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tions, under the excise tax law, is January 1, 1909, and for individuals, under the general income tax law, it is March I, 1913. Debts existing and carried as good on these dates may be treated as allowable deductions if subsequently found to be uncollectible. The entire amount may be deducted in the returns of the year during which the debt was found to be bad.

Where no reserve for bad debts has been carried, or where it has been carried and disallowed, this arrangement works out equitably. If there is to be no distinction between capital profits or losses and income profits or losses, it is obvious that the only account to which such bad debt can be charged is the profit and loss account for the year when ascertained. Taxpayers therefore should be careful when dealing with a loss occurring after January 1, 1909, if a corporation, or after March 1, 1913, if an individual, to follow this procedure, taking credit for the loss in the return, although in the books the amount may be charged against a reserve for bad debts or against surplus.

Special Types of Bad Debts-How Valued
Bankruptcy claim-Extent to which deductible.-

REGULATION. .... Only the difference between the amount réceived in distribution of the assets of a bankrupt and the amount of the claim may be deducted as a bad debt.

Claims against decedent's estate-Extent to which deductible.The difference between the amount received by a creditor of a decedent in distribution of the assets of the decedent's estate and the amount of his claim may be considered a worthless debt.

Accounts receivable purchased-Basis for deduction.A purchaser of accounts receivable which can not be collected and are consequently charged off the books as bad debts is entitled to deduct them, the amount of deduction to be based upon the price he paid for them and not upon their face value. (Art. 152.)

Notes receivable-Basis for deduction.

REGULATION. .... If a taxpayer computes his income upon the basis of valuing his notes or accounts receivable at their fair market value when received, which may be less than their face value, the amount deductible for bad debts in any case is limited to such original valuation. (Art. 151.)

The entry of notes at less than their face value is equivalent to the creation of a reserve for bad debts.

Worthless bonds-Extent to which deductible. As a bond is an obligation to pay money any failure to pay constitutes a bad debt.

REGULATION. Where bonds purchased before March 1, 1913, depreciated in value between the date of purchase and that date, and were in a later year ascertained to be worthless and charged off, the owner is entitled to a deduction in that year equal to the value of the bonds on March 1, 1913. Bonds purchased since February 28, 1913, when ascertained to be worthless, may be treated as bad debts to the amount actually paid for them, but not exceeding their amortized value if purchased at a premium. Bonds of an insolvent corporation secured only by a mortgage from which on foreclosure nothing is realized for the bondholders are regarded as ascertained to be worthless not later than the year of the foreclosure sale, and no deduction for a bad debt is allowable in computing a bondholder's income for a subsequent year. .... (Art. 154.)

The restriction on the amount of loss to be deducted when premiums have been amortized is equitable. The taxpayer will have deducted from income the amortization instalments and if he were to exclude the items from the computation the deduction for the loss would be excessive.

Likewise if bonds purchased at a discount have been written up and are sold at less than book value the measure of the deductible loss is the difference between the book value and the price received and not the difference between cost and the amount received, because the amortization instalments will have been reported as income.

Debts held prior to March 1, 1913.-Basis for deduction.-
Regulation. .... To authorize a deduction for a bad debt on

account of notes held prior to March 1, 1913, their value on that date must be established.* (Art. 154.)

Obviously if a taxpayer in 1919 charged off a debt which had been carried as good since March 1, 1913, it would be reasonable to inquire whether or not on that date the debt was deemed to be good. But the mere fact that on that date there was some doubt as to its value would not mean that the deduction was an improper one in 1919. The Treasury has always held and still holds that no debt could be charged off until it was 100 per cent bad. The Treasury's action did not accord with good accounting practice, but it is too late now for it to reverse its regulations in regard to bad debts as of a date long past. Subsequent transactions with debtor would indicate prima facie that debt was collectible at March 1, 1913.

Debts Must Be Actually Ascertained to be Worthless

The law specifies that a debt to be deductible as bad must be "ascertained to be worthless" [section 214 (a-7)].

When is a debt worthless?—In describing the deductions permitted to individuals the regulations set up the following general standard.

REGULATION. An account merely written down or a debt recognized as worthless prior to the beginning of the taxable year is not deductible. Where all the surrounding and attendant circumstances indicate that a debt is worthless and uncollectible and that legal action to enforce payment would in all probability not result in the satisfaction of execution on a judgment, a showing of these facts will be sufficient evidence of the worthlessness of the debt for the purpose of deduction. .... (Art. 151.)

'[Former Procedure]

REGULATION. “All debts representing amounts that became due and payable prior to March 1, 1913, and not ascertained to be worthless prior to that date, whether representing income or a return of capital, are held to be allowable deductions, under paragraph B of the law, in a return of income for the year in which they are actually ascertained to be worthless and are charged off.” (T. D. 2224, July 13, 1915.)

It should be noted that this statement is couched in terms broad enough to include all debts due the individual whether from corporations or from other individuals.

DEPRECIATION OF COLLATERAL SECURITY.—When a debtor who has put up collateral is known to be unable to pay and the collateral security is worth substantially less than the amount of the debt, there is no good reason why the taxpayer should be compelled to sell the collateral, or make a "wash” sale of it, in order to charge off the loss which has been sustained.

The regulations to some extent cover the point, but it should be made clear that an accrued loss of 50 per cent of a debt, when determined by recognized methods of accounting, is as deductible as a loss of 100 per cent.

BANKRUPTCY AS A TEST.

REGULATION. . .. . Bankruptcy may or may not be an indication of the worthlessness of a debt, and actual determination of worthlessness in such a case is sometimes possible before and at other times only when a settlement in bankruptcy shall have been had. Where a taxpayer ascertained a debt to be worthless and charged it off in one year, the mere fact that bankruptcy proceedings instituted against the debtor are terminated in a later year confirming the conclusion that the debt is worthless will not authorize shifting the deduction to such later year. In the case of debts existing prior to March 1, 1913, only their value on that date may be deducted upon subsequently ascertaining them to be worthless. .... (Art. 151.)

The foregoing regulation is almost humorous. For many years taxpayers claimed deductions on the basis now set forth in article 151, but during as many years the deductions were disallowed and additional assessments were imposed and collected. Any "shifting” of a deduction in the past was due to action by the Treasury, not by taxpayers.

Art. 151, page 674.

[Former Procedure] Article 8 of Regulations 33, 1918, stated that the "determination of worthlessness in such cases is possible only when settlement in bankruptcy shall have been had."

Foreclosure sale on a mortgage.

REGULATION. Where under foreclosure a mortgagee buys in the mortgaged property and credits the indebtedness with the purchase price, the difference between the purchase price and the indebtedness will not be allowable as a deduction for a bad debt, for the property which was security for the debt stands in the place of the debt. The determination of loss in such a situation is deferred until the property is disposed of, except where a purchase money mortgage is foreclosed by the vendor of the property. .... Only where a purchaser for less than the debt is another than the mortgagee may the difference between the debt and the net proceeds from the sale be deducted as a bad debt. (Art. 153.)

When the owner of a real estate mortgage is unable to collect principal and interest and decides that it is necessary to foreclose in order to protect his investment, and at foreclosure sale buys in the property as the highest bidder, it is difficult to understand why it is not a closed transaction. Usually property depreciates in value before foreclosures take place. If the owner could not claim credit for the loss arising from the foreclosure sale it is probable that years would elapse before the actual loss could be shown in any other way.

The law' provides that “when property is exchanged for other property the property received in exchange shall for the purpose of determining gain or loss be treated as the equivalent of cash to the amount of its fair market value, if any." Therefore when a mortgagee receives in place thereof real property the latter should be valued and the gain or loss, if any, returned.

Compositions and similar settlements.—The following ruling taken from the Bulletin of the National Association of Credit Men is of interest as bearing on the meaning of the word "worthless”:

A corporation had its annual statement to the Treasury Department rendered for income tax purposes questioned because of losses charged off through compositions. This seemed so unfair that the

'Section 202 (b).

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