Mason and Dixon Lines, Inc. v. U.S., 82-5027

• Decision Date: 01 June 1983
• Docket Number: No. 82-5027,82-5027
• Parties: 83-1 USTC P 9385 The MASON AND DIXON LINES, INCORPORATED, Plaintiff-Appellant, v. UNITED STATES of America, Defendant-Appellee.
• Court: U.S. Court of Appeals — Sixth Circuit

Page 1043

708 F.2d 1043

83-1 USTC P 9385

The MASON AND DIXON LINES, INCORPORATED, Plaintiff-Appellant, v. UNITED STATES of America, Defendant-Appellee.

No. 82-5027.

United States Court of Appeals, Sixth Circuit.

Argued March 16, 1983.

Decided June 1, 1983.

John Y. Merrell, [Lead Counsel] (argued), John Y. Merrell, Jr., Timothy J. Callahan, Merrell & Callahan, McLean, Va., T. Arthur

Scott, Jr., Hunter, Smith & Davis, Edwin O. Norris, Kingsport, Tenn., for plaintiff-appellant.

W. Thomas Dillard, U.S. Atty., Greeneville, Tenn., Guy W. Blackwell, Robert E. Rice, Trial Atty.--Tax Division Dept. of Justice, Washington, D.C., Glenn L. Archer, Jr. [Lead Counsel], Asst. Atty. Gen., Tax Div., U.S. Department of Justice, Ann Durney, Kenneth L. Greene (argued), Michael Paup, Washington, D.C., for defendant-appellee.

Before LIVELY, Circuit Judge, WEICK, Senior Circuit Judge; and ALDRICH, District Judge. ^*

LIVELY, Circuit Judge.

When a trucker is convicted in Virginia of a misdemeanor of operating a vehicle with a weight in excess of the statutory limits he is punished by a fine or imprisonment in jail, or both. Virginia Code Secs. 46.1-339 and 46.1-16 (1974 Replacement Volume). In addition Sec. 46.1-342 of the Code provides that upon conviction of any person for violation of a weight limit, state or local officials shall, after reasonable notice, assess the owner or operator of the overweight vehicle "liquidated damages." The question in this case is whether a trucker convicted of weight violations may deduct the "liquidated damages" paid to Virginia as ordinary and necessary business expenses in computing its federal income tax.

The Mason and Dixon Lines, Inc. (M-D) is a Tennessee corporation engaged in interstate trucking. During the years 1971-1975 its trucks were found to be overweight a number of times while operating on Virginia highways and M-D paid fines, court costs and liquidated damages. M-D never claimed the amounts paid as fines as deductions on its federal tax returns, but it did deduct the court costs and liquidated damages in one of the years, 1975. The Commissioner of Internal Revenue (Commissioner) disallowed the claimed deductions and assessed deficiencies. M-D paid the assessment, filed amended returns claiming deductions for the same expenditures in 1971-74, and sued for refunds. Prior to submission of the case for decision the Commissioner conceded that court costs were deductible. The remaining issue was submitted on a stipulation of facts and cross-motions for summary judgment.

The district court found that the payments of liquidated damages to Virginia were not deductible because they were not "necessary." Section 162(a) of the Internal Revenue Code, 26 U.S.C. Sec. 162(a), provides a deduction for "all ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business...." The district court reasoned that the payments in question were not necessary because they could have been "easily averted." In reaching this conclusion the district court relied upon a statement in Hoover Motor Express Co. v. United States, 356 U.S. 38, 78 S.Ct. 511, 2 L.Ed.2d 568 (1958), where the Court noted that a problem of shifting loads and improper weight listings on bills of lading could have been alleviated by securing the loads and carrying scales on the trucks. The district court noted that the explanations given by M-D for its violations revealed relatively minor problems which could have been easily averted, or at least alleviated, by carrying scales on the trucks.

We believe the district court misconstrued the holding in Hoover Express. The Court issued decisions in three tax cases on March 17, 1958. All involved the issue of the deductibility of business expenses having some connection with illegal activity. In Commissioner v. Sullivan, 356 U.S. 27, 78 S.Ct. 512, 2 L.Ed.2d 559 (1958), the Court held that rent and wages paid by taxpayers engaged in gambling enterprises which were illegal under local law were deductible in the computation of federal income taxes. The expenditures were found to be ordinary and necessary business expenses, and the illegality of the business was held not to affect their deductibility. In Tank Truck Rentals v. Commissioner, 356 U.S. 30, 78 S.Ct. 507, 2 L.Ed.2d 562 (1958), fines paid by truckers for violations of state weight limits were held not deductible. It was conceded that most of the violations were deliberate. However, the Court held that it made no difference whether state laws were violated deliberately or unintentionally since the state law which was violated made no such distinction. Referring to its earlier decision in Commissioner v. Heininger, 320 U.S. 467, 64 S.Ct. 249, 88 L.Ed. 171 (1943), the Court held that a deduction cannot be considered a necessary business expense "if allowance of the deduction would frustrate sharply defined national or state policies proscribing particular types of conduct, evidenced by some governmental declaration thereof." (Citation omitted) 356 U.S. at 33-34, 78 S.Ct. at 509.

Hoover Express was the last of the tax trilogy decided on March 17, 1958. In that case the trucker claimed that all of its violations were inadvertent, and that a distinction should be made between deliberate and unintentional violations of weight limitations. Hoover had challenged the disallowance of the fines as deductions on the two grounds that none of them were willful and that it had taken all practicable precautions to avoid them. See Hoover Motor Express Co. v. United States, 241 F.2d 459-60 (6th Cir.1957). The language in the Supreme Court's Hoover opinion which the district court relied upon here appears to have been inserted in answer to the contention that the trucker had taken all practicable precautions to avoid violations. Justice Clark concluded this was not true since relatively simple steps were available to alleviate the problems. However, this was not the basis of the decision. The actual holding in Hoover Express, as in Tank Truck Rentals, was that there is no difference between willful and innocent violations if allowance of a claimed deduction would severely and directly frustrate state policy. 356 U.S. at 40, 78 S.Ct. at 512.

In Commissioner v. Tellier, 383 U.S. 687, 694, 86 S.Ct. 1118, 1122, 16 L.Ed.2d 185 (1966), the Supreme Court cited Tank Truck Rentals and Hoover together as cases where the Court "upheld the disallowance of deductions claimed by the taxpayers for fines and penalties imposed upon them for violating state penal statutes." The Court reasoned that "to allow a deduction in those circumstances would have directly and substantially diluted the actual punishment imposed." In discussing Hoover Express in Tellier the Supreme Court did not refer to the statement that the violations could easily have been averted, and so far as we can determine it has never been cited by any court for the proposition that an expense which can be easily averted will never qualify as a "necessary" business expense. The court costs in the present case could have been as easily averted as the liquidated damages. Both grew out of the operation of overweight trucks. If such overweight operation could have been easily averted, and this were a valid reason for denying deductibility, the court costs should have been found non-deductible too.

A number of reported cases provide examples of easily averted expenses being allowed as necessary business deductions. This court approved the deductibility under a predecessor statute to Sec. 162(a) of settlement payments and legal expenses of a taxpayer found guilty of civil fraud. Caldwell v. Commissioner, 234 F.2d 660 (6th Cir.1956) (per curiam). Obviously the taxpayer could easily have averted these expenses by merely refraining from defrauding the victims. Even more compelling is the holding in Commissioner v. Tellier, supra, where a securities dealer was permitted to deduct as ordinary and necessary business expenses the cost of unsuccessfully defending criminal charges of securities fraud, mail fraud and conspiracy. All of these expenses could have been easily averted by refraining from the illegal activities which led to the expenditures. See also Commissioner v. Heininger, supra, where legal expenses incurred in defending against business-related administrative charges of mail fraud were held deductible as ordinary and necessary. We conclude that the district court erroneously applied Hoover Express.

The Supreme Court has set out the proper approach when claimed deductions are denied by the IRS because the deducted expenses have some relation to violations of law by the taxpayer. A court should determine first whether the expenditures come within the literal requirements of Sec. 162(a). This test is satisfied if the expenses are incurred in connection with a business and if they are ordinary and necessary. The significance of "ordinary" is to distinguish between capital expenditures which must be amortized if deductible at all and expenditures for current operations of the business. The "necessary" limitation imposes "only the minimal requirement that the expense be 'appropriate and helpful' for the development of the [taxpayer's] business." Commissioner v. Tellier, supra, 383 U.S. at 689, 86 S.Ct. at 1120, quoting Welch v. Helvering, 290 U.S. 111, 113, 54 S.Ct. 8, 9, 78 L.Ed. 212 (1933). If an expenditure falls within the general definition of Sec. 162(a) it will be disallowed nonetheless if deductibility is prohibited by "specific legislation" or "a precise and longstanding Treasury Regulation prohibiting the deduction in a specified category of expenditures...." Tellier, 383 U.S. at 693, 86 S.Ct. at 1122. Justice Stewart, writing in Tellier, then went on to deal with one other "sharply limited and carefully defined category" where deductibility is denied for expenditures which fall within the general definition of Sec. 162(a), that category...