Huff v. Comm'r of Internal Revenue

• Decision Date: 26 April 1983
• Docket Number: 10903-77,10954-77.,Docket Nos. 10902-77
• Citation: 80 T.C. 804
• Parties: LARRY D. HUFF and DARLENE HUFF, ET AL v. COMMISSIONER of INTERNAL REVENUE, RESPONDENT
• Court: U.S. Tax Court

80 T.C. 804

LARRY D. HUFF and DARLENE HUFF, ET AL

v.COMMISSIONER of INTERNAL REVENUE, RESPONDENT

Docket Nos. 10902-77

10903-77

10954-77.

United States Tax Court

Filed April 26, 1983.

Petitioner-husbands were employees of B, a corporation. A California court imposed civil penalties on B and other civil penalties on petitioner-husbands and other employees of B, for which petitioner-husbands and the others were severally liable.

Held:

(1) B's payments of the civil penalties imposed on petitioner-husbands resulted in gross income taxable to petitioners.

(2) Since these civil penalties were imposed in order to punish petitioner-husbands for violating State law, sec. 162(f), I.R.C. 1954, bars any deduction otherwise allowable under sec. 162(a), I.R.C. 1954. Herman P. Scampini, Jr., and Patricia E. Cole, for the petitioners in docket Nos. 10902-77 and 10903-77.

John R. Wolfe, pro se, in docket No. 10954-77.

Woodford G. Rowland, for the respondent.CHABOT , Judge:

Respondent determined deficiencies in Federal individual income tax against petitioners for 1973 as follows:

+----------------------------------------------------------+
                ¦                                ¦Docket No.  ¦Deficiency  ¦
                +--------------------------------+------------+------------¦
                ¦Larry D. Huff and Darlene Huff  ¦10902-77    ¦$31,552     ¦
                +--------------------------------+------------+------------¦
                ¦E. James Rohn and Judith M. Rohn¦10903-77    ¦28,430      ¦
                +--------------------------------+------------+------------¦
                ¦John R. and Louise R. Wolfe     ¦10954-77    ¦22,950      ¦
                +----------------------------------------------------------+
                

These cases have been consolidated for trial, briefs, and opinion .¹ The parties have settled most of the adjustments made in the notices of deficiency. The issues remaining for decision are as follows:

(1) Whether, under section 61(a),² the payments by Bestline Products, Inc., of civil penalties imposed on petitioner-husbands by the California Superior Court result in gross income taxable to petitioners;³ and, if so,

(2) Whether the civil penalties are deductible by petitioners under section 162(a) or are nondeductible because of section 162(f).

FINDINGS OF FACT

Some of the facts have been stipulated; the stipulations and the stipulated exhibits are incorporated herein by this reference.

When the petitions in the instant cases were filed, petitioners Larry D. Huff (hereinafter sometimes referred to as Huff) and Darlene Huff, husband and wife, resided in San Jose, Calif.; petitioner E. James Rohn (hereinafter sometimes referred to as Rohn) resided in San Jose, Calif., and petitioner Judith M. Rohn resided in Scottsdale, Ariz. (Rohn and Judith M. Rohn were husband and wife during 1973 and filed a joint return for that year); and petitioners John R. Wolfe (hereinafter sometimes referred to as Wolfe) and Louise R. Wolfe, husband and wife, resided in Walnut Creek, Calif.

Bestline Companies

Bestline Corp. (hereinafter sometimes referred to as Corporation), at all times relevant to these cases, was a holding company. It owned and held all of the outstanding stock of Bestline Products, Inc. (hereinafter sometimes referred to as Products). Corporation and Products are hereinafter sometimes collectively referred to as the Bestline Companies. The Bestline Companies had their principal place of business in San Jose, Calif. The sole business enterprise of the Bestline Companies was the manufacture, development, and sale of detergent cleaning products through distributors located in the 50 States and to affiliated corporations in several foreign countries.

The Bestline Companies' marketing program consisted of three levels of distributors—-local, direct, and general. The local distributors, the lowest level, were supposedly the retail sales force of the Bestline Companies. Individuals were encouraged to begin working at the middle level as direct distributors so they could become general distributors, the highest level. Individuals had to work as direct distributors before they could become general distributors.

From January 15, 1971, through March 1973, the Bestline Companies had three plans, whereby individuals who wanted to become general distributors paid Products certain charges and training fees. Under each of the plans, a general distributor received compensation when he sponsored a new direct distributor, or when a direct distributor he had sponsored in turn sponsored a new direct distributor. All of the plans were endless chain schemes and were illegal under California's penal laws. An “endless chain” is defined under California law as “any scheme for the disposal or distribution of property whereby a participant pays a valuable consideration for the chance to receive compensation for introducing one or more additional persons into participation in the scheme or for the chance to receive compensation when a person introduced by the participant introduces a new participant.” Cal. Penal Code sec. 327 (West Cum. Supp. 1968).

The corporate management structure of Products consisted of the following employees:⁴ a president; about 25 vice presidents (including executive vice presidents, 6 divisional vice presidents, and a number of assistant vice presidents); about 30 regional directors; and a number of area coordinators.

Products conducted operations in all 50 States. For purposes of managing its operations, Products divided the United States into six or seven geographical divisions and further divided each division into regions. Generally, a region consisted of one or two States. California, however, contained four regions.

The top manager of each region was the regional director. The regional director was responsible for communicating corporate policy, dealing with corporate policy in the field, training distributors in both product and distribution operations, and dealing with consumer complaints.

Huff first became associated with the Bestline Companies in 1968 as a part-time distributor. In 1969, he became a fulltime distributor⁵ In 1970, Huff became an employee of Products as a regional director in Michigan. Sometime in 1970 or 1971, Huff became the assistant to the vice president of marketing at the home office, located in San Jose, Calif. and later, the assistant to the vice president of sales at the home office. Finally, sometime in 1971, Huff became the vice president of sales. As vice president of sales, Huff trained distributors and set up training programs for product knowledge and sales, including the drafting of recruitment scripts to be used by distributors, and enforced corporate policies. In 1972, Huff also became a member of Products' board of directors. Sometime in 1973, Huff stopped working for Products.

Rohn first became employed by Products in 1968 as the assistant to a vice president. Before then, Rohn delivered a seminar called “Adventures in Achievement” to Products' distributors but was not an employee of Products. In 1971, he became a vice president of Products. As the assistant to a vice president and as a vice president, Rohn's sole duty was delivering the seminar which explained techniques of recruiting and goal-setting to Products' then-current distributors.

Wolfe first became associated with the Bestline Companies in 1969 as a distributor; he later became a general distributor and then an area coordinator. In 1971, he became regional director for northern California, and held that position until September 1973. As regional director, he was responsible for recruitment meetings in the region and the managing of five area coordinators.

California Actions and Judgments

Sometime before January 14, 1971, the attorney general for the State of California filed a civil action (hereinafter sometimes referred to as the first action) against the Bestline Companies and William E. Bailey⁶ and Robert Depew (hereinafter sometimes referred to as Bailey and Depew, respectively), acting individually and in their capacities as officers and directors of the Bestline Companies, in the Superior Court of California for the county of Los Angeles (hereinafter sometimes referred to as the California court).

On January 14, 1971, the California court entered a final judgment in the first action pursuant to a stipulation between the parties. The final judgment enjoined and restricted the type of multilevel distributors' organization the Bestline Companies could operate and it enjoined all defendants in the first action from making false or misleading representations about the amount of earnings which could be made through the marketing program, and about the ease of recruiting new distributors and selling products to consumers. The final judgment also required the defendants in the first action to inform all current and prospective participants, salesmen, or other persons engaged in the sale of the Bestline Companies' products orally and in writing of the terms of the final judgment. This final judgment stated that it was applicable to—-

all persons, corporations or other entities acting under, by, through or on behalf of the corporate and individual defendants and to all other persons acting in concert or participating with any other defendants having actual or constructive notice of this final judgment * * *

Subsequently, the attorney general filed another action (hereinafter sometimes referred to as the second action) in the California court against the Bestline Companies, Bailey, Depew, petitioner-husbands, and numerous other individuals. After a trial which ended on June 15, 1973, the California court issued its findings of fact and conclusions of law in the second action (hereinafter sometimes referred to as the findings). The California court concluded that the Bestline Companies and 14 individual defendants, including all 3 petitioner-husbands, had willfully violated the final judgment in the first action and, in three separate respects, had violated California Business and Professions...