1972 Tax Ct. Memo LEXIS 244 | Tax Ct. | 1972
Memorandum Findings of Fact and Opinion
FAY, Judge: The respondent determined deficiencies in the petitioners' income taxes for the years 1965 and 1966 in the amounts of $2,186 and $2,576.73, respectively.
Concessions having been made, the only issue1972 Tax Ct. Memo LEXIS 244" label="1972 Tax Ct. Memo LEXIS 244" no-link"="" number="3" pagescheme="<span class=">1972 Tax Ct. Memo LEXIS 244">*246 remaining for decision is whether the petitioners are entitled to deduct losses incurred in the money lending business as either bad debt losses under
Findings of Fact
Some of the facts have been stipulated. The stipulation of facts and the exhibits attached thereto are incorporated herein by this reference.
The petitioners, Herbert E. and Virginia Tharp, are husband and wife, and at the time of filing the petition herein they were residents of Houston, Texas. Their joint Federal income tax returns for the calendar years 1965 and 1966 were filed with the district director of internal revenue at Austin, Texas. Herbert E. Tharp will sometimes hereinafter be referred to as the petitioner.
During the years here involved and in prior years the petitioner was engaged in the business of making loans of money to customers. He was engaged in such business for over 30 years. The larger part of his business income was the result of interest received from the lending of money. In addition to other business1972 Tax Ct. Memo LEXIS 244" label="1972 Tax Ct. Memo LEXIS 244" no-link"="" number="4" pagescheme="<span class=">1972 Tax Ct. Memo LEXIS 244">*247 activities he operated two loan businesses in Birmingham, Alabama, as a sole proprietor - one under the name of Post Loan and Luggage Co. (hereinafter referred to as Post) and another named Eagle Brokers (hereinafter referred to as Eagle). His Post and Eagle operations were successful and many regular customers repeatedly borrowed money from Post and Eagle. All but a small part of the loans made were repaid in the ordinary course of business.
During the years here involved, and in prior years, Post and Eagle followed a system of accounting whereby accrued but uncollected interest on loans made during the calendar year would at the close of the calendar year be reported as gross receipts on petitioners' income tax return for the calendar year.
Post and Eagle were licensed under the Alabama Pawn Shop Act for the years 1965 and 1966 but neither was licensed under the Alabama Small Loan Act. Businesses making loans under the Pawn Shop Act were required by Alabama State law to receive sufficient collateral from borrowers. 2 If this Pawn Shop Act requirement was met the business was held to1972 Tax Ct. Memo LEXIS 244" label="1972 Tax Ct. Memo LEXIS 244" no-link"="" number="5" pagescheme="<span class=">1972 Tax Ct. Memo LEXIS 244">*248 be exempt from the Alabama Small Loan Act. 3
Post and Eagle made individual loans of under $300 each and did not demand sufficient collateral. Consequently, they did not qualify for the Pawn Shop Act exemption and were therefore subject to the requirements of the Alabama Small Loan Act.
The Alabama Small Loan Act specifies that one engaged in the business of lending money in amounts of $300 or less must be licensed. One so engaged and not licensed under the provisions thereof may charge interest no greater than that permitted by law. 4
Title 9, Code of Alabama, Section 60, provides that the legal interest rate is 8 percent per annum by written contract and 6 percent per annum if not by written contract. The petitioner on the vast majority of loans was charging an interest rate of 50 percent per month and was clearly in 23 violation of the Act. Such a violation1972 Tax Ct. Memo LEXIS 244" label="1972 Tax Ct. Memo LEXIS 244" no-link"="" number="6" pagescheme="<span class=">1972 Tax Ct. Memo LEXIS 244">*249 incurs the following penalty:
Any contract of Joan in the making or collection of which any act shall be done which violates this section shall be void and the lender shall have no right to collect, receive or retain any principal, interest, or charges whatsoever
Pursuant to the penalty provision, on July 28, 1966, the State of Alabama, Ex Rel. Lehman J. Lewis, as supervisor of the Bureau of Loans of the State Banking Department, filed a Bill of Complaint in a civil action against certain named and unnamed individuals and an unnamed corporation.
The respondents in that complaint filed their answers alleging that Tharp was the true owner of Post and Eagle. Thereupon, the State of Alabama added Tharp as a respondent. In the final decree entered August 2, 1966, agreed to by all the respondents, including the petitioner herein, the respondents were permanently enjoined from collecting any of the outstanding principal and interest on loans made in violation of the Alabama Small Loan Act.
The petitioner did not know which of the loans made by Post and Eagle were lawful under the Alabama statutes governing loans by licensed pawnbrokers.
After entry of the State court judgment the1972 Tax Ct. Memo LEXIS 244" label="1972 Tax Ct. Memo LEXIS 244" no-link"="" number="7" pagescheme="<span class=">1972 Tax Ct. Memo LEXIS 244">*250 petitioner went to Birmingham with the intention of applying for a small loan license and continuing the Eagle and Post businesses. Petitioner discovered his employees had closed the businesses. He subsequently decided not to continue the businesses for he was unable to hire competent employees. Furthermore, the City of Birmingham alleged that he owed approximately $3,600 in back taxes with respect to Eagle and Post for the past five years. The petitioner left Birmingham and never reopended either of his businesses.
In closing his books for the taxable year 1965 the petitioner determined that his uncollectible loans as of the end of said year attributable to the Post and Eagle operations amounted to $3,060.50, which the petitioners deducted as bad debts on their 1965 income tax return.
In closing his books for the taxable year 1966 the petitioner determined that his uncollectible loans as of the end of the year attributable to Post and Eagle amounted to $14,400.55, which the petitioners deducted as bad debts on their 1966 income tax return.
The amounts deducted on the petitioners' 1965 and 1966 income tax returns as bad debts of Post and Eagle include both principal and interest.
1972 Tax Ct. Memo LEXIS 244" label="1972 Tax Ct. Memo LEXIS 244" no-link"="" number="8" pagescheme="<span class=">1972 Tax Ct. Memo LEXIS 244">*251 In their returns for the taxable years 1965 and 1966 the petitioners deducted the amounts of $3,060.50 and $14,400.55, respectively. The respondent in his notice of deficiency increased the petitioners' taxable income to reflect the disallowance of these deductions.
Opinion
The issue presented is whether the petitioners are entitled to deduct losses incurred in the money lending business as either bad debt losses under
In
1972 Tax Ct. Memo LEXIS 244" label="1972 Tax Ct. Memo LEXIS 244" no-link"="" number="9" pagescheme="<span class=">1972 Tax Ct. Memo LEXIS 244">*252 The respondent instead comes forward with the following dual-headed argument:
(1) The uncollected loans receivable are not deductible as bad debts under
(2) The uncollected loans receivable are still categorized as debts and as such must be deducted under
It has long been settled law that losses and bad debts are mutually exclusive, and that a bad debt loss is deductible according to the rules of
The making of the specific provision as to debt indicates that these were to be considered as a special class and that losses on debts were not to be regarded as falling under
See also
The respondent is correct in contending that if these apparent obligations were "debts" for purposes of
To determine the "debt" status of the original obligations we must resort to State law. State law determines whether or not a debt was created. See
The Alabama Small Loan Act, Title 5, Code of Ala., sec. 279(d), provides that the loans in question were "void and the lender shall have no right to collect, receive, or retain any principal, interest, or charges whatsoever." Under Alabama State law
A void thing is no thing. It has no legal effect whatsoever, and no rights whatever can be obtained under it or grow out of it. 1972 Tax Ct. Memo LEXIS 244" label="1972 Tax Ct. Memo LEXIS 244" no-link"="" number="12" pagescheme="<span class=">1972 Tax Ct. Memo LEXIS 244">*255 In law it is the same thing as if the void thing had never existed.
In
But an act under the police power, designed to regulate the business, to protect the public against fraud and imposition, requiring a license as evidence of qualification and fitness, and prohibiting any act of business under penalty, unless such license is first obtained, does render such contracts illegal, void and unenforceable in actions for the recovery of compensation1972 Tax Ct. Memo LEXIS 244" label="1972 Tax Ct. Memo LEXIS 244" no-link"="" number="13" pagescheme="<span class=">1972 Tax Ct. Memo LEXIS 244">*256 and the like.
See also
Contracts specially prohibited by law, the enforcement of which violates the laws enacted for regulation and protection of private citizens are void and non-enforceable in the courts of this state.
There is no question in our mind that the Small Loan Act was enacted for regulation and protection of private citizens. The legislative intent as expressed in Title 5, Code of Alabama, section 277, shows clearly that one of the major purposes of this act was to protect the public against fraud and imposition. 25
Sec. 277. Declaration of legislative intent. - The legislature finds as facts and determines that: * * *
4. Interest charges are often disguised by the use of subterfuges to evade the usury law. These subterfuges are so complicated and technical that the usual borrower of small sums is defenseless even if he is aware of the usurious nature of the transaction and of his legal rights.
5. As a result, borrowers of small sums are being exploited, to the injury of the borrower, his dependents, and the general public. Charges are generally exorbitant1972 Tax Ct. Memo LEXIS 244" label="1972 Tax Ct. Memo LEXIS 244" no-link"="" number="14" pagescheme="<span class=">1972 Tax Ct. Memo LEXIS 244">*257 in relation to those necessary to the conduct of a legitimate small loan business; trickery and fraud are common; and oppressive collection practices are prevalent.
6. These evils characterize and distinguish loans of three hundred dollars ($300) or less. Legislation to control this class of loans is necessary to protect the public welfare.
7. It is the intent of the legislature in enacting this law to bring under public supervision those engaged in the business of making such loans, to eliminate practices that facilitate abuse of borrowers, to establish a system of regulation for the purpose of insuring honest and efficient small loan service and of stimulating competitive reductions in charges, to allow lenders who meet the conditions of this article a rate of charge sufficiently high to permit a business profit, and to provide the administrative machinery necessary for efficient enforcement.
Clearly under Alabama State law the petitioner had no enforceable rights to collect loans made in his lending business. In light of this fact we must determine whether such an unenforceable obligation can be categorized as a "debt" for purposes of
In
As early as 1930 the Board of Tax Appeals stated that the word "debt" as used in the statutory provisions of bad debts was to be taken in its usual and accepted meaning. The Board went on to define "debt" as a "specific sum of money, which is due and owing from one person to another, and denotes not only the obligation of the debtor to pay, but the right of the creditor to receive and enforce payment." [Emphasis added.]
From the foregoing authorities we think it is clear that the loans in question were unenforceable at all times and that a debt for purposes of
1972 Tax Ct. Memo LEXIS 244" label="1972 Tax Ct. Memo LEXIS 244" no-link"="" number="17" pagescheme="<span class=">1972 Tax Ct. Memo LEXIS 244">*260 For purposes of
An ordinary loss deduction is appropriate under
Tharp earned a significant amount of taxable income from this business and he paid the requisite taxes on this income. The losses incurred in earning1972 Tax Ct. Memo LEXIS 244" label="1972 Tax Ct. Memo LEXIS 244" no-link"="" number="18" pagescheme="<span class=">1972 Tax Ct. Memo LEXIS 244">*261 such income are properly deductible.
To deny a deduction in this case would come close to making this business taxable on the basis of gross receipts, while all other businesses would be taxable on the basis of net income.
Decision will be entered for the petitioners. *
Footnotes
1. Unless otherwise indicated, all section references are to the Internal Revenue Code of 1954.↩
2. Title 9, Code of Alabama, sec. 14. ↩
3. Title 5, Code of Alabama, sec 279(b).↩
4. Title 5, Code of Alabama, sec. 279(a).↩
5. We are concerned here with public policy and its relation to
sec. 165 . WhileCommissioner v. Sullivan, 356 U.S. 27">356 U.S. 27 (1958) and recent Congressional action have been in relation to sec. 162, the respondent's concession on this issue extends the rationale of these authorities to the case at bar. Congress recently amended sec. 162 to provide that certain punitive damages were not deductible; it also included in the statute the rulings that certain other payments were not deductible because they were contrary to public policy. Sec. 902, Tax Reform Act of 1969. At that time the report of the Senate Finance Committee included the statement that:The provision for the denial of the deduction for payments in these situations which are deemed to violate public policy is intended to be all inclusive. Public policy, in other circumstances, generally is not sufficiently clearly defined to justify the disallowance of deductions. * * *↩
6. In accepting the respondent's argument that there is no deduction under
sec. 166 we reaffirm our decision inWilliam K. Harriman, T.C. Memo. 1967-190 . In that case, which also involved usurious loans that became worthless, this Court denied a bad debt deduction on the grounds that there was no enforceable obligation to pay and therefore the petitioner never was the possessor of a "bona fide debt." In denying the deduction we relied on the Commissioner'sTreasury Regulation 1.166-1(c) :§ 1.166-1 Bad Debts.(c) Bona fide debt required. Only a bona fide debt qualifies for purposes of
section 166 . A bona fide debt is a debt which arises from a debtor-creditor relationship based upon a valid and enforceable obligation to pay a fixed or determinable sum of money. A gift or contribution to capital shall not be considered a debt for purposes ofsection 166 . The fact that a bad debt is not due at the time of deduction shall not of itself prevent its allowance undersection 166 . * * * However, the case at bar is distinguishable fromHarriman, supra↩ , in that Harriman was never engaged in the trade or business of lending money. Harriman made one series of advances to one individual who then invested the amounts in theatre tickets which he hoped to sell at inflated prices.7.
SEC. 165 . LOSSES(a) General Rule. - There Shall be allowed as a deduction any loss sustained during the taxable year and not compensated for by insurance or otherwise.
* * *
(c) Limitation on Losses of Individuals. - In the case of an individual, the deduction under subsection (a) shall be limited to -
(1) losses incurred in a trade or business;
* * * ↩
*. By official Tax Court Order, dated 2/14/72 and signed by Judge Fay↩, these words were changed from "Decision will be entered under Rule 50." - CCH.