*114 Decision will be entered for the respondent.
Petitioner James Alex, an agent selling life insurance on a commission basis, paid rebates or gave discounts to purchasers of policies. Held, since petitioner was not the seller of the insurance, the rebates or discounts are not adjustments to the purchase price excludable from gross income but deductions from gross income precluded by
*322 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*117 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 *323 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 *118 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*119 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 *324 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*120 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; 1 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*121 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
*325 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
*122 Prior to the enactment of
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
After careful consideration, we now*124 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 5 and that our decision in Schiffman 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
In reaching our conclusion that Schiffman should be overruled, we have taken into account the fact that there is no clear legislative recognition that the holding in*125 Schiffman should be encased in concrete through the enactment of
Decision will be entered for the respondent.
*327 Wilbur, J., concurring:
(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, *127 generally is not sufficiently clearly defined to justify the disallowance of deductions. * * * [S. Rept. 91-552 (1969),
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),
In neither Act did Congress focus on the issue of what constitutes gross income. However, a series of decisions, beginning with
*128 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.
In the present case, as in the Pittsburgh Milk Co. line of cases, we are not concerned with a deduction from gross*129 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
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*130 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 *329 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
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 [sec. 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)]. [
In
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 *132 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 *330 the present case, 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 (
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 *133 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*134 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" (
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 *331 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*135 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*136 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
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
The asymmetrical treatment of above and below the line illegality is no tribute to judicial logic. It should be narrowly circumscribed.
*139
*333 Raum, J., dissenting:
Quealy, J., dissenting: The majority would gratuitously overrule
In
We must assume that Congress was aware of the decision of this Court in the Pittsburgh Milk case. At the time that the legislation was enacted, the respondent had acquiesced in that decision. If Congress had intended to overrule the Pittsburgh*141 Milk case, it is only reasonable to expect that the amendment would have been more specific in so doing or that the congressional intent would find expression in the Report of the Finance Committee accompanying the bill. No mention of any such intent is made in the Report of the Finance Committee accompanying the bill. S. Rept. No. 92-437, 92d Cong., 1st Sess. 72-73.
*334 Nor am I able to distinguish the Schiffman case on the facts. Both there and in the present case, the taxpayer was selling insurance. Such insurance was sold with the agreement that all or a portion of the premium would be "rebated" to the insured. The mechanics of carrying out this agreement does alter the nature of the transaction. If petitioner had not agreed to apply his commission to the payment of the premium, there would have been no sale. The transaction upon which the respondent relies as a basis for taxing the petitioner encompassed as an essential element the understanding that petitioner would, in effect, waive his right to the commission. A taxpayer cannot realize income to the extent that he gives the buyer the money to purchase the product that the taxpayer is selling, regardless*142 of the legality of the transaction.
The decision of the Court in this case, if correct, not only would result in a tax to petitioner on the amount rebated to the insured, but would require that such amount be included in the income of the insured. In the fact of the law as it stood when the Congress amended
On the contrary, section 310(a) of the Revenue Act of 1971 indicates, at least by implication, that the Congress recognized that a "rebate" of a portion of the price paid by the seller to the purchaser was not within the scope of
What we have here is a statute which had been interpreted by the courts so as*143 to exclude from its scope a refund or rebate of a part of the purchase price between the seller and the buyer, regardless of its legality. That was the state of the law when Congress reenacted
The respondent also, at least by implication, recognized that the Congress had not overruled the Pittsburgh Milk line of cases in the changes which were enacted in section 310(a) of the 1971 Act. In his interpretation of that section, respondent's only example is that of the traditional "kickback" to the ship's captain by the shipyard.
Goffe, J., dissenting: I respectfully dissent. The majority gratuitously undertakes to overrule a reported opinion of this Court which respondent has not even requested. Respondent argued only that
The doctrine of stare decisis embodies an important social policy representing an element of continuity in law and is rooted in the psychologic need to satisfy reasonable expectations.
The majority fails to address itself to the rationale upon which Schiffman was based; i.e., that the taxpayer had no claim of right to the money represented by the rebate or kickback. The Court was correct when it stated in Schiffman,
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. Rather, we think that the fundamental consideration is whether the customer*147 paid or was required to pay such amounts to petitioner, so that it could be said that he received them under a claim of right or turned his back on income to which he was otherwise entitled. * * * [
In my view the majority in the instant case incorrectly overrules that test and presumably bases its opinion upon a proposition rejected in Schiffman; i.e., an examination of the relationships to see who is the seller of the insurance policies.
The majority fails to focus upon the facts as applied to the taxpayer before the Court. Petitioner had no claim of right to commission income unless and until he was responsible for the issuance of an insurance policy. In order to build up a right to future commissions he constructed transactions with customers which resulted in the issuance of policies of life insurance. By reason of the bargains he struck, however, he had no claim of *337 right to the commissions; they were dedicated, as part of the overall bargains which he struck, to the payment of premiums. Petitioner was a cash basis taxpayer and the transactions he entered into to sell the life insurance policies did not confer upon*148 him a claim of right to the commission income. The substance of the transactions for the sales of insurance nets no income to petitioners. I would, therefore, hold that the commission income dedicated to the payment of premiums by use of rebates and loans is excludable from petitioner's gross income. He had no right to the income unless he sold the insurance policies but he did not sell the insurance policies without dedication of the commission income to the payment of premiums. I do not condone what petitioner did any more than I condoned the activities involved in Schiffman or Max Sobel Wholesale Liquors, but I strongly oppose warping the claim of right doctrine in favor of respondent when he didn't ask for it to construct phantom income and a phantom deduction that must be denied under
Chabot, J., dissenting: The issue is *149 whether the rebates paid or the discount given by petitioner James Alex (a) may be taken into account as downward adjustments to gross income or (b) are to be taken into account, if at all, only as trade or business expenses under
Under Schiffman, the rebates and discounts would be gross income adjustments -- a decision on this issue for petitioners. However, the majority in this case choose to overrule Schiffman.
*338 For the following reasons I believe the majority is wrong in overruling Schiffman:
(1) The majority's only stated reason for overruling Schiffman is insufficient.
(2) The Court's holding in this case is likely to have an impact in many cases unrelated to the majority's only stated reason for overruling Schiffman.
(3) Schiffman is not properly distinguishable from the line of cases including
(4) The overruling of Schiffman is not required by cases such as
The only reason set forth in the majority opinion for overruling Schiffman is that failure to do so "would open the door to wholesale evasion of the purposes of
During the taxable years dealt with in Schiffman (1961, 1962, 1963),
No showing has been made that Schiffman has vitiated the purpose of any part or all of
The majority draw a line between Schiffman and the Pittsburgh Milk and Atzingen-Whitehouse line of cases. Apart from the reference to
In Schiffman (
Although the majority opinion states its concern with respect to the impact of Schiffman on
*154 The majority do not suggest that their holding in this case is mandated by the statute. The majority do not suggest that their holding must be adopted regardless of the consequences to other taxpayers. Under these circumstances, it seems to be a peculiar exercise of judicial discretion for this Court to overrule Schiffman and change the law without considering the effect of this action on other taxpayers. Indeed, this aspect of the case suggests that the appropriate forum for making the particular change in the law which the majority make is the Congress, and not this Court.
4. Distinction Between Schiffman and Ostheimer, etc.
It has been suggested that petitioners must include the amounts of the discounts and rebates in gross income because in
In those cases, it can at least be maintained that the taxpayer did receive something as compensation in connection with his employment, namely, the excess of the fair market value of the item over what he paid for it. By way of contrast, petitioner herein neither realized nor could have realized anything beyond the amount he actually reported as income. [
This distinction seemed persuasive in 1967; no reason has been *341 offered as to why this Court should now reject the analysis we stated in Schiffman.
For the reasons discussed above, I would hold that our decision in Schiffman continues to represent the law and that the issue presented in this case should be decided in favor of the petitioners.
Footnotes
1. 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.↩
2. All section references are to the Internal Revenue Code of 1954, as amended and in effect during the taxable year at issue.↩
3.
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. * * *↩
4. 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.↩
5. Cf.
Freedom Newspapers, Inc. v. Commissioner, T.C. Memo. 1977-429↩ .6. These holdings were recently reaffirmed in the context of
sec. 162(c) . SeeMax Sobel Wholesale Liquors v. Commissioner, 69 T.C. 477↩ (1977) .1. 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.↩
2. 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.1.
Acq., 2 C.B. 3">1967-2 C.B. 3 , nonacq.,18 I.R.B. 6">1977-18 I.R.B. 6↩ .2.
Nonacq., 1 C.B. 6">1959-1 C.B. 6 , acq.,2 C.B. 5">1962-2 C.B. 5 , nonacq.,33 I.R.B. 6">1976-33 I.R.B. 6↩ .1. The disallowance provision also was broadened to apply where the sanction may be "loss of license or privilege to engage in a trade or business" as well as where the sanction may be" a criminal penalty."↩
2. The 1969 Act added a paragraph (3), to provide a special statute of limitations rule. The 1971 Act deleted that paragraph (3), replacing it with the present provision, described above.↩
3. For example, this distinction applies to salespeople who give rebates or discounts which are not illegal. The result of the majority opinion in this case will be that such legal rebates and discounts are to be taken into account, if at all, only by way of trade or business expense deductions and not by way of exclusions from gross income. Since Treasury Department regulations provide that employee trade or business expenses of part-time salesmen cannot be deducted in arriving at adjusted gross income (
sec. 1.62-1(b), Income Tax Regs. ), it follows that, under those regulations, any such legal deductions can be taken by part-time salespeople only if they itemize their deductions in arriving at taxable income. Less than 25 percent of individual income tax returns itemize deductions. Tax Reduction and Simplification Act of 1977: H. Rept. 95-27 (Part 1) p. 40,1 C.B. 507">1977-1 C.B. 507 ; S. Rept. 95-66, p. 50,1 C.B. 479">1977-1 C.B. 479 ; H.R. (Conf. Rept.) 95-263, p. 24,1 C.B. 519">1977-1 C.B. 519 . Consequently, the holding of the majority in this case results in potentially increased tax liabilities for what may be substantial numbers of people under circumstances not remotely related to those dealt with in any of the three paragraphs ofsec. 162(c)↩ .