin is entitled to a greater deduction under
In the instant case, Martin made only partial payments as a guarantor of the original debt. Accordingly, if we correctly understand the applicable State law, the Northern Trust Co. retained its rights in the original debt; Martin did not succeed to those rights by subrogation. However, Martin's payments gave rise to a new debt in the form of an unconditional obligation on the part of Missile City to indemnify him in the amount of his payments. At the time the contract of guaranty was entered into, the law implied a promise on the part of Missile City to make Martin whole from any loss suffered on the guaranty. While this implied contract of indemnity created only a conditional obligation, Martin's subsequent payment made that obligation an unconditional one to reimburse him for a fixed sum of money. This was so independently of whether he might later have to pay more; it was money paid to Missile City's use for which it became liable at once. This was decided as early as
The dissolution of Missile City prior to Martin's payments is without consequence with respect to our determination that a debt was created upon such payments. Before its dissolution, Missile City had undertaken, as a conditional obligation to Martin, to repay him any sums he might have to pay under his contract of guaranty on its behalf. It required no further consent on behalf of Missile City when the condition occurred and Missile City became bound unconditionally to pay Martin fixed sums of money. Too, dissolution did not terminate Missile City's existence for all purposes; at the time Martin made his payments, Missile City still existed for the purpose of being sued upon and discharging its obligations.
Having determined that Martin's loss was "attributable to the worthlessness of a debt," we hold it cannot be deducted under
The worthlessness of this debt at its inception is without consequence with regard to our holding that Martin's loss is not deductible under
In holding Martin is entitled to a short-term capital loss only we do not rely solely upon our finding that Martin's loss was "attributable to the worthlessness of a debt." 1969 U.S. Tax Ct. LEXIS 144">*154 We think
We refer to the following as further evidence that
The objectives sought to be achieved by the Congress in providing short-term capital loss treatment for nonbusiness bad debts are also persuasive that § 23(k)(4) applies to a guarantor's nonbusiness debt losses. The section was part of the comprehensive tax program enacted by the Revenue Act of 1942 to increase the national revenue to further the prosecution of the great war in which we were then engaged. n16 It was also a means for minimizing the revenue losses attributable to the fraudulent practices of taxpayers who made to relatives and friends gifts disguised as loans. n17 Equally, however, the plan was suited to put nonbusiness investments in the form of loans on a footing with other nonbusiness investments. The proposal originated with the Treasury Department, whose spokesman championed it as a means "to insure a 1969 U.S. Tax Ct. LEXIS 144">*156 fairer reflection of taxable income," n18 and the House Ways and Means Committee Report stated that the objective was "to remove existing inequities and to improve the procedure through which bad-debt deductions are taken." n19 We may consider Putnam's case in the light of these revealed purposes. His venture into the publishing field was an investment apart from his law practice. The loss he sustained when his stock became worthless, as well as the losses from the worthlessness of the loans he made directly to the corporation, would receive capital loss treatment; the 1939 Code so provides as to nonbusiness losses both from worthless stock investments and from loans to a corporation, whether or not the loans are evidenced by a security. n20 It is clearly a "fairer reflection" of Putnam's 1948 taxable income to treat the instant loss similarly. There is no real or economic difference between the loss of an investment made in the form of a direct loan to a corporation and one made indirectly in the form of a guaranteed bank loan. The tax consequences should in all reason be the same, and are accomplished by § 23(k)(4). n21 [Footnotes omitted.]
These considerations apply with equal 1969 U.S. Tax Ct. LEXIS 144">*157 force to the case we have before us.
52 T.C. 140">*146 We hold Martin's loss is deductible as a short-term capital loss. To distinguish this case from
In deciding that Martin is entitled to a short-term capital loss only, we reaffirm this Court's holding in
In passing it might be helpful to comment on some cases which seemingly support petitioner's argument that the amounts which he paid are deductible as losses incurred in a transaction entered into for profit.
See
In the instant case * * * the petitioner, at the time he made the payments * * * and was released from his liability on his guaranty, had neither paid nor been called upon to pay any amount under his guaranty, * * *. The petitioner therefore under his guaranty had made no payment of any indebtedness * * * which could give rise to any bad debt owing to him * * *
And see
And in
The case that gives us more trouble is
In line with
Featherston,
Section 166(a) allows a deduction for "any debt which becomes worthless within the taxable year." If there is no "debt," the section, by its terms, does not apply. In
1. All statutory references are to the Internal Revenue Code of 1954 unless otherwise specified.↩