Appeal from the United States Tax Court, No. 9757-84, William M. Fay, Judge.
William J. Bauer, Chief Judge, Harlington Wood, Jr., and Michael S. Kanne, Circuit Judges.
HARLINGTON WOOD, JR., Circuit Judge.
The Internal Revenue Service ("IRS") audited Melvin J. and Harriet L. Cole's income tax returns for 1979 and 1980 and disallowed certain deductions. A notice of deficiency was issued on January 11, 1984. The Coles filed a petition with the United States Tax Court contesting the deficiency determination. They also requested permission to amend their 1979 or 1980 tax return to claim a $50,000 bad debt deduction. The disagreement over the original deductions was eventually settled, but this last issue -- whether the Coles were entitled to a bad debt deduction -- proceeded to trial. The Tax Court ruled in favor of the IRS and disallowed the deduction. The Coles appeal.
During 1979 and 1980, the Coles, who are husband and wife, lived in Skokie, Illinois. Mr. Cole practiced law throughout this same period. On February 1, 1979, Mr. Cole made a $50,000 business loan to Borde, Berke & DeLeonardi, Ltd. ("BB&D"), a professional legal corporation in which Mr. Cole was a 15% shareholder. Howard Borde ("Borde"), as president of BB&D, signed a note payable on demand after May 1, 1979 with a 13.25% interest rate. Borde also signed the note personally as a guarantor. BB&D borrowed $125,000 from First State Bank of Chicago ("First State Bank") on February 2, 1979. As security, BB&D pledged to the bank its leasehold, leasehold improvements, furniture, fixtures, accounts receivable and contract rights. Borde, Mr. Cole and the other shareholders of BB&D each signed a personal guaranty of up to $125,000 to further secure payment of the bank loan. In a subordination agreement, Mr. Cole agreed to subordinate his loan in favor of the bank's loan, and First State Bank specifically allowed BB&D to repay the $50,000 to Mr. Cole if BB&D was not in default on the bank loan at any time.*fn1
BB&D made interest payments of $1,707.08 on May 3, 1979, $1,000.00 on July 24, 1980, and $500.00 on October 29, 1980 on the $50,000 loan made by Cole. No other payments were ever made on the loan. Mr. Cole left BB&D's employment in November or December 1979. In a 1985 letter, submitted as an exhibit to the Tax Court, Mr. Cole indicated to his attorney that he considered the loan uncollectable as of September 1979. Yet, despite Mr. Cole's assertion that he considered the loan uncollectable as of 1979, the Coles did not take a worthless debt deduction on their 1979 or 1980 tax returns. They did take other deductions for those same taxable years, however, including deductions for automobile expenses and depreciation, medical expenses, and for losses incurred by a mining partnership in which the Coles had invested.
The evidence presented to the Tax Court concerning BB&D's financial condition consisted of the corporation's federal tax returns for the years ending June 30, 1979, 1980 and 1981, and a security agreement related to the $125,000 loan made to BB&D by First State Bank. The Tax Court summarized the balance sheets contained in BB&D's tax returns as follows:
furniture & fixtures 270,217 272,965 276,155
Less depreciation -20,590 -52,943 -85,780
249,627 220,022 . 190,375