Summary
holding that a taxpayer had "wholly failed to carry its burden of showing that prior deductions * * * were without tax benefit"
Summary of this case from Cutting v. Comm'rOpinion
Docket No. 33231.
1953-04-30
THE CHARLESTON NATIONAL BANK, CHARLESTON, WEST VIRGINIA, A NATIONAL BANKING ASSOCIATION, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
Charles M. Love, Esq., for the petitioner. Robert E. Johnson, Esq., for the respondent.
1. For the taxable years 1944 and 1945, petitioner paid premiums on life insurance policies held as security for certain debts previously charged off to profit and loss in prior years. Held, deductible as ordinary and necessary business expenses. Dominion National Bank, 26 B.T.A. 421, followed.
2. In 1945 petitioner made recoveries of portions of bad debts charged off and allowed as deductions in prior years. Held, for failure to establish that such prior deductions resulted in no tax benefit, the recoveries constitute taxable income.
3. In computing petitioner's excess profits net income for 1945, respondent limited the deduction for charitable contributions to 5 per cent of the excess profits net income computed without regard to the deduction for charitable contributions. Held, error. Cf. Gus Blass Co., 9 T.C. 15, appeal dismissed 168 F. 833. Charles M. Love, Esq., for the petitioner. Robert E. Johnson, Esq., for the respondent.
This is a proceeding involving a determination of deficiencies in petitioner's income and excess profits taxes as follows:
+----------------------------------+ ¦Year ¦Tax ¦Deficiency ¦ +------+--------------+------------¦ ¦1944 ¦Income ¦$157.80 ¦ +------+--------------+------------¦ ¦1945 ¦Income ¦8,881.88 ¦ +------+--------------+------------¦ ¦1945 ¦Excess profits¦8,143.74 ¦ +----------------------------------+
For the year 1944 petitioner claims an overpayment of income tax in the amount of $677.98.
The questions presented are (1) whether petitioner is entitled to deduct as ordinary and necessary business expenses premiums paid on certain life insurance policies held as collateral security for the payment of indebtedness; (2) whether in 1945, the year of recovery, petitioner is entitled to exclude from gross income amounts previously deducted and allowed as bad debt losses; and (3) whether in computing excess profits net income the deduction for charitable contributions is limited to 5 per cent of the excess profits net income computed under section 711(a)(2) of the Internal Revenue Code before deduction of charitable contributions.
All of the other issues presented by the pleadings were waived by petitioner.
FINDINGS of FACT.
The facts as stipulated are so found.
The petitioner is a national banking institution with its principal place of business in Charleston, Kanawha County, West Virginia. Its returns for the calendar years 1944 and 1945 were filed on a cash basis with the collector of internal revenue for the district of West Virginia at Parkersburg.
For more than 20 years prior to November 15, 1930, the Kanawha National Bank was engaged in the general banking business in Charleston, Kanawha County, West Virginia. The Charleston National Bank, likewise a national banking association, was similarly engaged in the general banking business in Charleston in 1930 and prior thereto. Effective as of the close of business Saturday, November 15, 1930, and in accordance with the provisions of the National Banking Act,
and with the approval of the Comptroller of the Currency, the two banks were consolidated under the charter and the corporate title of ‘The Charleston National Bank‘ with capital stock of $1,062,500.
An Act of Congress, entitled ‘An Act to provide for the consolidation of national banking associations,‘ approved November 7, 1918, as amended February 25, 1927 (44 Stat. 1224).
The reports of the Comptroller of the Currency, based primarily upon results of the examinations conducted by the National Bank Examiners, have been forwarded to the board of directors of petitioner and contain directions regarding the findings of the examiners, particularly regarding loans which the examiners determined to be ‘worthless‘ as well as others determined to be ‘partially worthless.‘
Petitioner's board of directors is required to acknowledge such reports from the Comptroller stating, in writing, that the recommendations have been complied with, or, in the rare cases of new developments, have been settled otherwise. This compliance entails the ‘charging off‘ of the worthless loans and of ‘partial charge-offs‘ of those designated ‘partially worthless.‘
Issue 1.
The records of the Kanawha National Bank show that prior to 1924 one F. L. Middleton was indebted to it as make on notes in the principal amount of $24,000, which were secured by a deed of trust upon certain residential property, In addition, Middleton was endorser on an unsecured not of $15,000 which the bank had charged to profit and loss on June 30, 1923. Subsequently, in the early part of 1924, Middleton filed a petition in bankruptcy and the Kanawha National Bank filed its claims for both the secured and unsecured indebtedness in the amounts of $24,322.70 and $16,203.73, respectively. In the liquidation of Middleton's estate the secured claim was paid in full by sale of the property held as collateral. In the fall of 1929 a first and final liquidating dividend in bankruptcy was paid. Kanawha National Bank received $928.10 which it credited to profit and loss on November 16, 1929. There also appears a credit of $2.39 on this account on March 16, 1926, which was the remnant of an old checking account balance.
During the first world war the brothers, E. M. Cox, O. J. Cox, and W. R. Cox, were active in West Virginia in mining and selling coal. They were the principal stockholders and active officers in several coal corporations. The three Cox brothers were individually liable as endorsers on notes held by the Kanawha National Bank, on which such corporations were either makers or endorsers in the aggregate amount of $58,208.09, and which amount the bank had charged to profit and loss on May 4, 1925.
The three Cox brothers were also severally and/or jointly liable to Kanawha National Bank on notes aggregating $23,483.50, which amount was charged to profit and loss on May 4, 1925, and also on notes aggregating $4,161.50, which amount was charged to profit and loss on November 4, 1925. The three Cox brothers were adjudicated individual bankrupts and discharged in bankruptcy prior to April 27, 1927. No part of their indebtedness, severally or otherwise, was paid prior to or during the taxable years in question.
In the consolidation with The Kanawha National Bank on November 15, 1930, petitioner received policies of life insurance on the lives of each of the three Cox brothers and Middleton, which policies had been previously assigned to the Kanawha National Bank as security for the loans to each respective debtor. The policies had no cash surrender value prior to 1931. The status of these policies for the years 1944 and 1945 is set forth in the following table:
+---------------------------------------------------------------+ ¦ ¦ ¦Cash surrender value ¦Premium paid ¦ +---------------+-------+---------------------+-----------------¦ ¦Insured ¦Face ¦ ¦ ¦ ¦ ¦ +---------------+-------+----------+----------+--------+--------¦ ¦ ¦amount ¦1944 ¦1945 ¦1944 ¦1945 ¦ +---------------+-------+----------+----------+--------+--------¦ ¦W. R. Cox ¦$20,000¦$5,500.00 ¦$5,900.00 ¦$456.20 ¦$456.20 ¦ +---------------+-------+----------+----------+--------+--------¦ ¦O. J. Cox ¦20,000 ¦6,100.00 ¦6,540.00 ¦511.00 ¦511.00 ¦ +---------------+-------+----------+----------+--------+--------¦ ¦E. M. Cox ¦10,000 ¦4,250.00 ¦4,490.00 ¦383.60 ¦381.30 ¦ +---------------+-------+----------+----------+--------+--------¦ ¦F. L. Middleton¦14,000 ¦4,463.08 ¦4,853.80 ¦738.64 ¦722.12 ¦ +---------------+-------+----------+----------+--------+--------¦ ¦Total ¦64,000 ¦20,313.08 ¦21,783.80 ¦2,089.44¦2,070.62¦ +---------------------------------------------------------------+ Premiums on all of the above policies were paid by petitioner from 1931 to and including 1945. On its annual income tax returns, petitioner claimed such premiums as deductions for each of the years 1931 to 1941, inclusive, with the exception of the year 1932. The respondent allowed the deductions claimed in all such years except 1940 and 1941 when they were disallowed.
For the year 1942 petitioner made no claim for a deduction of insurance premiums paid on its return, but filed a claim for refund in the amount of $2,101.32, which was allowed and a refund was made of $840.53. In its returns for the years 1943 to 1945, inclusive, petitioner made no claim for a deduction of the insurance premiums paid. In a protest dated June 6, 1947, petitioner, for the first time, asserted a claim for deductions for premiums paid in the years 1944 and 1945. The respondent disallowed the claim.
The premiums paid by the petitioner on the insurance policies of the Cox brothers and F. L. Middleton, in the amount of $2,089.44 in the year 1944 and the amount of $2,070.62 in the year 1945, constitute ordinary and necessary expenses incurred and paid in carrying on petitioner's trade or business in those years.
Issue 2.
On May 20, 1932, M. Boiarsky was indebted to the petitioner on notes signed by him as sole maker as follows:
+------------------------------------------------------------+ ¦1. A note maturing May 22, 1932, for ¦$30,000 ¦ +---------------------------------------------------+--------¦ ¦2. A note maturing May 25, 1932, for ¦42,000 ¦ +---------------------------------------------------+--------¦ ¦3. 13 separate notes of various amounts aggregating¦60,700 ¦ +---------------------------------------------------+--------¦ ¦Total ¦$132,700¦ +------------------------------------------------------------+
The note of May 22, 1932, for $30,000, was renewed on several dates and on its maturity date of September 14, 1933, the principal and interest totaled $32,525.66.
The note of May 25, 1932, for $42,000, was also renewed on several dates and on its maturity date of September 17, 1933, the principal and interest totaled $45,534.94.
On May 31, 1932, Boiarsky paid petitioner $18,000 on account of an indebtedness evidenced by several notes, totaling $60,700 on June 8, 1932, and a new note for $42,700 was executed for the balance. This note was renewed on several occasions and on each renewal the accrued interest was paid. On September 1, 1933, the principal amount due was $42,700.
The principal amounts of the three notes were not increased or decreased, and in March 1934 Boiarsky's individual indebtedness, as evidenced by the three notes, maturing on May 12, May 15, and May 31, 1934, respectively, was in the aggregate amount of $120,760.60.
As collateral security for such indebtedness, petitioner held certain shares of stock, more particularly hereinafter described, and a ‘term‘ life insurance policy on Boiarsky's life in the fact amount of $25,000, due to expire on November 13, 1935, with the privilege in Boiarsky to convert it into an ordinary life policy before such expiration date.
As a result of an examination in March 1934 by the National Bank Examiners, petitioner received a report from the Comptroller of the Currency reflecting total assets to be charged off in the amount of $574,543.95. On June 30, 1934, petitioner charged off as directed by such report the amount of $70,000 against Boiarsky's indebtedness. The $70,000 charged off was not claimed as a partial bad debt loss deduction on petitioner's Federal income tax return for 1934. Petitioner charged the $70,000 to profit and loss, applying $40,161.20 to the note due May 15, 1934, and $29,838.80 to the note due May 12, 1934, leaving a balance of $8,060.60 on such two notes. The note of $42,700 due May 31, 1934, was not charged off.
On May 29, 1935, Boiarsky and his wife executed a joint note to petitioner in the face amount of $2,250. The note was due 120 days from date, but was renewed from time to time and the interest paid on each renewal. During 1935 Boiarsky considered placing himself in voluntary bankruptcy, but, after discussing the matter with petitioner's officers, expressed a desire to make an agreement he considered within his ability to fulfill. Under date of September 17, 1935, Boiarsky and petitioner executed the following agreement:
THIS AGREEMENT, Made the 17th day of September, 1935, between M. Boiarsky, of Charleston, West Virginia, party of the first part, and The Charleston National Bank, A national Banking Association, of Charleston, West Virginia, party of the second part:
WHEREAS, The party of the first part is now indebted to the party of the second part, said indebtedness being evidence by the following described notes, to-wit:
(a) A note dated August 23, 1935, signed by M. Boiarsky, in the principal sum of $42,700, payable to the order of The Charleston National Bank, thirty days after date.
(b) A note dated May 29, 1935, in the principal sum of $2,250.00, signed by M. Boiarsky and R. Boiarsky, payable to the order of The Charleston National Bank one hundred twenty days after date.
(c) A note dated September 17, 1935, in the principal sum of $8,060.60, signed by M. Boiarsky, payable to the order of The Charleston National Bank sixty days after date.
(d) A note dated September 17, 1935, in the principal sum of $80,808.83, signed by M. Boiarsky and payable to the order of The Charleston National Bank two years after date.
WHEREAS, The party of the first part has pledged with The Charleston National Bank as collateral security for the payment of the above described indebtedness the following described shares of corporate stock, to-wit:
3000 shares Graham-Paige Motors Corporation
30 shares The Charleston Building & Loan Association
200 shares Liberty Insurance Agency
259 shares The Liberty Building & Loan Association
129 1/2 shares Liberty Savings & Loan Company
WHEREAS, The party of the first part, as additional collateral security for the payment of the above described indebtedness, has caused his life to be insured by Aetna Life Insurance Company under a certain term life insurance Policy No. N-878797, in the sum of $25,000.00, naming The Charleston National Bank as beneficiary thereunder, which policy may be converted unto (sic) an ordinary life policy on or before 5:00 o'clock P.M. on the 13th day of November, 1935.
NOW THEREFORE, in consideration of the promises and agreements hereinafter contained to be kept and performed by The Charleston National Bank the said M. Boiarsky doth hereby covenant and agree to and with said The Charleston National Bank that he will promptly and faithfully from time to time execute renewal notes for the indebtedness now evidenced by the notes above described as (a), (b) and (c), as they and their renewals mature, said note (b) also to be renewed and renewals thereof executed by R. Boiarsky, and pay the discount thereon at such renewals, curtailing the principal indebtedness evidenced by such notes as required by The Charleston National Bank; and that on or before 5:00 o'clock P.M., on the 13th day of November, 1935, he will cause the above described term life insurance policy to be converted into a new policy of ordinary life insurance with The Charleston National Bank, its successors or assigns, to be named as beneficiary therein and deliver the same to The Charleston National Bank; and that he will promptly pay the premiums as they mature and come due for payment, on said new policy of insurance, keeping the same in full force and effect, and deliver the premium receipts to The Charleston National Bank.
The party of the first part further covenants and agrees that he will, if and when requested so to do by The Charleston National Bank, cause all or any of the above described corporate stocks, which are now pledged as security to The Charleston National Bank, to be transferred to the name of The Charleston National Bank or to the name of such other person as it may nominate, and that The Charleston National Bank shall have the full right and privilege at any time it may so to do and whether any of the indebtedness above described be past due and in default or not, to sell any or all of said corporate stocks at the expense of the party of the first part and to apply the net proceeds thereof to the indebtedness now evidenced by the above described notes (a), (b) and (c) or any one or more of them; and The Charleston National Bank shall be the sole judge of the propriety of any such sale or sales of collateral and of the adequacy of price or prices to be obtained by it for such stocks.
In consideration of the full and complete performance of each and every of the covenants and agreements herein contained to be kept and performed by the said M. Boiarsky, and upon condition that he does so keep and perform said covenants and agreements The Charleston National Bank on its part covenants and agrees that if and when it shall have received full payment of the indebtedness now evidenced by the notes above described as (a), (b) and (c), and full payment of any and all other indebtedness, obligations and liabilities to it which may hereafter be incurred or created by the said M. Boiarsky, from whatsoever source such payments are received, it will fully release and discharge the said M. Boiarsky and/or his estate from the indebtedness now evidenced by the note above described as (d) and from all interest which may have accrued on said last mentioned indebtedness up to the time of such full and final payment.
It is further covenanted and agreed by and between the parties hereto that upon the failure of the said M. Boiarsky to pay any of the premiums on said new life insurance policy, The Charleston National Bank may do so at its election, in which event all amounts so expended by The Charleston National Bank shall be considered new indebtedness of the said M. Boiarsky incurred and created after the execution of this agreement; and the said M. Boiarsky covenants and agrees that when requested so to do he will execute and deliver to The Charleston National Bank his promissory note or notes for the amounts so expended by The Charleston National Bank; but it is understood and agreed that any payment of such premiums by The Charleston National Bank is optional with it. and in no event shall The Charleston National Bank be bound or obligated to pay any of such premiums.
Should any of the covenants and agreements herein contained to be kept and performed by the said M. Boiarsky be breached by him or should the said M. Boiarsky be adjudged bankrupt or insolvent, The Charleston National Bank may, at its election, upon notice to said M. Boiarsky, cancel and annul this agreement on its part retaining all of the security of the above described pledged corporate stocks and of said life insurance policy; but no forbearance on the part of said bank or failure by it to avail itself of the right of such cancellation shall operate to deprive it of the right of cancellation on account of any subsequent breach of covenant.
The note for $8,060.60, dated September 17, 1935, referred to in paragraph (c) of the aforesaid agreement, represents the remaining balance, after the charge-off of $70,000, applied against the two notes in the respective amounts of $45,534.94 and $32,525.66. The note of $80,808.83, referred to in paragraph (d), represents the charge-off of $70,000, plus unpaid interest of $10,808.83.
Upon its Federal income tax return for 1935 petitioner claimed as a deduction the sum of $70,000 as a loss realized upon a debt due it from M. Boiarsky. Respondent denied the deduction for 1935 but allowed it for 1934.
As a result of examinations by the National Bank Examiners and pursuant to instructions from the Comptroller of the Currency, petitioner made the following charge-downs or partial charge offs due to the partial worthlessness of the Boiarsky account on the following dates and in the following amounts:
+-------------------------+ ¦May 17, 1938 ¦$5,000.00 ¦ +--------------+----------¦ ¦Nov. 15, 1938 ¦5,000.00 ¦ +--------------+----------¦ ¦Apr. 4, 1939 ¦4,837.50 ¦ +--------------+----------¦ ¦Dec. 26, 1939 ¦3,060.00 ¦ +--------------+----------¦ ¦Aug. 5, 1941 ¦3,060.00 ¦ +--------------+----------¦ ¦Total ¦$20,957.50¦ +-------------------------+
Also, on August 5, 1941, the joint note for $2,250 was charged off. Each of the above amounts was claimed by petitioner as deductions for the years indicated and was allowed by the respondent.
After September 17, 1935, agreement Boiarsky converted his life insurance policy from a term policy to an ordinary life policy, and until September 25, 1945, he kept the premiums paid thereon and had such policy assigned to petitioner as security on his indebtedness. The principal amount of this policy was $25,000. Boiarsky also kept the interest paid on the notes identified in the agreement as (a), (b), and (c), and kept them renewed in current form. No interest on the (d) note in the principal amount of $80,808.83 was ever paid subsequent to its maturity date of September 17, 1937, nor did petitioner ever make any demand for such interest. Boiarsky made timely payments upon the principal indebtedness of $53,010.60, evidenced by the (a), (b), and (c) notes, and eventually paid all of the principal thereon by September 25, 1945.
After the September 17, 1935, agreement Boiarsky made the following payments on the principal of his indebtedness as follows:
+--------------------------+ ¦Nov. 18, 1935 ¦$0.60 ¦ +---------------+----------¦ ¦July 7, 1937 ¦4,475.00 ¦ +---------------+----------¦ ¦Mar. 17, 1938 ¦450.00 ¦ +---------------+----------¦ ¦Dec. 12, 1938 ¦3,237.50 ¦ +---------------+----------¦ ¦Mar. 15, 1939 ¦383.00 ¦ +---------------+----------¦ ¦Dec. 15, 1939 ¦1,295.00 ¦ +---------------+----------¦ ¦Feb. 15, 1940 ¦542.00 ¦ +---------------+----------¦ ¦Nov. 30, 1940 ¦4,532.50 ¦ +---------------+----------¦ ¦Feb. 17, 1941 ¦407.00 ¦ +---------------+----------¦ ¦Dec. 29, 1941 ¦647.50 ¦ +---------------+----------¦ ¦Feb. 9, 1942 ¦609.00 ¦ +---------------+----------¦ ¦Dec. 14, 1942 ¦3,846.50 ¦ +---------------+----------¦ ¦Apr. 22, 1943 ¦4,534.90 ¦ +---------------+----------¦ ¦Dec. 9, 1943 ¦1,942.50 ¦ +---------------+----------¦ ¦Jan. 17, 1945 ¦3.699.75 ¦ +---------------+----------¦ ¦Feb. 2, 1945 ¦.25 ¦ +---------------+----------¦ ¦Aug. 1, 1945 ¦4,397.50 ¦ +---------------+----------¦ ¦Sept. 25, 1945 ¦18,010.10 ¦ +---------------+----------¦ ¦Total ¦$53,010.60¦ +--------------------------+
In accordance with the provisions of their agreement, petitioner thereupon returned to Boiarsky note (d) in the principal of $80,808.83 and the life Insurance policy which had been assigned to it for security.
Petitioner realized taxable income in 1945 on the recoveries in the sum of $20,957.50 with respect to the Boiarsky bad debt, which had been deducted in the years 1938, 1939, and 1941 with tax benefit.
Issue 3.
In the taxable year 1945, petitioner made charitable contributions in the total amount of $23,250. For the purpose of determining petitioner's excess profits tax liability, the respondent allowed a deduction for charitable contributions of $15,092.99, or 5 per cent of the excess profits net income computed without regard to the deduction for charitable contributions, thereby increasing excess profits net income by $8,156.01.
OPINION.
LEMIRE, Judge:
The first question presented is whether in the taxable years 1944 and 1945 petitioner is entitled to deduct premiums paid on certain policies of life insurance assigned to it as collateral security as ordinary and necessary business expenses under section 23(a)(1)(A) of the Internal Revenue Code.
Petitioner contends that, since the insurance premiums were paid to protect its security in the hope of ultimately recovering as much of the indebtedness as possible, the expenditures are deductible as ordinary and necessary business expenses under the rationale of Dominion National Bank, 26 B.T.A. 421, and First Nat. Bank & Trust Co. of Tulsa v. Jones, 53 F.Supp. 842, affd. 143 F.2d 652.
In our opinion the above-cited cases establish the principle that insurance premiums, paid by a creditor to whom a debtor has assigned an insurance policy on the debtor's life as security, are deductible as ordinary and necessary business expenses where the payments are made with the hope of recovery of the full amount of the indebtedness.
The respondent acquiesced in the result reached in the Dominion National Bank case, supra (XI-2 C.B. 3), on the ground that nothing could have been collected from the debtor, and the unpaid debt itself exceeded the cash surrender value of the policies, and not for the reasons stated by this Court.
It is the contention of the respondent that such insurance premiums are not deductible as a matter of right, but their deductibility depends upon whether the taxpayer has a right to reimbursement, and whether in the year of payment of the premium the right is worthless. I.T. 2867, XIV-1 C.B. 291 (1935), modifying, XIV-1 C.B. 52 (1935). It is then argued that the Dominion Bank case is distinguishable, since the unpaid debt exceeded the cash surrender value of the policies, and, whereas in the instant case the debtors were all discharged in bankruptcy and their indebtedness to the Kanawha National Bank had been charged to profit and loss prior to the consolidation with petitioner, the latter's base was zero. Hence, it is said that as the cash surrender value less the basis of the debt is in excess of the premiums advanced, there is reasonable hope or expectancy of the repayment of the premiums, and the right is not worthless.
Assuming, arguendo, that petitioner had a zero basis for certain purposes, we think such fact is unimportant here. Concededly, neither the charge-off nor the discharge of the debtor in bankruptcy had the effect of canceling the indebtedness. The petitioner had the right to protect its security by keeping the insurance policies alive by the payment of premiums in the hope of recovering as much of the debt as possible.
We hold that the facts presented in the instant case bring it within the ambit of Dominion National Bank, supra, and on this issue we sustain the petitioner.
The second question presented is whether petitioner realized taxable income in 1945 on recoveries of portions of bad debts charged off to profit and loss on account of partial worthlessness and allowed as deductions in the prior years. In accordance with their agreement of September 17, 1935, petitioner in 1945 received from M. Boiarsky payments totaling $26,107.60 on the principal of the latter's indebtedness. Of this total amount petitioner did not report as income in 1945 the sum of $20,957.50 on the ground that such sum was properly excludible from gross income under the provisions of section 22 (b)(12) of the Internal Revenue Code.
Respondent treated the $20,957.50 as taxable income and determined that $17,897.50 of that recovery was subject to income tax only and the remaining $3,060 was subject to both income and excess profits taxes.
SEC. 22. GROSS INCOME.(b) EXCLUSIONS FROM GROSS INCOME.— The following items shall not be included in gross income and shall be exempt from taxation under this chapter:(12) RECOVERY OF BAD DEBTS, PRIOR TAXES, AND DELINQUENCY AMOUNTS.— Income attributable to the recovery during the taxable year of a bad debt, prior tax, or delinquency amount, to the extent of the amount of the recovery exclusion with respect to such debt, tax, or amount. For the purposes of this paragraph:(A) Definition of bad debt.— The term ‘bad debt‘ means a debt on account of worthlessness or partial worthlessness of which a deduction was allowed for a prior taxable year.(D) Definition of recovery exclusion.— The term ‘recovery exclusion‘, with respect to a bad debt, prior tax, or delinquency amount, means the amount, determined in accordance with regulations prescribed by the Commissioner with the approval of the Secretary, of the deductions or credits allowed, on account of such bad debt, prior tax, or delinquency amount, which did not result in a deduction of the taxpayer's tax under this chapter (not including the tax under section 102) or corresponding provisions of prior revenue laws, reduced by the amount excludible in previous taxable years with respect to such debt, tax, or amount under this paragraph.
A recovery of bad debts deducted and allowed in prior years except as provided in section 22 (b)(12), which was added by section 116(a) of the Revenue Act of 1942, and made retroactive to all prior taxable years, results in taxable income. Under that section, amounts attributable to the recovery of a bad debt are not includible in gross income if the prior deduction allowed for such item did not reduce the taxpayer's income tax liability. Accordingly, petitioner, in order to prevail, must satisfactorily establish that the $20,957.50 recovered on the Boiarsky indebtedness in 1945 is attributable to amounts previously deducted and allowed as bad debts in prior years without any tax benefit.
On June 30, 1934, petitioner, at the direction of supervisory banking authorities, charged off to profit and loss the sum of $70,000 on account of the partial worthlessness of Boiarsky's indebtedness of $120,760.60. Respondent subsequently allowed petitioner this deduction for the year 1934. On September 17, 1935, in order to enable Boiarsky to avert placing himself in bankruptcy, petitioner and Boiarsky entered into an agreement in which it was agreed that ‘if and when it (petitioner) shall have received full payment of the indebtedness (therein agreed as totaling $53,010.60) * * * it will fully release and discharge the said M. Boiarsky and/or his estate from the indebtedness‘ of $80,808.83, which represents the prior 1934 charge-off of $70,000, plus unpaid accrued interest of $10,808.83.
Respondent contends that the legal effect of the 1935 agreement was in the nature of a novation limiting Boiarsky's indebtedness to the agreed amount of $53,010.60, which was paid in full prior to September 25, 1945. Respondent further contends that the petitioner has failed to establish that the subsequent charge-offs in 1938, 1939, and 1941 in the total amount of $20,957.50, which were claimed and allowed in those years, were without tax benefit. We agree that upon this record the petitioner has wholly failed to carry its burden of showing that the prior deductions in the aggregate amount of $20,957.50, which were allowed for the years 1938, 1939, and 1941, were without tax benefit.
So holding, it is unnecessary for us to determine the legal effect of the September 17, 1935, agreement. We, therefore, hold that respondent did not err in including in gross income the sum of $20,957.50, recovered by petitioner in the taxable year 1945 on the Boiarsky indebtedness. On this issue we sustain the respondent.
The final question presented is whether in computing excess profits net income the deduction for charitable contributions made by petitioner in 1945 is limited to 5 per cent of the excess profits net income computed under section 711(a)(2) of the Internal Revenue Code before deduction of charitable contributions.
During the year 1945 petitioner made charitable contributions in the total amount of $23,250, which amount was allowed by the respondent for purposes of computing petitioner's normal tax and surtax net income.
For the purpose of determining petitioner's excess profits tax liability, respondent allowed a deduction for charitable contributions in the sum of $15,092.99, or 5 per cent of the excess profits net income computed without regard to the deduction for charitable contributions, thereby increasing excess profits net income by the amount of $8,156.01.
The petitioner contends that the case of Gus Blass Co., 9 T.C. 15, appeal dismissed 168 F.2d 833, supports its position and is a controlling authority. We there held that in computing excess profits net income for the fiscal year ending January 31, 1941, the deduction for charitable contributions is the same as that allowed in computing the income tax liability and is not limited to 5 per cent of the excess profits net income, computed under section 711(a)(1), before deduction of charitable contributions. The fact that petitioner uses the invested capital method under section 711(a)(2), and its taxable year is 1945, furnishes no basis on which to distinguish the Blass case, supra.
The respondent argues that when Congress amended the Code in 1941 by adding subparagraph (g) to section 711(a)(1) and subparagraph (I) to section 711(a)(2), which provide:
In determining any deduction the amount of which is limited to a percentage of the taxpayer's net income (or net income from the property), such net income (or net income from the property) shall be computed without regard to the deduction on account of the tax imposed by this subchapter.
It indicated a legislative intent to limit the charitable deductions for the purpose of computing excess profits net income to the net income as adjusted under section 711(a)(2). Section 206(b) of the Revenue Act of 1942 repealed subparagraphs (G) and (I), effective under section 201 for the years beginning after December 31, 1941, because under that Act the excess profits tax could not be used as a deduction. See 7A Mertens, Law of Federal Income Taxation, Sec. 42.33. This argument of respondent, based on legislative history, is not convincing.
In the taxable year 1945, whether the excess profits tax is computed under either the income or invested capital method of credit, the starting point is the normal tax net income used for the purpose of computing normal income tax as in the Blass case, supra, and hence, that decision is controlling. We, therefore, hold that in computing petitioner's excess profits net income for 1945 the respondent erred in limiting the charitable deductions to the amount of $15,092.99, thereby increasing excess profits net income by the amount of $8,156.01. On this issue we sustain the petitioner.
Decision will be entered under Rule 50.