The Tax Court issued no opinions last week, likely because it was holding its Judicial Conference at Northwestern School of Law in Chicago. Our colleagues over at Procedurally Taxing attended and blogged about it here. Les Book reports (here) that the last session of the Conference was looking forward to the future of the Tax Court.
Future, Schmoocher. My love of history keeps my head buried firmly in the sands of the past. For not only is the past prologue, it’s also epilogue. That’s the lesson I take away from this Tax Court classic: Harold Jenkins v. Commissioner, T.C. Memo. 1983-667, a case I teach as an epilogue to the Supreme Court's classic Welch v. Helvering, 290 U.S. 111 (1933).The Jenkins case deserves your attention not only because of its lesson about the difference between business and personal deductions but also because of the poetry (?) it inspired both from Tax Court Judge Leo H. Irwin and from the IRS Office of Chief Counsel
All that, and more, below the fold.
The Lyrics (Facts):
Harold Jenkins, of course, was the birth name of the man better known as Conway Twitty. He was best known as a country music singer, less known as a baseball player and fan, and almost unknown as a chef. Still, he thought it would be a great idea to start a restaurant business that featured his favorite hamburger, involving canned pineapple rings deep-fried in graham cracker crumbs. Here’s the recipe (hat tip to Tuphat who commented on an earlier post about country mustic). Here’s a fun video. So Twitty created a new business entity, Twitty Burger, Inc. and solicited capital contributions, using his connections in the country music scene.
All told, Twitty got about 75 folks to contribute capital in 1968 and 1969 including such big country music names as Harlan Howard, Sonny James and Merle Haggard. Because of some hiccups with the SEC, the contributors ended up getting debentures in exchange for their contributions. Twitty Burger began operations in 1969. By late 1970, however, after continual problems with revenue production and with the SEC, Twitty pulled the plug on the business. At that point Twitty Burger, Inc. had no assets. The debentures were worthless.
So what about those investors? When it all went to pieces, Twitty did not want to leave their blue eyes cryin’ in the rain. He did not just want to say “sorry.” His friends would just respond “don’t tell me your sorry.” And, unlike some singers today, he wasn’t going to say “it ain’t my fault.” Nosirree, he was going to take it like a man (what we might now say “man up”) and repay the investors (some of them with interest, even) out of his personal funds.
It took him a couple of years, but in 1973 and 1974 he repaid most of the investors. And he deducted those payments from his country music income: $93k in 1973 and $3.6k in 1974.
On audit, the IRS disallowed the deductions. Twitty went to Tax Court. Twitty was represented on the record by Theodore “Ted” Jones, William G. Whatley and Alva C. Smith, all out of Baton Rouge. Mr. Whatley, a criminal defense attorney by trade, took the lead and tried the case. Representing the IRS was Charles W. Kite. I was able to contact Mr. Kite---who is semi-retired outside of Knoxville---and had a nice chat with him about the case. He recalled Mr. Whatley striding around the courtroom with a cup of ice that he would chew and suck and that Judge Irwin had to repeatedly ask him to speak up. He also recalls that in his various interactions with the taxpayer, Twitty was a gentleman through and through.
The Parties Sing Their Tunes:
The IRS argued that while §162 allows deductions for all “ordinary and necessary” expenses related to a taxpayer’s business, §262 disallows any deduction for personal expenses. Even if these were related to the taxpayer's business, §263 would require capitalization. In other words, to deduct an expense, it has to be one that relates to an ongoing business of the taxpayer. Since Twitty Burgers, Inc. was no longer operational and since there was no legal obligation for Twitty to personally repay the investors, any connection to a business was only make believe. The IRS pointed to the Welch v. Helvering case. There, Mr. Welch worked for a company that went bankrupt. He then started working for another company in the same line of business. Even though he had no obligation, he used personal funds to repay the creditors and customers of the bankrupt company on the theory that doing so enabled would “solidify his credit and standing” with the former creditors and customers who were important to the success of his new company. The Supreme Court affirmed the IRS, Tax Court, and Eight Circuit decisions that he could not immediately deduct payments under §162. He instead had to capitalize them as goodwill. Twitty should receive the same treatment said the IRS.
Twitty argued that the payments did in fact relate to the carrying on of a trade or business, just not the hamburger business. They related to his country music business. Yep, country music, “that’s my job.” Twitty supported his argument with his personal testimony. He said “I’m 99 percent entertainer. That’s just about all I know.” He acknowledged that he had received letters from attorneys for some of the investors and that he feared lawsuits would damage his music business: “If my fans didn’t give up on me, it would warp me psychologically. I couldn’t function anymore because I’m the type of person I am.”
Twitty’s lawyers also introduced expert testimony from one William Ivey, Ph.D., who at that time was the head of the Country Music Foundation and who later became head of the National Endowment for the Arts. Dr. Ivey's testimony was that “Country entertainers to go great lengths to protect their images, for they correctly realize that both business associates and fans judge their artistic efforts in the light of perceptions of the artist’s personality, professional conduct and moral character.”
Tax Court Rules: In Harmony with Welch?
In Welch v. Commissioner, Justice Cardozo wrote this famous passage:
“We try to classify [an] act as ordinary or the opposite, and the norms of conduct fail us. *** Men do at times pay the debts of others without legal obligation or the lighter obligation imposed by the usages of trade or by neighborly amenities, but they do not do so ordinarily, not even though the result might be to heighten their reputation for generosity and opulence. Indeed, if language is to be read in its natural and common meaning, we should have to say that payment in such circumstances, instead of being ordinary, is in a high degree extraordinary. There is nothing ordinary in the stimulus evoking it, and none in the response. Here, indeed, as so often in other branches of the law, the decisive distinctions are those of degree, and not of kind.
One struggles in vain for any verbal formula that will supply a ready touchstone. The standard set up by the statute is not a rule of law; it is rather a way of life. Life in all its fullness must supply the answer to the riddle.” (290 U.S. at 114-115)(internal citations omitted).
In other words, it is all a question of fact. In Welch, the Supreme Court disclaimed any special powers to create a rule of law narrower than “life in all its fullness.” This is very similar to its decision in Commissioner v. Duberstein, 363 U.S. 278 (1960), where the Court decided that the question of when a taxpayer receives a “gift” is also such a fact-intensive issue that the appellate courts should stay out of it. Footnote 9 in Duberstein, in fact, cites to Welch for that proposition.
We have seen this lesson before (here). While the IRS’s determination gets a presumption of correctness, the taxpayer is allowed to produce evidence to persuade the trial judge that the facts do not support the determination. The judicial task of figuring out the facts falls on the trial judge.
Here, Twitty got lucky. Judge Irwin liked Twitty’s tune better than that IRS’s and so found that the payments were ordinary and necessary to Twitty’s country music business. So Twitty did not have to capitalize the repayments but was instead allowed to take the deductions.
Judge Irwin emphasized the harmony with Welch---and the fact-driven nature of his decision---by ending his opinion with this “Ode to Conway Twitty.” Now, I was not able to find out whether the poem was written by Judge Irwin himself or by a attorney advisor or by a collaborative effort. But what does it matter? It's a classic.
Twitty Burger went belly up
But Conway remained true.
He repaid his investors, one and all.
It was the moral thing to do.
His fans would not have liked it,
It could have hurt his fame,
Had any investors sued him
Like Merle Haggard or Sonny James.
When it was time to file taxes
Conway thought what he would do
Was deduct those payments as a business expense
Under section one-sixty-two.
In order to allow these deductions
Goes the argument of the Commissioner.
The payments must be ordinary and necessary
To a business of the petitioner.
Had Conway not repaid the investors
His career would have been under cloud,
Under the unique facts of this case Held:
The deductions are allowed.
Coda: Since Judge Irwin’s decision was based on a factual determination (notice the "unique facts" language?) it would be reversed by a Court of Appeals only if Judge Irwin had abused his fact-finding discretion. That’s a difficult result to get when you are the losing party on an issue of fact.
Whenever the IRS loses a trial, someone has to decide whether to appeal. That someone is the Associate Solicitor General (Tax) in the Solicitor General’s Office at the Department of Justice. That person does not make a decision in a vacuum, however. They receive up to three memos recommending whether to appeal or not: one from the IRS Office of Chief Counsel; one from the Department of Justice Tax Division Appellate Section; and, when applicable, one from the Department of Justice Tax Division Trial Section. When I worked in Chief Counsel’s office, drafting appeal memos was one of the really fun aspects of my job.
In addition to drafting appeal memos, the Office of Chief Counsel will sometimes publish a document called “Action on Decision” (AOD) to alert practitioners to how a decision will affect tax administration. Especially when the IRS loses a position, it helps practitioners to know whether the IRS will abandon the position in future cases or not. Chief Counsel does not do this as often now as it used to. I am not sure why.
In response to the loss in Jenkins v. Commissioner, however, the Chief Counsel did indeed issue an AOD, AOD 1984-022 (March 22, 1984). This memorable AOD ends with this “Ode to Conway Twitty: A Reprise.” I also love reading this one to my classes, because I think it just perfectly expresses the lesson of this case and of the tension between §162 and §262:
Harold Jenkins and Conway Twitty
They are both the same.
But one was born
The other achieved fame.
The man is talented
And has many a friend
They opened a restaurant
His name he did lend.
They are two different things
Making burgers and song
The business went sour
It didn't take long.
He repaid his friends
Why did he act
Was it business or friendship
Which is fact?
Business the court held
It's deductible they feel
We disagree with the answer
But, let's not appeal.
The AOD was drafted by docket attorney David C. Fegan and signed off by Clifford M. Harbourt, the Senior Technician Reviewer for Branch 2 of the Tax Litigation Division. I had the pleasure of talking with Mr. Harbourt, who was a Chief Counsel attorney for 37 years, retiring in 2010. He recalls that Mr. Fegan was something of a character and was the one who drafted the poem. Mr. Harbourt was all for it, but the AOD had to be signed off by the Chief Counsel after working its way through a chain of reviewers. As one might imagine, the idea of putting poetry in an AOD met with some resistance and someone up the chain ordered it stricken. At that time the Acting Chief Counsel was Joel Gerber (later Tax Court Judge Gerber). Mr. Harbourt recalls that it was Mr. Gerber who, hearing about the poem, allowed it to be kept in the AOD. Good call!