Opinion
Docket No. 5625.
1945-07-20
EDGAR V. ANDERSON, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
James F. Collins, Esq., and Nelson Gammans, Esq., for the petitioner. Scott A. Dahlquist, Esq., for the respondent.
As a distributee of his father's estate the petitioner became entitled to receive two-thirds of the balance due the estate from a stock brokerage partnership of which his father was a member and which was dissolved by his death. Among the assets of the dissolved partnership was a debt owed to the partnership by one of the partners. This debt became worthless in 1941 and in his income tax return for that year the petitioner deducted what he claimed was his pro rata share of the worthless debt, which deduction was disallowed by the respondent in the determination of the deficiency. Held, that the amount is not a legal deduction from gross income. James F. Collins, Esq., and Nelson Gammans, Esq., for the petitioner. Scott A. Dahlquist, Esq., for the respondent.
This proceeding is for the redetermination of a deficiency in income tax for the calendar year 1941 in the amount of $8,627.58. The question in issue is whether the petitioner as legatee of his father is entitled to a deduction for a bad debt within the meaning of section 23(k), Internal Revenue Code, by reason of the fact that a debt due to the partnership of which his father was a member became worthless in the taxable year.
FINDINGS OF FACT.
The petitioner is a resident of Poughkeepsie, New York. He filed his income tax return for 1941 with the collector of internal revenue for the fourteenth district of New York.
The petitioner's father, C. Edgar Anderson, died testate on October 1, 1939, leaving his property, including his interest in a partnership previously existing, to his three children, share and share alike, and named his grandson and petitioner executors. The executors duly qualified and proceeded with the administration of the estate. One of the sons, H. W. Anderson, died testate March 30, 1940, leaving his property, including his interest in his father's estate, to the petitioner. The estate of the father was fully administered and its assets distributed during the month of January 1941. The brother's estate was also fully administered and its assets distributed during the month of April 1941.
C. Edgar Anderson at the time of his death and for a number of years prior thereto was a general partner in a stock brokerage partnership known as Chauncey & Co.
The articles of copartnership of Chauncey & Co. in effect in 1939 provided, among other things:
13. PAYMENT OF PARTNERSHIP INTEREST. Upon the retirement of any General Partner from the firm, or upon the death or insanity of a General Partner, the capital contribution of such deceased, insane or retiring General Partner and his share of the profits, if any, distributable in accordance with Paragraph ‘11‘ hereof, shall be paid over by the partnership or by the liquidating partners to such retiring General Partner, or to the legal representatives of such deceased or insane General Partner, not later than six (6) months after such retirement, or such death or insanity; except, however, that any sum which shall be credited pursuant to Paragraph ‘10‘ hereof as an addition to the capital contribution to the partnership of such retiring, deceased or insane General Partner need not be paid over by the partnership or by the liquidating partners to such retiring, deceased, or insane General Partner, or his legal representatives, until the expiration of one (1) year after such retirement, death or insanity.
Paragraph 10 of the articles of the partnership referred to, related to the membership of Edward G. King, and is not material in this proceeding.
Paragraph 11 of the articles of copartnership provided as follows:
11. DISTRIBUTION OF ASSETS. The capital and surplus, if any shall be applied as follows:
(a) To the payment of all debts and liabilities due or to become due, except those to the Limited Partner on account of capital contribution, and excepting liabilities to General Partners.
(b) To the payment to the Limited Partner, or his legal representative, of his compensation upon his capital contribution.
(c) To the payment to the Limited Partner, or his legal representative, of One Hundred and Twenty-Five Thousand Dollars ($125,000), the amount of his capital contribution.
(d) To the payment to the General Partners or their legal representatives, of any sums due, other than on account of capital and profits.
(e) To the payment to the General Partners, or their legal representatives, of their share of profits.
(f) To the payment to the General Partners, or their legal representatives, of their capital contributions, pro rata, according to the value of their capital contributions on the date of the dissolution, excluding memberships in the New York Stock Exchange, which memberships are not to be considered partnership assets except for the benefit of creditors, and for the re-payment to James F. Pierce of his One Hundred and Twenty-Five Thousand Dollars ($125,000) capital contribution.
(g) If the assets of the partnership in liquidation are insufficient to pay the claims of creditors, and to pay James F. Pierce his One Hundred and Twenty-Five Thousand Dollars ($125,000) capital contribution, and the amount of such deficit becomes a charge upon the memberships of William Raymond, Raymond Chauncey, Arthur D. Weekes and Edward G. King in the New York Stock Exchange, such deficit shall be borne by William Raymond, Raymond Chauncey and Arthur D. Weekes in the relative proportions in which they share profits.
Article 12 provided:
12. RETIREMENT, DEATH OR INSANITY. Any partner may retire from the firm by giving sixty (60) days' notice in writing of his intention to all the other partners, and the partnership shall be dissolved upon the death or insanity of one or more of the General Partners, or of the Limited Partner; PROVIDED, HOWEVER, that upon the retirement, death or insanity of a General Partner, the business may be continued by the remaining General Partners with the consent of all the members.
Article 9 provided:
9. TERMINATION. Upon the dissolution of the partnership, the books shall be balanced as of the date of dissolution, the liabilities shall be ascertained and satisfied, and the value of the interest of each partner shall be determined as follows:
(a) Listed securities held for the firm account shall be valued at the fair market value.
(b) Unlisted securities shall be valued at the fair market value.
(c) All other property shall be valued at the cost price on the partnership books, it being agreed that there is no good will in the business of Chauncey & Co., or in the firm name, and that no claim shall be made or allowed therefor. If any partner, or the legal representative of any deceased partner, shall object to the valuation of any securities or property of the partnership, other than good will, the value of such securities and property shall be appraised by an appraiser to be unanimously agreed upon, or if such appraiser cannot be unanimously agreed upon, by three appraisers, one selected by the dissenting partner or the legal representative of the deceased partner, and two selected by the other partners. All appraisers shall be members of the New York Stock Exchange.
(d) Upon the dissolution of the partnership any partner who is indebted to the firm will pay the amount of such indebtedness in full within thirty (30) days after such dissolution.
(e) If any partner who is a member of the New York Stock Exchange shall, in violation of this agreement, fail to pay the amount of his indebtedness to the firm in full within thirty (30) days after such dissolution, such indebted partner will immediately upon the expiration of such thirty (30) days offer his membership in the New York Stock Exchange for sale, and sell said membership at the best price then obtainable, and upon the sale of such membership the proceeds of such sale, or so much thereof as may be necessary, shall be applied to payment of the indebtedness of such member to the firm, and of his share of the partnership losses. The fact that any partner indebted to the partnership shall have furnished collateral security in respect of his indebtedness to the firm shall in no wise be deemed to limit the application of this paragraph, and the firm shall be under no obligation to look to such collateral security for reimbursement, or to take any action in respect thereto.
Article 6 provided:
6. DIVISION OF PROFITS AND LOSSES. The net profits of the partnership shall be divided in the following proportions:
+-----------------------------------------------+ ¦William Raymond ¦Twenty Per Cent. (20%). ¦ +-----------------+-----------------------------¦ ¦C. Edgar Anderson¦Twenty Per Cent. (20%). ¦ +-----------------+-----------------------------¦ ¦Raymond Chauncey ¦Twenty—Three Per Cent. (23%).¦ +-----------------+-----------------------------¦ ¦Arthur D. Weekes ¦Twenty Per Cent. (20%). ¦ +-----------------+-----------------------------¦ ¦Edward G. King ¦Seventeen Per Cent. (17%). ¦ +-----------------------------------------------+
The General Partners shall be liable for and shall share all losses sustained by the partnership in the same proportions as they share in the net profits as above stated. No loss shall be charged against the capital contribution, or the compensation due for such capital contribution, of the Limited Partner unless and until all the other assets of the partnership shall first have been used to pay such losses. In no event shall the loss to be borne by said Limited Partner exceed his contribution to capital and compensation owing to him thereupon.
The credit and debit positions of the five general partners at the time of C. Edgar Anderson's death were as follows:
+---------------------------------------------------+ ¦ ¦Credit ¦Debit ¦Net (debit) ¦ +--------------+------------+----------+------------¦ ¦ ¦ ¦ ¦or credit ¦ +--------------+------------+----------+------------¦ ¦C. E. Anderson¦$260,191.50 ¦ ¦$260,191.50 ¦ +--------------+------------+----------+------------¦ ¦W. Raymond ¦277,107.24 ¦$15,502.02¦261,605.22 ¦ +--------------+------------+----------+------------¦ ¦R. Chauncey ¦313,794.18 ¦657,443.30¦(343,649.12)¦ +--------------+------------+----------+------------¦ ¦A. D. Weekes ¦36,178.15 ¦90,911.69 ¦(54,733.54) ¦ +--------------+------------+----------+------------¦ ¦Edward G. King¦* 69,368.19¦141,072.44¦(71,704.25) ¦ +---------------------------------------------------+ FN* This represents the value of the King seat which might be applied as partial satisfaction of his debit balance.
The surviving partners elected under paragraph 12 of the articles of copartnership to continue the business of the old partnership under the name of Chauncey & Co. The new partnership took over the assets of the old. The debtor partners were not required by the surviving partners to pay the amount of their several indebtednesses within 30 days as provided in paragraph 9(e) of the partnership agreement, but these indebtedness were taken over by the new firm as a part of its assets. They appear on the balance sheets of the new firm as elements of the financial condition of that firm.
The value of decedent's interest in Chauncey & Co. at the date of his death, computed in accordance with the partnership agreement, was $249,811.57. In making such computation the debt owed to the partnership by Edward G. King, one of the general partners, was taken in at its face value.
Within the six months which paragraph 13 of the partnership agreement allowed for the payment of the amount due to the estate of the deceased partner approximately $200,000 was paid in cash and securities. The cash payment was made on March 13, 1940, and amounted to $189,400. Thereafter for about a year and nine months, or until December 31, 1941, the books of the new partnership showed a credit balance of $49,825.57 in favor of the estate of C. Edgar Anderson. Interest was paid upon this amount of indebtedness by the new partnership through 1941 at the rate of 4 percent per annum.
Some time in October 1940 one of the partners of the new firm learned that Edward G. King, one of the general partners of both the old and new firms, had been taking trades which had been made on behalf of Chauncey & Co. and diverting them into an account in which he had an interest with another Stock Exchange firm. This was contrary to the rules of the New York Stock Exchange. The matter was referred to a committee of the New York Stock Exchange for investigation, since the Stock Exchange alone had authority to inspect the books of other Stock Exchange houses. In order to avoid undesirable publicity, King's resignation from Chauncey & Co. was requested and accepted some time in October 1940. An investigation by the Stock Exchange committee resulted in the expulsion of King from the Stock Exchange in April 1941. Thereupon the account due from King became worthless and uncollectible in so far as it exceeded the value of the Stock Exchange seat which stood in his name.
When it became apparent to the new partnership that the amount owed by King could not be collected, the petitioner was informed and advised that his father's estate would have to bear its portion of the loss. The petitioner granted that contention and the amount by which the new partnership's liability to the estate and its beneficiaries should be reduced was determined to be $34,977.80 and that amount, on December 31, 1941, was charged to the account of the estate of C. Edgar Anderson standing on the books of the new partnership. The new partnership continued to pay interest upon the remaining balance due to the estate of C. Edgar Anderson until such debt was finally liquidated by the new partnership on January 10, 1945, by the payment of $7,500 cash.
In his income tax return for 1941 the petitioner claimed the deduction from the gross income of $23,318.53, representing two-thirds of the $34,977.80 referred to above, which deduction was disallowed by the respondent in the determination of the deficiency.
OPINION.
SMITH, Judge:
The question presented is whether under the facts stated in our findings the petitioner is entitled to deduct from gross income in his return for 1941 $23,318.53 of the debt of Edward G. King owed to the partnership of Chauncey & Co., dissolved by the death of petitioner's father, which debt became worthless in 1941. The deduction is claimed by the petitioner as a worthless debt.
In the deficiency notice the respondent disallowed the deduction of the $23,318.53 for the reason that it:
* * * represents a deduction made by you in connection with the liquidation of the interest of C. Edgar Anderson in the firm of Chauncey and Company. You have failed to show that there existed as at December 31, 1940 any value to the item claimed nor have you shown any acceptable identifiable event occurring in the year 1941 to sustain your claim to this deduction.
The respondent now admits that the debt of Edward G. King to Chauncey & Co. became worthless in 1941 as a result of his expulsion from the Stock Exchange without any assets except the seat on the Stock Exchange standing in the name of Edward G. King, the cost of which had been borne by the firm. He still insists, however, that the amount is not a legal deduction from petitioner's gross income.
His theory of the case is that the new partnership of Chauncey & Co. assumed the liability to pay to the estate of C. Edgar Anderson, $249,811.57; that a balance of $49,825.57 was owing to the estate as of December 31, 1941, before any charge-off; and that there is no evidence that the new partnership was insolvent or unable to pay such indebtedness. He further contends that the petitioner as a legatee of his father gratuitously relieved the new partnership from the payment of $34,977.80 on December 31, 1941, and that such forgiveness of the debt did not give rise to any deduction from gross income on the part of the petitioner.
The only articles of copartnership shown by the record are those which were executed by the partners on December 31, 1938. Those articles of copartnership were to be effective for only one year. The death of C. Edgar Anderson on October 1, 1939, dissolved the partnership. The surviving partners continued the business of Chauncey & Co. and the books of account of the new partnership show an indebtedness to the estate of C. Edgar Anderson equaling the amount receivable by such estate. That liability was not liquidated within the period of time required by the articles of copartnership in effect at the date of C. Edgar Anderson's death. Approximately $200,000 of the amount was paid within six months of the date of death. The petitioner, speaking for himself and his sister, who are the legatees of his father, whose estate has been distributed, testified that ‘realizing that a brokerage firm could not liquidate in a very short time, we accepted $200,000 on account with future payments to come after liquidation would take place.‘ What the articles of copartnership of the new firm provided with respect to its liability to the estate of C. Edgar Anderson if a new partnership agreement should be entered into is not disclosed by the record.
When the new firm was unable to collect from Edward G. King the amount of his indebtedness, the petitioner was advised that this was an account due the old firm and that the estate of C. Edgar Anderson would have to bear its portion of the loss, which was determined to be $34,977.80. The petitioner granted this contention and the indebtedness of the new firm to the estate was reduced by a like amount on December 31, 1941.
It is the petitioner's contention that, since he was a distributee of his father's estate and was entitled to receive two-thirds of the balance owed to his father's estate by the new firm, he is entitled to consider Edward G. King his debtor and entitled to the deduction of $23,318.53 claimed in his return for 1941.
We think that it is apparent that the credit balance due from Edward G. King was an asset of Chauncey & Co. In Guggenheim v. Helvering (C.C.A., 2d Cir.), 117 Fed.(2d) 469; certiorari denied, 314 U.S. 621, it was held that under the New York Partnership Law a deceased partner's executors had no interest in the firm's assets, but only the right to an accounting. We therefore think that in the instant proceeding the petitioner was not in 1941 a creditor of Edward G. King and that he is not entitled to the deduction of any part of King's indebtedness to Chauncey & Co., which became worthless in 1941. A taxpayer is not entitled to deduct from gross income any part of a worthless debt owed to some one other than the taxpayer.
In Lillie V. Kohn, 16 B.T.A. 662, the question was whether the residuary legatees were entitled to deduct in 1922 a loss on a note which had been valued at par on the date of the death of the decedent and became worthless in 1922. We held that the note was vested in the residuary legatees, since the debts and legacies of the estate had been paid, and that they were entitled to the deduction. It will be noted that in that case the maker of a note was indebted to the estate of the decedent and to the residuary legatees. It was a debt due to them. The worthlessness of such a debt was a legal deduction from gross income. That case is distinguishable on its facts from the proceeding at bar.
Decision will be entered for the respondent.