The opinion of the court was delivered by: DUMBAULD
This is a suit to recover income tax collected for the year 1952. The wife-plaintiff is impleaded only as co-signer of a joint return. The husband-plaintiff, R. J. Cleary, a Pittsburgh attorney, conducted the transactions which the Government claims resulted in taxable income. This Court has jurisdiction under 28 U.S.C. § 1346(a)(1). Jury trial has been waived. This opinion shall be deemed to embody the Court's findings of fact and conclusions of law.
Cleary was acquainted with one Earl Knudsen who in 1947 was financially embarrassed and in need of money. In order to obtain $ 17,500.00 for Knudsen, it was necessary for Cleary to borrow $ 23,500.00 from the Allegheny Trust Company of Pittsburgh in order to pay off a balance Cleary owed his broker and to obtain the use of the stocks thus liberated so that they could be pledged as collateral for the note for the larger sum of $ 23,500.00.
Of the proceeds of this loan, Cleary on the same day paid his broker (Kay, Richards & Company) $ 6,128.22, and paid Knudsen the $ 17,500.00.
On June 2, 1947, Cleary borrowed an additional $ 6,500.00, pledging 500 shares of United Paper Board, belonging to Knudsen and accompanied by a hypothecation agreement signed by him. On the same day Cleary turned over the proceeds of this loan to Knudsen, together with the proceeds of a dividend check for $ 1500.00 on Knudsen's Paper Board stock.
Cleary from time to time paid the interest on the loans, being reimbursed by Knudsen for the portion applicable to the proceeds Knudsen had received. (Knudsen in fact continued to pay a uniform amount per month, even after the principal of the loans had been reduced, but Cleary testifies that he accounted for this excess interest in his tax return, and this matter is not an issue in this case.)
In 1948 the loans were consolidated into a single loan of $ 30,000.00, secured by all the collateral securing the former loans. At the request of the bank, Knudsen furnished Cleary $ 1,000.00 which was applied in reduction of the principal. On February 7, 1949, at the request of the bank Cleary put up additional collateral belonging to him (100 Central of Georgia Railway voting trust certificates and $ 1600.00 Central of Georgia Railway bonds). On February 11, 1949, Cleary paid $ 7,000.00 to the bank on the loan.
Likewise, on February 11, 1949, Cleary authorized sale of 800 shares of Rockwell common stock, and the proceeds of the sale ($ 9,564.58) were applied to reduce the principal of the loan.
On October 10, 1951, Cleary paid off the note in full and obtained possession of all the collateral.
In May of 1951 Knudsen sued Cleary in the Court of Common Pleas of Allegheny County at No. 2098 July Term, 1951 In Equity to recover the collateral which Knudsen had delivered to Cleary in 1947 to secure the loan. This action was settled when pursuant to stipulation an order was signed as of October 20, 1952, by Judge A. Marshall Thompson, pursuant to which Knudsen was to deliver to Cleary 800 shares of Rockwell stock and pay reimbursement of interest amounting to $ 550.65 and also the sum of $ 9,899.35. Knudsen having performed this order on his part, he received back from Cleary the collateral belonging to him.
It is stipulated that the value of 800 shares of Rockwell stock on October 21, 1952, was $ 20,800.00, as compared with the $ 9,564.58, which constituted the proceeds of the sale of Cleary's stock when it was sold in 1949.
The Government's claim for additional tax turns upon this difference in the market value of 800 shares of Rockwell stock. The Internal Revenue agent auditing Cleary's 1952 return added an item of income amounting to $ 7,699.35, stating that 'taxpayer received during October 1952 in full settlement of the loan -- stock having a market value of $ 20,800.00 and cash in the amount of $ 9,899.35 total of $ 30,699.35. Income of $ 7,699.35 has been realized on the transaction -- measured by the difference between the balance of the loan -- $ 23,000.00 and the amount received thereon or $ 30,699.35.'
Knudsen testified at the trial that he did not know that Cleary's Rockwell stock was being used as collateral, and that the first time he heard anything about the Rockwell stock was when he tried to get his own collateral back. Cleary's letter of May 7, 1947 (the date of the note) omits to mention the Rockwell stock when listing the collateral, and indicating what portion of it belonged to Knudsen. However, 'Plaintiff's Reply to Amended New Matter' in the Allegheny County suit, verified by Knudsen on February 6, 1952, contains in paragraph 2 an averment 'that Defendant informed Plaintiff that if Plaintiff would deliver certain securities to Defendant, Defendant would use said securities and other securities of Defendant as collateral for a loan which would produce sufficient additional cash to permit Defendant to lend money to Plaintiff'. Similarly, in paragraph 11 of said pleading Knudsen states 'It is admitted that there were discussions between Plaintiff and Defendant as to the advisability of selling said 800 shares of Rockwell Manufacturing Company stock and that subsequently said 800 shares of Rockwell Manufacturing Company stock were sold by Defendant, but it is denied that such sale was motivated by a desire to make application of the proceeds to said loans. On the contrary, it is averred that said sale was against the advice of Plaintiff.'
From these admissions in the Allegheny County pleadings, it is clear that, contrary to his present recollection, Knudsen did know that Cleary's Rockwell stock was pledged as collateral for the loan. It is also clear from paragraph 19 of the stipulation between plaintiff and the Government in the present proceedings that the proceeds of the sale of the Rockwell stock were in ...