Opinion ID: 381453
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Heading: Reimbursement Method

Text: 3 Alex used two distinct methods to finance the insureds' premiums. Under the reimbursement method, the insured would write a check for the amount of the premium payable to Jefferson National Life Insurance Company (Jefferson), Alex's principal, and Alex would write a personal check payable to the insured for the same amount. Jefferson would immediately pay Alex his 90 percent commission and other sums, which he would deposit to make good his own check, which the insured would then deposit to cover his own check. In effect, the insured paid the premium and Alex reimbursed him.
4 Alex's commissions, allowances, and bonuses were gross income to him. I.R.C. § 61(a)(1). He received them under a claim of right (in return for his selling services, pursuant to his contract) even though he was obligated to, and did, immediately pay them over to the insureds. It is not true that one's paycheck is received without a claim of right and therefore is excludable from gross income, whenever it is spoken for by creditors. The situation is the same even if the income which is used to satisfy a debt would not have been obtained absent the transaction that created the debt; for example, Jefferson receives first-year premiums under a claim of right even though that income is immediately paid out to its successful agents. 5 Nor can Alex claim that he received his commissions, allowances, and bonuses without claim of right because he was a mere conduit. Jefferson did not intend its monies to flow through Alex to the insureds (and thence back to itself); it was stipulated that Jefferson was unaware of Alex's scheme.
6 Gross receipts minus exclusions equals gross income, I.R.C. § 61. Gross income minus allowable deductions equals taxable income, I.R.C. § 63. 7 In many cases, expenses related to the obtaining of business income are deductible under I.R.C. § 162(a), and therefore are not reflected in taxable income; for example, Jefferson can deduct its payments to its agents. But Alex can claim no such deductions for his illegal payments, because of § 162(c)(2). Only if the payments can be classified as exclusions from Alex's gross income (commissions, allowances, and bonuses) can they serve to lower his taxable income. 8 The payments could constitute exclusions only under the price-adjustment theory of Pittsburgh Milk. But the Tax Court below correctly held that that theory applies only in the two-cornered situation where a seller effects a price adjustment by making a payment to its customer. Thus, if Alex had rebated part of his commissions directly back to Jefferson, the rebate would be an exclusion from Alex's gross income; if Jefferson had rebated part of an insured's premium directly back to the insured, the rebate would be an exclusion from Jefferson's gross income. 9 But here the situation is three-cornered, and no price was adjusted by any seller. Jefferson sold insurance, the promise to pay upon a contingency, to the insureds; Jefferson did not adjust this price. The insureds sold to Alex their willingness to participate in his scheme; they made no payments to Alex to adjust that price. Finally, Alex sold his services to Jefferson; he made no payment to Jefferson to adjust that price. Alex claims that he comes within Pittsburgh Milk because he also sold insurance to the insureds. In fact, he sold nothing to the insureds; they paid him nothing and received no product or service from him in return. 10 Therefore, Alex's payments to the insureds were not the acts of a seller adjusting his price, and did not qualify as Pittsburgh Milk exclusions. If legal, they might have been deductible as business expenses under § 162(a); because they were illegal, however, § 162(c)(2) barred any deductions. 1