Opinion
Docket No. 3531.
1947-06-11
LLOYD H. FAIDLEY, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
Don W. Stewart, Esq., for the petitioner. Richard A. Jennings, Esq., for the respondent.
The recoupment in 1941 of an investment in an oil venture which the petitioner had deducted as a loss in 1930, held taxable as ordinary income in 1941 to the extent that the deduction resulted in a reduction of taxable income for such prior year. Don W. Stewart, Esq., for the petitioner. Richard A. Jennings, Esq., for the respondent.
This case arises on respondent's determination of a deficiency of $8,349.43 in petitioner's income tax for the year 1941. Petitioner's return was filed with the collector of internal revenue for the district of Nebraska. The questions raised are whether the recoupment by the petitioner in 1941 of a loss of $22,500, which he had deducted in his return for 1930, is includible in income of 1941 and, if so, whether it is taxable as a capital gain or as ordinary income. By an amendment to his answer the respondent asserts that the petitioner is now estopped to contend that the amount recovered in 1941 is not taxable income for that year.
FINDINGS OF FACT.
The facts herein are based on a stipulation of facts, oral testimony, and documentary evidence. The stipulation is incorporated herein by reference.
The petitioner during the years 1928, 1929, and 1930 invested $22,500 in an oil venture. The investments were made through petitioner's brother, H. C. Faidley, acting as trustee for a group of investors interested in the project. H. C. Faidley promised to reimburse petitioner for any loss which he might sustain in the event the oil venture proved unsuccessful. The oil venture did prove unsuccessful and the manager, Howard M. Naylor, abandoned the project entirely in the year 1930. The petitioner in his income tax return for 1930 deducted the entire amount of $22,500 as a loss on a transaction entered into for profit under section 23(e) of the Revenue Act of 1928. The deduction, which was allowed by the respondent, reduced petitioner's net income for that year from $31,236.33 to $8,736.33. The recitals of the 1930 return regarding this deduction in schedule F thereof are as follows:
Item 18— Other Deductions: Amount invested during years 1928 and 1929 in ‘Wild-Cat‘ oil venture with Howard M. Naylor , Morland, Kansas, through H. C. Faidley, Trustee for group of investors. Naylor failed and abandoned project in August, 1930. My total investment of $22,500 is a complete loss, there being no salvage. No deduction taken in prior returns for investment, having elected to treat same as capital expenditures in accordance with Art. 243, Reg. 74. * * *
For normal tax purposes the petitioner had an exemption of $11,453.50 for dividends and a personal exemption of $3,500, leaving no income subject to normal tax. Since the Revenue Act of 1928, applicable for the year 1930, did not impose any surtax on the first $10,000 of surtax income, the return showed no surtax due.
In 1930, after Naylor had abandoned the project, H. C. Faidley and others purchased the interest of Naylor and continued the work under new management. Petitioner contributed to H. C. Faidley an additional $100 to be used in furtherance of the project. H. C. Faidley died in February 1931, and the petitioner and another of the investors were selected as trustees for the group.
In 1933, all the funds contributed to the oil drilling project having been exhausted, the work ceased and the project was permanently abandoned.
After the death of H. C. Faidley the petitioner, in July 1931, filed a claim against his estate for recovery of the $22,600 which he had invested in the oil venture upon his brother's guaranty to make good any loss sustained.
On September 12, 1940, the County Court of Hall County, Nebraska, entered judgment and order allowing petitioner's claim against H. C. Faidley's estate on account of his guaranty in the oil venture for the principal sum of $22,600, together with interest totaling $9,944.
The court's order recited that, the oil venture having failed and having been completely wound up in May 1933, the claim of petitioner against the H. C. Faidley estate had become absolute and should be allowed in the sums above set forth.
H. C. Faidley and the H. C. Faidley estate were solvent at all relevant times.
In 1941 petitioner received payment from the H. C. Faidley estate of $22,600 of principal and $6,651.15 interest. He reported the $6,651.15 in his 1941 return as interest, but did not report any of the principal amount.
The return contained a statement regarding this item which read, in part, as follows:
In 1941 the taxpayer received from the estate of his brother, H. C. Faidley, the sum of $29,251.15 of which $22,600 was for reimbursement of funds invested by the taxpayer and guaranteed by H. C. Faidley, and $6,651.15 was for part of the interest on the $22,600 from 1933, the date the investment became worthless. The interest of $6,651.15 is reported herein as income but the $22,600 is treated herein as a return of capital.
In 1928, 1929 and 1930 the taxpayer invested $22,600 in an oil venture. These funds were invested through H. C. Faidley who acted as trustee for a group of investors. At the tine the taxpayer made his investment H. C. Faidley promised that he would reimburse the taxpayer for any loss that the taxpayer might suffer in case the oil venture was unsuccessful. This agreement was confirmed by a letter from H. C. Faidley to the taxpayer in 1929.
The manager of the venture, Howard M. Naylor, abandoned the project in 1930 and the taxpayer assumed that his investment was lost and that he was entitled to deduct the same from his income for 1930. Thereupon he deducted on his 1930 return the sum of $22,500 as a loss on a transaction entered into for profit under Section 23(e) Revenue Act of 1928. The remaining $100 was not deducted as it was advanced to H. C. Faidley upon his representation that the venture would be successful under a new manager.
In his deficiency notice the Commissioner determined that the recoupment of the loss from the oil venture which was claimed and allowed as a deduction from gross income in 1930 constituted taxable income of 1941, the year of recovery. In making this adjustment he increased petitioner's net income by the amount of $21,950. This was the net amount of the recovery after allowance of $550 as attorney fees and expenses.
After H. C. Faidley's death, it was discovered that he had invested about $3,000 of the trust funds which he had held in oil royalties. These royalties were assigned to and held by the petitioner and his cotrustee. After about 1939 the petitioner held them as sole trustee. Petitioner voluntarily transferred his beneficial interest in these royalties to the H. C. Faidley estate, after payment of his claim against the estate as above shown.
In the spring of 1943 petitioner discussed his 1941 income tax return with an internal revenue agent and offered to waive the statute of limitations or any other bar to collection of an additional tax for the year 1930 which would be due if the loss in the oil venture were eliminated from his return for that year. Petitioner is still willing to make such waiver and pay such additional tax for the year 1930.
OPINION.
LEMIRE, Judge:
The petitioner contends, first, that the deduction of his investment in the oil venture was erroneously claimed and allowed in his return for 1930 because of his brother's guaranty of the investment and that therefore the amount which he recovered from his brother's estate in 1941 in satisfaction of that guaranty was not taxable income of that year, except as to the portion thereof which constituted interest, and that if taxable at all it constituted a capital gain and not ordinary income.
We think that the facts support the respondent's contention that the doctrine of estoppel is applicable. The petitioner took a deduction in his 1930 return which he now claims should not have been allowed. He stated in his return that his investment was ‘a complete loss, there being no salvage.‘ The petitioner, who had knowledge of the true facts, never undertook to correct the return. The return was accepted and audited as being correct. The evidence does not justify any finding that the respondent had knowledge of any facts other than those stated in the return. In short, there was no mutual mistake. The year of deduction is now closed by the statute of limitations and is not before us. It can not be reopened by waiver in this proceeding. We hold that the petitioner is estopped to contend that the recovery in 1941 does not constitute taxable income because of the fact that the deduction may have been erroneously claimed and allowed in 1930. Cf. Commissioner v. Liberty Bank & Trust Co., 59 Fed.(2d) 320. In that case estoppel was applied on facts similar to those in the instant case and the recoveries of debts erroneously reported as being worthless in a prior year were held to be chargeable to gross income for the years in which they were collected.
The remaining questions are controlled by the principles set forth in Dobson v. Commissioner and Harwick v. Commissioner, 320 U.S. 489, affirming John V. Dobson, 46 B.T.A. 770, and H. J. Harwick, Docket No. 105790 (memorandum opinion, Mar. 30, 1942). Those cases hold that the recoupment of a loss which has been claimed and allowed as a deduction in the taxpayer's return for a prior year is taxable as ordinary income in the year of the recovery to the extent that the deduction in the prior year served to reduce taxable income.
The petitioner's 1930 return shows a net income of $8,736.33 after deduction of $22,500 on account of loss in the oil venture. The return also shows that for normal tax purposes he had credits for dividends and personal exemptions aggregating $14,953.50. The Revenue Act of 1928, then in effect, provided a surtax exemption of $10,000.
Applying the principles of the Dobson case, supra, it is apparent that the deduction in 1930 of the amount recovered in 1941 did effect an offset in taxable income and the taxpayer realized a tax benefit in 1930 on account of the deduction and to that extent we hold the 1941 recovery taxable as ordinary income.
Reviewed by the Court.
Decision will be entered under Rule 50.