Putnam v. Commissioner, 352 U. S. 82 (1956)

A non-business bad debt deduction requires a valid and enforceable debt that becomes totally worthless within the taxable year.

Summary

In Putnam v. Commissioner, the Supreme Court clarified the criteria for claiming a non-business bad debt deduction under section 166(d) of the Internal Revenue Code. The case involved a taxpayer who paid a settlement for an auto accident and sought to deduct the amount as a bad debt from a now-defunct insurance company. The Court ruled against the taxpayer, emphasizing that a deductible non-business bad debt must be a valid and enforceable obligation that becomes totally worthless within the tax year. The decision hinged on the taxpayer’s failure to meet claim filing deadlines and the lack of proof that the debt was totally worthless in the year claimed.

Facts

Petitioner was insured by Banner Mutual Insurance Co. when his vehicle was involved in an accident causing injury to the Herns. After Banner’s insolvency and subsequent liquidation order by the Illinois State Department of Insurance, the petitioner settled the Herns’ claim for $8,000 without filing a claim against Banner by the required deadline. He later sought to deduct this amount as a non-business bad debt on his 1967 tax return, claiming it was due from Banner under the insurance policy.

Procedural History

The IRS disallowed the deduction, prompting the taxpayer to appeal to the Tax Court. The Tax Court upheld the IRS’s decision, and the case was then appealed to the Supreme Court, which affirmed the lower court’s ruling.

Issue(s)

1. Whether the taxpayer’s payment to the Herns created a valid and enforceable debt against Banner that became totally worthless within the taxable year?

Holding

1. No, because the taxpayer did not file a claim by the required deadline, and thus no valid and enforceable debt existed against Banner in the taxable year. Furthermore, the debt did not become totally worthless within the taxable year as the liquidation process was ongoing.

Court’s Reasoning

The Supreme Court emphasized that for a non-business bad debt to be deductible, it must be a “bona fide debt”—a valid and enforceable obligation to pay a fixed or determinable sum of money that becomes totally worthless within the taxable year. The Court applied section 166(d) of the Internal Revenue Code, which specifies that a non-business debt must be totally worthless in the year claimed to be deductible. The Court found that the taxpayer failed to file a timely claim with the liquidator, which was necessary to establish a valid claim against Banner’s assets. The Court also noted that the taxpayer did not prove that the debt became totally worthless in 1967, as Banner’s assets were still being liquidated until 1972. The Court’s decision was influenced by policy considerations to prevent premature deductions and to ensure that only genuinely worthless debts are claimed.

Practical Implications

Putnam v. Commissioner sets a precedent that taxpayers must strictly adhere to legal deadlines and procedures when pursuing claims against insolvent entities to establish a valid debt for tax deduction purposes. It underscores the importance of proving total worthlessness within the taxable year for non-business bad debt deductions. This ruling impacts how similar cases are analyzed, requiring clear evidence of a fixed debt and its complete worthlessness. Legal practitioners must advise clients on the necessity of timely filing claims and documenting the worthlessness of debts. The decision also affects how insurance companies and their liquidators manage claims, emphasizing the finality of claim filing deadlines. Subsequent cases have followed this ruling, reinforcing the strict criteria for non-business bad debt deductions.