Love Box Company, Inc. v. Commissioner of Internal Revenue

842 F.2d 1213, 61 A.F.T.R.2d (RIA) 944, 1988 U.S. App. LEXIS 3665

• Court: Court of Appeals for the Tenth Circuit
• Decided: March 28, 1988
• Docket: 85-1804
• Status: Published

Opinions

McKAY, Circuit Judge.

The issue before the court is whether the costs a company incurred in sponsoring seminars by a well-known free enterprise advocate are deductible expenses under the Internal Revenue Code of 1954 (I.R.C.).¹

Love Box Company, Inc. (Company) is a Kansas corporation which manufactures and sells boxes and other fiberboard and wood products. The Company operates facilities located in Kansas, Oklahoma, Kentucky, Ohio and Arkansas. The Company is also engaged in agricultural operations in Kansas and in real estate enterprises in Arizona. Over the years, the Company has developed a strong corporate philosophy concerning economics, finances, societal interests, and other subjects of a general nature. This philosophy manifests itself in a commitment to such things as individual freedom and responsibility, free enterprise, excellence and quality in products and service, honesty, truthfulness, hard work and integrity.

The Company has actively sought to project its philosophical perspective to its employees and customers by arranging public speeches and seminars. For many years the Company has sponsored seminars by well-known scholars. The stated purpose behind these seminars was to educate Company employees and to advertise the Company’s perspective to the public. In 1978 and 1979, the Company sponsored two intensive, five-day seminars featuring Mr. Robert LaFevre. The seminars were limited to thirty-five participants, and employees were given first priority to attend. Attendance was voluntary, and any of the Company’s employees who desired to attend were given time off work without a reduction in pay. Of approximately 600 employees, 10 attended the 1978 seminar and 7 attended the 1979 seminar. Record, exh. 9 and 10. The remaining attendees for both years included two customers, two prospective customers, other business representatives, and individuals from the general public.

In presenting the 1978 and 1979 seminars, the Company incurred expenses of $8,949.91 and $9,545.01 respectively. The primary costs were the speaking fees, room, and meals of Mr. LaFevre. Record, vol. 1, doc. 10, at 3. The Company deducted these costs as part of their “Public Promotion” expenses. Upon audit, the Commissioner determined that these expenses were not deductible because they were not ordinary and necessary business expenses under I.R.C. § 162. Id., vol. 1, doc. 11, at 11-12.

The Company filed a petition with the Tax Court seeking a redetermination of the deficiencies assessed by the Commissioner. The Tax Court found that no proximate relationship existed between the seminars and the job skills of the Company employees. Therefore, the seminar expenses were not deductible as educational expenditures which maintained or improved job skills. See Treas. Reg. § 1.162-5 (as amended in 1967). The Tax Court also found that the relationship between the nonemployee attendees and the Company was too tenuous to justify the Company’s claim that the expenses could alternatively be deducted as “good will” advertising. See Treas. Reg. § 1.162-20(a)(2) (as amended in 1969). Both rulings are before this court upon appeal.

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.” I.R.C. § 7482. Appellate courts ordinarily apply a “clearly erroneous” standard when presented with factual questions. Commissioner v. Duberstein, 363 U.S. 278, 289-91, 80 S.Ct. 1190, 1198-99, 4 L.Ed.2d 1218 (1960) (review of whether a transaction constitutes a gift under the I.R.C. raised a factual issue subject to “clearly erroneous” standard). A de novo standard of review is used when evaluating questions of law. Helvering v. Tex-Penn Oil Co., 300 U.S. 481, 491, 57 S.Ct. 569, 573, 81 L.Ed. 755 (1936) (review of tax board decision was “a conclusion of law or at least ... mixed question of law and fact” and is subject to independent judicial review). However, the standard of review of mixed questions is not entirely established.² See Pullman-Standard v. Swint, 456 U.S. 273, 289-90 n. 19, 102 S.Ct. 1781, 1790 n. 19, 72 L.Ed.2d 66 (1982). The Circuit Courts of Appeals have applied both de novo and clearly erroneous review when deciding mixed questions of law and fact. Id. The Tenth Circuit has concluded that if “the mixed question involves primarily a factual inquiry, the clearly erroneous standard is appropriate. If, however, the mixed question primarily involves the consideration of legal principles, then a de novo review by the appellate court is appropriate.” Supre v. Ricketts, 792 F.2d 958, 961 (10th Cir.1986); see United States v. McConney, 728 F.2d 1195, 1200-04 (9th Cir.), cert. denied, 469 U.S. 824, 105 S.Ct. 101, 83 L.Ed.2d 46 (1984) (a “clearly erroneous” standard is applied if the issue tends to be more factually based and concerns factors more appropriately decided by the trial court).

Since we must consider both the facts regarding the 1978 and 1979 seminars and the law as applied by section 162, this case presents a mixed question of fact and law. Courts reviewing section 162 expenses have usually emphasized the factual characteristics surrounding the expenditures. The Supreme Court stated early on that “[wjhether an expenditure is directly related to a business and whether it is ordinary are doubtless pure questions of fact in most instances. Except where a question of law is unmistakably involvedf,] a decision of the Board of Tax Appeals on these issues ... should not be reversed by the federal appellate courts.” Commissioner v. Heininger, 320 U.S. 467, 476, 64 S.Ct. 249, 254, 88 L.Ed. 171 (1943) (footnote omitted); see Welch v. Helvering, 290 U.S. 111, 114-15, 54 S.Ct. 8, 9, 78 L.Ed. 212 (1933) (payments to creditors not ordinary and necessary business expenses under the facts of that particular situation); Glasgow v. Commissioner, 486 F.2d 1045, 1046 (10th Cir.1973) (per curiam) (expenses of educational courses deducted under I.R.C. § 162(a) involved “essentially a question of fact”). To resolve the issues before us now, we must examine the characteristics and circumstances of the 1978 and 1979 LaFevre seminars and determine how these features link the seminars to the business purpose of the Company. Therefore, we regard these issues as primarily factual and will uphold the findings of the tax court unless the findings are clearly erroneous.

“Whether and to what extent deductions shall be allowed depends upon legislative grace; and only as there is clear provision therefore can any particular deduction be allowed.” New Colonial Ice Co. v. Helvering, 292 U.S. 435, 440, 54 S.Ct. 788, 790, 78 L.Ed. 1348 (1934). Moreover, the taxpayer bears the burden of proving that his expenditures are deductible. Welch v. Helvering, 290 U.S. at 115, 54 S.Ct. at 9; Medco Products Co. v. Commissioner, 523 F.2d 137, 138 (10th Cir.1975).

Section 162 and its supporting regulations create a framework which allows deductions for various types of expenses, including certain educational and advertising expenses. The primary requirement for deductibility under section 162 is that the particular expense be an ordinary and necessary expense which bears a “proximate and direct relationship to the taxpayer’s trade or business.” Carroll v. Commissioner, 51 T.C. 213, 218 (1968), aff'd, 418 F.2d 91, 95 (7th Cir.1969). Thus, our examination of whether plaintiffs educational and advertising expenses come within section 162 deductibility focuses on whether the expenses bear a close enough relationship to the Company’s business to say that they are ordinary and necessary.

The Company first claims that the LaFevre seminar expenses are deductible by the company as ordinary and necessary education expenses of its employees.³ Education expenses satisfy the ordinary and necessary requirement of section 162 provided they meet the enumerated tests of Treasury Regulation 1.162-5. Rev.Rul. 76-71,1976-1 C.B. 308, 310. Treasury regulation 1.162-6 sets forth a series of non-qualifying and qualifying tests. The first examination is to see if the educational expense is disqualified from deduction because it was incurred to (1) meet the minimum educational requirements of the trade or business or (2) qualify the taxpayer for a new trade or business. Treas.Reg. 1.162— 5(b)(2) and (3). Provided the educational expenses are not disqualified from deduction, they must also satisfy the qualifying requirement of either (1) maintaining or improving job skills or (2) meeting the express requirements of the employer or the law for retention of employment. Treas. Reg. 1.162-5(a), (c)(1) and (c)(2). In satisfying the requirement of maintaining or improving skills required in his employment, it is insufficient that the educational expenses merely improve general skills. To be deductible the expenses must improve skills that bear a “proximate and direct relationship to the taxpayer’s trade or business.” ⁴ Carroll v. Commissioner, 51 T.C. 213, 218 (1968), aff'd, 418 F.2d 91, 95 (7th Cir.1969); see Anaheim Paper Mill Supplies, Inc. v. Commissioner, 37 T.C.M. (CCH) 403 (1978) (although employer’s expenses for employee’s general college education were generally beneficial to the company, they were not deductible because there was no direct relationship between the skills required to operate the company’s business and the courses taken); see generally Smith v. Commissioner, T.C. Memo 1981-149 (1981) (business classes were not proximately related to skills of section foreman in the quality control department); McAuliffe v. Commissioner, T.C.Memo 1980-189 (1980) (English classes increased defense attorney’s general understanding and competency but did not proximately relate to the improvement of legal skills); Baker v. Commissioner, T.C. Memo 1971-279 (1971) (courses in geology, economics of transportation, etc. were not closely enough related to improve flight operations officer’s job skills).

In the present case, the commissioner did not argue that the seminar expenses were nondeductible because they were disqualified, but rather because they did not meet one of the two qualifying tests. The Company did not contend that the seminar expenses were an express requirement as a condition to continued employment. In fact, the record reveals that attendance at the seminars was purely voluntary. Thus, in light of the above authority, the expenses for the LaFevre seminar would be deductible only if the Company could demonstrate that the seminars maintained or improved job skills in its employees that directly contributed to its trade and business. The Company gave testimony that the seminars promoted a philosophy based upon traits such as honesty, self-reliance, and dependability. Record, transcript, at 23-26, 84-85. However, the record does not indicate that participation in the seminars improved job performance in any measurable way or that the Company used seminar attendance to select employees for advancement. Rather, the Company’s testimony reveals that the seminars emphasized broad attributes which would be beneficial in any line of work or personal endeavor. The evidence presented by the Company never bridged the gap from individual improvement to business improvement. The Company’s testimony never established how the seminars maintained or improved job skills which were a direct and proximate benefit to the Company in the production and sale of wood and fiberboard products.

We do not deny that the teaching of individual freedom, responsibility, hard work, thrift, honesty, truthfulness, and integrity may have benefited the employees and thus benefited the Company; but rather we conclude that the seminar expenses are more analogous to general education expenses which are too tenuous to the specific job skills of the Company to qualify for deduction under section 162. In light of the evidence and our deferential standard in this case, the Tax Court’s finding that the seminar expenses were too attenuated from the Company’s business purpose to be deductible as ordinary and necessary education expenses was not clearly erroneous.

The Tax Court also ruled that the “relationship between the nonemployee attendees of the seminar and the business ... [was] too tenuous to support a deduction for advertising expenses." Treas.Reg. § 1.162-20(a)(2). Record, doc. 11, at 12. An advertising and promotional scheme may be deductible even though the methods are unusual or nonconventional. Poletti v. Commissioner, 330 F.2d 818, 822 (8th Cir.1964). However, “[t]he burden still remains upon the taxpayer to prove the connectivity of business purpose to establish his right to the claimed, deductible expenses.” Id. at 824. If the cost relates to an activity more properly characterized as personal, the deduction cannot be allowed. W.D. Gale, Inc. v. Commissioner, 297 F.2d 270, 271 (6th Cir.1961) (maintaining and operating racing speedboats was for personal pleasure and not for business purpose).

The Company claims the seminar expenses bear a direct relationship to its publicity and to the patronage it might expect in the future, even though the seminars were only publicized by word-of-mouth and no evidence was produced to show that the seminars kept the Company's name before its advertising market. The 1978 and 1979 seminars were attended by only two of the Company's 10,000 to 15,000 customers, and by two potential customers. Record, exh. 9 and 10. The Company did produce as witnesses two of its current customers. Both customer-witnesses regarded the Company's philosophy as important because it represented an excellent “corporate culture” that was favorable to their business relationship. Record, transcript, at 88-89, 96-99. However, this testimony does not reveal that the seminars in any way influenced these witnesses to become customers. Indeed, one customer-witness testified upon cross-examination that he would attend such seminars regardless of who promoted the event. “I know some other people who have sponsored LaFevre seminars and I think they're pretty much the same kind of people.” Id. at 92. This witness went on to testify that “I think people who attend this kind of seminar, it helps them to get a broad picture, a philosophical outlet, direction, and yes, I think that helps them a lot.” Id. at 93. Although the evidence presented by the customer-witness circumstantially connects the seminars with a business purpose, we agree that the Company failed to meet its burden in showing a direct relationship between the seminar’s focus upon individual character development and the Company’s solicitation of new customers. We conclude that the finding of the Tax Court was not clearly erroneous.

AFFIRMED.

1 . Unless otherwise indicated, all statutory references are to the Internal Revenue Code of 1954, as amended, and in effect for the years 1978 and 1979, the years in issue.

2 . 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.” Pullman-Standard v. Swint, 456 U.S. 273, 289 n. 19, 102 S.Ct. 1781, 1790 n. 19, 72 L.Ed.2d 66 (1982).

3 . We note at the outset that the education expense deduction is historically provided to an individual who makes expenditures to maintain or improve his job skills. Treas.Reg. § 1.162-5(a). When a corporation makes expenditures to help employees improve their job skills, the expenditures are more frequently deducted under section 162 as ordinary and necessary expenses of doing business or as some form of compensation to the employee. Because the case law in this area is so fact-oriented and geared to individual taxpayers, the guidance provided by the application of previous decisions must primarily be by analogy.

4 . Prior to 1967, Treasury Regulation 1.162-5 required that educational expenses be undertaken with the primary purpose of maintaining or improving skills required in the taxpayer’s trade or business. This primary purpose requirement was eliminated by an amendment to the regulation in 1967. Treas.Reg. 1.162-5 (as amended by T.D. 6918, 1967-1 C.B. 36); see also Carroll v. Commissioner, 418 F.2d at 91, 94-95. Although the improving of skills no longer has to be the primary purpose for the educational expenses, the skills improved must still bear a direct relationship to the taxpayer's trade or business. Schwartz v. Commissioner, 69 T.C. 877, 889 (1978) (taxpayer failed to prove “sufficient nexus” between expenses and skills of business); McAuliffe v. Commissioner, T.C. Memo 1980-89 (education deduction disallowed because expenses only tenuously related to job. skills).