Case Name: James Alex and Betty Jean Alex, Petitioners v. Commissioner of Internal Revenue, Respondent
Court: United States Tax Court
Jurisdiction: United States
Decision Date: 1978-05-24
Citations: 70 T.C. 322
Docket Number: Docket No. 10458-75
Parties: James Alex and Betty Jean Alex, Petitioners v. Commissioner of Internal Revenue, Respondent
Judges: Drennen, Dawson, Simpson, Sterrett, and Wiles, JJ., agree with this concurring opinion.
Reporter: Reports of the Tax Court of the United States
Volume: 70
Pages: 322–341

Head Matter:
James Alex and Betty Jean Alex, Petitioners v. Commissioner of Internal Revenue, Respondent
Docket No. 10458-75.
Filed May 24, 1978.
Barney B. Shiotani, for the petitioners.
Hector C. Perez, for the respondent.

Opinion:
Tannenwald, Judge:
Respondent determined a deficiency of $38,444 in petitioners' Federal income tax for the year 1972. As a result of concessions by the parties, the sole issue is whether rebates and discounts paid by James Alex to purchasers of life insurance policies reduced his commissions and thereby are properly excludable from petitioners' gross income.
FINDINGS OF FACT
Some of the facts have been stipulated and are found accordingly. The stipulation of facts and exhibits attached thereto are incorporated herein by this reference.
James Alex (James or petitioner) and Betty Jean Alex are husband and wife who resided in Los Angeles County, Calif., at the time the petition herein was filed. They filed a joint 1972 Federal income tax return with the District Director of Internal Revenue, Los Angeles, Calif.
During 1972, petitioner was engaged in the business of selling life insurance in the Los Angeles area. He was an agent for the Jefferson National Life Insurance Co. (Jefferson). Under the terms of his contract with Jefferson, petitioner would be paid as commissions a fixed percentage of the first year's premium on each policy sold and lesser percentages of renewal premiums. The policies sold produced commissions of 75 or 90 percent of first-year premiums. In addition, petitioner was entitled to an office allowance from Jefferson of 20 percent of commissions earned, if certain conditions were satisfied, and a production or persistency bonus of up to 45 percent of first-year premiums. The size of this bonus depended upon the percentage of policies on which the second-year premium was paid within a specified period. The office allowance was paid 15 days following the close of the month in which the commissions were earned; the production bonus was to be paid within 60 days of the close of the calendar year.
Petitioner perceived that, under this compensation schedule, he would be paid an amount in excess of the first year's premiums on every policy sold if he could qualify for the production bonus. He devised two schemes to take advantage of this situation, the "rebate" and the "discount."
In either case, petitioner approached a prospective customer and stated that he could provide a life insurance policy guaranteed to stay in force for 2 years, with no cash outlay required. If the individual was interested, an application would be made. Under the rebate scheme, which was used with policies producing a 90-percent commission, petitioner would issue a check to the client in the amount of the first year's premium, and the client simultaneously gave petitioner a check in like amount payable to Jefferson. Petitioner would then turn the premium check over to Jefferson and would receive his commission, which was immediately deposited. The client was then notified that he could deposit petitioner's check.
The discount scheme was used only in connection with a policy that had a substantial cash value during the first year that the policy was in effect. Petitioner received a commission of 75 percent of the first year's premium on this type of policy. Instead of exchanging checks with the client, petitioner reduced the premium payable on the policy by the sum of the cash value and commission payable to him and submitted the difference (a small percentage of the premium) to Jefferson.
Petitioner exchanged notes with every client in the amount of the first year's premium. Petitioner would collect on his note only if the client died during the first 2 years of the policy. If the beneficiary collected the insurance proceeds, the note of the client would enable petitioner to collect the first year's premium. If Jefferson successfully contested its liability for payment, Jefferson would refund the premium to the insured's estate, and petitioner was required to refund his commission to Jefferson. In such circumstances, the note of the client would enable petitioner to collect the refunded commission from the estate. The client's note could also be used to show insurance investigators that the client was obligated for the amount of the premium. The note which petitioner furnished the client was designed to protect the latter in the event that the premium was not refunded upon cancellation of the policy and petitioner sought to collect on the client's note which he held. Neither petitioner nor any client ever collected on any of the notes.
In 1972, petitioner sold life insurance policies to 21 individuals. All of these policies were renewed for the subsequent year by borrowing on the policy, or by petitioner paying minimal amounts. With the exception of one payment in the amount of $300, no policyholder made any out-of-pocket payment for this insurance. Petitioner hoped to build up a clientele by selling insurance in this manner.
During 1972, petitioner paid the following amounts incidental to his insurance selling schemes:
(1) $754.40 to Jefferson as premiums;
(2) $88,104.72 to policyholders; and
(3) $9,839.90. to pay off a loan obtained to finance a premium payment.
It is illegal in California to offer as an inducement to purchase insurance any rebate of the premium payable or of the agent's commission on the insurance contract, and the statute so providing is generally enforced. Petitioner was aware that he was conducting his business in an illegal manner.
Petitioner received $129,944.15 in commissions and office allowances for 1972 and he included this amount in his gross receipts for tax purposes. He claimed a deduction as "cost of goods sold and/or operations" in the amount of $98,403 which was described as "Discounted Premiums." In the notice of deficiency, respondent disallowed the deduction for "Discounted Premiums" on the ground that they were not allowed under section 162(c).
OPINION
The single issue for decision is whether the rebate paid or the discount given by petitioner constitutes a downward adjustment to the amount of gross income received, as petitioners now claim by way of an amended petition, or are business expenses deductible under section 162. If the latter is the case, petitioners concede that the deduction is barred by section 162(c).
Prior to the enactment of section 162(c), this Court consistently held that discounts or rebates from the purchase price are generally to be treated as adjustments of that price and are consequently exclusions from gross income. See, e.g., Schiffman v. Commissioner, 47 T.C. 537 (1967), and cases collected therein. See also Pendola v. Commissioner, 50 T.C. 509, 519 (1968). We have only recently concluded, in a Court-reviewed opinion, that section 162(c) does not change the principle embodied in the previously decided cases. Max Sobel Wholesale Liquors v. Commissioner, 69 T.C. 477 (1977).
In all but one of the decided cases, the arrangements for the discount or rebate were made by the seller directly with the buyer. The exception is Schiffman v. Commissioner, supra, which involved dealings between an agent of an insurance company and the purchaser of the insurance, as is the situation herein. While a careful reading of the facts of Schiffman shows that the taxpayer agent had such broad authority that he could arguably be considered the seller of the insurance and that therefore that case is distinguishable, we note that our opinion specifically stated that "In our judgment, the issue herein does not turn on whether there was a direct confrontation between the customer and the insurance company or whether the latter had knowledge of petitioner's clandestine arrangements." See 47 T.C. at 541. Under these circumstances, we do not think it can fairly be said that Sckiffman can be distinguished on the basis that, in that case, the taxpayer agent was the seller while the petitioner herein was not. See n. 4 swpra. Moreover, we are concerned over the appropriateness of differentiating among various types of insurance agents in situations such as are involved herein.
After careful consideration, we now think that any claim of exclusion from gross income, based upon an adjustment to the purchase price resulting from a discount or rebate, should at most be available only to the buyer or the seller and that our decision in Sckiffman is inconsistent with this principle and should be overruled. Any broader application of the exclusionary principle would open the door to wholesale evasion of the purposes of section 162(c). In short, since petitioner cannot be considered as the seller, there can be no selling price to which any adjustment as to him might be applied and, consequently, any tax benefit to which petitioners herein are entitled must be by way of deduction from gross income, which petitioners have conceded is precluded by that section.
In reaching our conclusion that Sckiffman should be overruled, we have taken into account the fact that there is no clear legislative recognition that the holding in Sckiffman should be encased in concrete through the enactment of section 162(c). We have also been mindful of the importance of the policy embodied in the doctrine of stare decisis. But we perceive no compelling reasons or considerations for continuing to adhere to Sckiffman's expansion of our holdings in Pittsburgh Milk Co. v. Commissioner, 26 T.C. 707 (1956), and Atzingen-Whitehouse Dairy, Inc. v. Commissioner, 36 T.C. 173 (1961), where, upon further reflection, we consider such expansion unwarranted. See Helvering v. Hallock, 309 U.S. 106 (1940).
Decision will be entered for the respondent.
Reviewed by the Court.
included in this is one check in the amount of $63,683 which related to a policy upon which commissions were earned and reported in 1973.
All section references are to the Internal Revenue Code of 1954, as amended and in effect during the taxable year at issue.
Sec. 162 provides in pertinent part:
SEC. 162. TRADE OR BUSINESS EXPENSES.
(c) Illegal Bribes, Kickbacks, and Other Payments.—

(2) Other illegal payments. — No deduction shall be allowed under subsection (a) for any payment (other than a payment described in paragraph (1)) made, directly or indirectly, to any person, if the payment constitutes an illegal bribe, illegal kickback, or other illegal payment under any law of the United States, or under any law of a State (but only if such State law is generally enforced), which subjects the payor to a criminal penalty or the loss of license or privilege to engage in a trade or business. For purposes of this paragraph, a kickback includes a payment in consideration of the referral of a client, patient, or customer.
Petitioner herein had only authority to "actively solicit applications for insurance, collecting initial premiums in exchange for official receipts furnished by the Company" and to deliver policies issued by the insurance company.
Cf. Freedom Newspapers, Inc. v. Commissioner, T.C. Memo. 1977-429.
These holdings were recently reaffirmed in the context of sec. 162(c). See Max Sobel Wholesale Liquors v. Commissioner, 69 T.C. 477 (1977).