Deputy, Administratrix v. Du Pont

1940-01-08

Headline: Court disallowed a wealthy investor’s claim to deduct $647,711.56 paid to a lender, ruling those stock-carrying payments were not ordinary business expenses or deductible interest for the investor.

Holding: The Court held that a large stockholder may not deduct the $647,711.56 he paid as either ordinary business expenses or as interest because the payments arose from the corporation’s business and were not ordinary for his activities.

Real World Impact:

Prevents large shareholders from deducting stock-carrying payments as ordinary expenses.
Limits the tax meaning of “interest” to compensation for use of borrowed money.
Reduces deductions for investors who finance or back employee stock purchase plans.

Topics: tax deductions, stock loans, investor expenses, corporate stock plans

Summary

Background

A man who owned about 16% of a big corporation arranged in 1919 to have 9,000 shares sold to nine company executives by borrowing the stock and selling it to them. When his ten-year obligation came due in 1929 and he lacked the shares to return, he borrowed replacement shares from a lending company and agreed to return them and to pay all dividends and related taxes. In 1931 he paid $567,648 in dividend equivalents and $80,063.56 in taxes — the $647,711.56 at issue — and tried to deduct those payments when computing his income. The tax commissioner disallowed the deduction, and lower courts reached different results before the case reached this Court.

Reasoning

The Court asked whether those payments were ordinary, necessary business expenses or interest on indebtedness. It held they were not deductible. First, the payments flowed from the corporation’s efforts to finance stock ownership for its executives, not from the investor’s ordinary business, so they did not proximately arise from his business. Second, the payments were not “ordinary” expenses for someone managing or conserving a personal estate. Third, the Court refused to stretch the word “interest” to include these carrying charges, saying interest means compensation for the use of borrowed money. On those grounds the Court reversed the appeals court and affirmed the lower court ruling denying the deduction.

Real world impact

The decision limits when large shareholders can deduct carrying charges tied to corporate stock arrangements. Investors who pay carrying charges to support employee or executive stock plans cannot assume those costs are ordinary business deductions or deductible interest. The Court left open whether other parts of the tax law might treat such payments differently.

Dissents or concurrances

Justice Frankfurter (joined by Justice Reed) emphasized that managing personal investments is not a “trade or business” for deductions. Justice Roberts (joined by McReynolds) argued the case was fact-specific and should not have been reviewed, urging deference to administrative practice and affirming the lower appeals court instead.