Court Opinion

ID: 4483738
Source: CourtListenerOpinion
Date Created: 2020-01-16 21:16:16.118555+00
Date Added: 2024-06-11T14:54:03.623938
License: Public Domain

Wilbur, J., concurring: Section 162(c)(2) of the Internal Revenue Code, as added by the Tax Reform Act of 1969, and amended by the Revenue Act of 1971, provides in part: (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. * * * [Emphasis added.] In enacting this provision, Congress was attempting to codify the law relating to the disallowance of deductions involving illegal payments that had been developed in a series of court decisions. In emphasizing that the new provisions dealt only with denial of deductions, Congress made it clear that the circumstances justifying disallowance should be defined by Congress. The Senate Finance Committee stated: The provision for the denial of the deduction for payments in these situations which are deemed to violate public policy is intended to be all inclusive. Public policy, in other circumstances, generally is not sufficiently clearly defined to justify the disallowance of deductions. * * * [S. Rept. 91-552 (1969), 1969-3 C.B. 423,597; emphasis added.] Again, in 1971, when Congress broadened the scope of deductions disallowed, this clearly expressed intent of Congress was reaffirmed: The Committee continues to believe that the determination of when a deduction should be denied should remain under the control of Congress. * * * [S. Rept. 92-437 (1971), 1972-1 C.B. 559,599; emphasis added.] In neither Act did Congress focus on the issue of what constitutes gross income. However, a series of decisions, beginning with Pittsburgh Milk Co. v. Commissioner, 26 T.C. 707 (1956), involved covert discounts reducing the actual sale price of merchandise below invoice prices based on minimum prices established by State law. We were asked to determine whether in computing sales receipts includable in gross income, the invoice price or the actual sale price reflecting the illegal discount was the appropriate bench mark. As we stated in Atzingen-Whitehouse Dairy, Inc. v. Commissioner, 36 T.C. 173 (1961): We have concluded on the evidence that the actual prices at which petitioner sold its products were the invoice prices minus the discounts agreed upon between petitioner and its customers. Accordingly, the problem before us is not whether such discounts are deductible as “ordinary and necessary” business expenses from gross income in arriving at net income, cf. Tank Truck Rentals v. Commissioner, 356 U.S. 30; rather it is whether the discounts must be taken into account in determining the amount of gross income chargeable to petitioner in the first instance. Cf. Lela Sullenger, 11 T.C. 1076 (1948), acq. 1952-2 C.B. 3. We hold, following Pittsburgh Milk Co., 26 T.C. 707, which involved a virtually identical situation, that in computing gross income the amount of petitioner’s sales must be based upon its actual prices and not upon the theoretical legal minimum prices. * * * [36 T.C. at 181; emphasis added.] In the present case, as in the Pittsburgh Milk Co. line of cases, we are not concerned with a deduction from gross income; rather we must determine the proper rules for computing gross income on the facts before us. Indeed, if we conclude that petitioner’s compensation was includable in his gross income in full, petitioner concedes that section 162(c)(2) precludes a deduction for the payments made, as they were illegal under a California law that was generally enforced. The facts demonstrate that the compensation petitioner received for his services was includable in gross income. Petitioner was a life insurance agent for Jefferson Life Insurance Co. (Jefferson). The contract with Jefferson for petitioner’s service specifically provided: 5. COMPENSATION SCHEDULE — You shall receive, in payment for your services, commissions, fees, and bonuses on first year and renewal premiums computed in accordance with the company’s rules and regulations and in accordance with the compensation schedule attached. Petitioner also received an office allowance from Jefferson based on the commissions he received. Jefferson provided monthly statements tabulating the income petitioner earned for the period involved. Petitioner included the compensation received from Jefferson National for his services in gross income. On his 1972 income tax return, he claimed a Schedule C deduction on the line for cost of goods sold of $98,403, which was labeled “discounted premiums.” The $98,403 deduction consists principally of payments made to individuals who purchased insurance from Jefferson through petitioner. The general procedure was for the client to make out a check to Jefferson for the first year’s premium and concurrent therewith petitioner would write out a check to the client for the same (or nearly the same) amount. In two instances, involving a new policy with high first-year cash value, petitioner paid Jefferson the net premiums due after deducting his commissions and the cash value. In 1972 petitioner also paid Jefferson $754 from his personal checking account for premiums on behalf of three policyholders. Section 61(a) specifically defines gross income to include “Compensation for services, including fees, commissions, and similar items.” No complicated statutory exegesis is required to determine that the commissions herein are clearly includable within this language. In Ostheimer v. United States, 264 F.2d 789 (3d Cir. 1959), also involving the includability in gross income of commissions received by an insurance agent, the court succinctly explained the horn book law applicable: in defining “gross income” as broadly as it did in [sec. 61(a)] Congress intended to “tax all gains except those specifically exempted.” The broad sweep of this language [see. 61(a)] indicates the purpose of Congress to use the full measure of its taxing power within those definable categories * * * Hence our construction of the statute should be consonant with that purpose. Technical considerations * * * or the legal paraphernalia which inventive genius may construct * * * should not obscure the basic issue. (Emphasis supplied.) Where the payment is in return for services rendered * * * such payment is gross income under [sec. 61(a)]. [264 F.2d at 792; fn. refs, omitted.] In Williams v. Commissioner, 64 T.C. 1085, 1088 (1975), a Court-reviewed opinion with no dissents, we summarized Ostheimer as follows: During 1947, 1948, and 1949, the taxpayer conducted a business as a life insurance agent. He had a contract with 11 different life insurance companies under which he was to receive a commission on each life insurance policy he wrote for them. During the tax years involved the taxpayer was the owner and beneficiary of life insurance policies which he had purchased on the lives of his business partner and three of his key employees. In addition, four of his children also owned policies issued on their lives which were paid for by the taxpayer and given to his children. In his joint Federal income tax returns for those years, he did not include in gross income any of the amounts equal to the commissions he received on the policies involved. In the Ostheimer case, as in the present ease, the taxpayer contended that the commissions he received on the premiums he paid were simply his “discount,” and not income. The Court of Appeals stated (264 F.2d at 792): the life insurance companies paid taxpayer commissions on the premiums as compensation for his services in placing the policies involved. The payments were in discharge of the contractual obligation of the insurance companies to pay taxpayer commissions on all premiums paid on policies which he wrote. In other words, the commissions were a “payment in return for services rendered,” and as such constituted “gross income.” It is difficult to see how “commissions” on “discounts” must be included in gross income when a partner, your children, or even the salespersons themselves are the purchasers, but may be excluded where a typical customer is involved. If the former is includable, a fortiori, so is the latter. Given the specific statutory language before us and the broad interpretation historically given to section 61 by the courts, it is beyond doubt that the commissions petitioner received were includable in gross income. Euphemistically labeling petitioner’s kickbacks as “rebates” and “discounts” from prices paid for the policies simply will not work. Insurance contracts were being sold by Jefferson. Jefferson assumed all liability under the contract — the liability to make payment in the event of death, the obligation to honor the loan privileges under the contract, the obligation to change beneficiaries, the obligation to surrender the contract for its cash value. The price for the contract sold was determined by the company and its actuaries for whom petitioner worked. Once an insurance contract was sold, Jefferson was obligated on the contract, was entitled to receive the premium, and did receive the premium. Petitioner’s compensation was predicated on a certain percentage of the sales price (premiums) for the insurance policy that was sold. Jefferson was the vendor, not petitioner. Petitioner had no authority to adjust “a specified gross price to an agreed net price” (Pittsburgh Milk Co. v. Commissioner, 26 T.C. 707, 717 (1956)) for the premiums (purchase price) were established by Jefferson. Petitioner’s income was not from net sales (net premiums); rather he received commissions and allowances for his services. He simply kicked back part of his compensation. The entire purpose of petitioner in making the payments in issue herein was to increase his future renewal commission income by increasing his volume. And to what source did he look to for this recompense? Obviously to Jefferson and the compensation he was entitled to receive from the company for his services. All of the payments were economically feasible only because of the contractual provisions specifying the income Jefferson was required to pay petitioner for his services. Petitioner’s relationship to the company is quite similar to that of a manufacturer’s representative. A manufacturer’s representative sells a product of the manufacturer or manufacturers that he represents, and receives compensation consisting of a salary and/or commissions, the latter being predicated on the number of products of the manufacturer sold. As in petitioner’s case, the compensation received is pursuant to the contractual arrangement the individual has as an agent or employee of the seller. The seller determines the price of the commodity sold, the circumstances under which it will be sold, the terms of payment, and the other conditions of the sale. The seller compensates its agent or representative for negotiating the sale. If the agent agrees to kick back a portion of his compensation to facilitate the sale, regardless of when the agent made this commitment, he nevertheless must include his compensation from the company in gross income. Whether or not he will be entitled to a deduction will depend on the relevant sections of the Internal Revenue Code permitting deductions from gross income to arrive at adjusted gross income and from adjusted gross income to arrive at taxable income. Additionally, the rule contended for by petitioner has both practical and theoretical deficiencies. Everyone would agree that if petitioner was paid a salary, he must include it in gross income, and section 162(c)(2) would preclude a deduction for the payments. Why should a different rule apply if he is paid a base salary with a bonus commensurate with production, or a base salary and commissions — a not uncommon practice? Assume an individual working for a base of $1,000 per month and commissions, earns an additional $1,000 in commissions in a given month. To facilitate a sale that will put him over an annual quota, qualify him for promotion, establish an “in” with a client, or for other reasons, he kicks back $1,800. Does theoretical consistency permit him to account for the commission compensation above the line and the salary below the line with the vastly different economic consequences contended for? And if so, how-is the practical, problem of priority resolved — did he kick back $800 or $1,000 in salary and did he “adjust the invoice price” by $1,000 or $800 of his commissions?1 Assume an individual is selling a product with a relatively inelastic demand curve for a firm dominating the market, and under the circumstances is salaried with an annual bonus. If he kicks back a part of his salary and/or bonus to make a sale that will move him into management, is he adjusting the sales price? These problems demonstrate the difficulties of petitioner’s position. Indeed petitioner’s interpretation would, at the minimum, potentially remove virtually all commission income from the scope of section 162(c)(2). This would be anomalous in the extreme since the kickback of commission income was a significant if not predominant part of the evil Congress perceived in enacting section 162(c)(2). The asymmetrical treatment of above and below the line illegality is no tribute to judicial logic. It should be narrowly circumscribed. Schiffman v. Commissioner, 47 T.C. 537 (1967), is not fairly distinguishable from the facts before us. Neither may it be distinguished from Ostheimer v. United States, 264 F.2d 789 (3d Cir. 1959), involving an insurance agent conducting a business with contracts with 11 different companies. See also Williams v. Commissioner, 64 T.C. 1085 (1975), and Moser v. Commissioner, T.C. Memo. 1959-25. If substance over form has any substance these cases must be treated alike concerning the only issue before us — the computation of gross income. When our decision herein is added to these precedents, Schiffmxm “has been sapped of its vitality to the point of extinction,” and the Court is correct in expressly overruling it. “We have an obligation, as Mr. Justice Cardozo once said, to ‘gather up the driftwood and leave the waters pure.’ ” See Lindeman v. Commissioner, 60 T.C. 609, 617 (1973) (Judge Tannenwald, concurring).2  Drennen, Dawson, Simpson, Sterrett, and Wiles, JJ., agree with this concurring opinion.   The anomaly of adjusting the sales price not by sales proceeds but by “commissions” comes perilously close to admitting we are dealing with a kickback.    Congress has in both 1969 and 1971 affirmed a desire to handle by statute matters historically handled on a case by case approach. Since Congress has assumed responsibility for the area, it ought to consider applying Mr. Justice Cardozo’s admonition to sec. 162(c). The current statute imposes enormous financial penalties varying with the type of business and the taxpayer’s marginal rate, frequently spelling financial ruin for an individual who would receive only a small financial penalty under State law. Any correlation between the tax penalty and the State law' penalty (if indeed any exists) is purely fortuitous. And often the tax penalty comes as a complete surprise to the taxpayer, so it can hardly affect his conduct one way or the other. Having incurred the specifically prescribed penalty for his violation under the criminal law of the State, he should be allowed to resume life with a clean start as best as he can. The unexpected financial ruin, attributable to a tax burden wholly unrelated to his net income in an economic sense, is not required by the exigencies of federalism— indeed it is most likely counterproductive. It is tangential at best to the object of collecting taxes on net income and ability to pay, and undermines the self-assessment system.