UNITED STATES v. GENERES ET VIR
No. 70-28
Supreme Court of the United States
Argued November 8, 1971—Decided February 23, 1972
405 U.S. 93
Matthew J. Zinn argued the cause for the United States. With him on the brief were Solicitor General Griswold, Assistant Attorney General Walters, and Ernest J. Brown.
Max Nathan, Jr., argued the cause and filed a brief for respondents.
MR. JUSTICE BLACKMUN delivered the opinion of the Court.
A debt a closely held corporation owed to an indemnifying shareholder-employee became worthless in 1962. The issue in this federal income tax refund suit is whether, for the shareholder-employee, that worthless obligation was a business or a nonbusiness bad debt within the meaning and reach of
The issue‘s resolution is important for the taxpayer. If the obligation was a business debt, he may use it to
In determining whether a bad debt is a business or a nonbusiness obligation, the Regulations focus on the relation the loss bears to the taxpayer‘s business. If, at the time of worthlessness, that relation is a “proximate” one, the debt qualifies as a business bad debt and the aforementioned desirable tax consequences then ensue.
The present case turns on the proper measure of the required proximate relation. Does this necessitate a “dominant” business motivation on the part of the taxpayer or is a “significant” motivation sufficient?
Tax in an amount somewhat in excess of $40,000 is involved. The taxpayer, Allen H. Generes,3 prevailed in a jury trial in the District Court. See 67-2 U. S. T. C. ¶ 9754 (ED La.). On the Government‘s appeal, the Fifth Circuit affirmed by a divided vote. 427 F. 2d 279 (CA5 1970). Certiorari was granted, 401 U. S. 972 (1971), to resolve a conflict among the circuits.4
The taxpayer as a young man in 1909 began work in the construction business. His son-in-law, William F. Kelly, later engaged independently in similar work. During World War II the two men formed a partnership in which their participation was equal. The enterprise proved successful. In 1954 Kelly-Generes Construction Co., Inc., was organized as the corporate successor to the partnership. It engaged in the heavy-construction business, primarily on public works projects.
The taxpayer and Kelly each owned 44% of the corporation‘s outstanding capital stock. The taxpayer‘s original investment in his shares was $38,900. The remaining 12% of the stock was owned by a son of the taxpayer and by another son-in-law. Mr. Generes was president of the corporation and received from it an annual salary of $12,000. Mr. Kelly was executive vice-president and received an annual salary of $15,000.
The taxpayer and Mr. Kelly performed different services for the corporation. Kelly worked full time in the field and was in charge of the day-to-day construction operations. Generes, on the other hand, devoted no more than six to eight hours a week to the enterprise. He reviewed bids and jobs, made cost estimates, sought
Taxpayer Generes from time to time advanced personal funds to the corporation to enable it to complete construction jobs. He also guaranteed loans made to the corporation by banks for the purchase of construction machinery and other equipment. In addition, his presence with respect to the bid and performance bonds is of particular significance. Most of these were obtained from Maryland Casualty Co. That underwriter required the taxpayer and Kelly to sign an indemnity agreement for each bond it issued for the corporation. In 1958, however, in order to eliminate the need for individual indemnity contracts, taxpayer and Kelly signed a blanket agreement with Maryland whereby they agreed to indemnify it, up to a designated amount, for any loss it suffered as surety for the corporation. Maryland then increased its line of surety credit to $2,000,000. The corporation had over $14,000,000 gross business for the period 1954 through 1962.
In 1962 the corporation seriously underbid two projects and defaulted in its performance of the project contracts. It proved necessary for Maryland to complete the work. Maryland then sought indemnity from Generes and Kelly. The taxpayer indemnified Maryland to the extent of $162,104.57. In the same year he also loaned $158,814.49 to the corporation to assist it in its financial difficulties. The corporation subsequently went into re-
In his federal income tax return for 1962 the taxpayer took his loss on his direct loans to the corporation as a nonbusiness bad debt. He claimed the indemnification loss as a business bad debt and deducted it against ordinary income.5 Later he filed claims for refund for 1959-1961, asserting net operating loss carrybacks under
In due course the claims were made the subject of the jury trial refund suit in the United States District Court for the Eastern District of Louisiana. At the trial Mr. Generes testified that his sole motive in signing the indemnity agreement was to protect his $12,000-a-year employment with the corporation. The jury, by special interrogatory, was asked to determine whether taxpayer‘s signing of the indemnity agreement with Maryland “was proximately related to his trade or business of being an employee” of the corporation. The District Court charged the jury, over the Government‘s objection, that significant motivation satisfies the Regulations’ requirement of proximate relationship.6 The court refused the Government‘s request for an instruction that the applicable standard was that of dominant rather than significant motivation.7
The Fifth Circuit majority approved the significant-motivation standard so specified and agreed with a Second Circuit majority in Weddle v. Commissioner, 325 F. 2d 849, 851 (1963), in finding comfort for so doing in the tort law‘s concept of proximate cause. Judge Simpson dissented. 427 F. 2d, at 284. He agreed with the holding of the Seventh Circuit in Niblock v. Commissioner, 417 F. 2d 1185 (1969), and with Chief Judge Lumbard, separately concurring in Weddle, 325 F. 2d, at 852, that dominant and primary motivation is the standard to be applied.
II
A. The fact responsible for the litigation is the taxpayer‘s dual status relative to the corporation. Generes was both a shareholder and an employee. These interests are not the same, and their differences occasion different tax consequences. In tax jargon, Generes’ status as a shareholder was a nonbusiness interest. It was capital in nature and it was composed initially of tax-paid dollars. Its rewards were expectative and would flow, not from personal effort, but from invest-
Thus, for tax purposes it becomes important and, indeed, necessary to determine the character of the debt that went bad and became uncollectible. Did the debt center on the taxpayer‘s business interest in the corporation or on his nonbusiness interest? If it was the former, the taxpayer deserves to prevail here. Trent v. Commissioner, 291 F. 2d 669 (CA2 1961); Jaffe v. Commissioner, T. C. Memo ¶ 67,215; Estate of Saperstein v. Commissioner, T. C. Memo ¶ 70,209; Faucher v. Commissioner, T. C. Memo ¶ 70,217; Rosati v. Commissioner, T. C. Memo ¶ 70,343;
B. Although arising in somewhat different contexts, two tax cases decided by the Court in recent years merit initial mention. In each of these cases a major shareholder paid out money to or on behalf of his corporation and then was unable to obtain reimbursement from it. In each he claimed a deduction assertable against ordinary income. In each he was unsuccessful in this quest:
1. In Putnam v. Commissioner, 352 U. S. 82 (1956), the taxpayer was a practicing lawyer who had guaranteed obligations of a labor newspaper corporation in which he owned stock. He claimed his loss as fully deductible in 1948 under
2. In Whipple v. Commissioner, 373 U. S. 193 (1963), the taxpayer had provided organizational, promotional, and managerial services to a corporation in which he owned approximately an 80% stock interest. He claimed that this constituted a trade or business and, hence, that debts owing him by the corporation were business bad debts when they became worthless in 1953. The Court also rejected that contention and held that Whipple‘s investing was not a trade or business, that is, that “[d]evoting one‘s time and energies to the affairs of a corporation is not of itself, and without more, a trade or business of the person so engaged.” 373 U. S., at 202. The rationale was that a contrary conclusion would be inconsistent with the principle that a corporation has a personality separate from its shareholders and that its business is not necessarily their business. The Court indicated its approval of the Regulations’ proximate-relation test:
“Moreover, there is no proof (which might be difficult to furnish where the taxpayer is the sole or dominant stockholder) that the loan was necessary to keep his job or was otherwise proximately related to maintaining his trade or business as an employee. Compare Trent v. Commissioner, [291 F. 2d 669 (CA2 1961)].” 373 U. S., at 204.
The Court also carefully noted the distinction between the business and the nonbusiness bad debt for one who is both an employee and a shareholder.8
III
We conclude that in determining whether a bad debt has a “proximate” relation to the taxpayer‘s trade or business, as the Regulations specify, and thus qualifies as a business bad debt, the proper measure is that of dominant motivation, and that only significant motivation is not sufficient. We reach this conclusion for a number of reasons:
A. The Code itself carefully distinguishes between business and nonbusiness items. It does so, for example, in
The point, however, is that the tax statutes have made the distinction, that the Congress therefore intended it
B. Application of the significant-motivation standard would also tend to undermine and circumscribe the Court‘s holding in Whipple and the emphasis there that a shareholder‘s mere activity in a corporation‘s affairs is not a trade or business. As Chief Judge Lumbard pointed out in his separate and disagreeing concurrence in Weddle, supra, 325 F. 2d, at 852-853, both motives—that of protecting the investment and that of protecting the salary—are inevitably involved, and an inquiry whether employee status provides a significant motivation will always produce an affirmative answer and result in a judgment for the taxpayer.
C. The dominant-motivation standard has the attribute of workability. It provides a guideline of certainty for the trier of fact. The trier then may compare the risk against the potential reward and give proper emphasis to the objective rather than to the subjective. As has just been noted, an employee-shareholder, in making or guaranteeing a loan to his corporation, usually acts with two motivations, the one to protect his investment and the other to protect his employment. By making the dominant motivation the measure, the logical tax consequence ensues and prevents the mere presence of a business motive, however small and however insignificant, from controlling the tax result at the taxpayer‘s convenience. This is of particular importance in a tax system that is so largely dependent on voluntary compliance.
D. The dominant-motivation test strengthens and is consistent with the mandate of
E. The dominant-motivation approach to
F. We see no inconsistency, such as the taxpayer suggests, between the Government‘s urging dominant motivation here and its having urged only significant motivation as the appropriate standard for the incurrence of liability for the accumulated-earnings tax under
G. The Regulations’ use of the word “proximate” perhaps is not the most fortunate, for it naturally tempts one to think in tort terms. The temptation, however, is best rejected, and we reject it here. In tort law factors of duty, of foreseeability, of secondary cause, and of plural liability are under consideration, and the concept of proximate cause has been developed as an appropriate application and measure of these factors. It has little place in tax law where plural aspects are not usual, where an item either is or is not a deduction, or either is or is not a business bad debt, and where certainty is desirable.
The conclusion we have reached means that the District Court‘s instructions, based on a standard of significant rather than dominant motivation, are erroneous and that, at least, a new trial is required. We have examined the record, however, and find nothing that would support a jury verdict in this taxpayer‘s favor had the dominant-motivation standard been embodied in the instructions. Judgment n. o. v. for the United States, therefore, must be ordered. See Neely v. Eby Construction Co., 386 U. S. 317 (1967).
As Judge Simpson pointed out in his dissent, 427 F. 2d, at 284-285, the only real evidence offered by the taxpayer bearing upon motivation was his own testimony that he signed the indemnity agreement “to protect my job,” that “I figured in three years’ time I would get my money out,” and that “I never once gave it [his investment in the corporation] a thought.”9
The statements obviously are self-serving. In addition, standing alone, they do not bear the light of analysis. What the taxpayer was purporting to say was that his $12,000 annual salary was his sole motivation, and that his $38,900 original investment, the actual value of which prior to the misfortunes of 1962 we do not know, plus his loans to the corporation, plus his personal interest in the integrity of the corporation as a source of living for his son-in-law and as an investment for his son and his other son-in-law, were of no consequence whatever in his thinking. The comparison is strained all the more by the fact that the salary is pre-tax and the investment is taxpaid. With his total annual income about $40,000, Mr. Generes may well have reached a federal income tax bracket of 40% or more for a joint return in 1958-1962.
We conclude on these facts that the taxpayer‘s explanation falls of its own weight, and that reasonable minds could not ascribe, on this record, a dominant motivation directed to the preservation of the taxpayer‘s salary as president of Kelly-Generes Construction Co., Inc.
The judgment is reversed and the case is remanded with direction that judgment be entered for the United States.
It is so ordered.
MR. JUSTICE POWELL and MR. JUSTICE REHNQUIST took no part in the consideration or decision of this case.
MR. JUSTICE MARSHALL, concurring.
I agree with and join the opinion of the Court. In doing so I add a few additional words of legislative history in support of the wording of the Internal Revenue Code itself.
It is now well-established law that a corporate employee is entitled to deduct as a business bad debt a bad debt incurred because of his employee status—e. g., a loan made to protect his job which becomes unrecoverable. See, e. g., Trent v. Commissioner, 291 F. 2d 669 (CA2 1961); Lundgren v. Commissioner, 376 F. 2d 623 (CA9 1967); Smith v. Commissioner, 55 T. C. 260 (1970). See also Whipple v. Commissioner, 373 U. S. 193, 201 (1963). The law is equally well established, however, that a shareholder is not entitled to a business bad-debt
The taxpayer in this case is both an employee and a shareholder of a single corporation, and the question thus presented is how to determine the proper tax treatment of loans made by him to the corporation that became uncollectible.
The Internal Revenue Code itself does not offer any test for determining when a bad debt is a business bad debt, but
The opinion of the Court properly concludes that acceptance of the test advocated by the taxpayer would blunt somewhat the distinction between business and nonbusiness expenses, and that the Commissioner‘s test is slightly more consistent with the thrust of various sections of the Internal Revenue Code. Were this all we had to work with, however, I would be as torn between the two tests as the lower courts have been. Compare Weddle v. Commissioner, 325 F. 2d 849 (CA2 1963), with Niblock v. Commissioner, 417 F. 2d 1185 (CA7 1969), and Smith v. Commissioner, 55 T. C. 260 (1970). As the Court‘s opinion points out, Congress did not
Prior to 1942 the Internal Revenue Code treated business and nonbusiness bad debts identically. But, in that year, Congress amended
The major congressional purpose in distinguishing between business and nonbusiness bad debts was to prevent taxpayers from lending money to friends or relatives who
A related congressional purpose in enacting the predecessor to
It is apparent that Congress was especially concerned about the possibility that closely held family businesses might exploit the technical differences among the forms in which investments can be cast in order to gain unwarranted deductions against ordinary income.
This case is a perfect example of how the “significant” motivation test undercuts the intended effect of the statute. The taxpayer was drawing an annual salary of $12,000 from a family corporation in which he had invested almost $200,000. As the guarantor of the corporation‘s performance and payment construction bonds, the taxpayer risked a potential liability of $2,000,000 and ultimately incurred an actual liability of $162,000, which is the amount that he sought to deduct as a business bad debt. The jury found that the risk was incurred because the taxpayer was “significantly” motivated by
If this taxpayer had simply lent his son-in-law $162,000 and then sought to deduct that amount as a business bad debt when the latter‘s business collapsed, he plainly could not have prevailed. This was just the sort of intra-family loan that Congress intended to bar from treatment as a business bad debt. The fact that a corporation served as a conduit for the loan should make no difference. If the taxpayer had received only interest on the loan rather than a salary, he could claim no business bad-debt deduction. The fact that he took a nominal salary for nominal services does not, in my opinion, require a different result. Moreover, if instead of guaranteeing the construction bonds, the taxpayer had invested $162,000 in the corporation to strengthen its economic position, that investment would receive the same treatment as the prior investment of $200,000 and any loss would not be deductible against ordinary income. The fact that the intra-family contribution was made in the form of a guarantee should be irrelevant for income tax purposes.
In sum, I find that the “significant” motivation test produces results that are totally at odds with the goals of the statute. The conclusion that I draw from the legislative history is that Congress wanted to permit deductions against ordinary income for bad-debt losses only when the losses bore the same relation to the taxpayer‘s trade or business as did other losses that the Code permits to be deducted against ordinary income. Under
MR. JUSTICE WHITE, with whom MR. JUSTICE BRENNAN joins.
While I join Parts I, II, and III of the Court‘s opinion and its judgment of reversal, I would remand the case to the District Court with directions to hold a hearing on the issue of whether a jury question still exists as to whether taxpayer‘s motivation was “dominantly” a business one in the relevant transactions under 26 U. S. C.
MR. JUSTICE DOUGLAS, dissenting.
The Treasury Regulations
The jury was instructed in the words of the Regulations: “Do you find from a preponderance of the evidence that the signing of the blanket indemnity agreement by Mr. Generes was proximately related to his trade or busi-
There was evidence to support the finding. Generes was an officer of the company and received a salary of $12,000 a year. His job as officer was to obtain the bonding credit needed by the company to perform the jobs on which it bid. To get the bond Generes, the president, and Kelly, the vice-president, were required to sign personally an indemnity agreement.
The bond was essential if the company was to operate. Without the bond the company could not obtain business and, if that happened, he as an officer would lose his job. It therefore seems to me that signing the bond had a “proximate” relation to his business as a salaried officer in the sense that it was directly related to the hoped-for success of that business.
Whether it was a prudent act is not our concern. Nor is it our concern whether with the benefit of hindsight we can now say that signing the bond entailed risks wholly disproportionate to the stake Generes had in maintaining a job with a $12,000-a-year salary.
Obtaining a bond was essential to the corporation; and it was only by keeping the business going that the salaried position of Generes could be made secure. If the Regulations do not meet the desires of the Treasury Department, they can be rewritten. See Helvering v. Wilshire Oil Co., 308 U. S. 90, 100-102.
I protest now what I have repeatedly protested, and that is the use of this Court to iron out ambiguities in the Regulations or in the Act, when the responsible remedy is either a recasting of the Regulations by Treasury or presentation of the problem to the Joint Committee on Internal Revenue Taxation which is a standing com-
As I said in Commissioner v. Lester, 366 U. S. 299, 307, “Resort to litigation, rather than to Congress, for a change in the law is too often the temptation of government which has a longer purse and more endurance than any taxpayer.” (Concurring opinion.) And see Knetsch v. United States, 364 U. S. 361, 371 (dissenting opinion).
Had I voted to grant this petition I would be in a position to vote to dismiss it as improvidently granted. But to give integrity to the “rule of four” by which certiorari is granted2 the objectors must participate in a
In that view I cannot say that on the facts of this case the loss did not have a “proximate” relation to this corporate officer‘s business of keeping the enterprise afloat. I would affirm the Court of Appeals, 427 F. 2d 279.
Notes
Ҥ 166. Bad debts.
“(a) General rule.—
“(1) Wholly worthless debts. — There shall be allowed as a deduction any debt which becomes worthless within the taxable year.
. . . . .
“(d) Nonbusiness debts.—
“(1) General rule.—In the case of a taxpayer other than a corporation—
“(A) subsections (a) and (c) shall not apply to any nonbusiness debt; and
“(B) where any nonbusiness debt becomes worthless within the taxable year, the loss resulting therefrom shall be considered a loss from the sale or exchange, during the taxable year, of a capital asset held for not more than 6 months.
“(2) Nonbusiness debt defined.—For purposes of paragraph (1), the term ‘nonbusiness debt’ means a debt other than—
“(A) a debt created or acquired (as the case may be) in connection with a trade or business of the taxpayer; or
“(B) a debt the loss from the worthlessness of which is incurred in the taxpayer‘s trade or business.”
See United States v. Skelly Oil Co., 394 U. S. 678, 690-691 (dissenting opinion).Treas. Reg. on Income Tax:
“26 CFR § 1.166-5 Nonbusiness debts.
. . . . .
“(b) Nonbusiness debt defined. For purposes of section 166 and this section, a nonbusiness debt is any debt other than—
. . . . .
“(2) A debt the loss from the worthlessness of which is incurred in the taxpayer‘s trade or business. The question whether a debt is a nonbusiness debt is a question of fact in each particular case. . . . For purposes of subparagraph (2) of this paragraph, the character of the debt is to be determined by the relation which the loss resulting from the debt‘s becoming worthless bears to the trade or business of the taxpayer. If that relation is a proximate one in the conduct of the trade or business in which the taxpayer is engaged at the time the debt becomes worthless, the debt comes within the exception provided by that subparagraph. . . .”
The “rule of four” is not in the statute. But in the hearings on the bill that became the 1925 Act, Mr. Justice Van Devanter, who headed the committee of the Court sponsoring the Act before the Congress, said:
“For instance, if there were five votes against granting the petition and four in favor of granting it, it would be granted, because we proceed upon the theory that when as many as four members of the court, and even three in some instances, are impressed with the propriety of our taking the case the petition should be granted. This is the uniform way in which petitions for writs of certiorari are considered.” Hearing on S. 2060 and S. 2061 before a Subcommittee of the Senate Committee on the Judiciary, 68th Cong., 1st Sess., 29 (1924).
And the Congress acted in reliance on that representation. See H. R. Rep. No. 1075, 68th Cong., 2d Sess., 3.
The bill was originally drafted in 1922 by Chief Justice Taft with the assistance of Mr. Justice Day, Mr. Justice Van Devanter, and Mr. Justice McReynolds. Hearings on Jurisdiction of Circuit Courts of Appeals and United States Supreme Court before the House Committee on the Judiciary, 67th Cong., 2d Sess. (1922). The Committee representing the Court in the 1924 Hearings were Mr. Justice Van Devanter, Mr. Justice McReynolds, and Mr. Justice Sutherland. Hearing on S. 2060 and S. 2061, supra, at 1.
Compare the decision below and Weddle v. Commissioner, 325 F. 2d 849 (CA2 1963), with Niblock v. Commissioner, 417 F. 2d 1185 (CA7 1969). In Smith v. Commissioner, 55 T. C. 260, 268-271 (1970), reviewed without dissent, the Tax Court felt constrained,
“You must, in short, determine whether Mr. Generes’ dominant motivation in signing the indemnity agreement was to protect his
“Mr. Generes is entitled to prevail in this case only if he convinces you that the dominant motivating factor for his signing the indemnity agreement was to insure the receiving of his salary from the company. It is insufficient if the protection or insurance of his salary was only a significant secondary motivation for his signing the indemnity agreement. It must have been his dominant or most important reason for signing the indemnity agreement.”