author: GeeeN :

text:
    Edgar B. Terrell, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 3132.
    Promulgated July 29, 1927.
    Income. — Usurious Interest. — During 1919 and 1920 petitioner was engaged in making small loans in tlie States of Minnesota and Texas at usurious rates of interest. Under the laws in force in those States the payer of such interest could, within two years, sue and recover from the lender the amount of such interest paid.
    The petitioner also sustained losses with respect to some of the loans, hut the amount of interest received each year exceeded the amount of the losses. Held, that the amount of the interest received in excess of the losses is taxable and should be reported as gross income. Appeal of James P. McKenna, 1 B. T. A. 326; Appeal of Mitchell M. Frey, Jr., 1 B. T. A. 338.

      I. Herman Sher, Esq., for the petitioner.

      P. S. Crewe, Esq., for the respondent.
    In this proceeding the petitioner seeks a redetermination of his income-tax liability for the calendar years 1919 and 1920, for which the Commissioner has determined deficiencies in the sums of $176.78 and $443.48, respectively. Two errors are assigned in the petition: (1) That the Commissioner erred in including in the petitioner’s taxable income certain usurious interest; and (2) that the Commissioner erred in refusing to allow as deductions certain losses sustained in connection with such usurious loans.

      FINDINGS OF FACT.
    The petitioner is an individual residing in San Antonio, Tex., whose principal business address is 710 Phoenix Building, Minneapolis, Minn. Prior to and during the years 1919 and 1920, the petitioner was engaged in the business of making small loans in the States of Minnesota and Texas, evidenced principally by unsecured notes, at rates of interest which were usurious under the laws of those States.
    The loans made by the petitioner were divisible into two groups: (1) Those in which the loan was liquidated or was not paid at maturity, and a renewal was not made; and (2) those in,which renewals were made one or more times before the loan was liquidated or resulted in a loss to the petitioner. It was customary for the petitioner to include the interest and fees charged for the loan as a part of the amount of the note received by him for the loan, with the result that the amount of each note in the first class of loans included principal, interest, and fees, and the amount of each note in the second class consisted of principal, interest, and fees unpaid on the previous note or notes, plus the interest and fees on the new principal of the last loan.
    The petitioner kept his books of account upon the cash receipts and disbursements basis.
    The petitioner duly filed his income-tax returns for the calendar years 1919 and 1920, showing a net income and resulting tax liability for each of the years as follows:

    In determining the net income for 1919 and 1920, the petitioner included as taxable income the interest, fees, and charges on all usurious loans made in Texas and Minnesota on the first group of loans mentioned above as follows:

    In determining the petitioner’s net income for 1919 and 1920, the respondent included, in addition to the above amounts reported by the petitioner, the interest, fees, and charges on the notes contained in the second group. In so doing the respondent considered each renewal in the second group of loans as a new loan and held that each matured note was the equivalent of cash. The record does not show the amount of the interest, fees and charges that was actually received by the petitioner during the respective taxable years.
    The petitioner, in connection with his usurious-loan business, sustained certain losses in the amounts of $1,580.80 and $3,056.42 for 1919 and 1920, respectively, by reason of the worthlessness, unen-forcibility and uncollectibility of some of the loans.
    In determining the petitioner’s taxable net income for 1919 and 1920 the respondent allowed as deductions on account of the above mentioned losses, only the amounts of $288.26 and $345.94 for 1919 and 1920, respectively, which represented the principal only of all loans made in Texas, and disallowed the balance of $1,292.54 and $2,710.48 for 1919 and 1920, respectively, consisting of the principal of loans made in Minnesota and the interest on such loans made in eitlyer State which he included as taxable income in computing net income.
    The Texas statutes in force during the years 1919 and 1920 provided that contracts for usurious interest were void as far as the interest only was concerned but that the principal of the loan could be recovered. They also provided that the payer of usurious interest could, by action of debt, within two years after payment, recover double the amount of usurious interest paid.
    The Minnesota statutes in force during the years 1919 and 1920 provided that contracts for usurious interest were void as to both principal and interest except as to bona fide purchasers of negotiable paper, in good faith, for a valuable consideration and before maturity. They also provided that the payer of usurious interest could, within two years after payment, recover the amount of such usurious interest paid, provided that one-half of the amount so recovered was to be paid into the treasury of the county where collected for the use of the common schools.
   OPINION.

GeeeN :

The petitioner’s argument with respect to the first assignment of error is substantially that in accordance with Eisner v. Macomber, 252 U. S. 189, no part of the usurious interest, fees or charges here in question is income within the Sixteenth Amendment for the reason that, according to the petitioner, he received nothing of exchangeable value “ for his separate use, benefit and disposal ” in that immediately upon receipt thereof he became liable under the statutes of Texas and Minnesota to pay back to the borrower at least the amount of the interest received; that at best no income could be said to have been realized until after the expiration of the two-year period within which the borrower could sue and recover back the amount of interest paid; that even at the end of the two-year period the petitioner realized no income because the failure of the borrower to sue amounted to a forgiveness of indebtedness on his part and a gift by the borrower to the lender; that under the Revenue Act of 1918 gifts are exempt from taxation; and that if all of the aforegoing contentions should fail, then, since he reported on the cash basis, only the amount of interest, fees and charges actually received during the respective taxable years was taxable income.

All of the foregoing contentions, with the exception of the very last one, have already been considered by this Board in the Appeal of James P. McKenna, 1 B. T. A. 326, in which we held that wagers won by a race-track bookmaker were income within the Sixteenth Amendment and taxable under the Revenue Act of 1918 in the year in which received, although under the laws of the State of Kentucky a loser could, within a certain period, recover his losses from the bookmaker. What we said there is controlling here. See also the following decisions holding that gains from dealings in illicit liquor are taxable. Steinberg v. United States, 14 Fed. (2d) 564; 5 Am. Fed. Tax Rep. 6160; United States v. Sullivan, 274 U. S. 259.

On the last contention regarding the first assignment of error the petitioner has failed in his proof. The record contains no evidence as to the amount of interest, fees, or charges actually received during the years in question or the amounts of interest, fees or charges on renewal notes which were not paid during either of those years. Without proof we can not disturb the Commissioner’s determination.

In connection with the second assignment of error we believe that the Commissioner erred in not permitting the petitioner to deduct from the gross receipts of usurious interest, fees, and charges the full amounts of losses actually sustained on such loans during 1919 and 1920 since the gross receipts as found by the Commissioner were in excess of the losses for each of those years. Appeal of Mitchell M. Frey, Jr., 1 B. T. A. 338; Appeal of M. L. Heide, 2 B. T. A. 451.

The deficiencies should be redetermined by deducting from the gross receipts of interest, fees, and charges for 1919 and 1920 losses in the amounts of $1,292.54 and $2,710.48 respectively.

Judgment will be entered upon 15 days’ notice, under Bule 50.

Considered by AkttNdell and SteeNhageN.


source: Caselaw Access Project

author: Green:

license: Public Domain

text:
    A. C. Kreipke, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 10716.
    Promulgated July 29, 1927.
    1. The petitioner was engaged in the general contracting business. He erected under contracts buildings, power plants, and other structural work for the State of Oklahoma and private citizens. His duties were prescribed and his compensation fixed by the contracts. Held, that the petitioner was not an officer or employee of the State of Oklahoma and the compensation paid to him by the State was subject to Federal income tax.
    2. Upon the evidence, held that the petitioner was justified in charging off as a bad debt in 1922 an amount of $12,502.46, representing expenditure made by him in 1922 for labor and materials in commencing the erection of certain additions and alterations to a high school building at El Reno, Oklahoma.

      Claude Collard, Esq., for the petitioner.

      Arthur H. Murray, Esq., for the respondent.
    In this proceeding the petitioner seeks a redetermination of his income-tax liability for the calendar year 1922, for which the Commissioner has determined a deficiency in the sum of $9,281.23.
    Two issues are presented: (1) Whether the Commissioner erred in including in the petitioner’s income for the calendar year 1922 compensation received from certain contracts with the State of Oklahoma and/or its political subdivisions; and (2) whether the Commissioner erred in refusing to allow as a deduction from gross income in 1922 an amount of $12,502.46 claimed by the petitioner as a bad debt.
    FINDINGS OP PACT.
    The petitioner has resided in the State of Oklahoma since the year 1900, and has been continuously engaged in the contracting business for the last 35 years. During this period, he has devoted most of his time to the erection of court houses, public school buildings and other public and private structures in the States of Arkansas, Texas, New Mexico, and Oklahoma and in the Republic of Mexico. Throughout this period, and particularly during the years from 1919 to 1922, inclusive, he maintained an organization consisting of a graduate structural engineer, a heating and plumbing engineer, an auditor, bookkeeper, stenographer and various superintendents of construction. By reason of past experience and a thorough study of the construction business the petitioner was, during the years 1919 to 1922, inclusive, familiar with the quality and nature of the materials, labor, expenses, and costs incident to the construetion of both public and private buildings, and with the state laws relating thereto.
    Beginning in the year 1919 and continuing throughout the years 1920, 1921, and 1922, the petitioner entered into, and consummated in the year 1922, certain contracts for the erection and construction of public buildings and other projects for the State of Oklahoma and/or its several political subdivisions, a summary description and statement of profits from which follow:
    Description: Amount of profit
    Enici Dam_ _$4, 541. 36
    Goodwell Science Hall-_ 2, 552. 85
    Livingston School Building-_ 2, 784. 71
    Repairs — -State Capitol Building _ 73.68
    Pauls Valley Training School— _ 5, 024. 71
    Stillwater School Building-_ 15,283. 25
    Tonkawa Wilkin Hall-390. 04
    Warehouse — Adjutant General _ _ 4, 004. 37
    Total_ 34, 654. 97
    Each of the above-mentioned contracts was executed on the same kind of a printed form and was similar in all essential and material respects. Each, with the one exception of the high school building at El Beno (involved in issue No. 2), provided for compensation at cost of construction plus 10 per cent.
    The Pauls Valley Training School contract is set out in full as follows:
    UNIFORM CONTRACT ADOPTED AND RECOMMENDED FOE GENERAL USE BY THE American Institute of Architects and the National Association of Builders
    Charles P. Nieder, Architects.

    This Agreement, Made and entered into, this seventh day of June in the year of one thousand nine hundred and twenty by and between Kreipke-Schafer Co., a co-partnership, consisting of A. C. Kreipke and Henry Schafer of M Reno, Oklahoma, party of the first part (hereinafter designated the Contractor), and The State of Oklahoma acting through the State Board of Public Affairs, party of the second part, (Hereinafter designated the Owner.)
    Witnesseth, That the Contractor in consideration of the fulfillment of agreements herein made by the Owners, agrees with the said Owners, as follows:
    Article X. The Contractor under the direction and to the satisfaction of Charles P. Nieder, or owner, Architects, acting for the purposes of this contract as agents of the owner, shall and will provide all the materials and perform all the work mentioned in the specifications and shown on the drawings prepared by said Architects, for the installation of laundry equipment and other necessary repair work for the State Training School for Boys at Pauls Valley, Oklahoma, which drawings and specifications are identified by the signatures of the parties hereto.

      Art. II. The Architect shall furnish to the Contractor such further drawings or explanations as may be necessary to detail and Illustrate the work- to be done, and the Contractor shall conform to the same as part of this contract so far as they may be consistent with the original drawings and specifications referred to and identified, as provided in Art. I.
    It is mutually understood and agreed that all drawings and specifications are and remain the property of the Architect.
    Art. III. No alterations shall be made in the work as shown or described by the drawings and specifications, except upon a written order of the Architects, and when so made, the value of the work added or omitted shall he computed by the architects, and the amount so ascertained shall be added to or deducted from the contract price. In the case of dissent from such award by either party hereto, the valuation of the work added or omitted shall be referred to three (3) disinterested Arbitrators, one to be appointed by each of the parties to this contract, and the third by the two thus chosen, the decision of any two of whom shall be final and binding, and each of the parties hereto shall pay one-half of the expenses of such references.
    Art. IY. The Contractor shall provide sufficient, safe and proper facilities at all times for the inspection of the work by the Architects, or their authorized representatives. I-Ie shall, within twenty-four hours after receiving written notice from the Architects to that effect, proceed to remove from the grounds or buildings all materials, whether worked or unworked, and to take down all portions of the work which the Architects shall by like written notice condemn as unsound or improper, or as in any way failing to conform to the drawings and specifications.
    Art. V. Should the Contractor at any time refuse or neglect to supply a sufficiency of properly skilled workmen, or of materials of the proper quality, or fail in any respect to prosecute the work -with promptness and diligence, or fail in the performance of any of the agreements herein contained, such refusal, neglect or failure being certified by the Architects, the Owner shall be at liberty, after days’ written notice to the Contractor, to provide any such labor or materials, and to deduct the cost thereof from any money then due or thereafter to become due to the Contractor under this contract; and if the Architects shall certify such refusal, neglect or failure is sufficient grounds for action, the Owner shall also be at liberty to terminate employment of the Contractor for the said work and to enter upon the premises, and take possession, for the purpose of completing the work included under this contract, of all materials, tools and appliances thereon, and to employ any other person or persons to finish the work, and to provide the materials therefor; and in case of such discontinuance of the employment of the Contractor, he shall not be entitled to receive any further payment under this contract until the said work shall be wholly finished, at which time, if the unpaid balance of the amount to be paid under this contract shall exceed the expense incurred by the Owner in finishing the work, such excess shall be paid by the Owner to the Contractor; but if such expense shall exceed such unpaid balance, the Contractor shall pay the difference to the Owner. The expense incurred by the Owner as herein provided* either for furnishing materials or finishing the work, and any damage incurred through such default, shall be audited and certified by the Architects, whose certificate thereof shall be conclusive upon all parties.
    Art. YI. The Contractor shall complete the several portions, and the whole of the work comprehended in this Agreement by and at the time or times hereinafter stated. Work shall begin at once by purchasing and assembling of necessary materials to properly progress the work, provided that the architect, by order of the owner, shall have the right to order suspension of the work at any time he may desire.
    Art. VII. Should the Contractor be obstructed or delayed in the prosecution or completion of his work by the act, neglect or default of the Owner or the Architect, or of any other Contractor, employed by the Owner upon the work, or by any damage which may happen by fire, lightning, earthquake or cyclone, or by the abandonment of the work by the employes through no fault of the Contractor, then the time herein fixed for the completion of the work shall be extended for a period equivalent to the time lost by reason of any or all causes aforesaid; but ho such allowance shall be made unless a claim therefor is presented to the Architects within twenty-four hours of the occurrence of such delay. The duration of such extension shall be certified to by the Architects, but appeal from their decision may be made to arbitration, as provided in Art. Ill of this contract.
    Art. VIII. The Owner agrees to provide all labor and materials not included in this contract in such manner as not to delay the material progress of the work and in event of failure to do so, thereby causing loss to the Contractor, agrees that he will reimburse the Contractor for such loss; and the Contractor agrees that if he shall delay the material progress of the work so as to cause any damage for which the Owner shall become liable (as above stated), then he shall make good to the Owner any such damage. The amount of such loss or damage to either party hereto shall, in every case, be fixed and determined by the Architects, or by arbitration, as provided in Art. Ill of this contract.
    Art. IX. It is hereby mutually agreed between the parties hereto that the sum to be paid by the Owner to the Contractor for said work shall be — -It is understood and agreed that the contractor shall agree with the architect on the amount and extent of the work to be performed so that the cost of such work shall not exceed the available funds as set out for General Repairs and Equipment, subject to additions and deductions as hereinbefore provided, and that such sums shall be paid in current funds by the Owner to the Contractor in installments, as follows: — The actual cost of materials, labor and expense incurred in the said work, plus ten percent as compensation for contractors service or fee. Payments shall be made by the owner to the contractor monthly as follows: During the construction of the work, the architect or an authorized representative of the owner shall, with the contractor, audit all accounts of labor, materials, freight or items of expense that form a part of the actual cost of such work, plus ten percent, for payment. Said voucher to be signed by both the architect, or owner’s representative, and the contractor accompanied with the architect’s certificate for such amount, which shall be presented to the State Board of Public Affairs for their audit and order on State Auditor for payment. All cost of transportation of machinery needed for the construction of this work shall be paid by the party of the first part.
    The final payment shall be made within 10 days after this contract is fulfilled.
    All payments shall be made upon written certificates of the Architects to the effect that such payments have become due.
    If at any time there shall be evidence of any lien or claim for which, if established, the Owner of the said premises might become liable, and which is chargeable to the Contractor, the Owner shall have the right to retain out of any payment then due or thereafter to become due, an amount sufficient to completely indemnify him against such lien or claim. Should there prove to be any such claim after all payments are made, the Contractor shall refund to the Owner all moneys that the latter may be compelled to pay in discharging any lien on said premises made obligatory in consequence of the Contractor’s default.
    Art. X. It is further mutually agreed between the parties hereto that no certificate given or payment made under this contract, except the final certificate or final payment, shall be conclusive evidence of the performance of this contract, either wholly or in part, and that no payment shall be construed to be an acceptance of defective work or improper materials.
    Art. XI. The Owner shall, during the progress of the work, maintain full insurance on said work, in his own name and in the name of the Contractor, against loss or damage by fire, lightning, earthquake, cyclone or other casualty. The policies shall cover all work incorporated in the building, and all materials for the same in or about the premises, and shall be made payable to the parties hereto, as their interest may appear.
    Art. XII. The said parties, for themselves, their heirs, executors, administrators and assigns, do hereby agree to the full performance of the covenants herein contained.
    In Witness Whereof, The parties to these presents have hereunto set their bands and seal, the day and year first above written.
    In presence of
    (Sgd) Kreipke-Schafer Co. [seal]
    A. C. Kreipke [seal]
    Geo. T. Clark [seal]
    H. V. Bisel [seal]
    Approved: June 12, 1920
    In the actual performance of the contracts, the architect and other representatives of the State of Oklahoma and/or its political subdivisions were at times on the premises and ordered certain changes and modifications of the general plans and arrangements of construction. While general plans and specifications were used, such plans were not at all times carried out literally.
    There was no fixed period of time for the completion of the work under these contracts, and the petitioner’s employment thereunder extended over a period from one to three years, depending upon the time required to assemble materials and labor.
    The petitioner devoted the major portion of his time to the performance of these contracts, but was at all times free to accept any other private employment.
    In the performance of his prescribed duties under the terms and provisions of the contracts, the petitioner obtained prices on materials, arranged for labor for the installation of materials, looked after the general contracts.in a general way, paid all labor and material bills when due and saw to it that the orders of the several state boards and other representatives of the State and its political subdivisions, were carried out.
    Although under the laws of the State of Oklahoma, a general contractor is required to furnish a bond with respect to all building contracts, the purpose of said bond being to guarantee the perform-anee of the contract by the contractor in strict conformity with plans and specifications and to indemnify the owner against unliquidated liabilities of the contractor, no contractor’s bond was required of the petitioner with respect to any of the contracts.
    In pursuance of the terms of the contracts, the petitioner paid all labor and material bills upon receipt of invoices therefor, after which, such invoices, having been receipted by the proper parties, were filed with the proper officers of the state or political subdivision thereof. Vouchers covering the actual costs of all labor, materials, and expenses plus 10 per cent as compensation, were then issued to reimburse the petitioner.
    In performing services under these contracts, the petitioner upon the advice and with the consent of the State or political subdivision thereof, made certain subcontracts.
    In carrying out these contracts and upon instructions of representatives of the State, the petitioner did not pay to the United States Treasury Department any so-called war tax on freight shipments of materials, such materials being considered the property of the State or political subdivision thereof.
    As a general proposition, an independent contractor in making bids, on contracts includes in his estimate 10, 12 or 15 per cent in addition to actual costs of construction to cover profits, losses and overhead expenses. At the time of making the contracts in question, the petitioner did not consider that his income therefrom was subject to a Federal income tax and such consideration was material in the making of such contracts and the fixing of the basis for and measure of his compensation.
    The Commissioner determined that the petitioner’s income from the contracts in the sum of $34,654.97 constituted taxable income for the year 1922.
    In the month of January 1922, the petitioner entered into a contract with the District School Board of the City of El Reno, Okla., for the erection of additions and alterations to a high school building. Article IX of the agreement provides in part as follows:
    Art. IX. It is hereby mutually agreed between the parties hereto that the sum to be paid by the Owner to the Contractor for said work shall be $155,000.00 (One hundred fifty-five thousand and no/100 dollars), subject to additions and deductions as hereinbefore provided, and that such sums shall be paid by the Owner to the Contractor in installments, as follows:
    Ninety per cent (90%) of the value of all labor performed and material incorporated in the building and on the building site to be paid every thirty (30) days upon certificates issued by the Architects.
    It is understood and agreed that the funds out of which the contractor is to be paid, are now represented by time certificates of deposit issued by the Commercial Bank of the City of El Reno, in amounts as follows: Certificates amounting to $19,000.00 due May 1st, 1922. $25,000.00 due June 1, 1922 and $25,000.00 due the 1st of each of the succeeding months, July, August, September, October and November, and the contractor is to receive his pay in these certificates of deposit without interest, that is to say that any interest which may accrue on said certificates of deposit is to be paid to the owner.
    The final payment shall be made within ten (10) days after this contract is fulfilled.
    During March 1922, the Commercial Bank failed, and was taken over and managed under the Oklahoma State Banking Department. The petitioner then ceased work on the contract, pending the outcome of the liquidation of the bank. Up to the time of cessation of the contract, the petitioner had expended $12,502.46 on account of materials and labor on this contract.
    The petitioner, in pursuance of the terms and provisions of the contract, was entitled to receive as compensation the certificates of deposit. These he never received at any time during the year 1922 or later years. Upon personal investigation made by the petitioner in the year 1922 it developed that the certificates of deposit were worthless. They were not secured by an indemnity bond as required by law. The Commercial Bank was insolvent to the extent that holders of interest-bearing certificates of deposit issued by it would never realize anything thereon.
    The petitioner, during the year 1922, ascertained that the transaction by which the school bonds were deposited with the Commercial Bank in exchange for unsecured certificates of deposit was illegal by reason of which certain officers of the bank had been indicted.
    Further investigation made during the year 1922 disclosed the fact that the Commercial Bank had exchanged the District School bonds for bonds of a defunct oil company; and that the bonds of such oil company were worthless. Representatives of the school board attempted to negotiate with the petitioner for the acceptance of the bonds of said oil company in lieu of the certificates of deposit. The petitioner refused to accept such oil company bonds for the reason that the same were worthless.
    The petitioner having determined from investigations that his claim against the school board in the sum of $12,502.46 was worthless, the same was charged off during the year 1922 and claimed as a deduction in his income-tax return. The Commissioner disallowed the deduction.
    During the year 1923, the school board by some method unknown to the petitioner was successful in having its certificates of deposit converted into an ordinary checking account and were then in a position to realize a part of their claim against the bank. The school board, in 1923, paid the petitioner the $12,502.46 previously advanced by him, which the petitioner reported as income in his 1923 return. During the year 1922, the petitioner had no knowledge or information that he would realize on his claim in this manner.
   OPINION.

Green:

The two issues presented in this appeal are: (1) Whether the income of $34,654.97 received by the petitioner during 1922 from the State of Oklahoma and/or its political subdivisions is taxable under sections 210, 211, 212 and 213 (a) of the Revenue Act of 1921, or whether it is nontaxable under section 1211 of the Revenue Act of 1926; and (2) whether the petitioner was justified in charging off as a bad debt in 1922 the amount of $12,502.46 expended by him in connection with the El Reno High School contract.

Section 1211 of the Revenue Act of 1926 provides that—

Any taxes imposed by the Revenue Act of 1924 or prior revenue Acts upon any individual in respect of amounts received by bim as compensation for personal services as an officer or employee of any State or political subdivision thereof (except to the extent that such compensation is paid by the United States Government directly or indirectly), shall, subject to the statutory period of limitations properly applicable thereto, be abated, credited, or refunded.

Based on the facts as set out in the findings, we are of the opinion that the petitioner was neither an officer nor an employee of the State of Oklahoma or any of its political subdivisions. The facts in this case are practically on all fours with the facts in Fred H. Tibbetts, 6 B. T. A. 827, in which we held that certain compensation received by Tibbetts from the State of California was taxable income and not exempt under section 1211, supra, and that an imposition of a tax on Tibbetts on such income did not amount to an interference with the exercise of Governmental functions by the State or its political subdivisions. What we said there is controlling here. See also Union Paving Co., 6 B. T. A. 527; Robert G. Gordon, 5 B. T. A. 1047; Emma B. Brunner, 5 B. T. A. 1135. It follows that the $34,654.97 in question was taxable income to the petitioner in 1922.

Concerning the second issue, the facts show that prior to the month of January, 1922, the El Reno Board of Education of the State of Oklahoma allowed to be issued certain district school bonds for the purpose of erecting in the City of El Reno, an addition to a high school building. Such bonds were shortly thereafter deposited with the Commercial Bank of El Reno and unsecured interest-bearing certificates of deposit of said bank issued in connection therewith. In the same month, the board of education entered into a written contract with the petitioner for the erection of the additions to the school building, the contract providing that the petitioner should receive his compensation in the form of the certificates of deposit. Pursuant to the contract, the petitioner began construction work and proceeded with the same until the month of March, 1922, at which time the affairs oí the Commercial Bank were taken over by the Oklahoma State Banking Department. It having been reported that the bank was in a failed condition, the petitioner ceased construction work under the contract, up to which time he had incurred expenses and costs of $12,502.46.

During the year 1922, the petitioner made numerous efforts to realize on his claim, but without success. Investigations made during said year developed the fact that the Commercial Bank was insolvent to the extent that nothing would ever be realized by holders of its certificates of deposit, that the district school bonds had been exchanged by the Commercial Bank for worthless bonds of a defunct oil company, that certain officers of the bank and board of education had been indicted because of illegal transactions pertaining to the district school bonds and that for such reason the certificates of deposit were worthless. Having made efforts in the year 1922 to realize on his claim, the petitioner concluded that it was worthless and charged off same as a deduction for bad debts on his Federal income-tax return.

The petitioner having made repeated and unsuccessful efforts to realize on his claim and having exercised reasonable efforts to ascertain its worthlessness, the same in our opinion constitutes an allowable deduction from gross income. Appeal of John E. Saddler, 2 B. T. A. 1305; Appeal of Pacific Pipe & Supply Co., 2 B. T. A. 870; Appeal of Stieglitz Trieber Co., 1 B. T. A. 452; Appeal of Huning Mercantile Co., 1 B. T. A. 130; Appeal of T. J. Donahoe, 2 B. T. A. 355; Appeal of Egan & Hausman Co., 1 B. T. A. 556; Appeal of C. S. Webb, Inc., 1 B. T. A. 269; Appeal of Alemite Die Casting c& Manufacturing Co., 1 B. T. A. 548.

Judgment will be entered on 15 days’ notice, under Rule 50.

Considered by Sterni-iagen and AruNdell.


author: Lansdon :

text:
    Real Estate & Trust Co. of Philadelphia and Samuel M. Gayley, Executors, Estate of George W. Milliken, Petitioners, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 10123.
    Promulgated July 29, 1927.

      Howard Burtt, Esq., for the petitioners.

      R. E. Copes, Esq., for the respondent.
    The respondent has asserted a deficiency in estate tax in the amount of $94.74. The petitioner alleges that the respondent erred in reducing the amount of charitable bequests deductible under the Federal estate tax law by the collateral inheritance tax thereon paid to the Commonwealth of Pennsylvania. The proceeding was submitted on the pleadings, with a copy of the will of the decedent, which the parties agreed should be received in evidence.
    FINDINGS OF FACT.
    George W. Milliken, the decedent, died \ resident of the Commonwealth of Pennsylvania on May 25, 1924. He left a will providing for the settlement and distribution of his entire estate, and such will was duly probated, and the provisions thereof put into effect.
    The will of the decedent provided for many charitable bequests in the total amount of $75,000, among which were two bequests, totaling $8,000, to the Leckpatrick Episcopal Church of County Tyrone, Ireland. In a codicil of the will, the decedent said:
    I do not wish any inheritance taxes paid out of my estate, except those on (lie bequests to Leckpatrick Episcopal Church * * *
    In the inheritance-tax return rendered by the executors the total of all bequests to charity, in the amount of $75,000, was deducted from the gross estate of the decedent. Upon audit of such return, the respondent reduced said deduction to the amount of $68,800 by disallowing the Pennsylvania collateral inheritance taxes on all the charitable bequests, except that made to the Leckpatrick Episcopal Church, and determined the deficiency here in controversy.
   OPINION.

Lansdon :

We are of the opinion that the issue here is conclusively determined on principle by our decision in the Appeal of Howard K. Walter, 2 B. T. A. 453.

Judgment will l>e entered for the petitioner on 15 days’ notice, under Rule 50.

Considered by Lansdon, Steenhagen, GREen, and ARundell.


author: Littleton :

text:
    Powers Manufacturing Co., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 7766.
    Promulgated July 29, 1927.
    1. Advances made to a company which was furnishing material to the petitioner, held, in this ease, to represent loans and not a part of the cost of goods purchased.
    2. Where the debtor corporation is yet in existence as an operating company with substantial assets and the creditor is continuing to make advances, held that the worthlessness of prior advances . has not been established.
    3. Loss denied for lack of proof as to when the transaction in question occurred.

      John T. Sullivan, Esq., for the petitioner.

      Thomas P. Dudley, Jr., Esq., for the respondent.

      This proceeding involves a deficiency of $378.47 for the fiscal year ended July 81, 1920, and also a claim in abatement of $11,465.64 on account of additional taxes assessed, but not paid, for 1917, the period January 1,1918, to July 31,1918, and fiscal year ended July 31, 1919.
    FINDINGS OF FACT.
    The petitioner is a corporation organized under the laws of Iowa, with its principal place of business at Waterloo, where it is engaged in the business of manufacturing canvas horse collars and other articles requiring the use of canvas.
    In 1917, the petitioner was having difficulty in securing duck with which to carry on its manufacturing operations and similar difficulty was being experienced by Couch Brothers Manufacturing Co., a corporation in Atlanta, Ga., which was engaged in a similar line of business. The shortage of a supply of this material was due to the fact that the United States Government was taking over all available material of this type for war use. The Couch Brothers Manufacturing Co. proposed to the petitioner that it (the Couch Brothers Manufacturing Co.) would organize a company, erect a plant, and manufacture the needed material.. A corporation, Couch Mills Co., was organized and proceeded to erect buildings, purchase and install machinery and manufacture cotton duck. To carry out the building and installation operations, as well as supply money for general operations of the plant, cash advances were made to the Couch Mills Co. by the petitioner as follows: latter part of 1917, $10,000; during 1918, $10,000, and in 1919, $35,000. The first two amounts were evidenced by promissory notes, though no note or written obligation was furnished for the last-named amount.
    The Couch Mills Co. agreed to furnish material to the petitioner, which was done, such material being billed to the petitioner at current market prices and payment being made for same weekly as shipments were made.
    Couch Mills Co., after repeated requests from the petitioner for payment of these advances, issued stock to the petitioner to apply on account thereof, though the stock was of doubtful value. The Couch Mills Co. failed in 1921 and the petitioner realized nothing on account of the $55,000 cash advances which it had made. The liability of the Couch Mills Co. was carried on the books of the petitioner until the former company was finally liquidated in 1921.
    In Í916 or 1917, the petitioner acquired stock in the Iowa-Alabama Farms Co. (hereinafter referred to as the Farms Company), a corporation owning land in Alabama and Iowa, where it was engaged chiefly in farming operations. These operations were not successful, it being necessary for the petitioner and R. M. Gunn, who were the principal stockholders after 1916, to make advances on various occasions to carry on the business of the company. The advances which had been made by the petitioner to July 31, 1918, amounted to approximately $12,000.
    In 1918, but prior to July 31, 1918, an option was given by the Farms Company for the sale of one-half of the Alabama land at $30 per acre, which land was mortgaged to the extent of $22.50 per acre. While the option was not exercised prior to July 31, 1918, the petitioner was informed prior to this time that it would be exercised and, accordingly, charged off its advances as a loss for the fiscal year ended July 31,1918.
    The sale was actually made in the following year. Later, the remainder of the land in Alabama was exchanged for land in Iowa. The Farms Company continued in existence for several years beyond the years involved in this proceeding and during all years the petitioner made advances to aid in its operations.
    In addition to the charge-off of approximately $12,000 for the ficsal year ended July 31,1918, $2,503.01 was charged off and claimed as a deduction for the fiscal year ended Jxxly 31, 1920, which represented similar advances made to, and interest paid for, the Farms Company.
    During the World War, the petitioner purchased Liberty bonds of a par value of $10,000. In order to secure a part of the money to pay for them, it borrowed $8,000 from a bank, giving its note as evidence of the indebtedness and leaving the bonds with the bank as collateral. The note had not been paid on July 30, 1920, when the petitioner instructed the bank to sell the Liberty bonds and discharge the note. The bonds were sold by the bank, and credit was given on the note as paid on August 2, 1920, to which date interest was computed on the note by the bank. The canceled note was returned to the petitioner and entry made on its books on August 3, 1920. Petitioner claimed a loss of $1,450 in the fiscal year ended July 31, 1920, on account of this transaction.
   OPINION.

Littleton :

The first issue in this case is whether the Commissioner was in error in refusing to allow the petitioner to consider the amounts advanced to the Couch Mills Co. in 1917, 1918 and 1919, as a part of the cost of goods purchased from this company in these years.

While the facts are not entirely clear as to all understandings between the petitioner and Couch Mills Co., with respect to these advances, it is clear that the parties themselves treated it as a loan and so at all times acted with respect thereto. Apparently, the petitioner made the loans on the assurance that when the Couch Mills Co. started operations, the petitioner would be supplied with material necessary for its operations, which it was difficult, if not im]pos-sible, to obtain at that time elsewhere. The fact, however, that this was what induced the petitioner to make the loan does not change its character. The first two amounts were evidenced by promissory notes and, as to the entire $55,000, the evidence is conclusive to the effect that the petitioner not only expected the repayment of the amount advanced but also, on various occasions, sought to obtain repayment. Whatever materials were furnished the petitioner were paid for at market prices and no attempt was made to credit the advances on the purchase price thereof. Certainly, if the Couch Mills Co. had been successful and could have repaid these advances as requested by the petitioner, it could not have been said that this represented income from a business transaction or have had any effect on the cost of goods sold — it would have been the mere liquidation of a liability. Whatever loss the petitioner suffered was sustained when the debt was proven worthless. The action of the Commissioner as to this issue must, therefore, be sustained.

The second issue involves the deductibility of certain advances to the Iowa-Alabama Farms Co. charged off as worthless in the period ended July 31, 1918, and fiscal year ended July 31, 1920.

The evidence shows that prior to July 31, 1918, advances had been made to the Farms Company, and that prior to this time an option had been given for the sale of a part of the land owned by the Farms Company, which the petitioner was informed, prior to July 31, 1918, would be exercised. The petitioner apparently decided that on the basis of the amount which would be realized from a sale of a part of the land, recovery could not be had on the advances previously made and charged them off as worthless. At this time the option had not been exercised and even outside of the part covered by the option, the Farms Company had 1,500 acres of land. Not only did the Farms Company continue in existence throughout 1919 when the option was exercised, but also the petitioner continued to make advances for carrying on its operations for at least several years beyond the years on appeal. The remainder of the land was later exchanged for other land which the evidence shows is being farmed at the present time — apparently by the Farms Company.

A requirement of the statute which the petitioner must meet in order to become entitled to the deduction here claimed is that the debt be “ ascertained to be worthless ” in the taxable year. The debtor corporation was in existence during the taxable year as an operating company with substantial assets, and the petitioner continued to make similar advances.

The Board is of the opinion that the evidence is insufficient to satisfy the burden imposed upon the petitioner of showing the worthlessness of these debts as a condition precedent to securing the benefit of the deduction claimed, and, therefore, the action of the Commissioner in denying the deduction must be sustained. Winthrop Ames, 1. B. T. A. 63; Steele Cotton Mill Co., 1 B. T. A. 299; Alemite Die Casting & Manufacturing Co., 1 B. T. A. 548.

The last issue is whether the petitioner is entitled to a loss in the fiscal year ended July 31, 1920, on account of a certain sale of Liberty bonds. The amount does not seem to be in question, the issue being whether the sale was made prior to July 31, 1920. The petitioner relies on the fact that on July 20, 1920, it instructed the bank to sell the bonds and argues that it is customary for banks to make almost immediate sale of such securities, instead of waiting almost two weeks.

No deductible loss was sustained until the bonds were sold, and in the absence of evidence showing that the bonds were sold within the fiscal year ending July 31, 1920, instead of on August 3, 1920, the Commissioner’s determination is approved.

Judgment will be entered for the respondent.

Considered by Littleton, Love, and Smith.


author: Marquette :

text:
    Kittie A. Knapp, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 2775.
    Promulgated July 29, 1927.
    Tlie excess of deductions for depletion based on minimum royalties, over the actual depletion sustained, does not constitute income to a lessor in the year in which the lease is abandoned.

      Frank W. Wilson, G.P. A., for the petitioner.

      ■John IF. Fisher, Esq., for the respondent.
    This proceeding is for the redetermination of a deficiency in income tax for the year 1919 in the amount of $550.67, and is based upon an alleged error of the Commissioner in adding to income in that year the difference between the depletion claimed by the petitioner upon minimum royalties received by her as one of the lessors of an iron mine, and the actual depletion of the mine when it was abandoned in 1919.
    FINDINGS OF FACT.
    The petitioner is the owner of an undivided interest in the fee of an iron mine in Minnesota. This mine was leased on September 4, 1912, on a royalty basis, the lease providing for a minimum payment each year of 50,000 tons of ore. The lease was abandoned by the lessee in the year 1919. In each of the years except 1913 and 1919, the petitioner was paid royalties on the minimum royalty basis, but in none of the years to the time the lease was abandoned, did the lessee mine and ship the minimum requirement of the lease. The petitioner, in computing the depletion allowance in each year, deducted depletion on the basis of the minimum royalties, which deductions were allowed by the respondent. Upon the abandonment of the lease in 1919, the respondent computed depletion actually sustained from the date of the lease to its abandonment and deducted the amount thereof from the depletion allowed the petitioner over the same period on the basis of the minimum royalties, and added the difference to income for the year 1919.
    The following tables show the royalties reported as income by the petitioner, royalties received by her, tons of ore paid for, tons of ore shipped, depletion claimed by the petitioner, depletion allowed by the respondent, and the petitioner’s income for the year 1919 as computed by the respondent:

    Net income reported on return_$6, 295.08
    Royalties not reported-$2, 971.18
    Depletion allowed on the royalty_ 1,163.01
    Difference to be added to net income_ 1,808.17
    Depletion allowed petitioner to date of surrender of lease. 7, 323. 01
    Depletion sustained by petitioner to date of surrender of lease_ 4, 533. 91
    Difference to be added to net income_ 2, 789.10
    Total net income subject to tax_ 10, 892. 35
   OPINION.

Marquette :

It is the contention of the petitioner that under section 5(a) Eighth (b) of the Revenue Act of 1916, as amended by the Revenue Act of 1917, she was entitled to a deduction for depletion “ not to exceed the market value in the mine of the product thereof which has been mined and sold during the year for which the return and computation was made ”; and that the respondent was in error •in adding to income for the year 1919, when the lease was abandoned, any greater amount than the difference between the depletion properly allowable to her for prior years under that section of law, and the amount of depletion actually sustained in those years. On the other hand, ,the respondent contends that his action in increasing the petitioner’s income for the year 1919 was proper, and he relies upon article 215(d) of Regulations 45 (1920 Edition), which provides:

Upon the expiration, termination, or abandonment of a lease, without the removal of any or all of the mineral contemplated by the lease, the lessor shall be required to restore to capital account so much of the bonus received and deducted from capital recoverable through depletion as is in excess of the actual depletion or loss in value sustained as a result of the operations under the lease and the corresponding amount will be income for the year in which the lease expires, terminates, or is abandoned.

We are unable to agree with either the petitioner or the respondent. In our view of the case the action of the respondent in requiring the inclusion in income for 1919 of any part of the difference between the depletion deductions allowed in prior years and the actual depletion sustained in those years, is without authority of law, and the regulations permitting or requiring such procedure are to that extent invalid. How excessive deductions allowed in prior years can, upon the happening of a specified event in a subsequent year, become income, is beyond our comprehension. If the respondent chooses to permit a depletion allowance on the basis of minimum royalties, he must take the risk of excessive deductions by taxpayers depleting their properties upon such basis, but taxpayers can not be required to return as income, when a lease is abandoned, the amount of depletion theretofore allowed in excess of the amount of depletion actually sustained.

We are of the opinion that no part of the depletion allowed the petitioner in the years prior to 1919, in excess of the amount of depletion sustained, is or can be, within the meaning of the law, income for the year 1919.

Reviewed by the Board.

Judgment will he entered on 15 days’ notice, under Bule 50.

AruNdell concurs in the result.


text:
    John H. Farish, doing business as J. H. Farish & Co., Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 7091.
    Promulgated July 29, 1927.
    Embezzlement by an employee of moneys entrusted to him by his employer, occurring and continuing over a period of five or six years, and causing loss to his employer, does not warrant the allowance of the amount as a deductible loss to the employer in computing his taxable income in a subsequent year when the defalcation was first discovered.

      Chase Morsey, Esq., and W. E. Diggs, Esq., for the petitioner.

      Thomas P. Dudley, Jr., Esq., for the respondent.
    The Commissioner determined deficiencies in income tax of $539.99 for 1920, $1,962.23 for 1921, $219.22 for 1922, and an over-assessment of $131.48 for 1919.
    Petitioner was engaged in the real estate business and in acting as agent for others in renting their property, and collecting and paying over to them of such rentals. One of the petitioner’s employees during five or six years immediately preceding 1921 embezzled moneys paid to petitioner by tenants and entrusted to him by petitioner. Such defalcation was not discovered until 1921 when petitioner was required to borrow money and restore the amount. The petitioner claims he sustained the loss occasioned by such embezzlement in 1921 when the embezzlement was discovered and the amount thereof was restored by him, and that same should be allowed as a deductible loss for that year.
    The Commissioner disallowed same on the ground that the loss occurred in prior years in certain amounts during indeterminate periods, and therefore the total was not a deductible allowance in the year 1921.
    FINDINGS OF FACT.
    The petitioner is a resident of St. Louis, Mo., where he is, and was during the years involved, engaged in the real estate business as an individual operating under the name of J. H. Farish & Co.
    From 1911 to March 3, 1921, petitioner had in his employ a young man as cashier and bookkeeper. The petitioner’s business was largely the collection of rents for his clients, and during 1918, 1919, 1920, and 1921 such collections amounted to approximately $100,000 a month. It was the duty of the cashier to see that the moneys collected from rentals were credited on the cash book to the owner of the particular piece of property from which such rents were collected and that moneys so collected were deposited in the Merchants Laclede Bank of St. Louis, to the credit of J. H. Farish & Co. Petitioner carried bis own personal account m the same bank m the name of J. H. Farish.
    In making payments to clients of the rents collected, checks were drawn Tpy the cashier on the J. H. Farish & Co. account, signed by petitioner and turned over to the cashier to be mailed out to the persons entitled thereto.
    In March, 1921, it was discovered that the cashier was short in his accounts; that he had for a number of years been embezzling or misappropriating moneys that came into his hands by virtue of such collections. Various amounts of currency or money received in payment of rents were misappropriated by the cashier and such defalcation or shortage was concealed from petitioner by informing him that certain collections had been made and deposited when part, or all of same, had been misappropriated to the cashier’s own use or embezzled by him.
    The checks which he had petitioner sign to be sent to clients in payment for rents collected were temporarily withheld by the cashier until later rent collections came in, sufficient when deposited in bank, to pay the checks temporarily withheld without causing an overdraft at the bank. No checks of petitioner issued for clients were ever cashed and their proceeds embezzled or appropriated by the cashier to his own use. The checks themselves were not embezzled nor permanently withheld by the cashier.
    His peculations began prior to 1916. When they were discovered on March 3,1921, petitioner took prompt steps to ascertain the amount of defalcation and employed more than a dozen accountants to go over his books of account, canceled checks, etc., to determine the amount of the shortage. The defalcation was found to be $57,000. The cashier admitted the embezzlement. Of the total amount embezzled, $5,930.08 was all that petitioner ever succeeded in recovering from his cashier. For certain reasons unnecessary to be here set forth, petitioner did not prosecute the cashier nor was any civil suit brought against him to recover any portion of his defalcation. Borne of the checks signed by petitioner to pay rents collected were held by the cashier for more than eighteen months before being mailed to the person entitled thereto. The amount of the defalcation was $57,000 on December 31, 1920, and the same in March, 1921, when petitioner paid the entire amount of same to his clients who held his checks totaling such amount for the payment of which there were no funds in petitioner’s account at the bank.
    In his determination the Commissioner allowed the petitioner a deduction of $10,000 in each of the years 1919 and 1920 as a loss resulting from the embezzlement of moneys by the cashier but allowed no deduction on that account for the year 1921 for the reason that the evidence showed that no funds were embezzled during that year.
   OPINION.

Littleton :

The evidence in this proceeding shows the misappropriation by petitioner’s cashier of $57,000 of money coming into his hands as an employee and cashier of petitioner. It further shows his peculations extended over a period of years from 1915 to the end of 1920. It does not disclose what amount was taken by him in any particular year, but the evidence indicates that his defalcation was $57,000 on December 31, 1920, and was the same when discovered In March, 1921.

The rent collections of petitioner for his various clients were deposited in the Merchants Laclede Bank to the account of J. H. Farish & Co., the name under which John H. Farish operated his real estate business.

Such collections were thus commingled and converted by petitioner into a common fund, upon which he drew checks to his various clients for the rentals due them. As rentals were collected, petitioner became liable for same to his clients and when the $57,000 defalcation was discovered in 1921, he promptly made it good by borrowing sufficient money and paying the $57,000 of checks which his cashier had temporarily withheld and representing rentals which had been paid to petitioner and embezzled by the cashier.

There is no evidence showing that the cashier in 1921 embezzled or misapplied any of the moneys of petitioner or of petitioner’s clients. The unpaid checks to clients of petitioner amounting to $57,000 were not embezzled. If they had been destroyed the defalcation of the cashier and the liability of petitioner to his clients would have remained the same.

The petitioner’s loss occurred when the cashier took the money from rent collections, the amount of which petitioner was then obligated to pay to his clients. It was never the practice of petitioner or the cashier to deliver to clients the identical money or checks paid to petitioner as rents. Such moneys and checks were to be deposited to the account of J. H. Farish & Co. Petitioner then issued his personal checks to his clients on this account for their rents. His obligation to his clients arose when rents were collected and his loss was sustained when his assets were depleted by his cashier’s misappropriation or embezzlement of rent collections.

There is no evidence from which the Board can find the amount or extent to which there was any embezzlement of money coming into petitioner’s hands in any particular year. The appropriation to his own use of the $57,000 of rent money by the cashier, however such action may be designated, occurred prior to 1921 and no certain or definite amount is shown to have been taken or misapplied by him in any particular year.

The case of the National Sash & Door Co., 5 B. T. A. 931, is cited and quoted in support of petitioner’s claim, as follows:

With respect to the embezzlement question involved in this proceeding, the only question is whether the loss was sustained within the year 1918 or 1919. The petitioner claimed the deduction from gross income of the year 1919. It had, no Imowledge that it had, sustained, awy loss through embezzlement in the year 1918.

The next paragraph of the Board’s opinion in that case, however, states:

The evidence before us indicates that the embezzlement occurred in the year-1919. Upon the record it must be decided that the loss was sustained in the year 1919 and that the amount thereof is a legal deduction from gross income in that year.

The case of United States v. ClevelandCincinnati, Chicago & St. Louis Ry. Co., unreported, involved the embezzlement of a large sum of money by the treasurer of the railroad company in years prior to 1909 and the embezzlement was discovered in the year 1909. The railroad company claimed a deduction of this amount from its gross income under the Corporation Excise Tax Act of 1909, which, like the Revenue Act of 1918, permitted a deduction on account of losses “ actually sustained during the year.” In the course of its opinion rendered February 23, 1916, the United States District Court for the Southern District of Ohio said:

The time of the discovery of a loss bears no relation to the date the loss was sustained. The loss was sustained when the theft occurred, although the defendant did not know at the time of the depletion of its assets. As each embezzlement occurred the defendant was poorer to the extent of it. It then sustained a loss. One of the definitions of “ sustained ” is “ undergo ”, As each embezzlement occurred, the defendant underwent the loss of that much money.

The petitioner contends that although the cashier embezzled certain moneys coming into his hands during each of several years prior to 1921, he concealed the shortage and prevented the discovery thereof for the time being in the following manner. TVAen cash or currency was paid to the petitioner by tenants the cashier embezzled a portion thereof in the year of payment and would have petitioner sign his personal checks to owners of property, the rent on which had been paid to petitioner, and such checks of petitioner would be withheld for the time being and not mailed to the owner of the property and as additional rents were paid the cashier would embezzle a portion thereof and have petitioner sign checks in payment thereof payable to the owner of the property different from the payee of the checks first withheld. The first checks made out and signed by petitioner, after sufficient collections to pay them had been made and deposited, would then be mailed out by the cashier, and the later checks withheld until sufficient rents had been paid to the petitioner to provide a fund in his bank account sufficient to pay them. The amount of embezzlement by the cashier, according to the evidence, increased from year to year. By reason thereof it was necessary for the cashier in order to conceal his peculations to withhold the sending out of a larger amount of checks each time. When the petitioner discovered the shortage the cashier was holding various checks totaling $57,000 payable to one individual owner of certain property, the rental on which had been paid to petitioner from time to time. When petitioner discovered the shortage on the complaint of this particular property owner that he had not received checks for the rental of his property, the petitioner called his cashier’s attention to the complaint and asked him to look into the matter and see what the trouble was. The cashier, without informing the petitioner at that particular time, mailed out the checks which petitioner had signed payable to this individual, the mailing of which the cashier had withheld, which resulted in an overdraft in petitioner’s account at the Merchants Laclede Bank of St. Louis.. Thereupon the cashier confessed to the petitioner that he had embezzled the moneys collected from time to time over the years 1916 to 1920, inclusive. By reason of this situation counsel for petitioner argues that the amounts embezzled in 1918 were paid back by the cashier with the funds of other property owners subsequently collected and that the funds embezzled in 1919 were paid back with funds collected in 1920 and that in 1921 the petitioner was compelled to make good the embezzlement of $57,000 and that, therefore, the real embezzlement occurred and the loss was sustained in the year 1921 notwithstanding that no actual embezzlement took place in that year. We think this position is untenable for the reason that, as was stated in United States v. Cleveland, Cincinnati, Chicago & St. Louis Ry. Co., supra, “As each embezzlement occurred the defendant was poorer to the extent of it ” and petitioner’s loss occurred when the embezzlement of funds by the cashier took place although the petitioner did not know of the shortage or defalcation until 1921 when he was compelled to borrow sufficient money to make good the shortage.

Section 214 (a) (6) of the Revenue Act of 1921 provides that “Losses allowed under paragraphs (4), (5), and (6) of this subdivision shall be deducted as of the taxable year in which sustained unless, in order to clearly reflect the income, the loss should, in the opinion of the Commissioner, be accounted for as of a different period.” We think, however, that under the facts in this proceeding it is not necessary to allow the deduction of the amount of $57,000 embezzled over tbe years 1916 to 1920, inclusive, in the year 1921 in order clearly to reflect the income. The allocation by the Commissioner oí the total amount embezzled as deductions in years prior to 1921 seems to us to clearly reflect income and to fulfill the intentment of the statute that the losses should be deducted in the year in which sustained.

Reviewed by the Board.

Judgment will be entered for the respondent.


text:
    A. T. Cooper, Petitioner, v. Commissioner of Internal Revenue, Respondent.
    Docket No. 3144.
    Promulgated July 29, 1927.
    Tke excess o£ deductions for depletion based on minimum royalties, over tbe actual depletion sustained, does not constitute income to a lessor in tbe year in wbicb tbe lease is abandoned.

      Frank W. Wilson, O. P. A., for the petitioner.

      John W. Fisher, Esq., for the respondent.
    This proceeding is for the redetermination of a deficiency in income tax for the year 1919 in the amount of $1,108.47, and is based upon an alleged error of the respondent in adding to income in that year the difference between the depletion allowed the petitioner upon minimum royalties received by him as one of the lessors of an iron mine, and the actual depletion of the mine when it was abandoned in 1919.
    FINDINGS OF FACT.
    The petitioner is the owner of an undivided interest in the fee of an iron mine in Minnesota. This mine was leased on September 4, 1912, on a royalty basis, the lease providing for a minimum payment each year on 50,000 tons of ore. The lease was abandoned by the lessee in the year 1919. In each of the years except 1913 and 1919, the petitioner was paid royalties on the minimum royalty basis, but in none of the years to the time the lease was abandoned did the lessee mine and ship the minimum requirement of the lease. The petitioner in computing the depletion allowance in each year, deducted depletion on the basis of the minimum royalties, which deductions were allowed by the respondent. Upon the abandonment of the lease in 1919 the respondent computed the depletion actually sustained from the date of the lease to its abandonment and deducted the amount thereof from the depletion allowed the petitioner over the same period on the basis of the minimum royalties, and added the difference to income for the vear 1919.

      The following tables show the royalties reported as income by the petitioner, royalties received by him, tons of ore paid for, tons of ore shipped, depletion claimed by the petitioner, depletion allowed by the respondent, and the petitioner’s income for the year 1919 as computed by the respondent:

    Net income reported on return_$19, 926. 75
    Royalties reported as received_$4, 456. 72
    Actual royalties paid to petitioner_ 2, 971.18
    Income overstated by_ 1,485. 54
    Depletion claimed on return_ 1, 960. 95
    Depletion allowed_ 1,163. 01
    Income understated by_ 797. 94
    Depletion allowed petitioner to date of surrender of lease- 9, 893. 01
    Depletion sustained by petitioner to date of surrender of lease_• 4, 533.91
    Income understated by. 5, 359.10
    26, 083. 79
    1,485.54
    Total net income subject to tax for the year 1919_ 24, 598. 25
   OPINION.

Marquette :

The question here presented is the same as that before the Board in Kittie A. Knapp, 7 B. T. A. 790, and it arises from the same transaction. In that proceeding we held that there is no authority of law for including in a taxpayer’s income in one year excessive depletion allowed as deductions for prior years, and in accordance with our decision therein, we hold that no part of the amounts allowed the petitioner as depletion deductions in the years prior to 1919 should be included in his income for that year.

Reviewed by the Board.

Judgment will he entered on 15 days' notice, under Bule 50.