Cook v. United States

• Decision Date: 09 July 1979
• Docket Number: No. 442-75.,442-75.
• Citation: 599 F.2d 400
• Parties: Robert H. COOK and Joan M. Cook v. The UNITED STATES.
• Court: U.S. Claims Court

599 F.2d 400

Robert H. COOK and Joan M. Cook v. The UNITED STATES.

No. 442-75.

United States Court of Claims.

April 18, 1979.

On Rehearing July 9, 1979.

Arthur G. Barnett, Seattle, Wash., attorney of record, for plaintiffs; Peter S. Lewicki, Seattle, Wash., of counsel.

Michael J. Dennis, Washington, D.C., with whom was Asst. Atty. Gen., M. Carr Ferguson, Washington, D.C., for defendant; Theodore D. Peyser and Robert S. Watkins, Washington, D.C., of counsel.

Before DAVIS, KASHIWA and KUNZIG, Judges.

Before DAVIS, Judge, Presiding, and KASHIWA and KUNZIG, Judges.

ON CROSS-MOTIONS FOR SUMMARY JUDGMENT

DAVIS, Judge:

This case revolves around the application of the foreign-income exclusion provided by section 911 of the Internal Revenue Code, 26 U.S.C. § 911, to the work of an American artist residing and creating abroad. Plaintiff Robert H. Cook, a United States citizen, is a sculptor, long-resident in Rome, Italy, who works in bronze.¹ Essentially, he uses a lost wax process, making a model of the sculpture in beeswax reinforced by strips of bamboo. The model is then taken to an outside foundry where it is cast in bronze. Mr. Cook creates his sculptures in his studio in Rome, and then sells them on a noncommissioned or a commissioned basis, primarily to persons in the United States.² In the two taxable years now in question, 1970 and 1971, plaintiff had both commissioned and noncommissioned sales; the commissioned work was a large bronze sculpture, commissioned in 1970 by Mr. Jack Rudin for placement in New York and delivered there in 1971, for a total price (including foundry expenses) of $65,000.³

For both 1970 and 1971 taxpayer's income tax returns excluded part of his income as foreign earned income under section 911 of the Code. On audit, the Internal Revenue Service disallowed portions of the claimed foreign income exclusion and increased plaintiff's tax liability. The Service made its recomputation mainly on the basis that Mr. Cook was not entitled to a section 911 foreign "earned income" exclusion for his noncommissioned sales in the United States (which were sold to purchasers in this country, usually through art galleries, after full completion of the sculpture in Italy). The Service's position at that time was that these noncommissioned sales were sales of tangible products, rather than the result of personal labor or services.

Taxpayer paid the additional amounts found due by the Service, and then filed timely refund claims for both years. These claims stated that in light of the Tax Court's decision in Tobey v. Commissioner, 60 T.C. 227 (1973) acq. 1979-10 I.R.B. at 6,⁴ taxpayer's returns for the respective years should have been accepted as filed. The refund claims were disallowed (except for a small mathematical adjustment for 1970) and this suit was then brought. Both parties have moved for summary judgment, on the basis of stipulated facts and affidavits, and we believe that the case can properly be disposed of on the materials we now have before us.

I.

At the center of the case is section 911(a), providing for the exclusion of foreign income if three general conditions are satisfied: (1) taxpayer must be either a bona fide foreign resident § 911(a)(1) or physically present abroad for 510 days § 911(a)(2); (2) the income received must be "from sources without the United States"; (3) the income received must constitute "earned income attributable to services performed" during foreign residency.⁵ The parties have stipulated that taxpayer was a bona fide resident of Italy under section 911(a)(1) and also agree that, under the then-existing provisions of section 911(c), taxpayer was entitled to an exclusion of up to $25,000 of foreign income. See I.R.C. § 911(c)(1)(B) (1970). Moreover, contrary to the Service's position on the audit, the Government does not now contest the application to plaintiff of the holding in Tobey v. Commissioner, supra, that both taxpayer's commissioned and noncommissioned income is earned income under section 911.

The currently disputed issues are these: (a) Is taxpayer correct that he is entitled to calculate his net earned income and then deduct his foreign income exclusion of $25,000? (b) Is the defendant right that a large part of plaintiff's income from his work was not "from sources without the United States"? (c) Is taxpayer bound, because of the nature and wording of his refund claims, by the figures and factual statements set forth in his returns for the two taxable years? and (d) Was capital a "material income-producing factor" for plaintiff's income? In the subsequent sections of this opinion, we answer the first three of these questions, and find it unnecessary to delve into the fourth; we also compute, on the basis of our analysis of the substantive issues taken together with the facts which have to be accepted on these motions, the amount of the taxes owed for each of the two taxable years.

II.

In claiming an exclusion under section 911(a), taxpayer argues that he is entitled to exclude his foreign source income from net income. Plaintiff would subtract his business expenses from gross receipts to arrive at a figure labeled "Schedule C Net Earned Income." From this net income figure taxpayer would then subtract his excludable foreign income, without any reduction for expenses allocable to the foreign income.

We reject this attempt to compute an exclusion from net income as contrary to the statute, as it has been implemented by regulations, revenue rulings, and case law. Section 911(a) begins with the statement that "the following items shall not be included in gross income and shall be exempt from taxation under this subtitle * * *" (emphasis added). This language, together with the last sentence of section 911(a) (precluding deductions from gross income when such deductions are "properly allocable to * * * amounts excluded from gross income under this subsection") tends to suggest at least for individual taxpayers, that the section 911 exclusion is to be computed on the basis of gross income.⁶

The tilt of the statutory language is strongly reinforced by the interpretative regulations, in effect since 1963, relating to individuals. See Treas.Reg. § 1.911-2(a)(1) ("amounts constituting earned income * * * shall be excluded from the gross income of an individual * * *") (emphasis added); id. at (a)(4) (specifying the maximum amount to be "excluded from the gross income of an individual") (emphasis added). See also Rev.Rul. 75-86, 1975-1 Cum.Bull. 242 (example number one). The cases which have discussed the section 911 exclusion for individuals also calculate the exclusion from the taxpayers's gross income. See, e. g., Brewster v. Commissioner, 154 U.S.App.D.C. 30, 473 F.2d 160 (1972) (per curiam), aff'g 55 T.C. 251 (1970); Tobey v. Commissioner, 60 T.C. 227 (1973); Brewster v. Commissioner, 67 T.C. 352 (1976), appeal docketed, No. 77-2010 (D.C.Cir. Nov. 14, 1977).

Against this statutory inference reinforced by consistent administrative and judicial interpretation taxpayer relies on a partnership case, Vogt v. United States, 537 F.2d 405, 210 Ct.Cl. 246 (1976), to support his theory that the foreign income should be excluded from net income. Particularly, plaintiff quotes language from Vogt which is said to hold that earned income (for purposes of section 911) is not necessarily equivalent to gross income and he argues that a revenue ruling here relied on by the Government, Rev.Rul. 75-86, 1975-1 Cum.Bull. 242, was specifically rejected in Vogt. Taxpayer ignores two salient features of Vogt that distinguish it from this case. First, that decision involved partners and the suggestion that section 911(a) does not literally compel use in every instance of gross income as the basis for the exclusion was made in the course of an analysis showing that the statutory language was not so clear as to invalidate a long-standing administrative interpretation allowing the foreign earned income exclusions of a partner to be based on his share of the partnership net profit. See Vogt v. United States, 537 F.2d 405, 409-17, 210 Ct.Cl. 246, 252-65 (1976). The whole rationale of the Vogt opinion was tied to the lengthy existence of that administrative construction for foreign-based partners. Second, Vogt parsed the language of section 911 and the post-litigation interpretation contained in Rev.Rul. 75-86 only in terms of partnership income, not individual returns. The decision in Brewster v. Commissioner, 154 U.S.App.D.C. 30, 473 F.2d 160 (1972) (per curiam), was specifically distinguished in Vogt as involving an individual, not a partnership return. 537 F.2d at 415, 210 Ct.Cl. at 262-63; see Brewster v. Commissioner, 67 T.C. 352, 358 n.7 (1976), appeal docketed, No. 77-2010 (D.C.Cir. Nov. 14, 1977).

Here, taxpayer is clearly reporting on an individual basis, and has not shown (or even argued) that the Service had any long-standing administrative policy allowing individuals to exclude foreign source income from a net figure. The contrary is clearly true, and there is therefore no reason to reject the facial suggestion of the statute that gross income is to be the starting point.

III.

A precondition for a section 911 exclusion is that the income received be "from sources without the United States." I.R.C. § 911(a)(1) & (2). Sections 861-864 of the Code provide general rules for determining the source of income, and the regulations interpreting section 911 specifically refer to these provisions for proper allocation of income sources. Treas.Reg. § 1.911-2(c)(4) (1971). Both parties accept reference to the sourcing provisions, but dispute vigorously whether the artwork sold by Cook constituted "labor or personal services" to be governed by the sourcing provisions of sections 861-862 (plaintiff's view) or whether the artwork was a sale of "personal property" to be sourced under section 863 (defendant's view). The Government insists that taxpayer's sales of...