Citizens National Bank, Petitioner, v. Commissioner of Internal Revenue, Respondent

Citizens National Bank, Petitioner, v. Commissioner of Internal Revenue, Respondent. Docket No. 6148. Decided October 21, 1926. A reserve for bad debts set up in 1921 held to be a legal deduction from gross income. W. 0. Rainey, G. P. A., for the petitioner. W. Frank Gibbs, Esq., for the respondent. Proceeding for the redetermination of a deficiency in income and profits tax for the period January 1 to February 28, 1921, in the amount of $4,351.29, arising from the disallowance of a deduction from gross income of a reserve set up to meet net losses in the amount of $41,441.13. FINDINGS OF FACT. The petitioner was incorporated in 1918 under the United States banking laws and carried on banking operations until February 28, 1921, when it was merged with the Ouachita National Bank, located at Monroe, La. The business was taken over on the basis of its net worth on February 28, 1921, determined as follows: Capital stock-$250, 000. 00 Paid in surplus- 50, 000.00 Undivided profits- SO, 095. 07 Total_ 330, 095.07 Plus net book income from Jan. 1, 1921, to Feb. 28, 1921_ 16, 453. 28 346, 548.35 Less reserve for losses_ 41, 441.73 Net worth, Peb. 28, 1921_ 305,106.62 The petitioner began operations during the World War. Due to a business depression in 1920 and 1921, it became apparent to the bank’s officers and the stockholders conversant with its affairs that a considerable amount of its accounts receivable would probably never be collected. The petitioner entered upon its books a reserve of $41,441.73 to take care of worthless accounts and other losses which it believed would be sustained. The Ouachita National Bank, located in the same city, offered to take over the assets and liabilities of the bank and to issue to its stockholders $300,000 of its own stock in exchange for their shares of stock in the petitioner bank. The offer was accepted. The Ouachita National Bank took over the assets after having made provision for a reserve of $41,441.73 to cover doubtful accounts receivable. The actual losses sustained upon these accounts receivable by the Ouachita National Bank were in excess of the amount of $41,441.73. The petitioner was delinquent in filing its income-tax return for the two-month period ended February 28, 1921. Upon an audit of such return the Commissioner disallowed the deduction of any amount representing the bad debts claimed to have been covered by the reserve of $41,441.73, and computed a net income of $18,183.18. [MAJORITY — Smith:] OPINION. Smith: Section 234(a) (5) of the Revenue Act of 1921 permits a corporation to deduct from gross income in its tax return: 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. It ivas very evident to the stockholders of the petitioner bank on February 28, 1921, that it would not be able to recover the full amount of its accounts receivable. The reason for winding up the affairs of the bank were that it was realized that losses must be sustained by it which would probably compel it to be dissolved. We are satisfied from the evidence adduced that the petitioner had ascertained that accounts receivable in an amount in excess of $18,183.18,— the net income determined by the Commissioner for the two-month period ended February 28, 1921, — were worthless and included in a reserve for bad debts. Judgment will he entered for the petitioner.