The opinion
ST. JOSEPH VALLEY BANK, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
St. Joseph Valley Bank v. Commissioner
Docket No. 19984.
United States Board of Tax Appeals
15 B.T.A. 185 ; 1929 BTA LEXIS 2905 ;
February 1, 1929 , Promulgated
*2905 Authorization to accumulate a so-called reserve to cover debts ascertained to be worthless by charging off a portion thereof each month over a period extending beyond the taxable year is not the equivalent of a charge-off as required by the statute to permit deduction of that portion accumulated by amounts charged off after the close of the year.
Robert C. Cooley, Esq., for the petitioner.
L. A. Luce, Esq., for the respondent.
SIEFKIN
*186 This proceeding results from respondent's determination of a deficiency in income and profits taxes in the amount of $11,433.22 in the year 1921. The sole error alleged is the denial of $40,000 of the amount claimed as a bad debt or loss deduction.
FINDINGS OF FACT.
Petitioner is an Indiana corporation with principal offices at Elkhart. It is engaged in the banking business at that place. During the latter part of 1921 the directors forced out the principal officer, who, due to inexperience, had committed a number of indiscretions. In October of 1921 a joint examination of the bank was made by State and Federal Reserve Bank examiners. The examiners required certain assets not involved in this controversy *2906 to be charged off, and ordered petitioner to create a reserve of $50,000 for certain poor paper then held by it.
The so-called "poor paper," totaling more than $50,000, consisted of the following obligations:
(1) One group of obligations consisted of a $10,000 note and a $5,000 note of a Mr. Traver, who was engaged in the canning business at Hartford, Mich. There were also $16,191.77 worth of open accounts purchased from Traver. The persons owing such accounts were not notified of the purchase through fear of incurring Traver's displeasure. Petitioner found that some of the accounts never existed and on some others Traver had collected the money. Traver, due to financial difficulties, had left the country before the close of 1921.
(2) There was a note of the Beattie & Decker Pickle Co. for $15,000, on which had been paid $903.38. Repeated promises to pay having failed to materialize, petitioner placed a chattel mortgage on that company's stock and credited it with the proceeds, leaving a balance due on the note of $14,042.87 at the date of the bank examination.
(3) Items totaling $2,500 received from another bank in a consolidation. These obligations were security *2907 for certain trust notes. The examiners had enough information upon these items to consider them worthless. They proved to be right, as subsequent recoveries were negligible.
(4) Another item was a $3,500 note of a business man who had gone into receivership and left the country for parts unknown prior *187 to the date of the examination. The note was secured by a life insurance policy on the debtor. Its value depended upon continued payments of premiums and no such payments have ever been made.
(5) The remaining items, totaling $1,556.96, were made up of overdrafts, small notes and judgments which were acquired from the other bank at consolidation.
The directors of the bank also considered the above items worthless and, at the instance of the examiners and to comply with their orders to set up a $50,000 reserve, called a meeting at which the examiners were represented, and passed a resolution which, so far as pertinent, reads:
It appearing also that a considerable depreciation would be sustained in the bond account of the bank, upon motion duly made, seconded and carried it was resolved to create a reserve for contingencies allowing same to accumulate at the rate *2908 of $5,000 per month, beginning November 1, 1921, until said account shall have totaled $50,000.
The method of charging off $5,000 per month was adopted to prevent any adverse reflection on the condition of the bank which might have resulted from charging off the entire amount at one time. The resolution was carried into effect by charging off $5,000 per month, beginning with November 1, 1921. No entries were made in 1921 setting up the so-called reserve of $50,000. Two entries charging off $5,000 each for the months of November and December were made in 1921. The Commissioner allowed this $10,000 charged off as a deduction. The petitioner was on a cash receipts and disbursements basis of accounting.
OPINION.
SIEFKIN: Section 234(a)(5) of the Revenue Act of 1921 provides for deduction of:
Debts ascertained to be worthless and charged off within the taxable year (or in the discretion of the Commissioner, a reasonable addition to a reserve for bad debts); and when satisfied that a debt is recoverable only in part, the Commissioner may allow such debt to be charged off in part.
Deductions under this section are conditioned upon the concurrent happening of two actions *2909 on the part of the taxpayer. The debt must be ascertained to be worthless and it must be charged off - both actions occurring within the taxable period.
Apparently petitioner contends the second prerequisite, i.e., the charge-off, is a technical provision. Perhaps that is true but it can not be disputed that it nevertheless is a requirement that demands recognition. It was enacted to incure a reasonable relationship between the deduction and the taxable period to which that deduction is applied. Several cases involving the question whether dividends were in fact declared were cited to show that "the rights of parties *188 can neither be established or impaired by booking methods." That is true in such cases, where book entries are mere evidence of an ultimate fact. But with respect to bad debts such entries are expressly made one of the ultimate facts upon which the right to deduction is conditioned. Petitioner also cites several cases, , and , in which this Board considered what constituted a chargeoff under several different methods of bookkeeping. *2910 They, however, are obviously authority for the proposition that there must be some sort of charge-off where any books are kept.
We deem it unnecessary to make an extended review of the many cases deciding what is or is not a charge off, in view of the fact that in this case there was no attempt made to charge off the full $50,000. On the contrary, the evidence is clear that the failure to charge off was deliberate and for a purpose. We are not concerned with the propriety of reasons or excuses for deferring or postponing the act of charging off, but whether the act in fact occurred.
Petitioner relies principally upon the decision in the case of . In that case the taxpayer claimed a deduction for a debt ascertained to be worthless and charged off and likewise claimed a deduction for an additional amount which had been added to a reserve maintained for bad debts. The taxpayer conceded that the entire deduction for bad debts should properly have been taken in the form of an addition to the reserve rather than dividing the total deduction into two claims under the alternative provisions, but urged *2911 that the failure to follow the proper form of deduction should not defeat that part claimed by erroneous form. The court upheld the contention and allowed the total of the two claims as an allowable addition to the reserve.
Apparently petitioner argues that if a deduction, taken by the charged-off method when it should have been taken by the reserve method, is allowable as an addition to the reserve, then a deduction erroneously taken by a reserve method should be allowed as a straight deduction. In other words he would have us hold that the setting up of a reserve is the equivalent of a charge-off, the difference being one of form rather than substance. Such a proposition may have intrinsic merit, but it has nothing to do with the case herein presented. It totally disregards the fact pointed out above, i.e., that no reserve was set up. A clear distinction exists between an error in the method or form of compliance with prerequisites and total failure to comply.
Judgment will be entered for the respondent.