Miller v. Commissioner

*293 The Commissioner determined a deficiency of $6,280.44 in petitioner's income tax for the year 1937. The deficiency is due to the following adjustments to petitioner's net income as shown by his income tax return for the year 1937:

The petitioner does not contest the correctness of adjustment (a).

By an appropriate assignment of error petitioner contests adjustment (b) and contends that he is entitled to the $20,000 loss which he claimed on his income tax return, that amount being the cost of 200 shares of stock which he surrendered to the Grossman Shoe Co. in the taxable year.

The respondent gave his reasons for disallowing this $20,000 loss in his deficiency notice as follows:

(b) You claimed a deduction of $20,000.00 for a loss on 200 shares of capital stock of Grossman Shoe Company donated by you to the corporation. This deduction is denied for the reason that said transaction is considered to be a contribution to capital, the basis of which is to be added to the*1142 cost of shares retained by you.

FINDINGS OF FACT.

The petitioner is an individual whose residence is Owensboro, Kentucky. He filed his income tax return for the calendar year 1937 with the collector of internal revenue for the district of Kentucky.

The Grossman Shoe Co., hereinafter referred to as the shoe company, is a corporation organized and existing under the laws of the State of West Virginia, with its principal place of business at Parkersburg, West Virginia, and is engaged in the business of manufacturing and selling shoes.

The shoe company was incorporated on August 8, 1935, with an authorized capital stock of $100,000, divided into 1,000 shares of common stock having a par value of $100 each, and from time to time thereafter it increased its authorized capital stock until it amounted to 2,500 shares of common stock having a par value of $100 per share.

On April 30, 1937, the outstanding common stock of the shoe company was held as follows:

*1143 *294 All of this outstanding stock was paid for by the holders thereof in cash, at par, excepting 50 shares belonging to Gilbert W. Gambill that were issued to him in return for legal services at the rate of $100 per share.

The 50 shares of stock in the name of A. G. Baker were owned or controlled by Albert A. Ahner.

The shoe company started operations in the late fall of 1935, and up to the month of December 1936 it had suffered an operating loss of approximately $50,000 and was indebted to the petitioner in the sum of $40,000 for money loaned, $15,000 of which was guaranteed by Ahner.

Up to the first day of January 1937 the shoe company had been financed by loans from petitioner and the bank. At that time the bank and the creditors of the shoe company were pressing for payment, and the shoe company was having difficulty in obtaining material for further operations.

In December 1936 petitioner and Ahner discussed the liquidation of the business, and each agreed to advance an additional $25,000 to the shoe company so that the business could be carried on and liquidated in a more orderly manner. In January 1937 petitioner did advance the additional $25,000, but*1144 when Ahner was called upon to make the loan of $25,000 which he had agreed to make he was unable and unwilling to do so, and in order to keep the shoe company going petitioner, in the last of January or first of February 1937, loaned the company an additional sum of $10,000. Ahner insisted at that time that the company be liquidated.

The loans made by petitioner to the corporation were evidenced by the promissory notes of the shoe company. Thereafter, petitioner and Ahner held various conferences with reference to the conduct of the shoe company, and agreed that it should be liquidated.

At that time Harry J. Grossman, the then president of the shoe company, was opposed to liquidation and proposed to petitioner and Ahner that, if they would agree to procure an assignment to him or his nominee, without consideration, of all of the stock of the shoe company, he would attempt to refinance the company and pay or satisfy the indebtedness due from the company to petitioner. Petitioner and Ahner accepted this proposition, but Grossman was not able to carry it out.

The business of a shoe manufacturing company is divided into two seasons, one from November 1 to May 1 of the succeeding*1145 year, devoted to the manufacture of spring and summer shoes, and the other from May 1 to November 1, devoted to the manufacture of fall and winter *295 shoes, and in the orderly conduct of the business the shoes manufactured during each season should be largely sold and distributed during the current season.

At the end of the spring season on May 1, 1937, the operating deficit of the shoe company had increased to $60,118.37, and the accounts payable and other current liabilities had increased to $81,031.76. At the same time the inventory of finished goods and goods in process was $58,000.

After various negotiations between petitioner and Ahner, they agreed that Ahner should surrender the 450 shares of stock owned or controlled by him to the shoe company in consideration for the payment of $1,000, and that petitioner should release Ahner from his guaranty of $15,000 of the indebtedness owed by the shoe company to petitioner. On June 3, 1937, the petitioner and Ahner entered into a written agreement carrying out such understanding.

The original understanding was that the stock should be delivered to the shoe company by Ahner, and the $1,000 paid to Ahner by the shoe*1146 company, but as the agreement was finally closed at St. Louis and no officer of the shoe company authorized to sign checks was present, the contract was made in the name of petitioner.

At that time the condition of the shoe company was such that it could not have continued without some financial adjustment of its affairs.

On June 9, 1937, at a meeting of the board of directors of the shoe company, the petitioner surrendered to the company the stock previously owned or controlled by Ahner, in consideration of the payment of $1,000, which had been advanced by petitioner to Ahner. At the same meeting the petitioner stated that on account of the losses theretofore sustained in the operation of the shoe company he would surrender $20,000 par value of the stock held by him, and he surrendered certificate No. 6 for 100 shares, dated December 9, 1935, and certificate No. 12, for 100 shares, dated July 24, 1936.

At the same meeting petitioner announced that he would subscribe for $75,000 par value of stock in the shoe company in consideration of the cancellation of the indebtedness due from the shoe company to petitioner, which subscription was accepted.

At the same meeting Harry*1147 J. Grossman stated that he would subscribe for 50 shares of the stock of the shoe company at par, which subscription was accepted.

At the time that the transactions in connection with the surrender of the stock by Ahner and petitioner to the shoe company took place, the books of the shoe company showed a book net worth value of $61,881.63.

*296 As of April 30, 1937, the condensed balance sheet of the shoe company was as follows:

*1148 As of April 30, 1937, adjusted to show capitalization changes as of June 9, 1937, the condensed balance sheet of the shoe company was as follows:

*297 The loss suffered by petitioner in the surrender of 200 shares of stock in the shoe company, which had a cost basis to him of $20,000, was $9,822 after due allowance is made for $10,178 increase in book value of his remaining 350 shares of stock in the shoe company by reason of such surrender and cancellation.

OPINION.

*1149 BLACK: In support of his contention that the Board should allow the full amount of his claimed loss of $20,000, the petitioner cites , and . We have examined these cases and we do not think they are in point.

In the City Builders Finance Co. case, the taxpayer was the owner of 32 1/2 shares of stock in another corporation and had a cost basis therefor which was not in dispute. The 32 1/2 shares which it owned was a one-eighth interest in the other corporation. In the taxable year a 100 percent stock dividend was declared and paid in order to give an interest to an outside party which was to render certain aid to the corporation. The taxpayer had to turn in its part of this stock dividend for issuance to this outside party. When all this was finished the taxpayer owned only a one-sixteenth interest in the corporation, whereas prior to the transaction in question the taxpayer owned a one-eighth interest in the corporation. Under these circumstances we allowed the taxpayer to deduct the full cost allocated to the shares which it turned in for issuance*1150 to the outside party. In that case none of the stock was turned in to the issuing corporation for cancellation and retirement by it, and the book value of the taxpayer's remaining stock in the corporation was not increased.

In the instant case, the 200 shares of stock in the shoe company were not reissued to some outside party, as was the case in , but were canceled by the shoe company. To the same effect as was our decision in , was the decision of the Court of Claims in

*298 In the Peabody Coal Co. case the taxpayer transferred a part of the stock which it owned in a subsidiary corporation to some investment bankers in consideration of their lending their services in financing the subsidiary. Under those circumstances the Court of Claims allowed the taxpayer as a loss in the taxable year the full amount of the cost of the stock which it transferred to the investment bankers. In its opinion the Court of Claims distinguished the facts in the Peabody Coal Co. case from those present in *1151 ; affd., . In discussing the Burdick case, the Court of Claims said:

The case of Burdick, Ex'x, v. Commissioner, supra, was appealed to the Circuit Court of Appeals for the Third Circuit and, by that court, affirmed. In that case the principle involved in the Wright Case, and here contended for by plaintiff, was applied but the loss allowed was measured by the total cost of the stock surrendered reduced by the definite and determined increase in value attaching to the remainder of the stock held by the stockholder through the surrender by him to the corporation for cancellation of a certain number of shares of outstanding preferred stock. With that result we entirely agree, but the same situation is not present here.

We think the facts of the instant case fall within the ambit of the Burdick case. A brief review of the facts of the instant case will show why we think the instant case should be decided in accordance with the principles of the Burdick case. The Grossman Shoe Co., in which petitioner owned a very substantial interest, had fallen into serious financial*1152 difficulties and it seemed doubtful that it could continue in business. Petitioner and Ahner were the principal stockholders, but Ahner refused to put up any more money for the corporation. He did agree that he would surrender all his 450 shares in the corporation for $1,000 and the release by petitioner of a guaranty which Ahner had given petitioner to stand good for one-half of $30,000 indebtedness which the corporation owed to petitioner. This Ahner transaction was cleared through petitioner, but it was for the benefit of the corporation and petitioner claims no gain or loss by reason therefor. Neither does the respondent. But at the same time as the Ahner transaction was made, petitioner turned in 200 shares of his own stock in the shoe company for cancellation by the corporation, for which he received no monetary consideration. He claims a loss of the full cost of this stock, $20,000.

Petitioner was the owner of 550 shares in the shoe company just prior to the time he surrendered these 200 shares for cancellation. Thereafter he remained the owner of 350 shares in the corporation and the book value of these 350 shares was very materially increased by the cancellation*1153 of the 200 shares in question, as was also the book value of stock owned by the other stockholders. This increase in *299 the book value of petitioner's remaining 350 shares must be deducted from the total cost of the 200 shares surrendered to arrive at the loss which petitioner is entitled to take under the rule of the Burdick case. We find that the book value of petitioner's remaining 350 shares was increased by $10,178 by reason of the cancellation of the 200 shares. By deducting this $10,178 from $20,000, the stipulated cost to petitioner of the 200 shares canceled, we arrive at a loss of $9,822 on the stock canceled. The latter amount should be allowed as a deduction to petitioner in a recomputation of the deficiency under Rule 50, instead of the $20,000 loss which he claimed on his income tax return.

Petitioner in his brief arrives at a figure of $11,288.50 for the claimed loss instead of the $9,822 which we have named above. The reason for this difference is that petitioner has excluded from his computation in arriving at the loss $8,933.92 deferred charges included as assets in petitioner's balance sheet on the basic date. We know of no warrant in law for*1154 excluding this $8,933.92 and there is nothing in the facts which justifies this exclusion in making the apportionment.

The $10,178 of the $20,000 loss which petitioner claims, which is disallowed for the reasons above stated, will of course be added to the cost basis of petitioner's remaining stock in the shoe company and will be recovered by petitioner when his remaining stock is sold or otherwise disposed of.

In support of his contention that when petitioner surrendered 200 shares of his stock to the shoe company it was a capital contribution to the corporation and petitioner is not entitled to take any loss by reason thereof, respondent cites , and . We think both of these cases are distinguishable on their facts. In the Charles M. Haft case all the stockholders surrendered and had canceled 50 percent of their stock. We held that in view of the fact that all stockholders had made a ratable contribution of their stock to the corporation their relative positions in the corporation remained the same, and therefore there was no deductible loss.

To the same effect was the*1155 Bed Rock Petroleum Co. case, supra.

We have no such situation here. After the Ahner stock was turned in and canceled for $1,000, petitioner was the only one of the remaining stockholders who turned in stock for cancellation. Under these circumstances we think that the rule of the Burdick case applies, instead of the rule followed by the Board in the Haft case and the Bed Rock Petroleum Co. case.

Decision will be entered under Rule 50.