Opinion ID: 381453
Heading Depth: 2
Heading Rank: 3

Heading: Payments as Deductions or Exclusions

Text: 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