Docket Nos. 30306, 30307.

19 T.C. 329 (1952)


United States Tax Court.

Promulgated November 25, 1952.

Attorney(s) appearing for the Case

Benjamin L. Bird, Esq., for the petitioners.

W. B. Riley, Esq., for the respondent.

These proceedings were consolidated for hearing and involve deficiencies in income tax for 1946, $2,562.47 in Docket No. 30306, and $2,627.76 in Docket No. 30307. The issue is whether the amount of $6,909.68 paid to the Ray Crowder Service Insurance Company is deductible as an ordinary and necessary expense incurred in business or in the production of income, or, in the alternative, as a nonbusiness bad debt. Petitioners filed their returns with the collector of internal revenue for the second district of Texas.


Petitioners are husband and wife and reside in Fort Worth, Texas. All of their income and deductions in the taxable year were community income and deductions. For convenience, the husband will be hereinafter referred to as petitioner.

From January 1935 until November 1, 1946, petitioner owned and operated the Ray Crowder Funeral Home, a mortuary in Fort Worth, hereinafter referred to as the Funeral Home. On November 1, 1946, the business of the Funeral Home was transferred to the Ray Crowder Funeral Home, a Texas corporation organized for that purpose, hereinafter referred to as the Corporation, all of the stock of which is owned by petitioners and Kenneth Anglin.

Prior to and during 1946 there were in operation in Texas mutual assessment life insurance associations or companies which had been organized under the laws of that state with the assistance of owners of funeral homes for such benefit as they could derive from the business of the insurers. One type of the insurers was known as burial associations, the benefits of whose policies of insurance were payable wholly or in part in burial services of a funeral home designated in the policy. Another type was a local mutual aid association which issued policies payable in cash to a designated beneficiary upon the death of the insured without restrictions on the use of the proceeds of the policy. Similar companies are in operation in other states.

The general practice among funeral homes in Texas is to have a burial insurance association connected with it. There are about 400 burial associations in operation in Texas, all but a few of which have a name similar to the funeral home which had organized it. Similarity of names was selected to advertise the funeral home. The officials or owners of funeral homes usually served as the officers and constituted a majority of the directors of the insurance company. They operated by preparing literature describing the insurance, its cost and benefits and the sponsoring funeral home and its services; employing agents at a small salary, plus a commission, who called at homes to sell insurance and while there, to advertise by literature and otherwise the funeral services of the sponsoring funeral home. The agents used the insurance as a means of opening discussion of the two subjects. In that manner personal contacts were established, friends were made, and the services of the funeral home were advertised. Other contact was made through weekly or biweekly collections of premiums. The policyholders quite frequently called at the funeral home to pay premiums. Burial insurance is an effective method of advertising the funeral home connected with it and it serves to hold and protect the business of the funeral home.

During the early part of 1946, seven of petitioner's competitors in Forth Worth had burial associations associated with them which employed about 75 solicitors of policies. One of the competitors had a local mutual aid association as a supplementary organization. Petitioner concluded that to meet this competition it would be necessary for him to organize a local mutual aid association, even though he realized that it would not have sufficient income to pay organization and operating expenses.

On May 1, 1946, the petitioners, Kenneth Anglin and two other individuals organized a local mutual aid insurance association under the provisions of Articles 4875a and 5068-1 of the Revised Civil Statutes of Texas in the name of Ray Crowder Service Insurance Company, hereinafter referred to as the Insurance Company. The Insurance Company had, as required by law, 500 applications for policies at the time of its organization, of which about ten were from petitioners and individuals associated with them in their business. It was authorized to do business within a radius of 75 miles of its home office, and had no capital stock, stockholders, or any initial capital. The members of the association were its policyholders, each of whom had one vote in the selection of directors and other matters under their control. Petitioners had no financial interest in the Insurance Company other than the policies each of them held. They were elected directors. The other directors were connected with petitioners' business. Alpha Crowder was elected president; Kenneth Anglin, vice president, and petitioner, secretary-treasurer. The officers can be ousted at any time. The Insurance Company can not pay dividends. The only salary paid to officers was to Anglin, who received $10 per week for services performed as office manager and accountant.

Individuals up to 85 years of age were eligible for membership in the Insurance Company. Premiums on policies ranged from 2 cents to 58 cents per week. The amount payable at death of the insured was never less than $100, nor more than $500. The sole source of income of the Insurance Company was from premiums on policies. During the first year a policy was in force 75 per cent of the premium could be used for general expenses and 40 per cent thereafter. The remainder of the premium had to be placed in a mortuary fund, out of which only death benefits could be paid.

The burial associations in Fort Worth and the Insurance Company advertised the funeral homes connected with them whenever possible. The solicitors of the Insurance Company were instructed to endeavor to convince prospective policyholders of the excellency of the services of the Funeral Home and Corporation.

The funeral sales of the Funeral Home and the Corporation1 during the years 1943 to 1950, inclusive, were, omitting cents, as follows:

                                                    Funeral sales
Year                                                 and service

1943 --------------------------------------------      $85,600
1944 --------------------------------------------       97,063
1945 --------------------------------------------       92,075
1946 to May 1 -------------------------   $27,734
May 1 to Nov. 1 -----------------------    52,910
Nov. 1 to Dec. 31 ---------------------    17,607
                                          _______       98,251
1947 --------------------------------------------      102,634
1948 --------------------------------------------      100,875
1949 --------------------------------------------      114,577
1950 --------------------------------------------      105,132

The receipts of the Insurance Company from premiums during the taxable year were $3,477.24, of which 75 per cent, or $2,607.88, was credited to the general fund for payment of expenses and the remaining 25 per cent, or $869.36, to the mortuary fund. It had 610 policies in force at the close of the year. The Insurance Company paid one claim of $100 out of the mortuary fund and the following amounts out of the general fund:

Statutory deposit ---------------------------------------      $500.00
Furniture purchased -------------------------------------       112.50
Social security taxes paid ------------------------------       365.35
Commissions paid ----------------------------------------     2,860.15
Wages paid ----------------------------------------------     4,379.16
Traveling expense ---------------------------------------        12.00
Insurance department fees -------------------------------        21.00
Advertising, printing, etc ------------------------------       896.61
Telephone, postage, etc ---------------------------------        65.16
Bond premiums -------------------------------------------        65.00
Other disbursements -------------------------------------       131.85
Automobile expense allowance ----------------------------       275.00
   Total ------------------------------------------------   2$9,683.78

It received from petitioner a total of $6,909.68, of which $5,040.22 was received prior to November 1, 1946, and $1,869.46 thereafter to the close of the year. The amounts were credited to the general fund. Any debt created by the payments had no value when they were made and at all times thereafter. The credits to the general fund in each of the years 1947, 1948, and 1949 out of premiums collected were less than the disbursements from the account. During those years amounts were received from the Corporation for credit to the fund.

The amounts received by the Insurance Company from petitioners were entered in the books of the former as advances and in the books of the latter as loans. Early in 1947 the Board of Insurance Commissioners of Texas determined that by treating the amounts as advances the Insurance Company was insolvent, a condition which, if continued, would have rendered the Insurance Company ineligible for a charter for another year. To correct the financial deficiency, the petitioner, at the request of the Board of Insurance Commissioners, on February 21, 1947, waived all claims for the return of the total amount with the provision "* * * that should the financial condition of the general fund ever justify it, I shall be entitled to the return of the amount so advanced upon making a satisfactory showing of the general fund to the Board of Insurance Commissioners." The balance in the general fund has not at any time thereafter been sufficient to pay the amount. Since the execution of the waiver the amount has not been carried in the books of the Insurance Company as a liability. Similar waivers were executed by the Corporation for amounts paid the Insurance Company in subsequent years to meet deficits in the general fund. Notwithstanding the foregoing, it was not the intention of either the Insurance Company or petitioner that the payments made to the Insurance Company were loans or were intended to be repaid.

During the years 1946 to 1950, inclusive, the Insurance Company paid claims and the Corporation performed the funeral services for the insured involved in the claims, as follows:

Year                                                 Claims   Services

1946 ---------------------------------------------       1        1
1947 ---------------------------------------------      13        8
1948 ---------------------------------------------      15       12
1949 ---------------------------------------------      25       15
1950 ---------------------------------------------      15        7

Petitioner and the Corporation spent considerable sums for advertising. The advertising included announcements in telephone directories and newspapers, and pencils bearing advertising. A competitor of petitioner and the Corporation in Fort Worth advertised by television. Deductions taken by the petitioners in their returns for the taxable year included the following amounts:

Advertising ---------------------------------------------   $2,522.37
Club dues and luncheons ---------------------------------      289.50
Sales promotion -----------------------------------------    4,348.53

In the separate returns filed by the petitioners for the taxable year they treated the amount of $6,909.68 paid to the Insurance Company as a nonbusiness bad debt deductible as a short term capital loss. In his determination of the deficiencies the respondent held that the amount did not constitute an allowable deduction.

Of the amount disallowed by respondent, $5,040.22 is deductible as an ordinary and necessary business expense. The remaining amount, $1,869.46, is not deductible as an ordinary and necessary expense in carrying on a business or in the production of income, or as a non-business bad debt.



Of the amount of $6,909.68 in controversy, petitioner paid $5,040.22 prior to November 1, 1946, while he was operating the Funeral Home in his individual capacity, and the remainder of $1,869.46 thereafter to the close of the taxable year while the funeral business was being conducted by the Corporation for its own account. We shall first discuss the deductibility, as an ordinary and necessary business expense, of the amount expended by petitioner before his business was transferred to the Corporation.

The nub of the contention of petitioner is that the amount was expended for advertising his business of conducting a funeral home. The issue arose because of the fact that the plan of advertising does not conform to normal procedure.

We have said that "* * * expenditures made to protect or to promote a taxpayer's business, and which do not result in the acquisition of a capital asset, are deductible" as ordinary and necessary expenses of transacting business. Edward J. Miller, 37 B. T. A. 830. The rule was applied in Scruggs-Vandervoort-Barney, Inc., 7 T.C. 779; Catholic News Publishing Co., 10 T.C. 73; L. Heller & Son, Inc., 12 T.C. 1109; United States v. Bruce Co., 180 F.2d 846.

The general practice in Texas and elsewhere was the use of burial associations as a means of advancing the interests of funeral homes by advertising and otherwise. Instead of creating such an adjunct to his business, petitioner and other individuals organized a local mutual aid insurance association with the same end in view. It served, by means not otherwise available to him, to advertise for the purpose of expanding his business, and to match similar effort of his competitors. The object of the plan obviously was to promote and to protect the business of the funeral home. The evidence discloses no other motive.

That the expense was ordinary is shown by the use of a similar plan in the community where petitioner conducted his business and it was necessary in the sense that petitioner regarded the form of advertising as helpful in carrying on his activity.

The fact that petitioner was under no legal or contractual obligation to make up operating deficits of the Insurance Company is not decisive. Luther Ely Smith, 3 T.C. 696; L. Heller & Son, Inc., supra. It was the practice among other funeral homes to assume the operating deficits of the associations they were sponsoring instead of endeavoring to have the associations levy assessments against policyholders to make up the loss. If petitioner had refused to bear the loss while its competitors were assuming the burden, the action would have had a detrimental effect on his business. Practical business considerations required petitioner to keep in line with the prevailing practice in the community where he operated. To absorb the operating deficits of the associated association was a way of conduct in the business field in which petitioner was engaged, Commissioner v. Heininger, 320 U.S. 467, and, therefore, a normal course of action, a test that has been said to be "crucial and controlling." Deputy v. Du Pont, 308 U.S. 488.

Petitioner had no interest in the Insurance Company greater than any other policyholder. His payments merely put the Insurance Company in funds to meet operating expenses and therefore did not result in the acquisition of a capital asset.

The remaining amount of $1,869.46 was paid by petitioner after his business was transferred to the Corporation. Petitioner is claiming the payment as an ordinary and necessary business expense or as an ordinary and necessary expense paid in the production of income. It is not a deductible expense of the petitioner individually under either provision of the statute. Deputy v. Du Pont, supra; Low v. Nunan, 154 F.2d 261.

Petitioner alleges in the alternative that the amount in dispute is deductible as a nonbusiness bad debt. The proof here is that petitioner was aware at the time he made the payments before and after the Corporation was organized that the Insurance Company would not have sufficient income at any time to repay the amounts. No proof was made that the debts, if such they were, had any value when incurred or at any time thereafter. Debts which are worthless when created are not deductible. Eckert v. Burnet, 283 U.S. 140; Hoyt v. Commissioner, 145 F.2d 634; Fred A. Bihlmaier, 17 T.C. 620. Accordingly, the amount of $1,869.46 is not deductible as a nonbusiness bad debt.

Reviewed by the Court.

Decisions will be entered under Rule 50.


1. Fiscal year ended October 31.
2. Deficit balance $166.22.


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