I was going to title this week’s blog “The Concept of Inherently Personal.” But I could not resist trying to put some clickbait in the title. Today I want to discuss two classic cases from Tax Court. They explore the never-ending balancing act needed to decide when an expense is deductible when it has both a personal and business aspect. Between them, the two cases teach us a lesson about life in all its fullness. That they both involve sex makes the lesson perhaps more memorable, but no less appropriate to any type of mixed business/personal deduction. And while both cases involve sex, they do so from interestingly different perspectives.
In Vitale v. Commissioner, T.C. Memo. 1999-131 (Judge Fay), the Court denied deduction of certain expenses (payments to prostitutes), finding that the concededly business purpose of the expense was overcome by its inherently personal nature. Yet in Hess v. Commissioner, T.C. Summary Opinion 1994-79 (Judge Joan Seitz Pate), the Court permitted a depreciation deduction for certain expenses (breast implants), finding that the inherently personal nature of the expense was overcome by its obvious business purpose.
You will find the surprisingly non-salacious details below the fold.
Law: The Fight Between §162 and §262
The law for today’s lesson is simple. It’s the never-ending tension between business and pleasure, a tension that is exacerbated when sex is part of the taxpayer’s business.
On the one hand, Congress recognizes that it takes money to make money and so allows taxpayers to deduct the money it takes from the money being made. Specifically, §162(a) allows taxpayers to deduct “all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business.” (emphasis supplied). And when expenditures may not be immediately expensed because they are capital in nature, §167 permits the taxpayer a deduction for “a reasonable allowance for the exhaustion, wear and tear...of property used in the trade or business.....”
On the other hand, §262(a) expressly forbids taxpayers from deducting “personal, living, or family expenses.”
These two hands fight when an expense has both a personal component and a business component. Take haircuts. In Hynes v. Commissioner, 74 T.C. 1266, 1291-1292 (1980), for example, the taxpayer was a news anchor who attempted to deduct his hairstyling expenses, claiming that they were necessary for him to carry out his business. Had to be lookin’ good for the camera! The Tax Court snipped: “The fact that the petitioner's employment contract with the station required him to maintain a neat appearance does not...elevate his expenses for personal grooming to a business expense.”
Sex might be one of the ultimate personal experiences. But it’s also one of the world’s oldest business (along with farming). And there are many other sexually oriented businesses which, together with prostitution, form a well-recognized “sex industry.”
Today’s cases help us see how the Tax Court balances the §162/§262 tension when it comes to sex-related expenses of a trade or business. The balance seems to turn on the nature of the business and who is claiming the deduction.
Facts and Outcome In Vitale.
The tax year at issue was 1993. Mr. Vitale was in the business of writing. He had just retired after 35 years as a budget analyst for the Department of Treasury. He now wanted to make a second career of writing, an activity he had always done and enjoyed doing. But he now wanted to make money at it. And it appears he wanted to write about sex. Judge Fay explains:
“[P]etitioner had an idea for another book, a story about the experiences of two men who travel cross-country to patronize a legal brothel in Nevada. In early 1993, petitioner wrote an 18,000-word draft of this basic story line, which he submitted for copyright protection in June. In order to authenticate the story and develop characters for the book, petitioner visited numerous legal brothels in Nevada by acting as a customer for prostitutes.”
Notably absent from the opinion is any finding on whether or not Mr. Vitale had sex during these visits. The opinion does say, however, that Mr. Vitale kept a detailed contemporaneous journal of these visits, showing the time, place, and duration of each visit with each prostitute. Mr. V. recorded voluminous details about each visit and apparently quizzed each prostitute extensively about her life and background. He took many notes. He told each one that he was writing a novel.
Using the information thus obtained, Mr. Vitale wrote a book and contracted to publish it. It was in fact published. It’s titled "Searchlight, Nevada." You can buy it on Amazon. One reviewer there, Melinda Tucker, says the book gives “sensitive insight” and was “written with warmth and humor.” The Tax Court’s opinion details how Mr. Vitale was totally serious about making money from his writing, even to the extent of reclaiming his copyright when the publisher went bankrupt.
On his 1993 return Mr. Vitale deducted, inter alia, $3,480 he paid to visit prostitutes. That amount was less than the total amounts he paid for visits to prostitutes. It represented approximately 3/5th of the total. It appears that Mr. Vitale “characterized the money he paid to prostitutes as business related [only] if he incorporated the material from the interviews in his book.” Op. at ___. He was trying to separate the expenses he could justify as directly associated with his writing business from the expenses that were only indirectly associated, likely because of section 274(a).
The IRS disallowed the deduction on two grounds. First, it determined Mr. Vitale’s writing activity was a hobby. Since he had no income from that activity in 1993, he could have no deductions. Second, even if his writing was a trade or business, the prostitute payments were disallowed by §262.
After first finding that Mr. Vitale’s writing activity was a legitimate business venture, the Tax Court turned to the question of whether the prostitute payments were deductible. As framed by the IRS and the Tax Court, the issue was not §162 versus §274(a), but was instead the classic fight between §162 and §262. Judge Fay concluded that §262 won the fight because of the “inherently personal” rule: “We find that the expenditures incurred by petitioner to visit prostitutes are so personal in nature as to preclude their deductibility.” Op. at ___.
I have to believe that Judge Fay thought Mr. Vitale was having sex on each visit. That would be a reasonable assumption from the fact that Mr. Vitale visited the prostitutes in their place of business posing as a customer, rather than interviewing them at a more neutral location such as a local diner. Thus, the inherently personal nature of sex trumps the customer’s otherwise legitimate business reason for incurring the expense. Section 262 wins. In contrast, if Mr. Vitale had visited each prostitute in a local diner or other purely interview-oriented location, it would be difficult to see the inherently personal nature of that expense. But sex? That’s personal.
So what happens when the taxpayer making the sex-related expense is not the consumer of sexually-related services, but is a provider of such services? The Tax Court addressed that in the case of Ms. Cynthia S. Hess.
Facts and Outcome in Hess
The tax year at issue was 1988. That year Ms. Hess was a what the court calls a “professional exotic dancer” more colloquially known as a stripper. To increase revenue she decided to increase her breast size, undergoing “multiple medical procedures to replace and to substantially enlarge her implants, and which finally expanded her bust size to an abnormally large size (56FF). The implants were so large that they each weighed approximately 10 pounds. During 1988, she was reintroduced into the market under the stage name of "Chesty Love".” Op at 2-3.
Ms. Hess convinced the Court that the implants helped her business. She showed the Court that she was able to double her per-performance fees after the surgeries. After the year at issue she again increased the size of the implants, to 56N, and was able to show the Court an impressive economic result, including some $70,000 earned in just a few months from appearances on various television talk shows. Big breasts sell.
While the implants increased income, they actually decreased Ms. Hess’s personal pleasure. She testified that the implants created medical problems with infections and leakage, and caused her and her husband to be ostracized by her family. She swore to the court that as soon as her exotic dancing career was over, she was going to have the implants removed.
Judge Joan Seitz Pate was sympathetic to Ms. Hess's claims. Judge Pate gives a good history of the inherently personal doctrine, noting that the key question is whether the expense at issue was at least as useful to the taxpayer’s personal needs as well as business needs. If so, the inherently personal rule would deny a deduction. Section 262 wins the fight. But in Ms. Hess’ case, the Judge finds that the implants at issue “were detrimental to her health and contorted her body into a grotesque appearance, all for the purpose of making money. Thus, even though the implants were surgically made a part of her body, we are convinced that they were not inherently personal in nature.” Op. at 9-10.
Thus, the implants were an allowable business expense although because they were a capital expense, the deduction would be authorized by §167 and not §162. But it’s the same idea: §262 loses the fight here. On balance, the business aspect of the expense outweighs the personal aspect.
Lesson: “Life In All Its Fullness”
This tension between personal and business is long-standing in the tax law. How are courts supposed to resolve that tension? How are advisors supposed to advise their clients? The short answer is “life in all its fullness supplies the answer.” That’s the money quote from the classic Supreme Court case Welch v. Helvering, 290 U.S. 111 (1933). There, the question was whether a taxpayer’s repayment of certain loans was a deductible expense. The taxpayer had no legal obligation to repay but instead did so to help his reputation in the community. The IRS had denied the deduction because the expense was not “ordinary” within the meaning of §162.
It is worth reading Justice Frankfurter’s rumination on the meaning of the word “ordinary” in full:
“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. 114-115 (internal citations omitted).
Thus, Justice Frankfurter instructs us to find the proper balance by using personal life experience. It becomes the job of a trial judge to apply their life experience to decide whether an expenditure that has both a personal and business dimension is deductible.
In that regard query whether the life experiences of either Judge Guy (a man judging a man) or Judge Pate (a woman judging a woman) might have affected their decisions. Would each have come to the same result if their cases were swapped?
I should like to think both would come to the same conclusion in each case, because the balance I see being drawn here is that even when an expense is inherently personal, if the taxpayer can show it gave little or no actual personal benefit but only a business benefit, then the balance falls in favor of deduction. That is what Ms. Hess was able to show. In contrast, Mr. Vitale did not make that showing, so for him the balance fell on the side of denying a deduction for that inherently personal expense.
Perhaps "life in all its fullness" is a cop-out as a rule. But it's the lesson I working well in these two classic cases from Tax Court.
Bryan Camp is the George H. Mahon Professor of Law at Texas Tech University School Thereof. He invites readers to return each week (usually on Mondays) for another Lesson From The Tax Court