T.C. Memo. 2004-173
UNITED STATES TAX COURT
EDMAN AND DEBBIE KAY HACKWORTH, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 9786-02. Filed July 22, 2004.
William H. Thomas III, for petitioners.
James R. Rich, for respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
COHEN, Judge: Respondent determined deficiencies and
penalties with respect to petitioners’ Federal income taxes for
1998 and 1999 as follows:
- 2 -
Penalties
Year Deficiency Sec. 6662 Sec. 6663
1998 $31,816 $4,063 $8,627
1999 76,768 9,250 22,887
After concessions by the parties, the issue for decision is
whether petitioners are entitled to a loss deduction for 1999 for
the cash that petitioner Edman Hackworth forfeited to the State
of South Carolina as a result of his violation of South
Carolina’s gambling laws.
Unless otherwise indicated, all section references are to
the Internal Revenue Code in effect for the years in issue, and
all Rule references are to the Tax Court Rules of Practice and
Procedure. All amounts have been rounded to the nearest dollar.
FINDINGS OF FACT
Some of the facts have been stipulated, and the stipulated
facts are incorporated in our findings by this reference. At the
time that the petition in this case was filed, petitioners
resided in Greer, South Carolina.
Background
During 1998 and 1999, petitioner Edman Hackworth
(petitioner) owned and operated Sand Trap, Inc., an
S corporation. Sand Trap, Inc., operated a bar named “Sand Trap
Lounge” (the Sand Trap) in Greenville, South Carolina, during
those years.
- 3 -
In December 1997, the Greenville County (South Carolina)
Sheriff’s Office (GCSO) began an investigation of petitioner
based upon information that he was operating an illegal gambling
business out of his residence and out of the Sand Trap. On or
about July 27, 1999, GCSO began surveillance on the Sand Trap and
on petitioners’ residence. Between August 4 and September 2,
1999, a GCSO officer frequented the Sand Trap in an undercover
capacity. While working undercover at the Sand Trap, this
officer placed bets on various sporting events and observed other
gambling and gambling-related activities. On or about August 28,
1999, GCSO officers collected several trash bags from the
roadside in front of petitioners’ residence. One of these trash
bags was filled with used gambling paraphernalia and business
records from petitioner’s gambling operation.
On or about September 7, 1999, GCSO officers executed a
search warrant on petitioners’ residence. Petitioner was at home
at the time that this search warrant was executed and was placed
under arrest for bookmaking and setting up a lottery. Shortly
after arresting petitioner, GCSO officers placed petitioner
Debbie Kay Hackworth (Mrs. Hackworth) under arrest at one of her
business locations for bookmaking and brought her back to
petitioners’ residence. Upon searching petitioners’ residence,
GCSO discovered, inter alia, (1) a betting room with seven
telephone lines, tape-recording devices, two computers, and
- 4 -
gambling paraphernalia; (2) keys to petitioner’s safety deposit
box at Carolina First Bank; and (3) a total of $63,589 in cash,
all of which was seized. The cash was discovered in the
following amounts and locations in petitioners’ residence:
(1) $46,814 in a safe in the betting room; (2) $3,516 in the
kitchen; (3) $1,259 in Mrs. Hackworth’s purse; and (4) $12,000 in
Mrs. Hackworth’s closet in the master bedroom. Also on or about
this date, GCSO officers executed a search warrant on the Sand
Trap and discovered and seized gambling paraphernalia, $10,705 in
cash from a back room safe, and $81 in cash from behind the bar
that was part of a betting pool.
On or about September 8, 1999, GCSO officers executed a
search warrant on petitioner’s safety deposit box at Carolina
First Bank and discovered and seized $90,900 in cash contained
therein. With this seizure, GCSO had seized a total of $165,275
in cash from petitioners.
On September 30, 1999, petitioner voluntarily consented to
forfeit to the State of South Carolina $152,016 of the cash that
had been seized by GCSO in connection with his arrest and the
execution of the search warrants described above by signing and
dating a document entitled “CONSENT FORFEITURE OF MONIES DERIVED
FROM GAMBLING” (consent form). The consent form provided, in
pertinent part, as follows:
Defendant’s/respondent’s property was seized as a
result of an investigation and arrest of the defendant
- 5 -
on SEPT. 09, 1999 for a violation of South Carolina
Gambling Statutes. The defendant was charged with
ADVENTURING IN LOTTERY
The parties now desire to enter into a compromise
settlement to avoid litigation whereby the defendant
agrees to voluntarily relinquish all rights and
ownership to the defendant’s property.
IT IS THEREFORE ORDERED that the
defendant’s/respondent’s property of $152,016.00 (ONE
HUNDRED AND FIFTY-TWO THOUSAND AND SIXTEEN DOLLARS) in
United States Currency be forfeited pursuant to sec.
16-19-80, Code of Laws of South Carolina (1976), as
amended.
GCSO gave petitioner a form that explained the consent form.
Also on this date, the $1,259 in cash that had been seized from
Mrs. Hackworth’s purse and the $12,000 in cash that had been
seized from Mrs. Hackworth’s closet were returned to petitioner.
On or about November 22, 1999, petitioner pleaded guilty to
“Adventuring in lotteries” in violation of section 16-19-20 of
the Code of Laws of South Carolina (1976). In connection with
petitioner’s guilty plea, he was issued a citation and paid a
$125 fine.
Petitioners’ Income Tax Return for 1999
Petitioners’ joint Federal income tax return for 1999 was
due to be filed with the Internal Revenue Service (IRS) Center in
Atlanta, Georgia, by October 16, 2000. Petitioners did not file
their 1999 return, however, until October 20, 2000. Louis G.
Manios prepared petitioners’ 1999 return.
- 6 -
Petitioners attached three Schedules C, Profit or Loss From
Business, to their 1999 return. The first two Schedules C
related to businesses operated by Mrs. Hackworth. The third
Schedule C related to petitioner’s gambling activities. On his
Schedule C, petitioner reported gross receipts of $178,236 from
his gambling activities, which were referred to as “services” on
this form. Petitioner also deducted $152,016 for “legal and
professional services” on this form. This deduction was taken
for the cash that petitioner forfeited to the State of South
Carolina as a result of his violation of South Carolina’s
gambling laws.
In the statutory notice of deficiency sent to petitioners,
in addition to the adjustments no longer contested, the IRS
disallowed the $152,016 deduction claimed on petitioner’s
Schedule C. The IRS determined that petitioners had not
established that any amount of this claimed deduction represented
a deductible expense, was an ordinary and necessary business
expense, or was expended for the purpose designated.
Accordingly, the IRS increased petitioners’ taxable income for
1999 by $152,016.
OPINION
Petitioners seek a deduction for the cash that petitioner
voluntarily forfeited to the State of South Carolina under
section 16-19-80 (“Forfeiture of wagers”) of the Code of Laws of
- 7 -
South Carolina (1976) as a result of his violation of South
Carolina’s gambling laws. Petitioners have not argued that this
deduction falls under section 162 as an ordinary and necessary
business expense, so we rely on the general principle that a
deduction for property forfeited under Federal or State
forfeiture laws, if allowed at all, falls under the loss
deduction provisions of section 165. See Fuller v. Commissioner,
213 F.2d 102, 105-106 (10th Cir. 1954), affg. 20 T.C. 308 (1953);
Holmes Enters., Inc. v. Commissioner, 69 T.C. 114, 116-117
(1977); Holt v. Commissioner, 69 T.C. 75, 78-79 (1977), affd. per
curiam 611 F.2d 1160 (5th Cir. 1980); see also Gambina v.
Commissioner, 91 T.C. 826, 827 n.3 (1988); Bailey v.
Commissioner, T.C. Memo. 1989-674, affd. without published
opinion 929 F.2d 700 (6th Cir. 1991); Mack v. Commissioner, T.C.
Memo. 1989-490; Farris v. Commissioner, T.C. Memo. 1985-346,
affd. without published opinion 823 F.2d 1552 (9th Cir. 1987).
Accordingly, we must decide whether petitioners are entitled to a
loss deduction under section 165 for 1999.
Section 165(a) allows a deduction for “any loss sustained
during the taxable year and not compensated for by insurance or
otherwise.” In the case of an individual, the deduction is
limited to losses incurred in the individual’s trade or business
or in any transaction entered into for profit and to certain
casualty losses. Sec. 165(c). The facts disclose that
- 8 -
petitioner was operating an illegal gambling enterprise in 1999.
Thus, the deduction asserted by petitioners falls conceptually
within the ambit of section 165(a) and (c)(1). Courts have
consistently found that a loss deduction will be denied, however,
where the deduction would frustrate a sharply defined Federal or
State policy. See, e.g., Wood v. United States, 863 F.2d 417,
420-422 (5th Cir. 1989); United States v. Algemene Kunstzijde
Unie, N.V., 226 F.2d 115, 119-120 (4th Cir. 1955); Fuller v.
Commissioner, supra at 105-106; Blackman v. Commissioner, 88 T.C.
677, 682-683 (1987), affd. without published opinion 867 F.2d 605
(1st Cir. 1988); Holmes Enters., Inc. v. Commissioner, supra at
117-118; Holt v. Commissioner, supra at 79-81; Murillo v.
Commissioner, T.C. Memo. 1998-13, affd. without published opinion
166 F.3d 1201 (2d Cir. 1998); Bailey v. Commissioner, supra; Mack
v. Commissioner, supra; Farris v. Commissioner, supra; Hopka v.
United States, 195 F. Supp. 474, 477-483 (N.D. Iowa 1961); see
also King v. United States, 152 F.3d 1200, 1202 (9th Cir. 1998);
Standard Oil Co. v. Commissioner, 129 F.2d 363, 370-371 (7th Cir.
1942), affg. 43 B.T.A. 973 (1941).
Respondent contends that petitioners should not be allowed a
loss deduction for the cash that petitioner forfeited to the
State of South Carolina because the allowance of such a deduction
would frustrate South Carolina’s sharply defined policy against
illegal gambling. Petitioners assert, without citation of
- 9 -
authority, that respondent has the burden of proving by clear and
convincing evidence that the “public policy exception” applies to
deny the loss deduction for the cash that petitioner forfeited.
Petitioners rely vaguely on the “legislative design under sec.
162". Neither the statutory language of section 165 nor the
caselaw interpreting that section supports petitioners’
proposition. In any event, the issue in this case is essentially
legal, and the outcome does not depend on the burden of proof.
South Carolina had a sharply defined policy against illegal
gambling in 1999 as expressed in its statutes and enforced by the
GCSO. Petitioner acknowledged that the forfeiture was made
pursuant to the laws of South Carolina and pleaded guilty.
(Petitioner’s claim that his consent to the forfeiture was
“revoked” is uncorroborated and unpersuasive.) To allow
petitioners a deduction for a loss arising out of petitioner’s
illegal activities would undermine South Carolina’s policy by
permitting a portion of the forfeiture to be borne by the Federal
Government, thus taking the “sting” out of the forfeiture. See
Tank Truck Rentals, Inc. v. Commissioner, 356 U.S. 30, 35-36
(1958); Wood v. United States, supra at 422; Holt v.
Commissioner, supra at 81; Murillo v. Commissioner, supra; Mack
v. Commissioner, supra; Farris v. Commissioner, supra; Hopka v.
United States, supra at 482-483. In accordance with these
controlling precedents, petitioners are not entitled to a loss
- 10 -
deduction under section 165 for 1999 for the cash that petitioner
forfeited to the State of South Carolina.
Petitioners contend that petitioner’s forfeiture is invalid
because it was disproportionate to his crime and violated the
Eighth Amendment to the Constitution and, also, because it did
not comply with the laws of South Carolina. Accordingly,
petitioners conclude that they should be allowed a loss deduction
for the cash that petitioner forfeited because the “public policy
exception” applies only “when the underlying action by the
government is legal and properly conducted by the state
authorities under their own laws and the laws of the United
States”. Petitioners’ contention as to the validity of the
forfeiture, however, is not properly an issue in this Court. The
Tax Court is a court of limited jurisdiction, and we may exercise
our jurisdiction only to the extent authorized by Congress. See
sec. 7442; Naftel v. Commissioner, 85 T.C. 527, 529 (1985); see
also Commissioner v. Gooch Milling & Elevator Co., 320 U.S. 418,
420, 422 (1943). This Court lacks jurisdiction over petitioners’
collateral attack on the forfeiture.
Petitioners further contend that the damage done to South
Carolina’s policy against illegal gambling is outweighed by
congressional intent that “business losses” be allowed to be
deducted and that the income tax be imposed upon a taxpayer’s net
income. In support of this contention, petitioners cite Lilly v.
- 11 -
Commissioner, 343 U.S. 90 (1952); Commissioner v. Sullivan, 356
U.S. 27 (1958); Commissioner v. Tellier, 383 U.S. 687 (1966);
Grossman & Sons, Inc. v. Commissioner, 48 T.C. 15 (1967); and
Edwards v. Bromberg, 232 F.2d 107 (5th Cir. 1956). As we discuss
below, petitioners’ reliance on these cases is misplaced.
Consequently, petitioners’ contention is unpersuasive.
In Lilly v. Commissioner, supra, opticians sought to deduct
payments that they made to eye doctors as ordinary and necessary
business expenses. These payments were made pursuant to
agreements that reflected an established and widespread practice
in that industry whereby the eye doctors agreed to recommend
their patients to certain opticians and the opticians agreed to
pay those referring eye doctors one-third of the retail sales
price that they received for the eyeglasses that they sold. The
Court of Appeals for the Fourth Circuit held such payments
nondeductible on the grounds that they were against public
policy. The Supreme Court reversed, however, holding that the
payments did not stand on the same basis as expenditures that
violated some Federal or State law or that were incidental to
such violations. The Court drew a distinction between these
payments, which were at most professionally unethical, and
outlawed expenditures, which, by virtue of their illegality,
frustrated some sharply defined Federal or State policy.
- 12 -
Petitioner’s proceeds from his illegal gambling enterprise
were not akin to the payments in dispute in Lilly. The moneys
seized from petitioner were presumptively the essence of his
illegal venture. The forfeiture was incidental to petitioner’s
violation of South Carolina’s gambling laws. Therefore, the
holding in Lilly does not support petitioner’s argument.
In Commissioner v. Sullivan, supra, the Supreme Court held
that an illegal gambling enterprise is a business for Federal tax
purposes and that deductions for ordinary and necessary business
expenses involved in operating the enterprise were allowable.
The Court reasoned that to deny such deductions would result in
taxing the gross receipts of the business rather than its net
income. In Commissioner v. Tellier, supra, the taxpayer sought a
deduction for legal fees incurred in the unsuccessful defense of
a criminal prosecution relating to his business. The
Commissioner conceded that the fees were ordinary and necessary
business expenses. The only question was whether the allowance
of a deduction would frustrate public policy. The Supreme Court
held that no public policy was frustrated by allowing these legal
fees to be deducted as ordinary and necessary business expenses.
Sullivan and Tellier stand for the proposition that a
taxpayer may be allowed to deduct legitimate (i.e., ordinary and
necessary) business expenses in the operation of an illegitimate
enterprise. That concept is not determinative in our analysis of
- 13 -
this case because we are dealing with a forfeiture that does not
qualify as an ordinary and necessary business expense under
section 162. Furthermore, the allowance of a loss deduction in
this case would undermine the impact of South Carolina’s sharply
defined policy against illegal gambling. Accordingly, Sullivan
and Tellier are inapposite.
In Grossman & Sons, Inc. v. Commissioner, supra, we
considered a situation in which a taxpayer sought a deduction for
the amount that it had paid to the United States in settlement of
a proceeding under the False Claims Act, 31 U.S.C. secs. 231-233
(the 1952 version). After examining the record of the settlement
negotiations and the settlement agreement between the United
States and the taxpayer, we concluded that this payment was made
to reimburse the Government for its damages for breach of
contract and was not a penalty or forfeiture. We also examined
the False Claims Act and concluded that the Act was partly
remedial and compensatory in nature and partly punitive. Based
upon that conclusion, we rejected the argument that no amounts
paid or incurred in satisfaction of claims of the United States
under the False Claims Act, whether by judgment or by settlement,
were deductible because of public policy. Accordingly, we
allowed the taxpayer to deduct the settlement amount as an
ordinary and necessary business expense under the pre-1969
version of section 162.
- 14 -
In Grossman & Sons, Inc., the taxpayer settled a breach of
contract dispute with the Government and was allowed to deduct
the settlement amount as an ordinary and necessary business
expense. Unlike the facts of Grossman & Sons, Inc., petitioner’s
“payment” (i.e., forfeiture) to the State of South Carolina
resulted from his violation of South Carolina’s gambling laws and
not from a settlement of a breach of contract dispute.
In Edwards v. Bromberg, supra, the taxpayer sought a loss
deduction for the theft of his money. The taxpayer had agreed to
provide money to another individual in order to bet on a “fixed”
horse race. The individual absconded with the taxpayer’s money.
After deciding that there was no scheme to defraud anyone except
the taxpayer himself, the court allowed the deduction.
Bromberg is also distinguishable. Petitioner’s funds were
seized by the State of South Carolina in the enforcement of its
gambling laws. The purpose of the seizure and forfeiture was to
cripple petitioner’s illegal gambling activities. If a loss
deduction were allowed in this case, the Federal Government would
in effect be carrying a portion of the loss inflicted on
petitioners by the State of South Carolina because of
petitioner’s illegal activities.
Finally, petitioners contend that imposing a liability for
Federal income taxes on the cash that petitioner forfeited
without allowing a loss deduction for the forfeited amount
- 15 -
violates the Double Jeopardy Clause of the Fifth Amendment to the
Constitution. In support of this contention, petitioners cite
United States v. Halper, 490 U.S. 435 (1989).
The Double Jeopardy Clause protects individuals only against
the imposition of multiple criminal punishments for the same
offense. Hudson v. United States, 522 U.S. 93, 99 (1997)
(abrogating United States v. Halper, supra, on this issue); see
also Helvering v. Mitchell, 303 U.S. 391, 399 (1938). The
imposition of a liability for a Federal income tax deficiency is
remedial and is not a criminal punishment. See Ames v.
Commissioner, 112 T.C. 304, 317 (1999); see also Ianniello v.
Commissioner, 98 T.C. 165, 178-180 (1992); cf. McNichols v.
Commissioner, 13 F.3d 432, 435-436 (1st Cir. 1993), affg. T.C.
Memo. 1993-61. A fortiori, the denial of a deduction (i.e., the
item that gave rise to the income tax deficiency in this case) is
not a criminal punishment. See, e.g., Murillo v. Commissioner,
T.C. Memo. 1998-13, affd. without published opinion 166 F.3d 1201
(2d Cir. 1998). Accordingly, denying petitioners a loss
deduction for the cash that petitioner forfeited does not violate
the Double Jeopardy Clause.
We have considered the arguments of the parties that were
not specifically addressed in this opinion. Those arguments are
either without merit or irrelevant to our decision.
- 16 -
To reflect the foregoing and the concessions of the parties,
Decision will be entered
under Rule 155.