Jackson v. C.I.R., s. 87-1173

• Citation: 864 F.2d 1521
• Decision Date: 10 January 1989
• Docket Number: Nos. 87-1173,87-1183,87-1178 and 87-1185,87-1184,87-1180,s. 87-1173
• Parties: -539, 89-1 USTC P 9123 John JACKSON, Yvonne Jackson, Gregory M. Barrow and Timsey Barrow, Petitioners-Appellants, Cross-Appellees, v. COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellee, Cross-Appellant.
• Court: United States Courts of Appeals. United States Court of Appeals (10th Circuit)

Page 1521

864 F.2d 1521

63 A.F.T.R.2d 89-539, 89-1 USTC P 9123

John JACKSON, Yvonne Jackson, Gregory M. Barrow and Timsey

Barrow, Petitioners-Appellants, Cross-Appellees, v. COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellee,

Cross-Appellant.

Nos. 87-1173, 87-1183, 87-1180, 87-1184, 87-1178 and 87-1185.

United States Court of Appeals,

Tenth Circuit.

Jan. 10, 1989.

R. La Mar Bishop, Salt Lake City, Utah, for petitioners-appellants and cross-appellees.

Elaine F. Ferris (Michael L. Paup, Chief, Jonathan S. Cohen, Atty., Appellate Section, Tax Div., Dept. of Justice, Washington, D.C., and Michael C. Durney, Acting Asst. Atty. Gen., on the brief), Atty., Appellate Section, Tax Div., Dept. of Justice, Washington, D.C., for respondent-appellee, and cross-appellant.

Before MOORE, BARRETT, and TACHA, Circuit Judges.

TACHA, Circuit Judge.

This is an appeal from a United States Tax Court decision upholding the disallowance of the taxpayers' deductions in 1978 for lease amortization and advertising expenses under I.R.C. Sec. 162 and the imposition of penalties under I.R.C. Sec. 6651 for one of the taxpayer's failure to file timely returns in the 1978, 1979, and 1980 tax years. We affirm.

Taxpayers Barrow and Jackson (hereinafter referred to jointly as "taxpayers") ¹ were involved in a business venture to manufacture, distribute, and sell a device known as the "Norris XLP," capable of playing and recording twenty-four hours of material on a single audio cassette. During the latter part of 1978, taxpayers negotiated with the inventor to obtain an exclusive license for the manufacture, sale, and distribution of the Norris XLP. Taxpayers obtained an informal agreement on October 13, 1978, and began to take preparatory steps to manufacture and distribute the product, including commissioning a marketing study and seeking a manufacturer.

In November 1978 taxpayers left their previous occupation as insurance agents to devote more time to the venture. About November 1, 1978, taxpayers formed a corporation, Norwood Industries, Inc. (Norwood), to serve as the primary licensee. Taxpayers planned to utilize Norwood to sell territorial sublicenses that would convey to the sublicensee the exclusive right to sell the device in a defined geographic region. At about the time Norwood was formed, taxpayers also formed a partnership, J & G Distributing (J & G), for the purposes of acquiring and reselling territorial sublicenses and distributing the device under its own territorial sublicenses. Taxpayers were equal partners in J & G, and equal shareholders in Norwood, during 1978.

A formal license agreement was executed between the inventor and Norwood on December 13, 1978. Taxpayers each acquired, individually, two territorial sublicenses from Norwood, and their partnership, J & G, also acquired sublicenses that it kept to develop for product distribution. J & G also sold territorial sublicenses for Norwood on a commission basis, earning $170,000 in commissions during 1978. As a condition of the sublicense agreement, each sublicensee was required to participate in a cooperative advertising program with Norwood. Taxpayers and J & G contributed to this program in 1978.

The parties have stipulated that "[i]n November and December 1978, Norwood and its licensee's [sic] contacted agents, distributors, and retail outlets in an effort to sell the new machines," and that "[o]rders were taken and the first units were sold in December 1978 and January of 1979." The only documentary evidence of a sale in 1978, however, is a shipping order for one player/recorder by Norwood to an individual in Chino, California. ² The inventor, Norris, received the first shipment of player/recorders from the factory in Hong Kong on December 30, 1978. Norris delivered these player/recorders to Norwood during the first two days of 1979.

Taxpayers took deductions for their contributions to the cooperative advertising program, and for license amortization. The tax court disallowed taxpayers' 1978 deductions on the ground that during that year neither of the taxpayers, nor their partnership J & G, was engaged in the trade or business of distributing player/recorders pursuant to their sublicenses. Jackson v. Commissioner, 86 T.C. 492, 514, 517 (1986).

The tax court found that taxpayers, acting in their capacity as sublicensees, neither "made ... sales during 1978, nor ... made any legitimate efforts to locate potential buyers for the [player/recorders]." Id. at 515. "The only activities that [taxpayers] undertook in regard to their individual sublicenses in 1978 was the purchase of the sublicense from Norwood and the initial payment under the advertising cooperative agreement." Id. Furthermore, the court concluded that "[m]erely acquiring a license to distribute a product within a territory does not place a taxpayer in the trade or business of distributing that product." Id.

Regarding J & G, the tax court found that "[a]ll of the gross income of J & G for 1978 was from the sale of Norwood sublicenses and none from the sale of Norwood products." Id. at 516. Although "J&G was clearly in the business of selling Norwood sublicenses during 1978," the tax court found that "[taxpayers] took no significant action to commence sales of Norwood products by J&G," "[n]o sales of Norwood products were, in fact, made by J & G during 1978," and "there is no indication that J & G purchased any inventory" in 1978. Id. at 516-17. On the basis of these findings, the tax court held that J & G was not in the trade or business of distributing Norwood products during 1978. Id. at 517.

The tax court held that taxpayers' advertising expenditures were not deductible under I.R.C. Sec. 162, ³ but were required to be capitalized as "preopening expenses." Jackson, 86 T.C. at 516-17. The court similarly held that taxpayers could not deduct the 1978 amortization of their sublicenses because they were not carrying on the trade or business of selling player/recorders under those sublicenses. ⁴ Id.

I.

Taxpayers contend that the tax court erred in holding that neither taxpayers, nor J & G, were carrying on the trade or business of distributing player/recorders in 1978. Alternatively, they contend that the tax court erred in separating the business activities of J & G and prohibiting taxpayers from offsetting the advertising and amortization expenses incurred by J & G for the sale of player/recorders against J & G's commission income from the sale of territorial sublicenses. We consider these issues in turn.

A.

"Congress directed the United States Courts of Appeals to review tax court decisions 'in the same manner and to the same extent as decisions of the district courts in civil actions tried without a jury.' " Love Box Co. v. Commissioner, 842 F.2d 1213, 1215 (10th Cir.) (quoting I.R.C. Sec. 7482), cert. denied, --- U.S. ----, 109 S.Ct. 62, 102 L.Ed.2d 40 (1988). The Supreme Court has stated that to "determine whether the activities of a taxpayer are 'carrying on a business' requires an examination of the facts in each case." Higgins v. Commissioner, 312 U.S. 212, 217, 61 S.Ct. 475, 478, 85 L.Ed. 783 (1941). This case, however, presents a mixed question of law and fact because we must apply the statutory standard of I.R.C. Sec. 162 to determine whether taxpayers have incurred expenses "during the taxable year in carrying on any trade or business." "The Supreme Court has defined mixed questions as those 'in which the historical facts are admitted or established, the rule of law is undisputed, and the issue is whether the facts satisfy the statutory standard, or to put it another way, whether the rule of law as applied to the established facts is or is not violated.' " Love Box Co., 842 F.2d at 1215 n. 2 (quoting Pullman-Standard v. Swint, 456 U.S. 273, 289 n. 19, 102 S.Ct. 1781, 1790 n. 19, 72 L.Ed.2d 66 (1982)). In this case we review the tax court's factual findings, including reasonable inferences that may be drawn therefrom, under the clearly erroneous standard, Commissioner v. Duberstein, 363 U.S. 278, 290-91, 80 S.Ct. 1190, 1199-2000, 4 L.Ed.2d 1218 (1960), but review de novo the application of the law to those facts, see Colorado Springs Nat'l Bank v. United States, 505 F.2d 1185, 1189 (10th Cir.1974).

Taxpayers contend that the trial court erred in finding that taxpayers, in their capacities as sublicensees or as partners in J & G, made no sales and made insufficient efforts to locate buyers for the player/recorders during 1978. Jackson, 86 T.C. at 515, 517. ⁵ This finding has ample support in the record and is not clearly erroneous.

As the tax court stated, taxpayers "wore many hats" in 1978 as they attempted to turn the player/recorder device into a profitable venture. Id. at 514. They acted as officers, directors, and shareholders of Norwood, as well as partners of J & G, and individual sublicensees. Although the parties have stipulated that "[i]n November and December of 1978, Norwood and its licensee's [sic] contacted agents, distributors and retail outlets in an effort to sell the new machines," and that "[o]rders were taken and the first units were sold in December of 1978 and January of 1979," the only documentary evidence of a sale in 1978 is a shipping order on a Norwood form showing a sale of a single player/recorder to an individual in Chino, California. Barrow's own testimony shows that Norwood, rather than a licensee, made that sale. If taxpayers participated in that sale, they did so on behalf of Norwood, not as individual sublicensees or as partners in J & G.

Barrow further testified that if the territory in which Chino, California was located belonged to a sublicensee, the sale would be credited to that sublicensee. Nothing in the record shows that licenses held by Jackson, Barrow, or J & G covered that territory. The record therefore supports the tax court's findings that no sales were made by taxpayers in their capacities as licensees or as partners in J...