Putnam v. Commissioner

Background

Max Putnam, a Des Moines lawyer, helped start a small publishing company in 1945, supplied its initial cash and property, and guaranteed two bank loans. The company stopped doing business, sold its assets, and Putnam wound up the firm in 1947. In December 1948 he paid $9,005.21 to the bank under his guaranty when the company could not pay. He claimed a full loss deduction on his joint 1948 return as a loss from a transaction entered into for profit; the Commissioner treated it as a nonbusiness bad debt allowing only short-term capital loss treatment. The Tax Court and the Eighth Circuit sided with the Commissioner, and the Supreme Court reviewed the conflict among lower courts.

Reasoning

The Court explained that when a guarantor pays a creditor, the original debt shifts by subrogation so the guarantor steps into the creditor’s position and acquires the debt. Under longstanding administrative practice and prior cases, losses that arise because a debt becomes worthless are treated as bad-debt losses. The Court relied on that rule, on prior decisions, and on Congress’s tax provisions to conclude Putnam’s payment was a nonbusiness bad debt and therefore deductible only as a short-term capital loss, not as a full ordinary loss.

Real world impact

The decision means individuals who pay a creditor under a guaranty for an insolvent company will normally get capital-loss treatment, not a full ordinary-loss deduction, limiting how much of the loss can offset ordinary income. The ruling settles a split among appeals courts about this tax issue.

Dissents or concurrances

Justice Harlan dissented, arguing the loss should be treated as an ordinary loss because the debtor was insolvent when the guaranty was paid and prior circuit decisions supported fuller deductibility.