Sterrett, Judge:
Respondent determined a deficiency in petitioners' Federal income tax for the calendar year 1968 in the amount of $143,895.95. Due to concessions made by the parties, four issues remain for our determination: (1) Is shareholder petitioner entitled to a deduction for a portion of the net operating losses of the two subchapter S corporations as calculated at their year ended January 31,1967, to the extent of his stock basis and basis of indebtedness therein; (2) is petitioner entitled to a section 163 interest deduction in 1968 by reason of payments on two notes of a bankrupt corporation which petitioner had guaranteed in solido; (3) should the gain petitioner realized in liquidating two other corporations be reduced by the balance outstanding on a note executed by one of the bankrupt corporations which had been guaranteed by petitioner and the liquidated corporations; and (4) should that gain be further reduced by deficiencies owed by the liquidated corporations for which petitioner, as transferee of those corporations, is liable.
FINDINGS OF FACT
Some of the facts have been stipulated and are so found. The stipulation of facts, together with the exhibits attached thereto, are incorporated herein by this reference.
Petitioners Jacob and Mary T. Abdalla, husband and wife, resided in Opelousas, La., at the time the petition herein was filed. Their joint Federal income tax return for the taxable year 1968 was filed with the District Director of Internal Revenue, Austin, Tex. Mary T. Abdalla is a party to this action only because she joined in the filing of this return and, accordingly, Jacob Abdalla will hereinafter be referred to as petitioner.
Petitioner was the owner of 100 percent of the outstanding stock of Abdalla's Furniture, Inc. (hereinafter Furniture), a corporation organized under the laws of the State of Louisiana oh December 30,1948. As of October 25,1966, his stock basis and basis of indebtedness in Furniture were $100,000 and $141,500, respectively. In addition, petitioner owned 1,255 of the 1,275 shares outstanding of Abdalla's Downtown Furniture, Inc. (hereinafter Downtown Furniture), a corporation organized under the laws of the State of Louisiana on November 28,1961. His stock basis therein was $125,500 as of October 25,1966. Both corporations used a fiscal year which ended January 31 for purposes of calculating their Federal income tax liabilities.
Furniture and Downtown Furniture timely filed a properly executed election in accordance with the provisions of sections 1371 and 1372 to be considered subchapter S corporations. During the taxable year 1967 petitioner was the president and William O. Johnson, petitioner's certified public accountant, was the secretary-treasurer of both corporations.
Petitioner was also the president, principal shareholder, and chief executive officer of three realty corporations, Park Development Corp. (hereinafter Park), Vista Development Corp. (hereinafter Vista), and Park Vista Home Owners Corp., all organized and existing under the laws of the State of Louisiana.
Furniture and Downtown Furniture were adjudicated bankrupt on October 26,1966. The parties stipulated that petitioner's stock basis and basis of indebtedness became completely worthless on that date. For the taxable year ended January 31, 1967, Furniture and Downtown Furniture had net operating losses of $255,825 and $208,170, respectively.
Prior to the adjudication of bankruptcy petitioner had endorsed two notes of Furniture in solido. In the taxable year 1968 he paid interest thereon totaling $10,650.36. One of these notes was also endorsed by Vista and Park. They each secured their endorsement of Furniture's liability by a promissory note payable to "bearer." The promissory notes were, in turn, secured by attached collateral mortgages executed by the respective corporation.
On October 10, 1968, Park and Vista were liquidated. Petitioner computed the gain realized on liquidation without including in his basis the balance of $107,500 remaining on the Furniture note that had been endorsed by Park and Vista.
Petitioner included a deduction for the net operating losses of Furniture and Downtown Furniture in his individual tax return filed for his taxable year ended December 31, 1967. In his individual tax return filed for his taxable year ended December 31,1968, he included a deduction for his personal net operating loss resulting from the flow through of these corporate losses carried forward to 1968.
OPINION
Issue 1. Net Operating Loss
The first issue before us is whether petitioner may deduct a portion of the net operating losses of the two subchapter S corporations, as calculated at their year ended January 31,1967, as a net operating loss carryover for his taxable year ended December 31,1968.
At the outset we note that respondent has stipulated that the filing or nonfiling of the U.S. Corporation Income Tax Returns (Form 1120-S) for the year ended January 31, 1967, is not an issue in this case. Indeed, no question has been raised with respect to the validity of the subchapter S elections of Furniture and Downtown Furniture for the taxable years involved. Finally, neither party has attached any significance to the fact of bankruptcy except to the extent that it established worthlessness.
Section 1374, I.R.C. 1954, allows a flow through of the net operating losses of subchapter S corporations to their shareholders. The flow through results in a deduction from the shareholder's gross income for the taxable year in which the corporation's taxable year ends in an amount equal to the shareholder's pro rata share of the net operating loss. A shareholder's pro rata share of that loss is based on his percentage of ownership and the number of days out of the taxable year during which he owned that percentage of the stock. Thus, if his ownership of stock is for less than the corporation's full taxable year his pro rata share is determined by cumulating the average daily losses of the corporation for his period of ownership. The deduction is limited to the adjusted basis of the shareholder's stock plus the adjusted basis of any debt the corporation owes to that shareholder, determined at the close of the corporation's taxable year or on the day before any disposition of the stock. Thus, within these prescribed limitations, petitioner, as a shareholder of two subchapter S corporations, may take advantage of their accrued net operating losses.
Petitioner asserts that his entire basis in his stock and indebtedness of these corporations was available for the purpose of calculating his share of the corporations' 1967 net operating losses and that his basis in said stock and debt should not be totally absorbed by basis adjustments arising due to any section 165 and 166 losses that emanate from the stipulated worthlessness as of October 26, 1966. He reaches this result by interpreting section 1016(a)(18) to be a specific rule which excludes application of 1016(a)(1). We do not believe that the two paragraphs are mutually exclusive. "[T]he normal assumption is that where Congress amends only one section of a law, leaving another untouched, the two were designed to function as parts of an integrated whole. We should give each as full a play as possible." Markham v. Cabell, 326 U.S. 404, 411 (1945).
Paragraph (a)(18) of section 1016 refers to section 1376 which adjusts the basis for amounts treated as dividends and for net operating losses which have passed through the corporation to the shareholder. These basis adjustments are necessary to integrate the unique treatment of shareholders of subchapter S corporations with the normal basis adjustments for shareholders of subchapter C corporations. It should be noted that sections 1376 and 1016(a)(18) were enacted concurrently. Section 1016(a)(1) applies to basis adjustments relating to capital loss.
To the extent applicable herein, which will be evident from the following discussions, we have no difficulty in finding paragraph 1016(a)(1) and (18) internally consistent.
Respondent'contends that petitioner became entitled to section 165 worthless securities losses and a section 166 bad debt deduction on October 26,1966, when the two corporations were adjudicated bankrupt. He concludes that such losses and deduction will absorb petitioner's basis in the two companies and leave nothing against which to offset petitioner's share of their net operating losses. A loss resulting from worthless securities is deductible as set forth in section 165(g). A debt that becomes worthless is deductible as set forth in section 166(d)(1).
It has been held that a loss within the framework of sections 165(g) and 166(d)(1) must be taken in the taxable year in which the worthlessness occurs. Boehm v. Commissioner, 326 U.S. 287 (1945). The taxpayer cannot juggle the year of deduction. The timing is important because the effect of the two sections is to treat the worthless asset as if it had been disposed of at a loss. Section 1.165-l(b), Income Tax Regs., refers to "identifiable events" that fix the time of loss. Section 1.166-2(a), Income Tax Regs., speaks in more general terms of "all pertinent evidence." Thus, generally there exists a factual issue as to the inception of worthlessness. Herein the stipulations resolve this issue. It was stipulated that petitioner's Furniture stock and his Downtown Furniture stock became worthless securities on October 26,1966, the date the corporations were adjudicated bankrupt. It was also stipulated that the debt Furniture owed petitioner lost all value on that date.
The conundrum is how to apply the rule of law with respect to the timing of stock and debt losses to the instant set of facts without destroying the concept behind the subehapter S corporations that such corporations are treated as partnerships to the extent that their shareholders are to receive the benefit of any net operating losses. Petitioner's view ignores the usual rules governing the timing of deductions for worthless securities and bad debts, and respondent's view would deny a shareholder of a subchapter S corporation any deduction for its operating losses in a year of bankruptcy.
We believe that the solution to the integration of the timing of the worthlessness deductions with the tax treatment of subchap-ter S corporations and their net operating losses lies in the recognition of the fact that the onset of worthlessness not only constituted the event which established the worthlessness of petitioner's investment for purposes of sections 165 and 166, but that it can also fairly be treated as amounting to a sale or exchange of the stock and debt for subchapter S purposes. After all, both sections 165(g) and 166(d) themselves provide that the fact of worthlessness shall cause the loss resulting therefrom to be treated as a loss from the sale or exchange of a capital asset. As a practical matter there can be no doubt that the onset of worthlessness constituted a disposition of petitioner's interest in the two corporations in that he lost all the economic benefits of his stock and debt ownership while that condition persisted. He could no longer vote the stock and could no longer control the corporate affairs which were in the hands of the trustee in bankruptcy. Barring a miraculous resuscitation of the corporations all that remained for petitioner after October 26,1966, was to receive distributions, if any, from the trustee in bankruptcy, just as in the case of a sale of stock when all that remains for the seller is to receive the purchase price.
Therefore, we believe it consistent with the concept of section 1374(c) to hold that the onset of worthlessness on October 26, 1966, caused a disposition of petitioner's stock and debt interest in the bankrupt corporations, amounting to a sale or exchange, as of that date. Accordingly, he is entitled, to deduct those corporate losses as if he had disposed of the stock on that date computed in accordance with section 1374(c). Thus, the limit on his losses is his adjusted basis in the respective stock and debt calculated as of October 25,1966.
According to our computations petitioner's portion of Furniture's net operating loss cumulating between January 31,1966, and October 26,1966, was $187,137.73; his portion of Downtown Furniture's net operating loss for that same period was $149,887.34 calculated as follows:
re Furniture — NOL as of 1/31/67 = $255,825 by 365 = $700.89 per day X 267 days of ownership = $187,137.63.
re Downtown Furniture — NOL as of 1/31/67 = $208,170 -s- by 365 = $570.33 X 267 = $152,278.11 X .9843 (petitioner's percent ownership) = $149,887.34.
Section 1374(c) limits the deduction available to him as follows:
re Furniture — stock basis of $100,000 plus basis of indebtedness of $141,500 = $241,500.
re Downtown Furniture — stock basis of $125,500 plus basis of indebtedness $0 = $125,500.
Therefore, his section 1374 net operating loss deduction in respect to Furniture is $187,137.63 and in respect to Downtown Furniture is $125,500.
This solution maintains the integrity of subchapter S without allowing a double deduction. We note that it is comparable to the treatment by consolidated groups for deductions growing out of operating losses of an affiliate and a loss on the sale of the affiliate's stock. Ambac Industries, Inc. v. Commissioner, 487 F.2d 463 (2d Cir. 1973).
To the extent that the discussion in Levy v. Commissioner, 46 T.C. 531, 538 (1966), is inconsistent with the above holding, we are no longer bound by that decision.
To make subsequent issues more understandable it is appropriate to add one caveat with respect to the net operating loss. The taxable year before the Court is 1968. The corporations' net operating loss accrued for their taxable year ended January 31, 1967. Therefore, we are considering petitioner's carryover of a net operating loss from his taxable year 1967 to his taxable year 1968.
Once the size of the net operating loss is calculated in compliance with section 1374 the amount of that loss not completely offset by petitioner's other income in that year becomes a net operating loss personal to petitioner. In other words, when petitioner individually has a net loss after the flow through of the corporations' net operating loss as limited by section 1374, the net loss of petitioner may be carried forward as dictated by section 172. Roberts v. Commissioner, 398 F.2d 340 (4th Cir. 1968), cert. denied 393 U.S. 936 (1968).
Of the total net operating loss of Furniture, $187,137.63 passed through the corporation to petitioner. By operation of section 1016(a)(18) his stock basis was thereby reduced to zero and his basis of indebtedness to $54,362.27 (NOL of $187,137.63 less stock basis of $100,000 = $87,137.63. Basis of indebtedness of $141,500 less NOL in excess of stock basis of $87,137.63 = $54,362.27). Sec. 1.1376-2(b)(l), Income Tax Regs. This amount gave rise to a section 166 bad debt loss for 1966, the taxable year in which worthlessness occurred. Boehm v. Commissioner, supra. Because the dominant motivation of petitioner in extending credit to Furniture was not to protect his trade or business of being an employee thereof but to protect his capital investment, the loss is characterized as a nonbusiness bad debt and treated under section 166(d) as a short-term capital loss. Miles Production Co. v. Commissioner, 457 F.2d 1150 (5th Cir. 1972). This deduction in turn caused a section 1016(a)(1) adjustment to basis as an item chargeable to the capital account. Thus, the adjustments to basis necessitated by paragraphs (a)(1) and (a)(18) of section 1016 reduced petitioner's basis to zero as of December 31,1966.
Petitioner argues further that subsequent events gave rise to an additional flow through of these net operating losses. Petitioner bound himself as a debtor in solido on the two notes of Furniture prior to the time it was adjudicated bankrupt. Subsequent to the adjudication he paid the accrued interest on these loans. Petitioner asserts that as an obligor in solido he was liable for the obligations of Furniture, and because he was entitled to a contribution from Furniture, a further increase in his basis of indebtedness should result when the payment was made.
Respondent contends that what petitioner paid is only deductible under section 166 as a bad debt and no adjustment to basis results. We agree with respondent.
Petitioner's basis for section 1374(c) purposes, as well as Furniture's net operating loss for its taxable year ended January 31, 1967, had become fixed prior to petitioner's taxable year 1968. Subsequent events cannot affect those calculations. See Roberts v. Commissioner, supra.
Issue 2. Interest Deduction
Petitioner contends that these same interest payments should result in an interest deduction under section 163. If we were to accept petitioner's arguments that this payment of interest should both increase his basis of indebtedness for purposes of calculating his portion of Furniture's net operating loss and result in a section 163 deduction, the possibility of double compensation for a single payment arises. We do not think Congress intended subchapter S to double the effect of the other provisions of the Code, but rather to make adjustments to subchapter C to reflect the realities of small business practices.
Prior to Putnam v. Commissioner, 352 U.S. 82 (1956), interest paid by a guarantor was deductible by him under section 163. Sherman v. Commissioner, 18 T.C. 746 (1952), overruled by Rushing v. Commissioner, 58 T.C. 996 (1972). Since Putnam, the interpretation of this section allows an interest deduction where the taxpayer is secondarily liable only if the interest was paid in connection with a real estate mortgage and the taxpayer is the legal or equitable owner of such property. Nelson v. Commissioner, 281 F.2d 1 (5th Cir. 1960).
Petitioner makes two arguments in support of his application of the section 163 deduction to these payments. First, he argues that he was primarily liable as a debtor in solido under Louisiana law. Under Louisiana law the right of the third party creditor to sue petitioner for an amount he had guaranteed in solido accrued upon the maturity of the note. Brock v. First State Bank & Trust Co., 187 La. 766, 175 So. 569 (1937). However, even though petitioner was liable in solido on the debt of Furniture and was thus primarily liable to the creditor, he was secondarily liable vis-a-vis Furniture. Meadow Brook National Bank v. Recile, 302 F. Supp. 62 (E.D. La. 1969). In other words, though the creditor was free to collect from petitioner without a prior attempt to recover amounts due from Furniture, the petitioner was only secondarily liable because he had recourse against Furniture. La. Civ. Code Ann. art. 2106 (West 1977).
Second, petitioner contends that he fulfills the Nelson test as the legal or equitable owner of property mortgaged to secure a note. He argues that, as shareholder or as transferee of these corporations, he was the legal or equitable owner of the property mortgaged to secure a note.
The note was secured by petitioner's signature and his signature as president of Park and Vista. The corporations secured their endorsement by executing collateral mortgages. A collateral mortgage is one step removed from a real estate mortgage. A collateral mortgage is "designed, not to directly secure an existing debt, but to secure a mortgage note pledged as collateral security for a debt. the companion promissory note is usually payable to bearer on demand." Thrift Funds Canal, Inc. v. Foy, 261 La. 573, 260 So.2d 628, 630 (1972). The promissory note is not the indebtedness but security pledged as collateral for the actual debt. M. Nathan and H. G. Marshall, "The Collateral Mortgage," 33 La. L. Rev. 497 (1973). Thus, the real estate, even if found to be legally or equitably owned by petitioner as a shareholder or transferee of the corporation, does not serve as collateral for the indebtedness, but as collateral for the collateral, the corporation's guarantee. This relationship is too remote to support the further expansion of section 163 that would be necessary to encompass this situation. Petitioner is limited to the relief provided by section 166.
Issue 3. Reduction of Gain Due to Mortgage
Petitioner argues that due to the guarantee of Park and Vista on the note of Furniture their liquidation caused him to assume a liability which should reduce the gain realized on that liquidation. He cites Lam v. Commissioner, 8 B.T.A. 785 (1927), and Rev. Rul. 59-228, 1959-2 C.B. 59, as so holding.
Both Rev. Rul. 59-228 and Lam involved situations wherein the taxpayer became liable for obligations of a corporation due to its liquidation. That is, the taxpayer's total liability increased due to his assumption of the corporation's obligations.
Herein, petitioner's total liability was unaffected by his assumption of the liability of Park and Vista on Furniture's note. He was already liable on the note in his own right. A reduction of gain upon liquidation due to an obligation that does not increase the taxpayer's liability duplicates the effect of the section 166 remedy already available to compensate for the loss.
Issue U. Reduction of Gain Due to Deficiencies
The final issue is whether petitioner can reduce the gain realized upon liquidating Park and Vista by the amount of any deficiencies in Federal income tax owned by these two corpora tions that he is required to pay as transferee thereof. The actual amount of this deficiency is not before us. The liability was the subject of the case designated as docket No. 1948-74 of this Court. Petitioner fully conceded the liability on October 28,1976, and a decision was entered by this Court on January 13, 1977, subsequent to the trial at hand.
Petitioner asserts that Arrowsmith v. Commissioner, 344 U.S. 6 (1952), supports such an adjustment. We do not agree. In Arrowsmith the prior liquidation transactions were determinative of the character of the loss realized in a subsequent taxable year. There was no attempt therein to readjust the amount realized in the original transaction.
Petitioner may not recalculate the gain realized upon liquidation of Park and Vista. Instead, the taxes paid as transferee of the liquidated corporations may result in a loss in the taxable year in which they are paid. Schneider v. Commissioner, 65 T.C. 18 (1975); Heiderich v. Commissioner, 19 T.C. 382 (1952).
Decision will be entered under Rule 155.
Reviewed by the Court.
SEC. 1374. CORPORATION NET OPERATING LOSS ALLOWED TO SHAREHOLDERS.
(a) General Rule. — A net operating loss of an electing small business corporation for any taxable year shall be allowed as a deduction from gross income of the shareholders of such corporation in the manner and to the extent set forth in this section.
(b) Allowance of Deduction. — Each person who is a shareholder of an electing small business corporation at any time during a taxable year of the corporation in which it has a net operating loss shall be allowed as a deduction from gross income, for his taxable year in which or with which the taxable year of the corporation ends , an amount equal to his portion of the corporation's net operating loss (as determined under subsection (c)).
(c) Determination of Shareholder's Portion.—
(1) In general. — For purposes of this section, a shareholder's portion of the net operating loss of an electing small business corporation is his pro rata share of the corporation's net operating loss for his taxable year in which or with which the taxable year of the corporation ends. For purposes of this paragraph, a shareholder's pro rata share of the corporation's net operating loss is the sum of the portions of the corporation's daily net operating loss attributable on a pro rata basis to the shares held by him on each day of the taxable year. For purposes of the preceding sentence, the corporation's daily net operating loss is the corporation's net operating loss divided by the number of days in the taxable year.
(2) Limitation. — A shareholder's portion of the net operating loss of an electing small business corporation for any taxable year shall not exceed the sum of—
(A) the adjusted basis (determined without regard to any adjustment under section 1376 for the taxable year) of the shareholder's stock in the electing small business corporation, determined as of the close of the taxable year of the corporation (or, in respect of stock sold or otherwise disposed of during such taxable year, as of the day before the day of such sale or other disposition), and
(B) the adjusted basis (determined without regard to any adjustment under section 1376 for the taxable year) of any indebtedness of the corporation to the shareholder, determined as of the close of the taxable year of the corporation (or, if the shareholder is not a shareholder as of the close of such taxable year, as of the close of the last day in such taxable year on which the shareholder was a shareholder in the corporation).
SEC. 1016. ADJUSTMENTS TO BASIS.
(a) General Rule. — Proper adjustment in respect of the property shall in all cases be made—
(1) for expenditures, receipts, losses, or other items, properly chargeable to capital account,
(18) to the extent provided in section 1376 in the case of stock of, and indebtedness owing, shareholders of an electing small business corporation
SEC. 1376. ADJUSTMENT TO BASIS OP STOCK OF, AND INDEBTEDNESS OWING, SHAREHOLDERS.
(a) Increase in Basis of Stock for Amounts Treated as Dividends. — The basis of a shareholder's stock in an electing small business corporation shall be increased by the amount required to be included in the gross income of such shareholder under section 1373(b), but only to the extent to which such amount is included in his gross income in his return, increased or decreased by any adjustment of such amount in any redetermination of the shareholder's tax liability.
(b) Reduction in Basis of Stock and Indebtedness for Shareholder's Portion of Corporation Net Operating Loss.—
(1) Reduction in basis of stock. — The basis of a shareholder's stock in an electing small business corporation shall be reduced (but not below zero) by an amount equal to the amount of his portion . of the corporation's net operating loss for any taxable year attributable to such stock (as determined under section 1374(c)).
(2) Reduction in basis of indebtedness. — The basis of any indebtedness of an electing small business corporation to a shareholder of such corporation shall be reduced (but not below zero) by an amount equal to the amount of the shareholder's portion of the corporation's net operating loss for any taxable year (as determined under section 1374(c)), but only to the extent that such amount exceeds the adjusted basis of the stock of such corporation held by the shareholder.
Obviously we are aware that sec. 165(g) goes on to provide that the loss from the sale or exchange shall be treated as if it occurred on the last day of the taxable year. However, this language was enacted as part of the Revenue Act of 1938 and, as explained in the Senate report, for the following reason:
"Under the House bill the loss from the worthlessness of the security was considered to have been sustained on the first day of the taxpayer's taxable year. By reason of the committee amendments relating to capital losses, this date has been changed to the last day of the taxable year. In some cases, if the first day is determinative, the effect would be to make the loss a short-term capital loss and thus deductible only against short-term gains. Fixing the date as the last day of the taxable year will, in many cases, make the loss a long-term capital loss and thus permit the application of the more favorable treatment accorded to such losses. [S. Rept. 1567,75th Cong., 3d Sess. 14 (1938).]"
In view of its stated purpose, the language with respect to the effective date of the worthlessness is not relevant to the inquiry at hand, particularly when we have a stipulated date on which the loss at issue occurred.
We recognize that the amount of the NOL available to petitioner cannot be calculated until the corporation's taxable year ends. Until the NOL is determined the amount of basis available for a bad debt loss is an unknown. Therefore, in the factual situation before us, the bad debt loss for petitioner's 1966 taxable year could not be determined prior to the close of the corporate year ended Jan. 31,1967.
This is one of several cases cited by petitioner as authority that does not withstand scrutiny.
Art. 2106. If the affair for which the debt has been contracted in solido, concerns only one of the co-obligors in solido, that one is liable for the whole debt towards the other codebtors, who, with regard to him, are considered only as his securities.