The petitioner, Max Putnam, in December 1948, paid $9,005.21 to a Des Moines, Iowa, bank in discharge of his obligation as guarantor of the notes of Whitehouse Publishing Company. That corporation still had a corporate existence at the time of the payment but had ceased doing business and had disposed of its assets eighteen months earlier. The question for decision is whether, in the joint income tax return filed by Putnam and his wife for 1948, Putnam's loss is fully deductible as a loss 'incurred in (a) transaction * * * for profit, though not connected with (his) trade or business' within the meaning of § 23(e)(2) of the Internal Revenue Code of 1939, or whether it is nonbusiness bad debt within the meaning of § 23(k)(4) of the Code, and therefore deductible only as a short-term capital loss.
The Commissioner determined that the loss was a nonbusiness bad debt to be given short-term capital loss treatment. The Tax Court and the Court of Appeals for the Eighth Circuit sustained his determination. Because of an alleged conflict with decisions of the Courts Appeals of other circuits, we granted certiorari.
Putnam is a Des Moines lawyer who in 1945, in a venture not connected with his law practice, organized Whitehouse Publishing Company with two others, a newspaperman and a labor leader, to publish a labor newspaper. Each incorporator received one-third of the issued capital stock, but Putnam supplied the property and cash with which the company started business. He also financed its operations, for the short time it was in business, through advances and guarantees of payment of salaries and debts. Just before the venture was abandoned, Putnam acquired the shares held by his fellow stockholders and in July 1947, as sole stockholder, wound up its affairs and liquidated its assets. The proceeds of sale were insufficient to pay the full amount due to the Des Moines bank on two notes given by the corporation and guaranteed by Putnam for moneys borrowed in August 1946 and March 1947.
The familiar rule is that, instanter upon the payment by the guarantor of the debt, the debtor's obligation to the creditor becomes an obligation to the guarantor, not a new debt, but, by subrogation, the result of the shift of the original debt from the creditor to the guarantor who steps into the creditor's shoes. Thus, the loss sustained by the guarantor unable to recover from the debtor is by its very nature a loss from the worthlessness of a debt. This has been consistently recognized in the administrative and the judicial construction of the Internal Revenue laws which, until the decisions of the Courts of Appeals in conflict with the decision below, have always treated guarantors' losses as bad debt losses. The Congress recently confirmed this treatment in the Internal Revenue Code of 1954 by providing that a payment by a noncorporate taxpayer in discharge of his obligation as guarantor of certain noncorporate obligations 'shall be treated as a debt.'
There is, then, no justification or basis for consideration of Putnam's loss under the general loss provisions of § 23(e)(2), i.e., as an ordinary nonbusiness loss sustained in a transaction entered into for profit. Congress has legislated specially in the matter of deductions of nonbusiness bad debt losses, i.e., such a loss is deductible only as a short-term capital loss by virtue of the special limitation provisions contained in § 23(k)(4). The decision of this Court in Spring City Foundry Co. v. Commissioner, 292 U.S. 182, 54 S.Ct. 644, 78 L.Ed. 1200, is apposite and controlling. There it was held that a debt excluded from deduction under § 234(a)(5) of the Revenue Act of 1918 was not to be regarded as a loss deductible under § 234(a)(4). Chief Justice Hughes said for the Court: