Opinion
No. 228.
June 24, 1942.
Petition to Review a Decision of the Board of Tax Appeals.
Petition by Harriet Lehman to review a decision of the Board of Tax Appeals, holding petitioner liable for a deficiency of $11,449.49 in income tax for the year 1935, resulting from the disallowance by the Commissioner of Internal Revenue of a deduction for bonds said by petitioner to have become partially worthless in the year 1935. Affirmed.
In the taxable year, the taxpayer owned 29 First Mortgage Bonds of the Syracuse Rapid Transit Company, which had been assumed by the New York State Railways, of a par value of $1,000 each. She also owned five First Mortgage Bonds of United Railways Company of St. Louis, which had been assumed by St. Louis Public Service Company, of a par value of $1,000 each. The deductions which were disallowed by the Commissioner, giving rise to this controversy, were the differences between prices paid by the taxpayer for these bonds and the market value thereof at the end of 1935.
The 29 Syracuse bonds had cost her $26,344. In December, 1929, New York State Railways went into receivership, and on March 1, 1930, defaulted on the interest due on these bonds. No interest payments were made thereafter. In 1934, a petition under the Bankruptcy Act, Section 77B, 11 U.S.C.A. § 207, was filed, and, under a plan approved in 1939, the bondholders received, in notes and common stock, a total market value of $172.31 per bond. From 1930 to 1935, New York State Railways' net income, before payment of bond interest, fluctuated between $527,095 and $1,067,233, as against a bond interest obligation of $1,274,078. According to its books, the assets were worth about 57 to 60 million dollars; the funded debt amounted to about 27 million. At the end of 1935, the bid price for the Syracuse bonds was 16¾, asked 17¾, and last sale, 17. During 1935, the taxpayer charged off $21,414 of her investment in these bonds, that being the difference between her cost ($26,344) and the market value of $4,930 (at $170 per bond). In 1937, she sold them for $4,047.40, writing off the balance of $881.10.
She had paid $4,000 for the St. Louis bonds. This company went into receivership in 1933, and filed under section 77B in 1934. It paid no interest from 1934 on. Under a plan of reorganization approved in 1939, bondholders received $84 in cash and securities of a market value of $282.90, or a total of $366.40 per bond. Its income before interest and certain minor expenses varied during the period 1931 through 1935 from $1,735,749 to $646,536, the charge for bond interest being slightly more than $1,000,000. According to its books, its assets were about $76,000,000, as against a funded debt of about $24,000,000. On December 31, 1935, the bonds were quoted at 26 bid, 27 asked. The taxpayer deducted in that year $2,700, or her cost ($4,000) less the bid prices ($1,300) of her five bonds. In 1938, she sold the bonds for $947.98, writing off the balance of $352.02.
Laurence Graves, of Washington, D.C. (J.S.Y. Ivins, of Washington, D.C., of counsel), for petitioner.
Samuel O. Clark, Jr., Asst. Atty. Gen., and Sewall Key and Carolyn E. Agger, Sp. Assts. to Atty. Gen., for respondent.
Before SWAN, CHASE, and FRANK, Circuit Judges.
Section 23(k) of the Revenue Act of 1934, 26 U.S.C.A. Int.Rev.Code § 23(k)(1), provides for deduction of "debts ascertained to be worthless and charged off within the taxable year * * *; and when satisfied that a debt is recoverable only in part, the Commissioner may allow such debt, in an amount not in excess of the part charged off within the taxable year, as a deduction." Treasury Regulations 86, Art. 23(k)-1 provides, "Before a taxpayer may charge off and deduct a debt in part, he must ascertain and be able to demonstrate, with a reasonable degree of certainty, the amount thereof which is uncollectible." That Regulation is entirely reasonable and valid. As a result, petitioner had the burden, at least, of demonstrating with a reasonable degree of certainty that the amount of the debts she sought to charge off was worthless. The Board found that she did not discharge that burden, and its findings are amply supported by the evidence. It may be that the evidence shows a justification for some partial deduction of the debt. But merely by claiming a large partial deduction, a taxpayer cannot put on the Commissioner the task of ascertaining that a substantially smaller deduction might have been justified. If the discrepancy between the partial deduction made by the petitioner and what would have been a justified partial deduction had been relatively small, our decision might have been different.
Petitioner, in ascertaining the amounts she deducted, relied solely upon the fact that the debtor corporations were involved in bankruptcy reorganization proceedings and upon the market values. Market values, in such circumstances as existed here, are often highly unreliable; that in one of the instances they happened to be a fairly accurate guess of what the bondholders received at the end of the reorganization proceedings, is immaterial. The book figures of the debtors indicated sufficient worth to make the debts entirely collectible at some future date; the earnings perhaps indicated the contrary, but they were not nearly so small as to warrant the amount of deduction taken by petitioner. It is the duty of a bankruptcy court to dismiss a proceeding under section 77B when there is no longer a likelihood of consummating the reorganization plan. That such proceedings had not been dismissed when the petitioner made her deductions raises a strong presumption that reorganization was by no means hopeless. Cf. Mayer Tank Mfg. Co. v. Commissioner, 2 Cir., 126 F.2d 588, 589, 591, 592. To be sure, the absence of such hopelessness could not be taken as a guarantee that petitioner would be paid in full; but the pendency of the reorganization proceedings and the amount of the corporate earnings, taken together, served to show that petitioner was indulging in mere conjecture which, as of the date of the deductions, could not be substantiated with a reasonable degree of certainty.
Petitioner's "subjectivity" argument, based upon our decision in Rosenthal v. Helvering, 2 Cir., 124 F.2d 474, was disposed of in Mayer Tank Mfg. Co. v. Commissioner, supra.
The order of the Board of Tax Appeals is affirmed.