Furrer v. Commissioner
| Decision Date | 28 October 1976 |
| Docket Number | Docket No. 1246-75. |
| Citation | 1976 TC Memo 331,35 TCM (CCH) 1525 |
| Parties | Ralph Furrer and Rosemarie Furrer v. Commissioner. |
| Court | U.S. Tax Court |
Gary M. Anderson and Preston C. Hiefield, Jr., Suite 775, Boise Cascade Bldg., Portland, Oregon, for the petitioners. Gary R. DeFrang, for the respondent.
Memorandum Findings of Fact and Opinion
Respondent has determined a deficiency in petitioners' Federal income tax for the taxable year 1970 in the amount of $38,530.74. Concessions having been made, there are two issues for our decision: (1) Whether a judgment award recovered by petitioner for an insurance company's breach of a special agency contract is taxable as ordinary income or capital gain; and (2) Whether claimed deductions for the operating and depreciation expenses of a boat should be disallowed pursuant to section 274(d).1
Some of the facts have been stipulated and are so found.
Petitioners Ralph Furrer and Rosemarie Furrer, husband and wife, resided in Tigard, Oregon, at the time they filed the petition herein. Petitioners filed a joint Federal income tax return for 1970 with the office of the Internal Revenue Service at Ogden, Utah.
Petitioner Ralph Furrer (hereinafter petitioner) worked for the National Hospital Association (NHA) from 1935 to 1946. He returned to NHA in 1953 to develop individual policies and an agency force for NHA, which, at that time, was primarily marketing group insurance and limited individual policy coverage for group conversions. Petitioner was executive sales manager and a member of NHA's board of directors and, during the time he worked for that company, he developed new individual policies and an agency force of 400 to 500 agents.
On May 1, 1959, petitioner entered into a special agency agreement with Industrial Hospital Association, subsequently International Health Assurance Co. (both companies hereinafter referred to as IHA). The 1959 agreement was applied, by mutual consent, to IHA of Washington and IHA of Oregon which were wholly owned subsidiaries of IHA formed in 1960 and 1963, respectively. By December 1965, both IHA and IHA of Washington had merged into IHA of Oregon.
Under the 1959 agreement, IHA appointed petitioner as special agent and authorized him to solicit qualified agents as sales representatives for IHA's individual membership department and to negotiate agency agreements with such agents on behalf of IHA. Petitioner was also authorized to sell IHA's individual insurance. The agreement provided for petitioner's compensation on a commission basis with such commissions computed as a percentage of gross dues received by IHA on individual insurance policies. Petitioner agreed that such commissions would be his only compensation from IHA and that all other expenses, such as travel and telephone expenses, would be borne by him. The agreement specifically provided that there was no intention between the parties to create an employer-employee relationship and that neither the agreement nor any earned commission under it could be assigned or transferred without the written approval of IHA. The agreement could be terminated by either party upon 60 days' notice. However, if IHA terminated the agreement, it was required to continue to pay the special agent such compensation as he would have been entitled had his services not been terminated for a period of three years on all dues received and accepted on individual policies sold by the special agent personally or agents whose agency agreements were negotiated by the special agent.
The 1959 agreement provided further that it could not be terminated if the gross annual dues received and accepted by IHA on individual policies sold by the special agent, or agents whose agreements were negotiated by him, exceeded a designated amount and if the claims on these individual policies were below a specified percentage of the gross dues received by IHA.
During the years 1959 to 1965, inclusive, petitioner received compensation pursuant to the 1959 agreement, and he reported such compensation as ordinary income on his Federal income tax returns filed for those years.
By 1965, petitioner had developed an agency force of over 800 active agents generating gross dues from individual policies in 1965 in excess of $900,000. Petitioner likewise was instrumental in the development of the "dollar deductible policy" which the IHA companies (IHA, IHA of Oregon, and IHA of Washington) offered for sale. However, insurance policies which are offered for sale are filed with the Insurance Commissioner and are available for inspection and copying by all insurance companies. It is common for an insurance company to use concepts developed by other companies and, in fact, insurance concepts which petitioner felt he had developed while associated with the IHA companies were subsequently used by other insurance companies.
Written agency agreements were executed between the IHA companies and the insurance agents who sold their insurance, and the IHA companies were designated as the principal in these agreements. However, several agents who worked under petitioner at IHA have become agents for petitioner's subsequent employer, Prudential Health Association (PHA).
Petitioner was instrumental in the development of these agency agreements. While associated with the IHA companies, petitioner maintained files on the agents that he supervised. These files contained the agency agreements, renewal agreements, and correspondence concerning claim disputes. Upon termination of petitioner's special agency agreement, the IHA companies took possession of these files.
While petitioner was associated with the IHA companies, they provided him office space and secretarial help at no charge. During the period from 1959 to 1965, the IHA companies incurred advertising expenses of $101,600. In connection with his activities as a representative of the IHA companies, petitioner incurred expenses of approximately $60,000 for travel and other items for which he received no reimbursement from the IHA companies.
In February 1966, IHA of Oregon notified petitioner that it was terminating the 1959 agreement as of May 1, 1966. On May 4, 1966, petitioner filed a complaint for a declaratory judgment in the Circuit Court of the State of Oregon for Multnomah County. The case was tried without a jury, and by a letter dated October 17, 1967, the court notified the parties of its opinion. This letter opinion held that IHA of Oregon (known as International Health Insurance Co. at the time of trial) had wrongfully terminated the 1959 agreement, and the court awarded petitioner $150,000 as compensation "for his services." This letter opinion was later modified by eliminating reference to the $150,000 award.
On December 20, 1967, petitioner filed a supplemental complaint in the state court proceeding seeking damages for breach of contract. At the conclusion of the damages trial, the court entered a decision for petitioner in the amount of $213,011.48. In computing the amount of damages, the trial court computed the present value of the commissions lost because of IHA's unlawful termination and subtracted from this amount, (1) the present value of the expenses necessary to perform the contract, (2) the present value of petitioner's earnings subsequent to the termination of the 1959 agreement, and (3) certain payments already made to petitioner by IHA. The trial court decision was affirmed on appeal in 1970 by the Supreme Court of Oregon in an opinion reported at 256 Ore. 429 and 474 P. 2d 759.
The pleadings in the above-described state court proceedings did not assert claims for the value of the records that petitioner maintained or for the goodwill and agency force that he developed during his association with IHA.
As a result of the circuit court's decision, as affirmed by the Oregon Supreme Court, petitioner, in 1970, received $213,011.48 as damages for breach of contract and $24,307.29 as interest on the judgment. He incurred expenses of $65,963.54 for attorneys' fees and court costs.
On his 1970 return, petitioner reported the $213,011.48 as capital gain income and allocated the deduction for attorneys' fees and court costs between the award and the interest. On a schedule attached as part of petitioner's return, he reported the interest on the award, less the allocable portion of attorneys' fees and court costs, as ordinary income, but, inadvertently, this amount was not carried forward from the schedule and included as a part of petitioner's adjusted gross income. Petitioner has conceded such inadvertent error. In his statutory notice, respondent determined the amount received as damages and the interest thereon to be ordinary income and allowed the full amount of the attorneys' fees and court costs as a deduction from ordinary income.
The parties have stipulated that petitioner should be allowed a deduction for attorneys' fees and court costs totaling $65,963.54 for the taxable year 1970 regardless of the characterization of the breach of contract award. However, if the award is characterized as capital gain income, then, by stipulation, $58,700 of the attorneys' fees and court costs should be applied as a deduction in the computation of net long-term capital gain income and the remainder of such fees and costs should be applied as a reduction in computing net interest income.
During 1970, petitioner incurred the following expenses in connection with a boat that he owned:
Repairs ....................... $ 857.97
Moorage ....................... 452.73
Gasoline, supplies, etc. ...... 2,213.68
Insurance ..................... 319.00
Depreciation .................. 919.27
Total: ...................... $4,762.65
In his petition filed herein, petitioner claims 75 percent of these expenses ($3,571.99) as a business expense deduction.2
Petitioner kept a boat guest register...
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