*17 Decision will be entered under Rule 155.
Petitioner, a U.S. citizen residing abroad, operated a farming business as a sole proprietorship in Ireland at a loss. Petitioner's personal services as well as capital were material income-producing factors in the business. Held, under
*352 Respondent determined the *20 following deficiencies in petitioner's Federal income tax:
| Year | Deficiency |
| 1962 | $ 25,071.98 |
| 1963 | 17,945.48 |
| 1964 | 32,787.48 |
| 1965 | 2,498.02 |
| 1967 | 24,505.82 |
| 1968 | 16,435.89 |
| 1969 | 68,912.27 |
The questions before us are: (1) Whether a portion of petitioner's gross farm income was excludable as earned *353 income under
FINDINGS OF FACT
Some of the facts have been stipulated and, together with the stipulated exhibits, are incorporated herein by this reference.
Petitioner was a citizen of the United States and a bona fide resident at Palmerstown Stud, in Kill, County Kildare, Ireland, at the time of filing her petition herein and*21 during all of the years at issue. She filed timely individual Federal income tax returns for the years 1962 through 1969 with the Director, Office of International Operations, Internal Revenue Service, Washington, D.C.
At all times material herein, petitioner was engaged in the farming business in Ireland as an individual proprietor. Both petitioner's personal services and capital were material income-producing factors in the business.
Petitioner acquired her farm, Palmerstown Stud, in 1956 after an extensive search. The premises are favorably situated on limestone land which is considered to be desirable for raising horses. The farm encompasses 700 acres. In 1962, petitioner owned approximately 120 horses at Palmerstown. By 1969, that number had increased to about 200, most of which were brood mares and immature stock with approximately 25 to 30 racing horses in training. During the years in question, petitioner employed 45 or 50 individuals at all times.
Petitioner operated both a horse breeding farm and a training and racing stable at Palmerstown. In addition, each year petitioner grazed about 250 head of cattle which were useful for keeping the horse pastures in good condition*22 and for controlling parasites.
Originally, petitioner intended only to carry on thoroughbred horse breeding; however, because of dissatisfaction with the results produced by public trainers, she began to train *354 horses at Palmerstown. Petitioner believed that the combination of breeding and racing operations, which had developed fully at Palmerstown by the beginning of the period in question, would produce a greater degree of knowledge about an individual horse's capacity, stamina, and temperament. Consequently, she believed that coordinated development would aid in both training and selection for breeding. With the exception of several smaller operations, a combined breeding farm and racing stable such as Palmerstown is unique in Ireland. During the years in question, Palmerstown was one of the largest thoroughbred horse operations in Ireland and horses bred and trained by petitioner won a number of internationally recognized races in Ireland, England, and France.
Petitioner was general manager and directed the breeding and racing operations herself during the years in question. She employed a stud groom who functioned as a foreman in charge of the breeding operation. *23 Likewise, a head lad was employed and he functioned as a foreman in charge of the racing operation. During brief absences from Palmerstown by petitioner, the stud groom and head lad were left in charge of the breeding and racing functions. Petitioner performed all of the secretarial work. She employed an accountant to maintain Palmerstown's books and records. He also supervised planting, cattle grazing, and farm equipment operations. Petitioner supervised and directed the sale of the horses at Palmerstown.
For the years 1962 through 1969, petitioner realized the following income and expenses from the farming operation. 2*24
| Gross | Gross | Net | |
| farm | farm | farm | |
| Year | income | expenses | loss |
| 1962 | $ 83,155 | $ 224,868 | 3 $ 141,713 |
| 1963 | 123,502 | 235,717 | 112,215 |
| 1964 | 38,238 | 234,241 | 196,003 |
| 1965 | 55,647 | 273,408 | 217,761 |
| 1966 | 64,070 | 290,674 | 226,604 |
| 1967 | 58,947 | 299,391 | 240,444 |
| 1968 | 48,809 | 262,685 | 213,876 |
| 1969 | 57,840 | 288,391 | 230,551 |
*355 On her Federal tax returns for each of these years, petitioner reported all of her gross farm income and deducted all of her farming expenses. Her gain from the sale of horses was reported separately as long-term capital gain. Thus, she offset her U. S. source income with 100 percent of the losses she sustained from her foreign business.
The respondent determined that 30 percent of petitioner's gross farm income was excludable from gross income under
*25 Petitioner's farming expenses for the years in question were as follows: wages, social insurance for employees, feed for horses, grass seed for pastures, general supplies, repairs, fertilizers, stud fees and boarding expenses of brood mares at other stud farms, veterinary and medicine expenses, machinery operating expenses, insurance, bank interest and charges, electricity, telephone, rent, local taxes, carriage and freight for transporting horses, motor car expenses, horseshoeing, *356 cost of training horses at other farms, straw, peatmoss, management fees, saddlery, periodicals, stationery, postage, gratuities to employees, travel and entertainment, subscription and entry fees for the registration of horses in stud book, tools and short life equipment, advertising, cattle buyers' commissions and fees, legal expenses, rental of special machinery, and entrance and jockey fees for horse races. 5 No part of these expenses claimed by petitioner was attributable to her personal expenditures.
*26 OPINION
*27 On a prior occasion, this same taxpayer asked us to decide the identical question initially before us herein, namely, whether, under
Petitioner herein renews her contention that a proprietor of a foreign service-capital business generating losses cannot have any earned income within the meaning of
*358 It is clear that a decision herein for respondent on this threshold issue is required under Golsen. Such being the case, we reject petitioner's renewed contention. 7
*29 We turn to the questions as to how the amounts of excludable gross income and related expenses should be calculated -- questions which did not have to be dealt with in the previous case because such amounts were stipulated by the parties.
Petitioner contends that if she had realized "earned income" from her farming operations, it was not determinable as a flat percentage of gross income. Rather, she maintains that the proper measure of her earned income is the amount she would have had to pay employees as reasonable compensation to perform all of the services she performed.
In making her argument, petitioner suggests that if we apply the prior decision in
In the first place, we are not convinced, as petitioner urges, that we should adopt precisely the same test for determining *359 reasonable compensation under
*32 Thus, while it cannot be gainsaid that there are similarities in the decisional process under section 162(a)(1) and
In the second place, even if we were to agree that
The ultimate question is what was the worth of petitioner's services in the generation of gross income of the business. 10 Although there is testimony as to how long and hard petitioner worked, we have been furnished with no evidence as to the value thereof, aside from the amount which purportedly would have had to be paid for replacement personnel. Such being the case, we are compelled to conclude that petitioner has failed to carry her burden of proof in overcoming respondent's determination that 30 percent of gross farm income constitutes "a reasonable allowance as compensation for the personal services rendered" within the meaning of
Petitioner further contends that, in computing the amount of her excludable earned income, the dollar limitations contained in
We now turn to the deduction side of the
An individual shall not be allowed, as a deduction from his gross income, any deductions (other than those allowed by section 151, relating to personal exemptions) properly allocable to or chargeable against amounts excluded from gross income under this subsection.
Petitioner first asserts that, since earned income should be determined by equating reasonable compensation with the amount she would have paid others to perform her services, nondeductible expenses allocable to earned income should only be those that such hypothetical other employees would have incurred. Since, according to petitioner, they would have incurred none of the expenses claimed by petitioner as a proprietor of a service-capital business, the excluded income should not be charged with any such expenses. *38 Our rejection of the "employee approach" in respect of income disposes of this argument. The invalidity of petitioner's position is further revealed by the fact that such an approach, an exclusion from income without any disallowance of expenses, would produce a tax loss in excess of petitioner's actual loss. 13
Petitioner next focuses on the statutory language disallowing deductions "allocable to or chargeable against" excludable income and argues that such language requires an item-by-item analysis of each farm expense to determine which expenses are definitely related to, or identified with, earned income. In this vein, petitioner takes the position that only four types of her farm expenses bore the requisite factual relationship to her personal services. Of these four expenses (motor car expense, motor car depreciation, travel*39 and entertainment, and periodicals), petitioner claims only one-third of the costs was attributable to her personal services and the balance was attributable to her employees.
While it is true that a good portion of petitioner's total farming expenses appears to be capital-related (e.g., feed, seed, *363 saddlery, repairs, etc.), the nature of this service-capital business is such that even these expenses are related to earned income since without them earned income could not have been realized. See
Petitioner attempts to attach some special significance to the words used by Congress in disallowing expenses "allocable to or chargeable against" excluded income in*41
Nor are we disposed to engage in a semantic exercise so as to divine shadings of legislative intention based on the use of the word "allocation" rather than "apportionment." It is of some significance that the dictionary defines "allocation" *42 in terms of "apportionment." See Webster's Third New International Dictionary (Unabridged) (1965). Whatever may be the interpretation of these words in other sections of the Code, 16 we are not persuaded that we should adopt a narrow interpretation of the phrase "allocable to or chargeable against" used in
*43 We see no reason to construe a provision of the Code excluding amounts from gross income in a fashion so favorable to the taxpayer when the language of the provision does not compel this result. Perhaps there will be situations where the deductible items can be sufficiently identified as solely capital-related so as to justify the conclusion that they should not be disallowed under
Perhaps because petitioner recognizes that her first two theories could produce situations where the deductible loss for tax purposes would exceed the actual loss, she makes a still further argument that*44 in no event should the amount of the disallowed deductions exceed the amount of excluded earned income. The basis for petitioner's contention is that such an approach is all that is necessary to avoid the double tax benefit against which the deduction provision in
*45 Respondent determined that the amount of gross farm expenses to be disallowed is --
Excluded earned income/Gross farm income x Gross farm expenses
Petitioner argues that even if this formula is correct, the amount of gross farm expenses to be plugged in should not include an amount attributable to gain from the sale of horses. 19 Petitioner reasons that because such gain, subject to *366 beneficial capital gain treatment under section 1231, was not included in the gross farm income for purposes of computing earned income, no part of the expenses attributable to the horses sold should be disallowed as being allocable to the excluded earned income. Because petitioner cannot identify the expenses relating to the horses sold, which she would insulate from the proportional disallowance, she seeks to accomplish her objective by arguing that the amount of section 1231 gain realized each year should be added to the amount of gross farm income used by respondent in the denominator of the fraction previously noted.
*46 The fact that the amount of such gain was not treated as part of gross income for purposes of computing excludable earned income is of no relevance in light of our rejection of the mechanical application of any percentage of gross income in arriving at such computation and our conclusion that petitioner has failed to carry her burden of proof that the amount excluded did not represent "reasonable allowance as compensation for [petitioner's] personal services."
As for petitioner's contention that a certain portion of her gross farm expenses should be immune from the operation of the disallowance because a portion of such expenses was attributable to horses sold, we disagree. On her tax returns, petitioner offset the gain from such sales with expenses clearly identifiable therewith (e.g., commissions). Other expenses relating to such horses were basically breeding, racing, or maintenance costs and the fact of the matter is that petitioner maintained many, if not all, of the horses sold for breeding and racing, activities generating ordinary gross farm income through the combination of capital input and petitioner's personal services. Compare
It cannot be gainsaid that the legislative and judicial situation relating to the treatment of earned income abroad is far from satisfactory. It has, as the Court of Appeals for the District of Columbia has observed in its opinion in the prior Brewster case, produced "certain incongruities" and a condition which "is not welcomed." See
Decision will be entered under Rule 155.
Hall, J. concurring: I agree with Judge Goffe on the merits but think Golsen requires a decision for respondent.
Goffe, J., dissenting: I respectfully dissent. The majority opinion is cast in terms of exclusions from gross income*48 but the end result is to deny the full losses petitioner sustained in the operation of her farm. This result is produced by holding that
Our holding in
The majority in the instant case disallows 30 percent of petitioner's deductions from the operations of her farm in Ireland under
The disallowance of petitioner's deductions comes about by requiring*51 petitioner to exclude 30 percent of the gross income from operations of her farm in Ireland. On her returns petitioner excluded no income from the operation of the farm *369 because it operated at a loss. In the first Brewster case we held that she must exclude 30 percent of the gross profits from the farm although
The exclusion provided in
The limitation of 30 percent of net profits should be applied in all cases, regardless of the existence of net profits. Therefore, applying the limitation literally, to a net loss as we have here, 30 percent of zero is zero and the limitation of
In the first Brewster case the Court of Appeals held that the statutory concept of "earned income" was structured in terms of gross income not net profits.
The net profits concept is the only rationale that is consistent with taxation generally. Requiring petitioner to exclude 30 percent of the gross profits of the proprietorship is not consistent with the general scheme of taxation of sole proprietorships or partnerships. Expression of the exclusion in terms of an exclusion from gross income in
The reliance by the Court of Claims on
I conclude that our interpretation of "earned income" in
Footnotes
1. All section references are to the Internal Revenue Code of 1954, as amended and in effect during each of the years before the Court.↩
2. The figures as to gross farm income and gross farm expenses include adjustments to the amounts of these items as shown in the deficiency notice to take into account the effect of petitioner's horse racing activities, adjustments based upon the stipulation of the parties. In addition, gross farm income is exclusive of gain realized from the sale of horses. See pp. 365-367, infra↩. The amount of such gain is stipulated as follows: 1962, $ 84,951; 1963, $ 67,712; 1964, $ 159,770; 1965, $ 25,657; 1966, $ 30,411; 1967, $ 138,265; 1968, $ 68,400; 1969, $ 209,760.
3. The parties stipulated this figure to be $ 141,173 in an obvious typographical error.↩
4.30% of gross 30% of farm Reduction farm income expenses in farm Year excluded disallowed loss 1962 $ 24,947 $ 67,460 $ 42,514 1963 * 35,000 * 66,801 31,801 1964 11,471 70,272 58,801 1965 16,694 82,022 65,328 1966 19,221 87,202 67,981 1967 17,684 89,817 72,133 1968 14,643 78,806 64,163 1969 17,352 86,517 69,165 * For this year, 30 percent of gross income exceeds the then-effective dollar limitation ($ 35,000) for the earned income exclusion.
Sec. 911(c)(1)(B) . The disallowance of farm expenses is accordingly proportionately reduced. See p. 365, infra↩.5. Petitioner also took deductions for depreciation in respect of property used in the business, but a portion of these deductions was attributed to the horses sold and reflected in the capital gain reported in respect of such sales.↩
6.
Sec. 911 provides in part:SEC. 911 . EARNED INCOME FROM SOURCES WITHOUT THE UNITED STATES.(a) General Rule. -- The following items shall not be included in gross income and shall be exempt from taxation under this subtitle:
(1) Bona fide resident of foreign country. -- In the case of an individual citizen of the United States who establishes to the satisfaction of the Secretary or his delegate that he has been a bona fide resident of a foreign country or countries for an uninterrupted period which includes an entire taxable year, amounts received from sources without the United States (except amounts paid by the United States or any agency thereof) which constitute earned income attributable to services performed during such uninterrupted period. The amount excluded under this paragraph for any taxable year shall be computed by applying the special rules contained in subsection (c).
* * *
An individual shall not be allowed, as a deduction from his gross income, any deductions (other than those allowed by section 151, relating to personal exemptions) properly allocable to or chargeable against amounts excluded from gross income under this subsection.(b) Definition of Earned Income. -- For purposes of this section, the term "earned income" means wages, salaries, or professional fees, and other amounts received as compensation for personal services actually rendered, but does not include that part of the compensation derived by the taxpayer for personal services rendered by him to a corporation which represents a distribution of earnings or profits rather than a reasonable allowance as compensation for the personal services actually rendered. In the case of a taxpayer engaged in a trade or business in which both personal services and capital are material income-producing factors, under regulations prescribed by the Secretary or his delegate, a reasonable allowance as compensation for the personal services rendered by the taxpayer, not in excess of 30 percent of his share of the net profits of such trade or business, shall be considered as earned income↩. (Emphasis added.)
7. We are cognizant of the intervening decision of the Court of Claims in
Vogt v. United States, 537 F.2d 405">537 F.2d 405 (Ct. Cl. 1976). But the issue in Vogt was an entirely different one, i.e., whether the dollar limitation ofsec. 911 should be applied to a partner's share of the gross income or net income of a profitable personal service partnership, and the Court of Claims carefully distinguishedBrewster v. Commissioner, 473 F.2d 160 (D.C. Cir. 1972) , affg.55 T.C. 251">55 T.C. 251↩ (1970).8. Indeed, even if a 30-percent limitation applied under the gross income theory, it is clear from the second sentence of
sec. 911(b)↩ that it only provides a ceiling and would not preclude a finding of less than 30 percent. That situation does not exist herein because neither party is contending for a lesser amount.9. Sec. 162(a)(1) allows a deduction, as an ordinary and necessary business expense, of "a reasonable allowance for salaries or other compensation for personal services actually rendered."↩
10. At the time the earned income credit was enacted by the Congress, the test as applied to a service-capital business was articulated as one "to determine what the man's own personal services are worth." See 65 Cong. Rec. 2850 (1924).↩
11. That paragraph provides:
(7) Certain noncash remuneration. -- If an individual who qualifies under subsection (a)(1) receives compensation from sources without the United States (except from the United States or any agency thereof) in the form of the right to use property or facilities, the limitation under paragraph (1) applicable with respect to such individual --
(A) for a taxable year ending in 1963, shall be increased by an amount equal to the amount of such compensation so received during such taxable year;
(B) for a taxable year ending in 1964, shall be increased by an amount equal to two-thirds of such compensation so received during such taxable year; and
(C) for a taxable year ending in 1965, shall be increased by an amount equal to one-third of such compensation so received during such taxable year.↩
12. In point of fact, petitioner herself allocated a portion of such expenses attributable to those facilities as personal and excluded them from the deductions claimed on her return.↩
13. This result would not obtain where it was possible to conclude that there were hypothetical employee expenses in an amount at least as great as the amount of excluded gross income.↩
14. See also Frieda Hempel↩, a Memorandum Opinion of this Court dated June 23, 1947, in which all expenses of a business where capital was not a material income-producing factor were chargeable against earned income, although some of the expenses were of the type petitioner herein would allocate solely to capital (e.g., office supplies, managerial and secretarial expenses, etc.).
15. We do not accept petitioner's suggestion that the comment of the Court of Appeals for the District of Columbia in the prior Brewster case (see
473 F.2d at 164↩ n. 6 ) requires an item-by-item analysis. That comment was made in the context of a stipulation in which the parties agreed as to which expenses were deductible and which were not, a situation which does not obtain herein.16. E.g., secs. 861 and 862 and the regulations thereunder, which were dealt with on a basis seemingly favorable to the taxpayer in
F. W. Woolworth Co., 54 T.C. 1233">54 T.C. 1233 , 1269 et seq. (1970), although we are constrained to note that respondent had the burden of proof. See54 T.C. at 1264↩ .17. Assume total gross income of $ 1,000, expenses of $ 1,500, of which only $ 100 are clearly identified with earned income. On the basis of a 30-percent exclusion from gross income, the taxpayer would report $ 700 of gross income and, under petitioner's theory, would be entitled to deduct $ 1,400. This produces a tax loss of $ 700, although the actual loss is only $ 500.↩
18. Moreover, the allowance of excess deductions (which is the other side of the same coin) was specifically rejected in Frieda Hempel (n. 14 supra). Compare also the discussion in
Ivor Cornman, 63 T.C. 653">63 T.C. 653 , 660↩ (1975), with respect to the failure to obtain legislative sanction of this position in connection with excess deductions related to tax-exempt income under sec. 265.19. Petitioner also argues that the gross expenses should be reduced by expenses attributable to horserace winnings. It would appear that this argument is addressed to an error in respondent's deficiency notice calculations which netted gross race winnings and expenses. Respondent has conceded his error in this regard and the necessary corrections are reflected in the figures shown in our findings of fact. See pp. 354-355, supra. It would appear that this disposes of petitioner's contention in respect of this item.
Although this adjustment results in the disallowance of more expenses than were disallowed in the notice of deficiency, it also results in the exclusion of more income. Thus, but for the operation of the dollar limitation on earned income in 1963, respondent's adjustment, like his deficiency notice, results in the same amount of reduction of petitioner's claimed losses. For 1963, the reduction in petitioner's allowable loss is less than that in the deficiency notice.↩