Brewster v. Comm'r of Internal Revenue

• Citation: 67 T.C. 352
• Decision Date: 30 November 1976
• Docket Number: Docket No. 7063-71.
• Parties: ANNE MOEN BULLITT BIDDLE BREWSTER, PETITIONER v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT
• Court: United States Tax Court

67 T.C. 352

ANNE MOEN BULLITT BIDDLE BREWSTER, PETITIONER

v.COMMISSIONER OF INTERNAL REVENUE, RESPONDENT

Docket No. 7063-71.

United States Tax Court

Filed November 30, 1976.

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 sec. 911(b), petitioner was required to exclude a portion of her gross farm income as ‘earned income.’ Brewster v. Commissioner, 473 F.2d 160 (D.C. Cir. 1972), affg. per curiam55 T.C. 251 (1970); Jack E. Golsen, 54 T.C. 742 (1970), affd. on the substantive issue 445 F.2d 985 (10th Cir. 1971). Held, further, respondent's determination that 30 percent of gross farm income was a reasonable allowance as compensation for petitioner's personal services and, therefore, the amount of excludable earned income, sustained, Held, further, respondent's determination that 30 percent of petitioner's farm expenses were allocable to or chargeable against excludable earned income and nondeductible under sec. 911(a) sustained. Thomas E. Jenks, Herbert L. Awe, and Michael Mulroney, for the petitioner.

Jon T. Flask, for the respondent.

TANNENWALD, Judge:

Respondent determined the 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 income under section 911¹ when her foreign farming proprietorship operated at a loss, (2) if a portion was so excludable, the amount thereof, and (3) the amount of petitioner's farming expenses ‘allocable to or chargeable against’ the excludable income.

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 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 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 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. 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

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 section 911 as earned income. He further determined that the portion of gross farm expenses allocable to the excludable income, and therefore nondeductible, was the same percentage of gross expenses that excludable income was of gross farm income. The net effect of respondent's determination (modified in accordance with n. 2 supra) is the reduction of petitioner's net farm loss for each year, except 1963, by 30 percent.⁴

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, 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.

OPINION

Section 911⁶ affords a tax benefit to citizens who are residents of a foreign country to the extent that they realize income abroad as a result of their personal services (earned income) rather than as a return on capital investments. In the case of a service-capital business, the statute provides that ‘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.’

On a prior occasion, this same taxpayer asked us to decide the identical question initially before us herein, namely, whether, under section 911, a citizen residing outside of the United States can have excludable ‘earned income’ from a farming proprietorship in which both capital and personal services are material income-producing factors (service-capital business) when such proprietorship operates at a loss. In a Court-reviewed opinion, we answered that question affirmatively. Anne Moen Bullitt Brewster, 55 T.C. 251 (1970), affd. 473 F.2d 160 (D.C. Cir. 1972). We reasoned that the 30-percent limitation on the amount of net profits deemed to be earned income only applies to a business realizing net profits, since the limitation is expressed in terms of a percentage of net profits. Based upon this approach and because the benefit conferred takes the statutory form of an exclusion from gross income, we held that the excludable compensation factor was to be determined with reference to gross income. 55 T.C. at 254. Our decision was affirmed by the Court of Appeals for the District of Columbia in a per curiam opinion (473 F.2d 160 (D.C. Cir. 1972)), which rather extensively analyzed the issue involved and the views expressed by this Court.

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 section 911(b) and urges us to reexamine and abandon our position to the contrary. Respondent counters with the assertion that the rule established in Jack E. Golsen, 54 T.C. 742 (1970), affd. on the substantive issue 445 F.2d 985 (10th Cir. 1971), requires us to follow our prior decision in view of its affirmance by the Court of Appeals for the District of Columbia, to which an appeal from a decision herein would lie.

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

We turn to the questions as to how the amounts of excludable gross income and related...