Opinion
Docket No. 72843.
1960-11-16
NICHOLAS D. WUSICH AND ELIZABETH S. WUSICH, PETITIONERS, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
James E. Flynn, Esq., and James W. Coombs, C.P.A., for the petitioners. Edward A. Tonjes, Esq., for the respondent.
In 1950 and 1951, petitioner, while employed as general manager of a bank, credited the account of a depositor with a deposit which had not in fact been made, honored checks on an account lacing funds to pay them, and falsified bank records to conceal the shortage. These acts were done with intent to injure and defraud the bank and were not approved of by the bank. In December of 1951, the petitioner and the depositor were indicted for willfully misapplying bank funds and falsifying bank records in violation of sections 656 and 1005 of Title 18 of the United States Code. The petitioner pleaded guilty to three counts and received a suspended sentence. The petitioner's bonding company paid the entire loss, and petitioner agreed to pay the amount of the loss to the bonding company in the event the depositor failed to make repayment. No payments were ever made by the depositor, who filed a petition of voluntary bankruptcy in 1953, and was declared bankrupt and was discharged in 1955. Pursuant to his agreement, the petitioner paid to the bonding company $12,500 principal and $2,925.62 interest in 1953 and $7,449.38 principal and $2,550.62 interest in 1954. Held, that the payments to the bonding company are not deductible as ordinary and necessary business expenses. But, held, further, that the amounts paid as interest were interest and are deductible as such. James E. Flynn, Esq., and James W. Coombs, C.P.A., for the petitioners. Edward A. Tonjes, Esq., for the respondent.
The respondent determined deficiencies in income tax against the petitioners in the amount of $5,087.88 for the taxable year 1953 and in the amount of $2,450.28 for the taxable year 1954. The questions are (1) whether the petitioners are entitled to deduct as ordinary and necessary business expenses amounts paid in 1953 and 1954 to a bonding company to indemnify it for payments it had made under an indemnity bond to a bank by which petitioner Nicholas D. Wusich had been employed, and (2) whether the portions of the payments paid as interest are deductible as such.
FINDINGS OF FACT.
The facts in substantial part and the evidence have been stipulated and the facts stipulated are found as stipulated.
The petitioners are husband and wife, and residents of Phoenix, Arizona. They filed joint income tax returns for the taxable years involved with the district director of internal revenue for Arizona.
From 1936 to December 1951, Nicholas D. Wusich, hereafter referred to as the petitioner, was employed by the Valley National Bank in Phoenix. During the years 1950 and 1951, while he was general manager of the West Van Buren Street branch office of the bank, the petitioner made out deposit slips to the credit of an account maintained by C. I. Walkington, a bank depositor, when in fact the bank had received no deposit, credit, or security for the amount credited, or any evidence of indebtedness therefor. The petitioner also cashed checks drawn on one of Walkington's accounts without debiting it at a time when Walkington did not have sufficient funds in the account to cover the checks. To conceal the shortage, the petitioner made or caused to be made false entries in the bank records. In converting the bank's funds to the use of Walkington, the petitioner acted with intent to injure and defraud the bank.
Walkington never repaid any of the funds to the bank, and the petitioner's bonding company, the Fidelity & Deposit Company of Maryland, was required to indemnify the bank for its loss.
Based on advice from his attorney that he was liable to the bonding company for the entire loss, the petitioner on January 8, 1952, entered into the following agreement with the bonding company:
There was a stipulation the ‘Walkington's notes aggregating $100,000.00 were not assumed by Petitioner nor were they assigned to him, but were retained by the bonding company to which the Bank had assigned them.’ The notes were not introduced in evidence, nor was there any testimony as to their terms. Since the facts do show that the bank received no evidence of indebtedness when Walkington received the funds, the notes presumably were executed after the discovery of the conversions.
WHEREAS Nicholas D. Wusich, party of the first part, during the course of his employment with The Valley National Bank of Phoenix, Arizona, incurred a liability to the party of the second part under that certain indemnity bond executed by the party of the first part, as principal, and the party of the second part, as surety, in connection with certain loans made by him in the regular course of his employment to C. I. Walkington amounting to $100,000.00; and
WHEREAS, the party of the second part has paid, or agreed to pay, the said $100,000.00 to The Valley National Bank of Phoenix, Arizona, under the terms of the aforementioned indemnity bond;
NOW, THEREFORE, for and in consideration of the mutual covenants and promises herein contained, it is hereby mutually agreed as follows :
1. The party of the first part, by these presents, hereby agrees to pay and indemnify the party of the second part in the amount of $100,000.00, or so much thereof as the party of the second part is required, under the terms of the aforementioned indemnity bond, to pay to The Valley National Bank of Phoenix, Arizona.
2. In order to effectuate the said indemnification by the party of the first part, the party of the second part hereby agrees that in the event the said C. I. Walkington fails to pay, within the period from the date hereof to each date set forth in the schedule below, the total principal amount set opposite each date, plus accrued interest on the entire amount due by him to that date, the party of the first part will pay to the party of the second part the deficiency between the total amount previously paid and the principal amount set opposite each date, plus any unpaid accrued interest at 3%:
+---------------------------+ ¦Date ¦Amount ¦ +----------------+----------¦ ¦January 8, 1953 ¦$12,500.00¦ +----------------+----------¦ ¦January 8, 1954 ¦25,000.00 ¦ +----------------+----------¦ ¦January 8, 1955 ¦37,500.00 ¦ +----------------+----------¦ ¦January 8, 1956 ¦50,000.00 ¦ +----------------+----------¦ ¦January 8, 1957 ¦62,500.00 ¦ +----------------+----------¦ ¦January 8, 1958 ¦75,000.00 ¦ +----------------+----------¦ ¦January 8, 1959 ¦87,500.00 ¦ +----------------+----------¦ ¦January 8, 1960 ¦100,000.00¦ +---------------------------+
3. The party of the first part hereby specifically waives all claims of every kind, character, nature or description which he now has, or may hereafter have, against the party of the second part for any lack of diligence on the part of the party of the second part in collecting any and all amounts due The Valley National Bank of Phoenix, Arizona, and/or its assignees, from C. I. Walkington and/or C. I. Walkington and Associates.
To secure the agreement with the bonding company, the petitioner and his wife gave the bonding company a joint note and a realty mortgage in the amount of $100,000.
No payments were received by the bonding company from Walkington, who on August 27, 1953, filed a petition of voluntary bankruptcy in the United States District Court for the District of Arizona. He was declared bankrupt, and was discharged on May 2, 1955.
Pursuant to his agreement, the petitioner made the following payments to the bonding company:
+---------------------------------------------+ ¦Date ¦Principal ¦Interest ¦Total ¦ +-------------+----------+---------+----------¦ ¦Jan. 8, 1953 ¦$12,500.00¦$2,925.62¦$15,425.62¦ +-------------+----------+---------+----------¦ ¦Jan. 20, 1954¦7,449.38 ¦2,550.62 ¦10,000.00 ¦ +---------------------------------------------+
In December of 1951 the petitioner and Walkington were indicted on 16 counts for violations of sections 656 and 1005 of Title 18 of the United States Code.
The petitioner pleaded guilty to three counts, which were as follows:
Sec. 656. Theft, embezzlement, or misapplication by bank officer or employee.Whoever, being an officer, director, agent or employee of, or connected in any capacity with any Federal Reserve bank, member bank, national bank or insured bank, or a receiver of a national bank, or any agent or employee of the receiver, or a Federal Reserve Agent, or an agent or employee of a Federal Reserve Agent or of the Board of Governors of the Federal Reserve System, embezzles, abstracts, purloins or willfully misapplies any of the moneys, funds or credits of such bank or any moneys, funds assets or securities intrusted to the custody or care of such bank, or to the custody or care of any such agent, officer, director, employee or receiver, shall be fined not more than $5,000 or imprisoned not more than five years, or both; but if the amount embezzled, abstracted, purloined or misapplied does not exceed $100, he shall be fined not more than $1,000 or imprisoned not more than one year, or both.Sec. 1005. Bank entries, reports and transactions.Whoever, being an officer, director, agent or employee of any Federal Reserve bank, member bank, national bank or insured bank, without authority from the directors of such bank, issues or puts in circulation any notes of such bank; orWhoever, without such authority, makes, draws, issues, puts forth, or assigns any certificate of deposit, draft, order, bill of exchange, acceptance, note, debenture, bond, or other obligation, or mortgage, judgment or decree; orWhoever makes any false entry in any book, report, or statement of such bank with intent to injure or defraud such bank, or any other company, body politic or corporate, or any individual person, or to deceive any officer of such bank, or the Comptroller of the Currency, of the Federal Deposit Insurance Corporation, or any agent or examiner appointed to examine the affairs of such bank, or the Board of Governors of the Federal Reserve System—Shall be fined not more than $5,000 or imprisoned not more than five years, or both.
COUNT VI
(18 U.S.C.A. 656)
2. That during said period of time, to-wit, on or about the 30th day of March, 1950, in said State and District of Arizona, said defendant, NICHOLAS DANIEL WUSICH, as such said officer, and said defendant, CECIL IRA WALKINGTON, with the intent then and there to injure and defraud said national bank, did unlawfully and wilfully misapply the moneys of said bank in the amount and of the value of $2,700.00, by then and there unlawfully and wilfully converting the said sum of $2,700.00 to the use and benefit of the said Cecil Ira Walkington and not to the use or benefit of said national bank, by making a deposit slip in the said sum of $2,700.00 to the credit of the said Payroll Account of the C. I. Walkington and Associates Company and causing said sum to be credited to the said account subject to the order of the said Cecil Ira Walkington to disburse the same, and all thereof, when in fact the bank received no deposit, credit, or security for said sum, or any part thereof, or any evidence of indebtedness therefor whatsoever.
COUNT X
(18 U.S.C.A. 656)
2. That during said period of time, to-wit, on or about the 29th day of January, 1951, in said State and District of Arizona, said defendant, NICHOLAS DANIEL WUSICH, as such said officer, and said defendant, CECIL IRA WALKINGTON, with the intent then and there to injure and defraud said national bank, did unlawfully and wilfully misapply the moneys of said bank in the amount and of the value of $1,028.42, by then and there unlawfully and wilfully converting the said sum of $1,028.42 to the use and benefit of the said Cecil Ira Walkington and not to the use or benefit of said national bank, by causing to be cashed in full, with the moneys of said bank, a check numbered 1198, dated January 26, 1951, for the sum of $1,028.42, to the order of Arizona Moulding Co., drawn by the said defendant, CECIL IRA WALKINGTON, on the said C. I. Walkington Millwork Sales Company account, when, in fact, the said Cecil Ira Walkington did not have sufficient funds in his said account to pay the amount of said check, and no entry was then and there made debiting said account with the amount of said check or any part thereof, all of which the defendants then and there well knew.
COUNT XVI
(18 U.S.C.A. 1005)
2. That said defendant, NICHOLAS DANIEL WUSICH, during said period of time, to-wit, on or about the 10th day of December, 1951, in said State and District of Arizona, as such said officer, did wilfully make and cause to be made a false entry in the sum of $25,000.00 in a report, statement and record of said bank, to-wit, in the General Account of C. I. Walkington and Associates Company, the said C. I. Walkington and Associates Company being then and there a depositor of said bank, which said entry purports to show that deposits in the said sum of $25,000.00 had been made on or about the said 10th day of December, 1951, to said bank by said depositor, whereas, in truth and in fact, as the said defendant then and there well knew, the said G. I. Walkington and Associates Company (sic) had made no such deposit to or with the said bank or placed with said bank any credits or security for said sum or any part thereof, or any evidence of indebtedness thereof whatsoever, and that said false entry was then and there made and caused to be made by the said defendant, while so employed, with the intent to deceive, injure and defraud the said national bank.
The remaining counts were dismissed, and on October 6, 1952, the petitioner received a suspended sentence.
On their joint returns for the years 1953 and 1954, the petitioners claimed as business losses the amounts paid to the bonding company. In his determination of the deficiencies herein, the respondent disallowed the deductions claimed.
The payments to the bonding company were not ordinary and necessary business expenses incurred in the petitioner's trade or business.
OPINION.
TURNER, Judge:
The first question is whether the petitioner is entitled to deduct as ordinary and necessary business expenses
amounts paid by him to a bonding company in 1953 and 1954 in satisfaction of his liability to the bonding company.
Section 162(a) of the Internal Revenue Code of 1954 and its predecessor, section 23(a)(1) of the Internal Revenue Code of 1939, provide for the deduction of ‘all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business.’
At the trial and on brief, the petitioner has made the contention that the amounts paid to the bonding company are deductible as ordinary and necessary business expenses. It is the respondent's position that the payments resulted from the petitioner's criminal activity which was outside the scope of his business or employment, and that the allowance of the deductions would frustrate the public policy embodied in sections 656 and 1005 of Title 18 of the United States Code.
To be deductible as an ordinary and necessary business expense, the expense must be both ordinary and necessary. One without the other is not enough. Lloyd v. Commissioner, 55 F.2d 942, 844. As the Supreme Court stated in Deputy v. du Pont, 308 U.S. 488, 497, ‘Congress has not decreed that all necessary expenses may be deducted. Though plainly necessary they cannot be allowed unless they are also ordinary.’ There is to our knowledge no ‘verbal formula that will supply a ready touchstone’ for determining whether an expense is ordinary and necessary. Welch v. Helvering, 290 U.S. 111, 115. And since the decided cases appear to turn on their own particular facts, a review of the great number of such cases would be burdensome rather than helpful.
The words ‘ordinary and necessary’ must be interpreted in their usual and everyday connotation, because ‘when it comes to construction of the statutory provision under which the deduction is sought, the general rule that ‘popular or received import of words furnishes the general rule for the interpretation of public laws' * * * is applicable.’ Deputy v. du Pont, supra at 493.
The answer to the question whether petitioner's payments to the bonding company were ordinary must be found in the facts leading up to the payments and supplying the basis therefor. ‘One of the extremely relevant circumstances (in determining whether an expense is ordinary) is the nature and scope or the particular business out of which the expense in question accrued. The fact that an obligation to pay has arisen is not sufficient. It is the kind of transaction out of which the obligation arose and its normalcy in the particular business which are crucial and controlling.’ Deputy v. du Pont, supra.
The petitioner's liability had its origin in his dealings with Walkington wherein the petitioner made out deposit slips indicating deposits which had not in fact been made, honored checks on an account lacking funds to pay them, and falsified bank records to conceal the shortage. As a result of these acts, the petitioner was indicted, and pleaded guilty to three counts alleging violation of sections 656 and 1005 of Title 18 of the United States Code. Two of the counts charged that the petitioner ‘with the intent then and there to injure and defraud said national bank, did unlawfully and wilfully misapply the moneys of said bank.’ It is well settled that the words ‘willfully misapplies' used in section 656 do not mean a mere act of maladministration such as neglect of official duty or indifference to the interests of the bank, an act which might subject the wrongdoer to personal liability for damages suffered by the bank or its shareholders. United States v. Britton, 108 U.S. 199, 206. Instead, there must be a willful misapplication with intent to injure and defraud the bank. Evans v. United States, 153 U.S. 584; United States v. Meyer, 266 F.2d 747; Seals v. United States, 221 F.2d 243; United States v. Matsinger, 191 F.2d 1014; Johnson v. United States, 95 F.2d 813; and Dow v. United States, 82 F. 904. There being no evidence to the contrary, and petitioner having pleaded guilty to counts in the indictment charging him with an intent to injure and defraud the bank, we have found as a fact that such was the case.
It does not seem to us ordinary for a bank manager to defraud his employer by crediting a depositor's account with fictitious deposits and by honoring overdrafts. These practices evidently were not approved of by the petitioner's employer and were not within the scope of his authority, otherwise there could not have been the conviction for violating section 656. See United States v. Klock, 210 F.2d 217. Since the respondent's determination is entitled to a presumption of correctness, the petitioner has the burden of proving that his actions were ordinary in the light of banking practice generally. This he has failed to do. Consequently, we hold that his payments to the bonding company are not deductible under section 162(a) of the 1954 Code or its predecessor in the 1939 Code, section 23(a)(1), regardless of whether or not they may have been ‘necessary’ within the meaning of those sections.
The petitioner relies heavily upon Commissioner v. Heininger, 320 U.S. 467, to demonstrate that the payments are deductible as ordinary and necessary business expenses. In that case, a dentist who operated a mail-order business was allowed to deduct his legal expense in unsuccessfully resisting the issuance of a civil fraud order by the Postmaster General barring him from using the mails. Unlike the petitioner here, the taxpayer in the Heininger case was seeking to defend his business against a court order which would have in effect destroyed it. The importance of this factor was recognized by the Supreme Court in the following discussion:
The government does not deny that the litigation expenses would have been ordinary and necessary had the proceeding failed to convince the Postmaster General that respondent's representations were fraudulent. Its argument is that dentists in the mail order business do not ordinarily and necessarily attempt to sell false teeth by fraudulent representations as to their quality; that respondent was found by the Postmaster General to have attempted to sell his products in this manner; and that therefore the litigation expenses, which he would not have incurred but for this attempt, cannot themselves be deemed ordinary and necessary. We think that this reasoning, though plausible, is unsound in that it fails to take into account the circumstances under which respondent incurred the litigation expenses. * * * Upon being served with notice of the proposed fraud order respondent was confronted with a new business problem which involved far more than the right to continue using his old advertisements. He was placed in a position in which not only his selling methods but also the continued existence of his lawful business were threatened with complete destruction. So far as appears from the record respondent did not believe, nor under our system of jurisprudence was he bound to believe, that a fraud order destroying his business was justified by the facts or the law. Therefore he did not voluntarily abandon the business but defended it by all available legal means. * * * (Emphasis supplied.)
Here, the petitioner was not, insofar as the record indicates, trying to retain his employment with the bank, and he makes no claim that he was, whereas the taxpayer in the Heininger case was attempting to prevent the destruction of his business.
Furthermore, the Heininger case is distinguishable upon another ground. The opinion of the Supreme Court specifically points out that the dentist was not convicted of a criminal violation, but was merely enjoined from using the mails. As the Court stated:
The single policy of these sections (under which the injunction was issued) is to protect the public from fraudulent practices committed through the use of the mails. It is not their policy to impose personal punishment on violators; such punishment is provided by separate statute, and can be imposed only in a judicial proceeding in which the accused has the benefit of constitutional and statutory safeguards appropriate to trial for a crime. * * *
On the other hand, the petitioner in the instant case was indicted and convicted of violating two criminal statutes, section 656 and section 1005 of Title 18 of the United States Code. Because of this distinction and the one referred to above, we do not believe the Heininger case is applicable here.
The petitioner also cites Helvering v. Hampton, 79 F.2d 358; William Ziegler, Jr., 5 T.C. 150; John Abbott, 38 B.T.A. 1290; and H. M. Howard, 22 B.T.A. 375, in support of the proposition that amounts paid as civil damages to a private individual are deductible. In each of those cases, the transaction out of which the civil liability arose was held to be an ordinary and necessary activity of the particular trade or business involved, there being no violation of a criminal statute. But we have found as a fact that the petitioner's dealings with Walkington were carried out with criminal intent to injure and defraud the bank and thus were not ordinary and necessary to his employment.
Nor are the payments deductible under section 165(a) and (c)(1) of the Internal Revenue Code of 1954 and section 23(e)(1) of the Internal Revenue Code of 1939, which provide for the deduction of losses ‘incurred in a trade or business.’ Even if the payments should be said to fall within the literal requirements of the statute, allowance of the deduction would, in our opinion, frustrate public policy under the existing facts. In Luther M. Richey, Jr., 33 T.C. 272, the taxpayer invested $15,000 in a scheme to duplicate United States $100 bills and was swindled out of his investment by his cohorts. He was denied a loss because of the sharply defined public policy against counterfeiting obligations of the United States. Likewise, there is an equally clear policy contained in sections 656 and 1005 designed to prevent willful misapplication of bank funds and falsification of bank records, and to punish such acts when and if they occur. The record establishes that the petitioner's conduct constituted a violation of these sections and that he was an active participant in the wrongdoing. Thus, on the basis of the Richey case, it is plain that the payments are not deductible as business losses.
In an alternative contention, the petitioner argues that the amounts paid to the bonding company as interest are deductible under section 163 of the 1954 Code and its predecessor in the 1939 Code, section 23(b), which provide for the deduction of ‘all interest paid or accrued within the taxable year on indebtedness.’ It is conceded by the respondent that deductions should be allowed under those sections, unless there would be a frustration of public policy. Citing Tank Truck Rentals, Inc. v. Commissioner, 356 U.S. 30, the respondent argues that ‘the interest, in effect, represents a penalty imposed on petitioner for causing the loss and deprivation of the use of the money’ which was misapplied. The fallacy in the argument seem apparent to us. The portion of each payment representing interest constitutes compensation to the bonding company for the use of its money, and is not of the nature of a penalty. We think it evident that a penalty such as that dealt with in Tank Truck Rentals, Inc., is a type of punishment inflicted by the Government upon a lawbreaker. See Jerry Rossman Corporation v. Commissioner, 175 F.2d 711. There is nothing punitive, in our opinion, in the requirement that the petitioner pay interest on his obligation to the bonding company, and the Tank Truck Rentals case lends no support to the respondent's position, since that case involved fines paid to the State of Pennsylvania, which were clearly penalties. Thus, we hold that the portions of the payments made by petitioner to the bonding company designated as interest are deductible.
An issue relating to the deductibility of claimed medical expenses was raised in the pleadings. It was neither pressed at the time of trial nor covered by petitioners on brief, and will be regarded as abandoned.
Decision will be entered under Rule 50.