Petition — Brewster v. Commissioner

Supreme Court brief1979

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Supreme Cour, U. & “|

FILED

i SEp 26 1979 |

IN THE | _MICMNGL RODSK, JR., CLERK

Supreme Court of the United States

OCTOBER TERM 1978

No. 79-51

ANNE MOEN BULLITT BIDDLE BREWSTER,

Petitioner,

COMMISSIONER OF INTERNAL REVENUE,

Respondent.

PETITION FOR A WRIT OF

CERTIORARI TO THE UNITED STATES

COURT OF APPEALS FOR THE

DISTRICT OF COLUMBIA CIRCUIT

THOMAS E. JENKS

MICHAEL MULRONEY

1200 18th Street, N.W.

Washington, D.C. 20036

Counsel for Petitioner

Of Counsel

Lee, Toomey & Kent

1200 18th Street, N.W.

Washirgton, D.C. 20036

Vincent Landy

Senior Counsel

of the Irish Bar

INDEX

EE ee 1

TE ee 2

ei a sae ke eee se sees 2

ee ee cei cc ess cceece 3

a cc ce ee eats eees 3

Reasons for Granting the Writ............... 6

I. The decisions below depart from the ac-

cepted and usual course of judicial proceed-

ings since they effectively preclude U.S.

taxpayers who reside abroad from receiv-

ing the same opportunity to be heard on a

given issue that is accorded their counter-

parts resident in this country ............ 6

II. The decision on the merits is wrong....... 11

III. The decision below conflicts with a decision

of the Court of Claims as to the construction

and application of section 911 to a foreign

service-capital business................. 14

IV. Review of this case is important to the ef-

fective administration of the Internal Reve-

ee ce wtw esses ecvcccs 18

ee alee Gas seen ce cscs rer 19

eos oe sc csc eee te la

EES ee 21a

ee aw was 5 sess es cece 49a

AEE SES OCTET 52a

Cases:

Addison v. Cherry Hill Co., 322 U.S. 607 (1944). = 12

Index Continued

Page

Anne Moen Bullitt Brewster, 55 T.C. 251 (1970),

aff'd per curiam, 473 F.2d 160

Se ME os 65h ao os a sae es oes passim, 4

Anne Moen Bullitt brewster, 67 T.C. 352 (1976),

aff'd per curiam, F.2d____- (79-1 USTC

§ 9398) (D.C. Cir. 1979), rehearing denied,

ME ylides aceced 6 aos 4-000 4:8 9b xe passim, 1

Commissioner v. Idaho Power Co., 418

DI et ey a veto l yoy avec 13

Commissioner v. Wolfe, 361 F.2d 62 (D.C. Cir.

1966), cert. denied, 385 U.S. 838.......... 13

Cook v. United States, F.2d... (C.C1.

No. 442-75, decided 4/18/79)............. 16, 17

Doyle v. Mitchell Brothers, 247 U.S. 179 (1918),

I arr e eI aa hon 15

Edelman v. Jordan, 415 U.S. 651 (1974)........ 17

Jack E. Golsen, 54 T.C. 742 (1970), aff'd on other

grounds 445 F.2d 985

CU EO ss 5 sas wos aw ee vse 5, 8, 9, 10, 12

Grannis v. Ordean, 234 U.S. 385 (1914)......... 9, 11

Helvering v. Flaccus Leather Co., 313 U.S.

| SRR PIS te ae ae 12

Helvering v. Hallock, 309 U.S. 106 (1940) ...... 10

Helvering v. Taylor, 293 U.S. 507 (1935)....... 9

Helvering v. Wardman, 68 F.2d 418 (D.C. Cir.

A a lg ae ge le sg nh, Gd x oc 12

Kurzner v. United States, 413 F.2d 97

EE ee ee 7

Laing v. United States, 423 U.S. 161 (1976) .... = 11

Marshall v. United States, 414 U.S. 417 (1974).. 17

Warren R. Miller, Sr., 51 T.C. 755 (1959) ...... 17

BNNs

ill

Index Continued

Page

National Cable Television Ass’n v. United

States, 416 U.S. SIS (ISTE) «wo ec ce cece 17

NLRB v. Savir Mfg. Co., 414 U.S. 270 (1973) ... 17

Old Colony Co. v. Commissioner, 301 U.S. 379

ER od a eres wa es Re 12

Daniel A. Robida, 29 T.C.M. 407 (1970), aff'd,

S00 F 2a 117e th Gab. WETS)... ccc ccnes 17

Snow v. Commissioner, 416 U.S. 500 (1974) .... 17

Sunshine Coal Co. v. Adkins, 310 U.S. 381 (1940) = 12

Stratton’s Independence v. Howbert, 231 U.S.

ES MOET STE TP ee Cee Te CTT re 15

Teleprompter Corp. v. United States, 415 U.S.

to errr rr rer reer Te ere re 19

United States v. American Trucking Ass'n,

i ge Be RL Pereeree er eer ere ees 12

United States v. Cannelton Sewer Pipe Com-

pany, 364 U.S. 76, rev’g, 268 F.2d 334

EE te cl yee ce Ca ee ea ee eee Gases 7

United States v. Kahn, 415 U.S. 143 (1974)..... 19

United States v. Maze, 414 U.S. 395 (1974)..... 17

Vogt v. United ania 537 F.2d 405 (C.C1.

Ce ak aw 8 ooo Renee wo 14, 15, 16, 17

Warden v. Marrero, 417 US. GGS (2974) .....5. 18

Max Zager, 72 T.C. ___(No. 82), decided

ee Se cu eas bar Ce eee are ees 10, 11

Rulings:

CO. GOOG, VIMEO C.S. BB6 bik cc ccc cscs 9,12

Rev. Proc. 65-27, 1965-2 C.B. 1017 ............ 7

Bev. Rul. 6B-171, 1905-1 C.B. GO... ccc cv canes 17

Index Continued

Page

Rev. Rul. 57-142, 1957-1 C.B. 246, revoked on

other grounds in Rev. Rul. 66-326, 1966-2

CB. 1 . us ciccesstus eee ee 17

Rev. Rul. 70-101, 1970-1 C.B. 278............. 7

Rev. Rul. 70-491, 1970-2 C.B.92.............. 17

Rev. Rul. 75-561, 1975-2 C.B. 129............. 7

Statutes:

5 U.S.C. §552 (Freedom of Information Act).... 18

26 U.S.C. $011 (LR.C. SA)... cds cnsssne, passim, 2

26 U.S.C. §7482(a) (I.R.C. §7482(a))........... 2

26 U.S.C. GISGGE). os cc dee 2

1966 TBO... . .. i secelne ee cee 3

§911, as amended by P.L. 94-455,

90 Stat. 1680 (2078) 2... eG si ees 18

§911, as amended by P.L. 95-615,

92 Stat. S007 (197B) o.. ck sce csksans 18

P.L. 95-615, §4(b)(1) (Tax Treatment Extension

Act of 1997} . ou. ieee 13

Miscellaneous:

Rules of the Supreme Court of the United

States, Rule 100O)..... .. <4 sciu neem ee 1,22

Joint Committee on Taxation, General Explana-

tion of the Foreign Earned Income Act of

1978 (2/23/70), p. 8 .ikeeiscuee eee 8

Magill, Taxable Income 367 (Knopf ed.)

(2066) ... . 00s wsd 65s eee 15

Surrey, Warren, McDaniel and Holt, (Vol. 1)

Federal Income Taxation 300 (1972)....... 15

1 Mertens, Law of Federal Income Taxation

$3.26 (1974 vev.). os. «cs caucus eee 12

Wiens

IN THE

Supreme Court of the United States

OCTOBER TERM 1978

No.

ANNE MOEN BULLITT BIDDLE BREWSTER,

Petitioner,

COMMISSIONER OF INTERNAL REVENUE,

Respondent.

PETITION FOR A WRIT OF

CERTIORARI TO THE UNITED STATES

COURT OF APPEALS FOR THE

DISTRICT OF COLUMBIA CIRCUIT

The petitioner, Anne Moen Bullitt Biddle Brewster,

respectfully prays that a writ of certiorari issue to

review the judgment and opinion of the United States

Court of Appeals for the District of Columbia Circuit

entered inthiscase. —

OPINIONS BELOW

The opinion of the Court of Appeals, not yet re-

ported, appears in Appendix A hereto. The opinion of

the United States Tax Court, 67 T.C. 352,* appears in

Appendix B hereto.

*Anne Moen Buttill Brewster, 67 T.C. 352 (1976), aff'd per

curiam, F.2d__—S——s«nA(79-1:~*USTC 99398) (D.C. Cir.

1979), rehearing denicd, 6/29/79 (hereinafter referred to as

Brewster II).

JURISDICTION

The judgment of the Court of Appeals for the Dis-

trict of Columbia Circuit was entered on June 1, 1979.

See, Appendix A hereto. Petitioner’s timely petition

for rehearing with a_suggestion for rehearing en banc

was denied on June 38 1979. Appendix C hereto is the

order of denial. The jurisdiction of this Court is in-

voked under 28 U.S.C. §1254(1) as provided in Section

7482(a) of the Internal Revenue Code of 1954 (26

U.S.C. §7482(a)).

QUESTIONS PRESENTED

1. Whether the court below properly withheld from

the petitioner her opportunity to be heard by invok-

ing the discretionary rule of stare decisis where the

issue before that court in this case differed from the

issue presented to it in previous litigation.

2. Whether the courts below improperly invoked

discretionary rules of review in the changed circum-

stances of this case so as effectively to render review

—proof both as to this taxpayer and all other U.S.

citizen taxpayers resident abroad the result reached

in the earlier litigation.

3. Whether 26 U.S.C. §911, which provides that

“earned income means * * * a reasonable allowance as

compensation for the [taxpayer’s] personal services

* * * not in excess of * * * 30 percent of * * * the net

profits” of the taxpayer’s business, can be construed

to mean that earned income exists when that business

has a net loss and can then be applied to the clear

detriment of a taxpayer resident abroad when Con-

gress’ plain intent in enacting that provision was to

benefit U.S. taxpayers resident abroad.

STATUTES INVOLVED

This case concerns the interpretation and applica-

tion of section 911 of the Internal Revenue Code of

1954 (the “Code”) ' (26 U.S.C. §911), pertinent por-

tions of which are set forth in Appendix D hereto.

STATEMENT OF THE CASE

This case involves the correctness of the Commis-

sioner’s determination of deficiencies totalling

$186,893.44 in the taxpayer’s Federal income tax for

the years 1962 through 1965 and 1967 through 1969

inclusive.

During those years the taxpayer was a U.S. citizen

residing in Ireland where she engaged in a farming

business as a sole proprietor. Both her personal ser-

vices and her capital were material income producing

factors in that business. In each of the years in ques-

tion the taxpayer’s gross business income was ex-

ceeded by her business expenses, hence she suffered

a net business loss.

Section 911(a) excludes “earned income” from gross

income for qualifying U.S. citizens resident abroad.

Section 911(b) defines‘earned income of a service-

capital business as a reasonable allowance for the pro-

prietor’s services, limited to 30 percent of the net

profit of the business. Section 911(a) goes on to pro-

vide that deductions attributable to excluded earned

income must be disallowed.

The Commissioner held that the taxpayer had ex-

cludable earned income from her business notwith-

‘References hereinafter to sections are to sections of the

Internal Revenue Code of 1954 unless otherwise indicated.

standing its net loss, then invoked the deduction

disallowance provision in a manner which resulted in

the disallowance of deductions greatly in excess of the

excluded earned income. The deficiencies in question

resulted.

In the courts below the taxpayer argued that in a

loss business earned income could not arise under

section 911, if only because under the specific statu-

tory limitation keyed to net profit, when there is not

net profit, 30 percent of zero is zero, and thus without

earned income the deduction disallowance provi-

sion could not operate.

The question whether section 911 can apply at all to

a foreign service-capital loss business was litigated as

a question of first impression by this taxpayer for

several earlier taxable years. A divided Tax Court

held that it could. The court of appeals affirmed.’

The facts in Brewster I were fully stipulated. That

stipulation was based on the agreement of the tax-

payer and of the Commissioner that if and only if

section 911 was held to apply to a foreign service-

capital loss business then a few, but not all, of the 28

expense items of the taxpayer’s business would be

treated as attributable to earned income and there-

fore subject to the section 911(a) deduction disallow-

ance provision. Against the backdrop of that stipula-

tion, Brewster J resulted in modest deficiencies for

the taxpayer in several of those years’ and a refund of

tax for one year.

*Anne Moen Bullitt Brewster, 55 T.C. 251i (1970) aff'd per

curiam, 473 F.2d 160 (D.C. Cir. 1972). The prior litigation will

hereinafter be referred to as Brewster J, and, as noted above,

the present case will be referred to as Brewster 1.

3 See 55 T.C. at 255.

In Brewster IJ, the Commissioner adopted a new

and different approach. Using Brewster J as a spring-

board, in the present case the Commissioner took the

position that all of the disbursements from the busi-

ness, but only a small portion of its gross receipts

should be subject to his calculation to arrive at a

net deduction disallowance. The result of using that

formula, admitted by the Commissioner to be ar-

bitrary*, necessarily produced a grossly distorted dis-

allowance of business deductions in relation to the

deemed earned income excluded from gross income.

Aggrieved by the Commissioner's change of posi-

tion, in this case the taxpayer asked the Tax Court to

reconsider its view of the statute in the light of un-

disputed evidence presented at trial to the effect that

none of the expenses of the taxpayer’s business were

of a sort which were properly attributable to her per-

sonal services.

The Tax Court majority, notwithstanding the Com-

missioner’s changed position as to the construction

and application of the statutory provision and the

trial testimony, refused to review its original ap-

proach to section 911 reasoning that, because the ap-

pellate court in Brewsfer J had affirmed its primor-

dial view of Section 911, and because the appeal from

its decision in Brewster IJ would lie to the same

circuit which had considered the issue previously, it

was bound by its own procedure not to do so.° How-

ever, it did not take that stance as a unified court.

‘Statements of Commissioner's counsel at trial in colloquy

with Judge Goffe. (R. 80-81).

°67 T.C. 357-358 (Appendix pp. 28a-29a); see ibid., 367-368

(dissent) (Appendix pp. 42a-43a); Jack E. Golsen, 54 T.C. 742

(1970), aff'd on other grounds 445 F.2d 985 (10th Cir. 1971).

All of the Tax Court judges who were willing to look

again at the statutory construction issue on its merits

concluded unanimously that Brewster J was wrong.

One judge agreed with the dissenters’ view, but felt

that she was barred from considering the questions

because of the internal procedural rule. Perhaps most

noteworthy among the dissenters in Brewster I] was

one judge who had aligned himself with the majority

in Brewster J in construing the statute against the

taxpayer, but was persuaded by the taxpayer's posi-

tion in this case.

The appellate court upheld the trial court by invok-

ing stare decisis and so also declined to review its

original position as to the construction of the statute.

As a result, in this case, the taxpayer was denied

judicial consideration of the basic legal issue, notwith-

standing the Commissioner's changed position.

In addition, the decision below is patently wrong

because it works an absurd perversion of Congress’

intent by using a statute plainly designed to benefit

U.S. taxpayers abroad to their immediate and signifi-

cant detriment. The result below is in apparent con-

flict with an opinion of the Court of Claims, and pre-

sents an issue of importance to the even-handed ad-

ministration of the revenue to this taxpayer and to

the many others who are similarly situated.

REASONS FOR GRANTING THE WRIT

I. THE DECISIONS BELOW DEPART FROM THE

ACCEPTED AND USUAL COURSE OF JUDI-

CIAL PROCEEDINGS SINCE THEY EFFEC-

TIVELY PRECLUDE U.S. TAXPAYERS WHO

RESIDE ABROAD FROM RECEIVING THE

SAME OPPORTUNITY TO BE HEARD ON A

GIVEN ISSUE THAT IS ACCORDED THEIR

COUNTERPARTS RESIDENT IN THIS COUN-

TRY.

The courts below denied the petitioner her oppor-

tunity to be heard. By doing so, they established a

precedent which can preclude this taxpayer and other

U.S. taxpayers who live abroad from litigating any

given tax issue to the extent that their peers in this

country could. That result is so plain a departure

from “the accepted and usual course of judicial pro-

ceedings” addressed in Rule 19(b) of this Court, that

-review is warranted. The result of that review should

be a remand with directions to give the taxpayer her

opportunity to be heard. In the alternative, the Court

should decide the case on its merits.

As a general rule, an issue which concerns the

construction and application of a federal tax statute

can receive diverse judicial consideration before it is

finally and fairly laid to rest either in favor of the tax-

payer * or of the government.’ During that process

individual taxpayers may win or lose their particular

case, but the issue itself can receive full and fair

consideration. :

® See, e.g., Kurzner v. United States, 413 F.2d 97 (5th Cir.

1969) and Rev. Proc. 65-27, 1965-2 C.B. 1017 (four circuits

favored taxpayers’ position before Commissioner agreed); Rev.

Rul. 70-101, 1970-1 C.B. 278 (Commissioner abandoned position

only after 14 defeats in different courts); Rev. Rul. 75-561,

1975-2 C.B. 129 (Commissioner abandoned position after losing

in 9 separate courts).

7 United States v. Cannelton Sewer Pipe Company, 364 U.S.

76, reversing 268 F.2d 334 (1957) (five circuits favored tax-

payers’ position before a decision by this Court in the govern-

ment’s favor.)

The group of U.S. taxpayers who reside abroad® do

not have the juridicial luxury of diverse judicial con-

sideration of an issue which their peers in this

country enjoy. Instead, they are locked in to consider-

ation of any tax issue particular to them, such as sec-

tion 911, by only one appellate court.® If that appel-

iate court refuses to consider a second issue which is

a permutation of a first issue already considered or,

indeed, refuses to reconsider the first issue, it can

effectively render review-proof its initial decision on

any issue and thereby theoretically leave the final

resolution of that issue only to this Court.

But, since the roster of federal tax cases taken to

be heard by this Court in any term is a bit scant, for

all intents and purposes an issue raised for the second

time by a U.S. taxpayer abroad is necessarily dead-

ended, in contrast to an issue questioned by U.S.-resi-

dent taxpayers who have, as a group, the opportunity

for multiple appellate judicial attention.

Given that, one would suppose the Tax Court and

its appellate court would literally bend over backward

to think or rethink their prior decisions on any given

issue for a nonresident U.S. taxpayer since it is rudi-

®*There are about 140,000 U.S. individual taxpayers who live

abroad and use, or are used by, section 911. See Joint Commit-

tee on Taxation, General Explanation of the Foreign Earned

Income Act of 1978 (2-23-79) p.1. The statistic is for 1975, the

most recent year for which data is available.

°*As Judge Goffe pointed out in his dissent (67 T.C. at 368;

Appendix p. 43a), “a whole class of taxpayers (U.S. citizens

residing abroad}, are precluded [by the application of the Golsen

rule] from having us reexamine [a] prior holding *** unless such

taxpayers pay the tax and sue the Court of Claims or unless

they change their residence to the United States, except to the

District of Columbia.”

mentary that “[T]he fundamental requisite of due

process of law is the opportunity to be heard.”

Grannis v. Ordean, 234 U.S. 385, 394 (1914).

This taxpayer was roundly denied that opportunity.

Under the approaches of the courts below others

similarly situated will also be denied that opportun-

ity, as to this and other issues, if the decision below is

allowed to stand.

As a practical matter the taxpayer here is still

seeking the first judicial consideration of her main

argument, viz., that in the context of this case as

newly framed by the Commissioner, a service-capital

proprietorship which operates at a loss does not

generate compensatory earned income.’® The Tax

Court majority, relying on its procedural Golsen rule,

refused to consider the question. The appellate court

followed suit saying, “the principle of stare decisis

precludes our consideration of appellant’s first argu-

ment’’,'' notwithstanding its admission that the Com-

missioner’s position on the merits produces “certain

incongruities” and “bizarre results.”

'° The taxpayer's position was initiated by the Service in 1929

when, as to earned income of a service-capital business it ruled

that “a taxpayer gets nothing for his services in a business which

results in a loss” (G.C.M. 6563, VIII-2 C.B. 186, 187). That ap-

parently remained the Service's position for about 40 years,

until Brewster J arose with its new position.

"Slip. op. 4 (Appendix p. 4a).

Slip op. 8, 10 (Appendix pp. 8a, 10a). The unfairness here is

further exacerbated by the Commissioner's admission at trial

that his formula for the application of section 911 was “an ar-

bitrary method.” (R. 81). Whatever the current general vitality

of Helvering v. Taylor, 293 U.S. 507 (1935), it is at least clear

that an admittedly arbitrary approach to the application of the

statute by the government in contrast to its approach in

Brewster I, should have compelled the courts below to rethink

the proper construction of the basic statutory provision.

This court has recognized that stare decisis is a

matter of even-handed judicial policy, not an inexor-

able rule of law which blinds a court to new ideas and

changed circumstances. Helvering v. Hallock, 309

U.S. 106, 119 (1940). The coupling of the Golsen rule

in the trial court with stare decisis in the appellate

court results in a grave injustice to this taxpayer and

will be an unconscionable impediment to all other

U.S. taxpayers abroad who must necessarily follow in

the narrow procedural path thus alloted them, in con-

trast to their peers resident in this country. This

Court, in its role as the steward of judicial adminis-

tration for inferior courts, must notice and correct the

blunder below in the interest of the uniform applica-

tion of justice.

The absurdly prejudicial treatment accorded to this

taxpayer, and to be accorded to others like her, is

case in bold relief by the Tax Court’s decision in Max

Zager, 72 T.C.___ (No. 82) (decided September 5,

1979). There, the court did for a resident U.S. tax-

payer precisely what it refused to do for this nonresi-

dent taxpayer. Faced with the Commissioner’s argu-

ment that it should review and overrule a prior ad-

verse decision to which he was a party, the court

painstakingly reviewed and weighed the intrinsic

rationale of its first decision, then considered care-

fully the new arguments presented by the Commis-

sioner. On balance, it determined that it would stand

by its original position and so decided adversely to

the Commissioner. In Zager the potential appeals in

the prior case and in Zager itself lay to different cir-

cuits. Since the Zager circuit had evidently not

spoken on the issue, the Tax Court found itself unfet-

tered by a self-imposed procedural restraint to recon-

sider its prior view, and did so. This taxpayer's case

is a much stronger one for full consideration or recon-

sideration of the issue since, unlike Zager, the Com-

missioner espoused a changed position here and,

unlike Zager, the issue has no other circuit as a

forum. Accordingly, in Zager—unlike this case—the

litigant challenging the initial decision, to which he

had been a party, was indee ' given the full ‘“oppor-

tunity to be heard” required by Grannis v. Ordean,

supra. Unless that opportunity is available, this tax-

payer and her peers will be impermissably isolated

from the remedies available to most other taxpayers.

See, Laing v. United States, 423 U.S. 161, 176 (1976).

Because this taxpayer has not been heard, the de-

cision below plainly departs from the “accepted and

usual course of judicial proceedings” contemplated by

Rule 19 of this Court, both as to this taxpayer and as

to other U.S. taxpayers resident abroad who may be

required to follow in her footsteps. Accordingly,

certiorari is warranted with a view to remanding the

matter for the full and fair consideration it deserves,

or for a decision by this Court on the merits.

II. THE DECISION ON THE MERITS IS WRONG.

The taxpayer does not insist on her opportunity to

be heard as a mere academic exercise. There appears

to be a good chance that she would prevail on the

merits.

Of the Tax Court judges who were willing to con-

sider the basic legal issue in this case, all were con-

vinced that Brewster J was wrong. In addition, the

Tax Court judge who concurred with the majority

stated flatly that she thought Brewster J was wrong.

(The remainder did not reach the issue because of

their view of Golsen.)

Apart from that, section 911 has been wrongly

applied ‘ere. By its terms, section 911 earned income

in a service-capital business is limited to a portion of

net profits. Accordingly, on the face of the statute,

absent a net profit a proprietor can have no earned

income.'®

The language of Section 911, like all other statutory

language, is to be given its plain and ordinary mean-

ing. See, Helvering v. Flaccus Leather Co., 313 U.S.

247, 249 (1941); Addison v. Cherry Hill Co., 322 U.S.

607, 617 (1944); Old Colony Co. v. Commissioner, 301

U.S. 379, 383 (1937).

If, however, section 911 is unclear or ambiguous

then it must be construed and applied in a manner

consistent with the legislative policy that was the

underpinning for its enactment. Addison v. Cherry

Hill Co., supra. Because of that, if two alternative

constructions are otherwise reasonable, the control-

ling alternative is that which preserves the purpose

of the enactment, see, Sunshine Coal Co. v. Adkins,

310 U.S. 381, 392 (1940), and which produces a com-

mon-sense result consistent with the Congressional

intent, see United States v. American Trucking

Ass'n, 310 U.S. 534, 543-545 (1940); Helvering v.

Wardman, 68 F.2d 418 (D.C. Cir. 1933); and see 1

Mertens, Law of Federal Income Taxation (1974 rev.)

§3.26.

'’ As indicated above, note 10, the Commissioner early con-

strued the statutory phraseology to mean that a loss service-

capital business produces no earned income. G.C.M. 6563, VIII-2

C.B. 186, 187.

The construction of section 911 and its application

to this case by the court below produces an absurd

result that cannot be consistent with the legislative

intent.

The appellate court has recognized that the Con-

gressional intent which underlies section 911 is to pro-

vide a benefit to U.S. taxpayers who work abroad.

Commissioner v. Wolfe, 361 F.2d 62, 66 (D.C. Cir.

1966) cert. denied, 385 U.S. 838.'* Congress continues

to view section 911 as a provision which is intended to

confer a benefit. Thus, for example, recent legislation

refers to “an individual * * * entitled to the benefits of

section 911”’.'° The trial court paid obedient lipservice

to that intent in the first sentence of its opinion’®

then proceeded to render an opinion diametrically

opposed to that intent. The result, therefore, appears

to be that while a limited benefit (a percent of net

profits) is given to successful proprietors an unlimited

detriment is applied against them when they suffer a

loss. It boggles the mind to believe that Congress

truly legislated that outcome.

It is plain that had the taxpayer carried on identical

farming operations in this country at a loss she would

not have had deductions disallowed and thereby in-

curred the substantial deficiency the courts below

have determined. Even if the legislative history is

otherwise unclear, it is inconceivable that Congress

could have intended section 911 to give rise to such an

'* See also, Anne Moen Bullitt Brewster, 55 T.C. 251, 255-256

(dissent).

6 PL. 95-615, see. 4(b)(1) (Tax Treatment Extension Act of

1977).

'6 67 T.C. at 356 (Appeidix pp. 26a-27a).

inconsistent and unfair result or to be used as a wea-

pon against a taxpayer.

III. THE DECISION BELOW CONFLICTS WITH A

DECISION OF THE COURT OF CLAIMS AS TO

THE CONSTRUCTION AND APPLICATION

OF SECTION 911 TO A FOREIGN SERVICE-

CAPITAL BUSINESS

The court below held that the earned income of a

service-capital business was to be determined by

reference to the gross income of that business with-

out regard to whether or not the business generated

a net profit. It said (slip op. 8, Appendix p. 8a):

“earned income’ in §911 is structured in terms of

gross income rather than net profits.”

The Court of Claims holds that the section 911

earned income of a partner arises only if his business

has a net profit. It said: “Section 911 * * * contrary to

the Government’s contention, is not structured

around gross income.” Vogt v. United States, 537

F.2d 405, 409 (C. Cl. 1976). That difference in concept

is not mere sophistry; it is of central importance to

taxpayers like this one.

According to Vogt, the owner of a business does

not have earned income (i.e., compensatory remuner-

ation from business profits) for his services unless and

until the business has a net profit. That result makes

economic sense because, absent a profit, the owner—

whether proprietor or partner—must dig into his own

pocket to make up the operating loss of his business.

Under the Brewster IJ concept, the proprietor thus

necessarily gets his compensatory earned income out

of his own capital. But a taxpayer's capital is not his

income.'’ Vogt properly rejected that view, hence a

conflict exists.

It is true that in the Vogt and Brewster J] opinions

each court went out of its way to avoid acknowledging

a conflict with the other: the Vogt opinion says that it

is different than Brewster J, and the Brewster I]

opinion enthusiastically agrees, pointing to the fact

that Vogt dealt with a partner and Brewster IJ dealt

with a proprietor. In fact, there is no real conceptual

difference, and both courts stayed well clear of saying

there was a real difference.

In Vogt'* one of the major concerns motivating the

court’s decision was its perception that the govern-

ment’s “gross income” method of applying the section

911 earned income exclusion resulted in unfair dis-

crimination between salaried employees abroad and

individuals conducting their business abroad in part-

nership form. That discrimination arises because a

partnership conducting a business will ordinarily gen-

erate a larger proportionate amount of expense in

earning income for a partner than will an employee of

that business in earning his salary. Since the effect of

the government’s position in Vogt was to disallow a

certain amount of the expenses incurred in earning a

'7In order to determine whether there has been gain or loss

{from a commercial activity], and the amount of the gain, if

any, we must withdraw from the gross proceeds an amount

sufficient to restore the capital value that existed at the

commencement of the period under consideration.”

Doyle v. Mitchell Brothers, 247 U.S. 179, 185 (1918) (dictum);

see, Stratton'’s Independence v. Howbert, 231 U.S. 399, 415

(1914); see also, Magill, Taxabie Income 367-73 (Knopf ed. 1945);

Surrey, Warren, McDaniel and Holt, Federal Income Taxation

(vol. 1) 300-304 (1972).

18 537 F.2d at 408-409, note 3.

partner's income that kind of disallowance would ob-

viously fall more heavily on the partner who had

greater expenses per dollar of available income, than

it would on an employee who received the same com-

pensatory dollar amount.

Exactly the same considerations apply to a sole

proprietorship as compared to an employee. Indeed,

the Vogt court’s concern about the discriminatory

result of the government’s section 911 position should

be heightened where a business is conducted as a sole

proprietorship. Like a partnership, a sole proprietor-

ship will ordinarily incur greater amounts and a wider

variety of expenses in earning income than would an

employee who earns income from activities equivalent

to those of a proprietor. Here, the court below puts a

salaried employee with earned income in a better tax

position than a sole proprietor to whom is attributed

the very same amount of earned income. The Vogt

result resolved the problem in favor of equality of

treatment: Brewster IJ fosters inequality with no dis-

cernable basis in section 911 for doing so.

Shortly before the Brewster IJ opinion was handed

down the Court of Claims decided Cook v. United

States, ___—sd«@F.2d ~__--—-—s (decided April 18,

1979, C. Cl. No. 442-75, petition for rehearing pend-

ing).'® Cook dealt with a U.S. sole proprietor residing

abroad. It adopted the Brewster approach, and dis-

tinguished Vogt holding, in effect, that the taxpayer's

earned income derived from his gross income.

'°The court below did not refer to Cook in its Brewster II

opinion even though Cook was decided about six weeks before

Brewster II. It seems fair to assume that omission was simple

oversight.

Cook does not detract from the conflict between

Brewster III and Vogt. In Cook the court appears to

' have suffered from a paucity of assistance by counsel

for both parties” since it complains that the taxpayer

(slip op. 6) “has not shown (or even argued) that the

Service has any long-standing administrative policy

allowing (sic) individuals to exclude foreign source

income from a net figure.” In fact, some of the long-

standing administrative authorities cited in Vogt in-

volved individuals.”’ If nothing else, Cook is a prime

illustration of the confusion in this area which only

this Court can resolve.

This Court has been disposed in recent years to

accept cases for consideration where there is only an

apparent conflict among intermediate courts.” Here,

there is not an apparent conflict, there is a real con-

*° The amount involved in Cook ($40) was de minimis and per-

haps therefore did not consume the intense attention of counsel

or of the court.

*! See, Warren R. Miller, Sr., 51 T.C. 755 (1959); Form 2555 as

issued in years through 1968; Daniel A. Robida, 29 TCM 407

(1970) aff'd 460 F.2d 1172 (9th Cir. 1972); Rev. Rul. 55-171,

1955-1 C.B. 80; Rev. Rul. 70-491, 1970-2 C.B. 92; and Rev. Rul.

57-142, 1957-1 C.B. 246, revoked on other grounds in Rev. Rul.

66-326, 1966-2 C.B. 281. All were relied on in Vogt, but disre-

garded in Cook.

* That has occurred, for example, where a circuit court has

declined to follow a Court of Claims decision (Commissioner

v. Idaho Power Co., 418 U.S. 1, 4 (1974)); where two circuits dis-

agreed on essentially the same issue tried in the Tax Court

(Snow v. Commissioner, 416 U.S. 500, 501 (1974)); where cir-

cuits differ on essentially the same issue rising from various dis-

trict courts (NLRB v. Savir Mfg. Co., 414 U.S. 270, 272 (1973));

United States v. Maze, 414 U.S. 395 397 (1974); Marshall v.

United States, 414 U.S. 417, 418 (1974); and where appellate

courts differed in reviewing orders of government agencies

(National Cable Television Ass'n v. United States, 415 U.S. 336,

340 (1974)); Edelman v. Jordan, 415 U.S. 651, 658 (1974).

flict in an important sense between the court below

and the Court of Claims. That conflict should not go

unresolved. Moreover, because of the narrow range

available for judicial consideration in cases like this,

the question here can only be decided in this Court.

Certiorari should be granted.

IV. REVIEW OF THIS CASE IS IMPORTANT TO

THE EFFECTIVE ADMINISTRATION OF THE

INTERNAL REVENUE CODE

According to information given to the taxpayer by

the Commissioner under the Freedom of Information

Act” there appear to be about 100 docketed cases

pending decision which involve section 911. While all

certainly do not deal with the precise procedural and

substantive issues presented here, based on a random

sampling by the taxpayer a fair estimate is that

roughly half of them have, implicitly or explicitly,

questions which concern either the potential denial of

review or the proper construction and application of

the statutory provision involved here.*

It is very difficult for a non-governmental litigant

to assert before this Court that his own particular

case poses issues of sufficient importance to the ad-

35 U.S.C. §552.

*4 Section 911 was amended in 1976 (P.L. 94-455, 90 Stat. 1520

(1976)), and in 1978 (P.L. 95-615, 92 Stat. 3097 (1978)). The

effect of the amendment is to end the application of the statu-

tory construction issue of section 911 as to this taxpayer after

1978. The issue remains for her taxable years 1970 through

1978. However, that change in statutory coverage does not

affect the more basic issue raised in the first point of this peti-

tion as to this taxpayer, and more generally for other U.S. indi-

vidual taxpayers abroad. Accordingly, the statutory change

does not undercut the need for certiorari in this case. See

Warden v. Marrero, 417 U.S. 653, 654 (1974).

ministration of the revenue to capture the time and

attention of this Court. Indeed, even when the gov-

ernment seeks review the Court may grant it with

some hesitation evident in the Court’s description of

an issue as “seemingly important.” United States v.

Kahn, 415 U.S. 1438, 150 (1974); and see, Teleprompt-

er Corp. v. United States, 415 U.S. 394, 399 (1974)

(both private litigants sought review).

Here, however, it is fair to say that the denial of

appropriate review by both courts below is not of

seeming importance, it is indeed important to the fair,

proper and effective administration of the Internal

Revenue Code for U.S. citizens, like this taxpayer,

resident abroad. Certiorari should be granted.

CONCLUSION

Certiorari should be granted and the case should

either be decided by this Court in favor of the tax-

payer or remanded with instructions that the basic

issue of statutory interpretation and application be

addressed, for the first time.

Respectfully submitted,

Thomas E. Jenks

Michael Mulroney

1200 Eighteenth Street, N.W.

Washington, D.C. 20036

Cvunsel for Petitioner

September 26, 1979

INDEX TO APPENDIX

Appendix Description Page

Appendix A Opinion of the U.S. Circuit Court

of Appeals for the District of

Columbia Circuit, entered June

1, 1979 (not yet reported), with

indication of entry of judgment

EN ec cne ew Wes wavesees la

Appendix B= Opinion of the United States Tax

Ss We Bc Ds bee we ccwens 21a

Appendix C Order of Denial of Taxpayer's

Petition for Rehearing and Sug-

APPE N DICES - gestion for Rehearing En Banc... 49a

Appendix D- Pertinent Portions of Section

911, Internal Revenue Code of

1964 (26 U.S.C. S611). ........6: 52a

APPENDIX A

Notice: This opinion is subject to formal revision before publication

in the Federal Reporter or U.S.App.D.C. Reports. Users are requested

to notify the Clerk of any formal errors in order that corrections may be

made before the bound volumes go to press.

United States Court of Appeals

FOR THE DISTRICT OF COLUMBIA CIRCUIT

No. 77-2010

ANNE MOEN BULLITT BIDDLE BREWSTER, APPELLANT

COMMISSIONER OF INTERNAL REVENUE, APPELLEE

Appeal from Decision of the

Tax Court of the United States

(U.S. Tax Court No. 7063-71)

EEE ON oer eee

Judgment ant sre

this dace

Decided June‘l1, 1979 —— —

Argued February 23, 1979

Michael Mulroney with whom Thomas E. Jenks was on

the brief, for appellant.

Gilbert S. Rothenberg, Attorney, Department of Jus-

tice, with whom M. Carr Ferguson, Assistant Attorney

Genera’, and Gary R. Allen, Attorney, Department of

Justice, were on the brief, for appellee.

Rills of costs must be filed within 14 days after entry of judgment. The

court looks with disfavor upon motions to file bills of costs out of time.

Also Stuart E. Seigel, Attorney, Internal Revenue

Service, entered an appearance for appellee.

Before MACKINNON and Ross, Circuit Judges, and

RICHEY,* United States District Judge for the

United States District Court for the District of

Columbia.

Opinion Per Curiam.

PER CuRIAM: A Tax Court decision upheld the Com-

missioner’s determination that there was a deficiency in

appellant’s returns for the years 1962-65 and 1967-69

inclusive, and she appeals. The Commissioner based his

determination upon section 911 of the Internal Revenue

Code of 1954, 26 U.S.C. $911 (1976). Section 911

which only applies to United States citizens who are

bona fide residents of a foreign country, excludes from

a taxpayer’s gross income certain amounts of “earned

income” attributable to personal services performed

abroad. It concomitantly disallows as deductions expenses

allocable to or chargeable against this earned income.

* Sitting by designation pursuant to 28 U.S.C. § 292(a).

1$911. FE i . : .

sia ~ Earned income from sources without the United

(a) General Rule

The following items shall not be i i

S § e included in gross incom

and shall be exempt from taxation under this subtitle: ,

(1) Bona fide resident of foreign country

In the case of an individual citizen of th i

who establishes to the satisfaction of ac mee a

he has been a bona fide resident of a foreign country or

countries for an uninterrupted period which includes an

entire taxable year, amounts received from sources with-

out the United States (except amounts paid by the

United States or any agency thereof) which constitute

earned income attributable to services performed during

During the years in issue here, appellant was a citizen

of the United States and a bona fide resident of Ireland,

where she owned and managed a farming business in

which her personal services and capital were material

income-producing factors. She argues that section 911

does not apply to a service-capital business that operates,

as hers does, at a loss. Alternatively, she contends that

if section 911 does apply to her business, then the Com-

missioner unlawfully and arbitrarily computed the

amounts of her excluded earned income and correspond-

such uninterrupted period. The amount excluded under

this paragraph for any taxable year shall be computed

by applying the special rules contained in subsection (c).

An individual shall not be allowed as a deduction from his

«ross income any deductions (other than those allowed by sec-

tion 151, relating to personal exemptions), or as a credit

against the tax imposed by this chapter any credit for the

amount of taxes paid or accrued to a foreign country or pos-

session of the United States, to the extent that such deduc-

tions or credit is properly allocable to or chargeable against

amounts excluded from gross income under this subsection.

(b) Definition of earned income

For the purposes of this section, the term “earned income”

means wages, salaries, or professional fees, and other amounts

received as compensation for personal services actually ren-

dered, but does not include that part of the compensation de-

rived by the taxpayer for personal services rendered by him

to a corporation which represents a distribution of earnings

or profits rather than a reasonable allowance as compensation

for the personal services actually rendered. In the case of a

taxpayer engaged in a trade or business in which both per-

sonal services and capital are material income-producing fac-

tors, under regulations prescribed by the Secretary, a reason-

able allowance as compensation for the personal services

rendered by the taxpayer, not in excess of 30 percent of his

share of the net profits of such trade or business, shall be

considered as earned income.

26 U.S.C. § 911 (1976).

ingly disallowed expense deductions.2. We hold that the

principle of stare decisis precludes our consideration of

appellant’s first argument. On appellant’s second conten-

tion we hold that the Tax Court correctly construed sec-

tion 911’s exclusion and disallowance provisions and did

not clearly err in upholding the Commissioner’s applica-

tion of those provisions in this case. Hence we affirm.

Since 1956, appellant has been the sole proprietor and

active manager of a 700 acre farm in County Kildare,

Ireland. Although appellant raises cattle and grows some

crops on the farm, these activities are incidental to the

principal object of the business, the breeding, training,

and racing of horses. When she acquired the farm, appel-

lant intended only to engage in the breeding and racing

business. Subsequently, poor results with outside train-

ers induced her to become involved in the training busi-

ness as well. Appellant believed that coordinated devel-

opment of breeding and training, a program fully imple-

mented at the outset of the period in issue here, would

produce a greater degree of knowledge about an indi-

vidual horse’s capacity, stamina, and temperament.

It is customary in Ireland for proprietors situated as

appellant to employ a stud farm manager and a racing

* Appellant also urges us to allow her to elect the income-

averaging provisions of 26 U.S.C. § 1301. Our review of the

record yields no indication that apellant raised this point

below. Accordingly, we decline appellant’s invitation to probe

the availability of section 1301. Cf. Doe v. McMillan, 459 F.2d

1304, 1311 n.10 (D.C. Cir. 1972), rev’d in part on other

grounds, 412 U.S. 306 (1973); Miller v. Avirom, 384 F.2d

319, 321 (D.C. Cir. 1968). We do not intend, however, to

attach res judicata effects to this issue so as to perclude the

Commissioner, in the interests of complete justice, from ex-

amining this question, and, if appellant’s position is sound,

from granting appropriate relief. Cf. Glowinski v. Commis-

sioner, 248 F.2d 635 (D.C. Cir. 1957) ; n.5 infra.

trainer to oversee, respectively, the breeding and aie

ing operations, as well as a general manager to —

vise the entire business. Appellant, however, performs

all three of these functions herself, personally supervis-

ing all facets of her horse farm. In her capacity ”

general manager, she works at the farm all day, seven

days a week. She is a professionally licensed saga

She personally directs such things as the breaking 0

yearlings in preparation for training and the nea

of apprentices and jockeys. She regularly checks all the

horses on her farm and determines such matters as when

corrective shoeing is necessary and when treatment of

foals is required. She aiso does her own secretarial work

and directs payments of all expenses.

To assist her on the farm, appellant employs approxi-

mately forty-five to fifty persons. Among these are an

accountant, who handles all the books and also supervises

the cattle-grazing and crop-growing operations ; a stud

groom, who acts as foreman of the breeding operation and

as its manager in appellant’s absence ; and a head lad,

who is the stud groom’s counterpart in the training opers-

tion. Appellant operates her farm as a proprietorship ;

she does not pay herself a salary.

On her federal tax returns for the years in question,

appellant reported all her gross farm income ane de-

ducted all her gross farm expenses. The gross farm in-

come, representing the ordinary income from the pinye

of appellant’s farm, consisted of income from the — )

cattle and manure, horse boarding fees, and net

winnings. It did not include income appellant apnea

from the sale of horses, which income appellant sepa-

rately reported as long-term capital gain. Apellant’s

gross farm expenses, representing the ordinary expenses

associated with the realization of ordinary income, oom

sisted of wages and social insurance for her employees ;

feed for horses; grass seed for pastures; depreciation

> Ss 5 .

penses those expenses i

‘entheialion Pp attributable to her personal

Upon audit, the Commiss;

it, mmissioner determined

< ae S gross farm income was ae ae

personal services on the farm, and therefore ak a

ee at Sie a

Bae =

earned abroad within the meaning of section 911. Like-

wise, the Commissioner determined that 30% of appel-

lant’s gross farm expenses was allocable to and chargeable

against this excluded earned income, and_ therefore

should not have been deducted. These determinations re-

duced by 30% appellant’s net farm loss in all but one

of the tax years in question.* Based on this reduction in

offsetting losses, the Commissioner calculated a deficiency

in appellant’s tax payments totalling in excess of

$188,000. The Tax Court upheld the Commissioner.

Brewster v. Commissioner of Internal Revenue, 67 T.C.

362 (1976). This appeal followed.

Appellant’s first and principal contention is that sec-

tion 911 has no application to a service-capital business

that is operated at a loss. This is appellant’s second

visit to this court in quest of a holding to that effect. In

the first proceeding, Brewster v. Commissioner of In-

ternal Revenue, 473 F.2d 160 (D.C. Cir. 1972) (“Brew-

ster I”), aff’'g per curiam, 55 T.C. 251 (1970), appellant

raised precisely the same question and offered basically

the same analysis that she poses here. In Brewster J,

which involved earlier years, the Commissioner and ap-

pellant had stipulated that appellant’s capital and per-

sonal services were material income-producing factors in

her business. Subsection (b) of section 911 limits ex-

cludable earned income from service-capital businesses to

a reasonable allowance that is not to exceed 30% of the

net profits from such a business. Appellant asserted that

this provision—in particular, the 30% limit on earned

8 For the year 1968, 30% of appellant’s gross farm income

exceeded the then applicable dollar limitation of $35,000 for

the earned income exclusion. See 26 U.S.C. §911(b) (1958

ed. Supp. IV). In consequence, the disallowance of gross farm

expenses for that year was also proportionately reduced.

income—displayed a congressional intent to confine ap-

plication of section 911 to service-capital businesses that

operate at a profit. She reasoned that excluding earned

income derived from a business that operated at a loss

would frustrate section 911’s goal of benefiting taxpayers

who live and work abroad. The Commissioner responded

that Congress designed subsection (b) as an administra-

tive convenience to alleviate the difficulties inherent in

computing the appropriate allowance for personal services

in a business in which both capital and services mate-

rially contributed to the production of income. He main-

tained that it had no relevance to a situation in which

the losses from a service-capital business exceeded income.

We agreed with the Commissioner, Emphasizing the

language of the statute, we wrote that “[t]he apparent

anomaly of ‘earned income’ from a business operated at

a loss is ascribable to the fact that the statutory concept

of ‘earned income’ in § 911 is structured in terms of

gross income rather than net profits.” Jd. at 162. We

pointed out that the preface of section 911 does not

mention profits or losses, but instead provides that “[t]he

following items li.e., earned income] shall not be in-

cluded in gross income,” 26 U.S.C. §911(a) (1976) (em-

phasis added). Although aware that the exclusions and

limitations in section 911 engendered “certain incongrui-

ties” in particular circumstances, we observed that the

Commissioner’s reading of the statute does not transgress

its basic rationale, which we described as an effort “to

permit American business men [ste] to compete abroad

with foreign entrepreneurs, without being subject to dou-

ble taxation possibilities.” 473 F.2d at 163. We also

noted that in the vast majority of situations section 911

does indeed benefit the taxpayer living and working in a

foreign country. In effect, avoiding appellant’s misguided

mingling of the concepts of “earned” and “taxable” in

come, we found no statutory barrier to a

that a taxpayer could earn income from pe

determination

rsonal services

eR AAP UL LIES Te SPUR PIE ST LT

despite the fact that the income derived from a business

that lost money. |

Our holding in Brewster | disposes of es gonna se

contention because the important principle of save a :

requires that result. Stare decisis compels adher eon

prior factually sonore insane re nl pi one ae

court. E.g., Braniff Atrways, Inc. Ve

vd, 581 F.2d 846, 848-49 (D.C. Cir. 1978); see

hate Federal Practice ¥\0.402(1] (2d ed. J. Moore &

T. Currier 1974). This principle assumes oo a

portance when the antecedent case involves construc .

of a statute. See 1B Moore's Federal Practice, —.

7 0.402[5]. In its intra-circuit application, yn es

demands that we abide by a recent decision 0 fe

of this court unless the panel has withdrawn the pe

or the court en banc has overruled it. See, _— pene

States v. Caldwell, vi ey a mgs ml ; Neon

Cir. 1974), cert. denied, Ss. “a oe

States v. Bryant, 471 F.2d 1040, 1046 (D.C. Cir. ny

q iam), cert. denied, 409 U.S. 1112, (1973). is

bschirnipaonttiieste uniformity in the smb of rie

standards, enhances predictability in sgt si

motes the interests of judicial efficiency an ion —

and evinces respect for the efforts of earlier — wd

have struggled to educe the appropriate legal norms.

Since our opinion in Brewster I no gto =

changes have arisen to require a different resu ee Pp

case. We do not reach this conclusion by rd — ot

mechanical application of the principle of s _ ord

Since 1973, the date of poy ee et ee

no changes in the text of section » pega

to this discussion. Nor has this court or age

Court issued any decision that in any way Bec

) I. Appellant offers no cogent asis

pate poner’ an go earlier —— _

only subsequent decision to which she refers, Vogt v.

10a

United States, 587 F.2d 405 (Ct. Cl. 1976), involved an

entirely different issue from the one presented in Brew-

ster I and the Court of Claims explicitly and carefully

distinguished our decision, sce id. at 415.". Thus, even

were a contrary Court of Claims decision sufficient to

relieve us of our obligation to follow a recent and well-

considered decision of this court, we would find Vogt of

only marginal value in a de novo analysis of this case.

Appellant insists that Brewster I is factually distin-

guishable from the instant proceeding because there the

parties stipulated to the reasonableness of the amounts

the Commissioner excluded from earned income and disal-

lowed as deductions whereas here appellant contests those

amounts. This argument misconceives the scope of the

narrow issue decided in Brewster I. The sole question

before that court was whether section 911 covered a

service-capital business that operated at a loss. The only

facts germane to that issue were that appellant’s per-

sonal services and capital had been material income-

producing factors in her business and that her business

indeed operated at a loss. Those facts are no more dis-

puted here than they were. We acknowledged that bizarre

results might accompany application of section 911 in

certain circumstances, but we did not condition our hold-

ing that section 911 applies to service-capital businesses

that operate at a loss on the reasonableness of the Com-

missioner’s determinations on excludable earned income

from year to year and from taxpayer to taxpayer. The

* Vogt involved the question whether the Commission could

apply the maximum dollar amount on excluded earned income

to the taxpayer’s share of the partnership’s gross income.

The Court of Claims, carefully noting that the question per-

tained only to the partnership setting, held that the Commis-

sioner could not, and that instead the limit had to be applied

to the taxpayer’s share of the partnership’s net income. 537

F.2d at 415. The court’s rationale rested upon considerations

peculiar to the tax status of partnerships. See id. at 410-15.

FREES RE ES

DS AE AEE CBE CHEE SS

lla

question of reasonableness is a separate inquiry, ag

which Brewster I did not engage. Accordingly, ba

issue of section 911 coverage, Brewster I controls

case.”

icipating our adherence to Brewster Lb appellant

Precis ae per that the Commissioner’s deter-

minations of the income she “earned” and of the cin ager

attributable to it are inconsistent with the statute wee

otherwise arbitrary and capricious. Courts play a =

stricted role in cases of this kind. Although our interpi

tation of the appropriate legal standards is bridled only

by the deference due the Commissioner in certain no

stances, see Commissioner of Internal Revenue v. St my

386 U.S. 287, 296 (1967); Nico v. Commissioner of In-

ternal Revnue, 565 F.2d 1234, 1237 (2d Cir. 1977 - <

review of the Commissioner’s and the Tax Court ~ app :

cation of the appropriate standards to a particular se i

facts is considerably more restrained. A presumption =

correctness accompanies a determination by the banana

sioner. Rockwell v. Commissioner of Internal age

512 F.2d 882, 885 (9th Cir.), cert. denied, 423 U. i. :

(1975) ; Plisco v. United States, 306 F.2d 784, 7 Pe

(D.C. Cir. 1962). This places the burden of pone -

on the taxpayer, see 9 J. Mertens, The Law of Fe a

Income Taxation § 50.61 (J. Doheny ed. sigh =.

thereafter the burden of persuasion rests with t dens

payer. Helvering v. Taylor, 293 U.S. 507, 515 ( :

That is, the taxpayer must show by a preponderance 0

i inci tare decisis con-

5 ing to our view that the principle of s :

Pi npn not consider whether Brewster I also ene

erally estops appellant from ro = ye nd “ —

age. The rules of collatera estoppel app ne

whol exclusively involving esuag = oa and yn

i f Internal Revenue v. Sunnen, 5S. , 598-

(1948), put they are to be sparingly used, see ae 600; 1B

Moore’s Federal Practice §0.442[3] (2d ed. 1974).

12a

the evidence that the Commissioner’s determination is in

error. See Burnet v. Niagra Brewing Co., 282 U.S. 648,

654 (1931) ; Valley Title Co. v. Commissioner of Internal.

Revenue, 559 F.2d 1139, 1141 (9th Cir. 1977); J. Mer-

tens, supra § 50.62. If the Tax Court resolves facts in

favor of the Commissioner or holds that the taxpayer has

failed to meet that burden, then we must uphold the

Tax Court unless its findings are clearly erroneous.

Farcasanu v. Commissioner of Internal Revenue, 436

F.2d 146, 149 (D.C. Cir. 1970) (per curiam).

Section 911 provides that the Commissioner shall con-

sider as earned income “a reasonable allowance as com-

pensation for the personal services rendered by the tax-

payer.” 26 U.S.C. §911(b) (1976). As we noted above,

the Commissioner here found that 30% of appellant’s

gross farm income, which did not include gains from the

sale of horses, constituted compensation for appellant’s

personal services on her farm. The Tax Court held that,

while the Commissioner could not mechanically apply the

30% figure in every case, the appellant had failed to show

that this assessment was unreasonable as applied to her.

Appellant challenges this holding on two grounds. First,

she argues, the Tax Court used the wrong test to deter-

mine whether she had in fact met her burden. She main-

tains that the Tax Court should have resorted to section

162(a) (1) of the Code for guidance in computing com-

pensation under section 911. Second, she contends that

no matter how the Commissioner computes earned income,

he must include the gains she derived from the sale of

horses in the base gross income figure. She maintains

that these gains were an integral part of her farm

income.

Section 162(a) (1) of the Code allows taxpayers to

deduct as an ordinary and necessary business expense

“a reasonable allowance for salaries or other compensa-

13a

tion for personal services actually rendered.” 26 or

< 162(a) (1) (1976). Noting the similarity between t -

language and that in section 911, appellant by igend

of analogy offered at trial evidence of the men °

would have had to pay replacement employees to perform

the services appellant herself performed. These sums,

appellant argues, are the proper measure of the —

sation for the services she actually rendered in apse

ing gross farm income. Appellant asserts that the “4

missioner’s alternative computation is an arbitrary e

ure, intimating that the Commissioner borrowed t :

ficure from subsection (b)’s limitation on the pes )

net profits a taxpayer can exclude as compensation from

gross income.

We endorse the Tax Court’s view that the aan

neither requires nor permits ‘the Commissioner, as i

ter of administrative convenience or otherwise, > by

form the reasonableness standard into a fixed 3 “a g-

ure. The theory of Brewster I forecloses use _— <

tion (b)’s limitation to accomplish that result. e war

guage of section 911 requires a case-by-case assessme .

of the income from a service-capital adageanen _ is *s :

sonably attributable to the taxpayer's persona oo

At the same time, however, we share the ps Cou ‘d

skepticism about the pertinence of a section ” a id

in the context of section 911.- When a court ce

two different sections of the Code, each serving a sa _

purpose and each having its own legislative bac groun ;

it must hesitate in the absence of a clear oo

mandate before importing the incidents of one into the

other. Grunebaum v. Commissroner of Internal tgp

420 F.2d 332, 335 (2d Cir.), cert. denied, 397 US. |

(1970). The considerations appropriate to a a,

tion of reasonableness under section 162 are nee _—

variegated, see 4A J. Mertens, supra § 25.69, an bey z ‘

of those factors are helpful in a situation in whic

14a

Commissioner must impute reasonable compensation where

no compensation has actually been paid. No doubt some

of the elements of a section 162 inquiry are useful in

computing a reasonable allowance under section 911, but

the latter provision may inipose a more complex burden

on the taxpaye~ to show that portion of the taxpayer’s

gross receipts chat ought to be attributed to personal

services rather than to capital.”

Appellant’s evidence on how much she would have had

to pay replacement employees does not directly address

the“crucial question of the contribution appellant’s serv-

ices made to the production of gross farm income. She

offered no evidence on the value of her services apart

from the testimony on how long and hard she worked.

Appellant was the proprietor and active manager of a

business that operated at a loss, yet the cost-of-

replacement evidence appellant offered does not reflect her

status as proprietor or the fact that her business lost

money. It belies common sense to assert that the services

of an employee are fully comparable to the owner of a

business who finances and manages the enterprise in

addition to performing tasks employees would normally

carry out. Using the compensation that would have been

paid to replacement employees makes no allowance for

the degree of the business’ profitability or lack of profit-

ability, a factor that is always relevant to consideration

of the reasonableness of the compensation. It also assumes

that appellant would have been willing to hire such re-

placement employees despite the existence of continual

losses in her business. Moreover, as the Tax Court noted,

appellant’s evidence does not permit consideration of the

work now done by appellant’s employees that would have

been done by replacements and which lessened the extent

of the work demanded of appellant. In light of these

factors, we cannot say that the Tax Court clearly erred

in upholding the Commissioner’s determination.

Similarly, we are unpersuaded by appellant’s claim

that her gross farm income must include receipts she

15a

realized from the sale of horses for the purpose of com-

puting the earned income exclusion. Appellant’s task

below was to show that the amount the Commissioner

excluded as compensation was unreasonable. In deter-

mining whether appellant had met her burden, the Tax

Court properly focused on the excluded amount rather

than the base from which it was computed. As we have

said, there is nothing magical about the 30% figure the

Commissioner used. The Commissioner might have used

a different figure, and it might have varied from year

to year. The only requirement is that the resulting ex-

cluded earned income be reasonable. Hence there is no

guarantee that the inclusion of horse sale receipts in the

gross farm income would have materially affected the

amount of excluded earned income. Moreover, appellant

stipulated that she was in the business of breeding, train-

ing, and racing horses; her occasional sale of horses was

incidental to that concern. Accordingly, on her tax re-

turns, appellant excluded from her gross farm income the

proceeds she received from the sale of horses and sepa-

rately reported those proceeds to obtain favorable capital

gains treatment. Styling those proceeds as part of her

gross farm income for section 911 purposes would at least

raise doubts about her entitlement to capital gains treat-

ment under section 1231 of the Code. See 26 U.S.C.

1231 (1976).

Section 911 provides that the taxpayer shall not be

allowed as a deduction from gross income any deductions

“properly allocable to or chargeable against amounts ex-

cluded from earned income.” 26 U.S.C. § 911(a) (1976).

As we noted above, the Commissioner found that 30%

of appellant’s gross farm expenses, which did not include

expenses directly associated with the sale of horses, were

allocable to or chargeable against appellant’s earned in-

come. The Tax Court, while again correctly warning that

the 30% figure could not be mechanically applied, held

16a

that the Commissioner had acted lawfully. Appellant

challenges this holding on four grounds. First she argues

that only those expenses that replacement employees

would have incurred should be subject to disallowance.

This contention is no more persuasive on the expense side

than it was on the income side, and thus we find it un-

necessary to discuss it further.° Second she maintains

that the statutory phrase “allocable to or chargeable

against” requires that only those expenses be disallowed

which are specifically identified with earned income.

Third she insists that the amount of disallowed deduc-

tions cannot in any event exceed the amount of excluded

earned income. Finally she contends that her gross farm

expenses, the base from which the Commissioner deter-

mined the 30% figure, should have been reduced by

excluding a portion of her ordinary farm expenses that

could be attributed to her sale of horses.

Appellant’s suggested item-by-item approach to sec-

tion 911’s disallowance provision hinges in part on her

assertion that disallowed expenses must be specifically

service-related rather than capital-related and in part on

her contention that the words “allocable to” exhibit a con-

gressional intent to confine disallowed expenses to those

with a definite factual relationship to earned income. It

may be that in some service-capital businesses the ex-

penses related to capital and those related to personal serv-

ices can be neatly cleaved in two. In appellant’s business,

however, it was an alliance of capital and personal serv-

* Appellant claimed in the Tax Court that because replace-

ment employees would have incurred none of the expenses

claimed by the appellant as the proprietor of a service-capital

business, the excluded income should not be charged with any

expenses. As the Tax Court noted, this approach, which

would exclude income without a necessary disallowance of

expenses, could produce a tax loss in excess of actual loss

unless the replacement employee expenses were at least as

great as the excluded earned income.

17a

ices that combined to produce gross income. The purpose

of section 911’s disallowance provision is to ensure that

the income excluded as “earned” remain burdened with

the costs associated with its production. Section 911

identifies the disallowed expenses with the “amounts ex-

cluded from gross income” rather than with the rendi-

tion of personal services per se. This parallels the

statute’s language on the income side, which avoids con-

ditioning a determination of earned income upon a

finding that a particular item of gross income is identified

with services rendered. A persistent failure to incur any

one of the farm expenses we listed above would result in

a gradual dimunition of appellant’s gross receipts. There

exists, then, a direct relationship between these expenses

and the income appellant “earned.” This relationship is

all that the statute requires. It follows that we are un-

convinced by appellant’s attempt to circumvent the sym-

metry in section 911 by attaching controlling significance

to the words “allocable to.” Appellant’s claim that Con-

gress would have used the word “apportioned” had it

contemplated use of a comparable ratio on the income

and deduction sides has no support in either the language

of the statute or its legislative history, and could lead to

a situation in which a taxpayer’s tax loss could exceed

his actual loss.’

Appellant’s contention that the amount of disallowed

deductions can never exceed the amount of excluded

earned income similarly lacks a foundation in either the

7 Cf. n.6 supra. The Tax Court’s example is useful:

Assume total gross income of $1,000, expenses of

$1,500, of which only $100 are clearly identified with

earned income. On the basis of a 30-percent exclusion

from gross income, the taxpayer would report $700 of

gross income and, under [appellant’s] theory, would be

entitled to deduct $1,400. This produces a tax loss of

$700, although the actual loss is only $500.

67 T.C. at 364 n.17.

18a

language or the history of section 911. As the Tax Court

pointed out, appellant’s suggestion would also render our

decision in Brewster I an academic exercise, for if the

taxpayer reduced both the income and deduction sides by

the same amount, the result would produce the same net

loss as if section 911 had never been applied. That is why

the Brewster I court, in dicta, expressly rejected this

position. See 473 F.2d at 164 n.6. We refuse to do sub

rosa what we earlier declined to do explicitly, see Part II

supra, and accordingly we hold that section 911 does not

forbid the disallowance of deductions in excess of the

amount of income excluded as compensation from gross

income.

Finally appellant poses the reflected image of her con-

tention that receipts from her sale of horses ought to be

included in her gross farm income for section 911 pur-

poses. Appellant maintains that a portion of her gross

farm expenses are properly allocable to the proceeds she

received from selling horses, and therefore, if those pro-

ceeds are not to be included in the gross farm income

figure, that such expenses should be excluded from her

gross farm expenses for the purpose of computing the

disallowance. The Tax Court correctly rejected this con-

tention. The gross farm expenses appellant incurred re-

flect the ordinary costs of maintaining a farm for the

breeding, training, and racing of horses. Appellant did

not hold her horses for sale in the ordinary course of

business and hence none of her ordinary expenses can be

attributed to horse sales. In invoking the advantages of

capital gains tax treatment on her sale of horses, appel-

lant offset a portion of her horse sale proceeds with the

expenses directly associated with those sales. See Part I

supra. The statute does not entitle appellant further to

offset her capital gain income by increasing in this man-

ner the amount of the expenses she may deduct.

19a

Brewster I binds this court to a holding that section

911 applies to service-capital businesses operating at a

loss. Appellant has failed to show that the Commissioner

misconstrued that provision or that the Tax Court clearly

erred in upholding the Commissioner’s determinations

thereunder. Accordingly, the decision of the Tax Court is

Affirmed.

APPENDIX B

2la

APPENDIX B

ANNE MOEN BULLITT BIDDLE BREWSTER,

PETITIONER v COMMISSIONER OF INTERNAL

REVENUE, RESPONDENT

Docket No. 7063-71. Filed November 30, 1976.

Petitioner, a U.S. citizen residing abroad, oper-

ated a farming business as a sole proprietorship in

Treiand at a loss. Petitioner’s personal services as

well as capital were material income-producing

factors in the business. Held, under sec. 911(b),

petitioner was required to exclude a portion of her

gross farm income as “earned income.” Brewster

v. Commissioner, 473 F.2d 160 (D.C. Cir. 1972),

affg. per curiam 55 T.C. 251 (1970); Jack E. Goll-

sen, 54 T.C. 742 (1970), affd. on the substantive

issue 445 F.2d 985 (10th Cir. 1971). Held, further,

respondent’s determination that 30 percent of

gross farm income was a reasonable allowance as

compensation for petitioner’s personal services

and, therefore, the amount of excludable earned

income, sustained. Held, further, respondent’s

determination that 30 percent of petitioner’s farm

expenses were allocable to or chargeable against

excludable earned income and nondeductible un-

der sec. 911(a) sustained.

Thomas E. Jenks, Herbert L. Awe, and Michael

Mulroney, for the petitioner.

Jon T. Flask, for the respondent.

Tannenwald, Judge: Respondent determined the fol-

lowing deficiencies in petitioner’s Federal income tax:

22a

Year Deficiency Year Deficiency

res $25,071.98 ee $24,505.82

i eee 17,945.48 eee 16,435.89

i eee 32,787.48 ee 68,912.27

ree 2,498.02

The questions before us are: (1) Whether a portion of

petitioner’s gross farm income was excludable as

earned income under section 911' when her foreign

farming proprietorship operated at a loss, (2) if a por-

tion was so excludable, the amount thereof, and (3)

the amount of petitioner’s farming expenses “alloca-

ble to or chargeable against” the excludable income.

FINDINGS OF FACT

Some of the facts have been stipulated and, togeth-

er with the stipulated exhibits, are incorporated here-

in by this reference.

Petitioner was a citizen of the United States and a

bona fide resident at Palmerstown Stud, in Kill, Coun-

ty Kildare, Ireland, at the time of filing her petition

herein and during all of the years at issue. She filed

timely individual Federal income tax returns for the

years 1962 through 1969 with the Director, Office of

International Operations, Internal Revenue Service,

Washington, D.C.

At all times material herein, petitioner was en-

gaged in the farming business in Ireland as an indi-

vidual proprietor. Both petitioner’s personal services

' All section references are to the Internal Revenue Code of

1954, as amended and in effect during each of the years before the

Court.

23a

and capital were material income-producing factors in

the business.

Petitioner acquired her farm, Palmerstown Stud, in

1956 after an extensive search. The premises are

favorably situated on limestone land which is consid-

ered to be desirable for raising horses. The farm en-

compasses 700 acres. In 1962, petitioner owned ap-

proximately 120 horses at Palmerstown. By 1969, that

number had increased to about 200, most of which

were brood mares and immature stock with approxi-

mately 25 to 30 racing horses in training. During the

years in question, petitioner employed 45 or 50 indi-

viduals at all times.

Petitioner operated both a horse breeding farm and

a training and racing stable at Palmerstown. In addi-

tion, each year petitioner grazed about 250 head of

cattle which were useful for keeping the horse pas-

tures in good condition and for controlling parasites.

Originally, petitioner intended only to carry on

thoroughbred horse breeding; however, because of

dissatisfaction with the results produced by public

trainers, she began to train horses at Palmerstown.

Petitioner believed that the combination of breeding

and racing operations, which had developed fully at

Palmerstown by the beginning of the period in ques-

tion, would produce a greater degree of knowledge

about an individual horse’s capacity, stamina, and

temperament. Consequently, she believed that coordi-

nated development would aid in both training and

selection for breeding. With the exception of several

smaller operations, a combined breeding farm and

racing stable such as Palmerstown is unique in Ire-

land. During the years in question, Palmerstown was

24a

one of the largest thoroughbred horse operations in

Ireland and horses bred and trained by petitioner won

a number of internationally recognized races in Ire-

land, England, and France.

Petitioner was general manager and directed the

breeding and racing operations herself during the

years in question. She employed a stud groom who

functioned as a foreman in charge of the breeding

operation. Likewise, a head lad was employed and he

functioned as a foreman in charge of the racing opera-

tion. During brief absences from Palmerstown by

petitioner, the stud groom and head lad were left in

charge of the breeding and racing functions. Peti-

tioner performed all of the secretarial work. She em-

ployed an accountant to maintain Palmerstown’s

books and records. He also supervised planting, cattle

grazing, and farm equipment operations. Petitioner

supervised and directed the sale of the horses at

Palmerstown.

For the years 1962 through 1969, petitioner real-

ized the following income and expenses from the

farming operation:?

Gross Gross Net

farm farm farm

Year income ~ expenses loss

a ee $83,155 $224,868 $141,713

BOs wt sese 123,502 235,717 112,215

? The figures as to gross farm income and gross farm expenses

include adjustments to the amounts of these items as shown in

the deficiency notice to take into account the effect of petitioner's

horse racing activities, adjustments based upon the stipulation of

the parties. In addition, gross farm income is exclusive of gain

realized from the sale of horses. See pp. 365-367, infra. The

amount of such gain is stipulated as follows: 1962, $84,951; 1963,

$67,712: 1964, $159,770; 1965, $25,657; 1966, $30,411; 1967,

$138,265; 1968, $68,400; 1969, $209,760.

* The parties stipulated this figure to be $141,173 in an obvious

typographical error.

25a

SN 6 ae 38,238 234,241 196,003

Pn ceekes 55,647 273,408 217,761

ES 64,070 290,674 226,604

Sr 58,947 299,391 240,444

ES os: iw 48,809 262,685 213,876

eeckwse 57,840 288,391 230,551

On her Federal tax returns for each of these years,

petitioner reported all of her gross farm income and

deducted all of her farming expenses. Her gain from

the sale of horses was reported separately as long-

term capital gain. Thus, she offset her U.S. source in-

come with 100 percent of the losses she sustained

from her foreign business.

The respondent determined that 30 percent of peti-

tioner’s gross farm income was excludable from gross

income under section 911 as earned income. He fur-

ther determined that the portion of gross farm ex-

penses allocable to the excludable income, and there-

fore nondeductible, was the same percentage of gross

expenses that excludable income was of gross farm

income. The net effect of respondent’s determination

(modified in accordance with n. 2 supra) is the reduc-

tion of petitioner’s net farm loss for each year, except

1963, by 30 percent.‘

30% of gross —. 30°%Jo of farm Reduction

farm income expenses in farm

Year excluded disallowed loss

re $24,947 $67,460 $42,514

eae *35,000 *66,801 31,801

eee 11,471 70,272 58,801

| ae 16,694 82,022 65,328

Pi wees ue 19,221 87,202 67,981

A 17,684 89,817 72,133

are 14,643 78,806 64,163

a eee . 17,352 86,517 69,165

*For this year, 30 percent of gross income exceeds the then-

effective dollar limitation ($35,000) for the earned income ex-

clusion. Sec. 911(c)(1)(B). The disallowance of farm expenses

is accordingly proportionately reduced. See p. 365, infra.

26a

Petitioner’s farming expenses for the years in ques-

tion were as follows: wages, social insurance for em-

ployees, feed for horses, grass seed for pastures,

general supplies, repairs, fertilizers, stud fees and

boarding expenses of breod mares at other stud

farms, veterinary and medicine expenses, machinery

operating expenses, insurance, bank interest and

charges, electricity, telephone, rent, local taxes, car-

riage and freight for transporting horses, motor car

expenses, horseshoeing, cost of training horses at

other farms, straw, peatmoss, management fees, sad-

dlery, periodicals, stationery, postage, gratuities to

employees, travel and entertainment, subscription

and entry fees for the registration of horses in stud

book, tools and short life equipment, advertising, cat-

tle buyers’ commissions and fees, legal expenses,

rental of special machinery, and entrance and jockey

fees for horse races.° No part of these expenses

claimed by petitioner was attributable to her personal

expenditures.

OPINION

Section 911° affords a tax benefit to citizens who

are residents of a foreign country to the extent that

they realize income abroad as a result of their per-

* Petitioner also took deductions for depreciation in respect of

property used in the business, but a portion of these deductions

was attributed to the horses sold and reflected in the capital gain

reported in respect of such sales.

* Sec. 911 provides in part:

SEC. 911. EARNED INCOME FROM SOURCES WITHOUT

THE UNITED STATES.

27a

sonal services (earned income) rather than as a return

on capital investments. In the case of a service-capital

business, the statute provides that “a reasonable al-

lowance as compensation for the personal services

(a) GENERAL RULE.—The following items shall not be in-

cluded in gross income and shall be exempt from taxation under

this subtitle:

(1) BONA FIDE RESIDENT OF FOREIGN COUNTRY.—In the

case of an individual citizen of the United States who

establishes to the satisfaction of the Secretary or his delegate

that he has been a bona fide resident of a foreign country or

countries for an uninterrupted period which includes an entire

taxable year, amounts received from sources without the

United States (except amounts paid by the United States or

any agency thereof) which constitute earned income at-

tributable to services performed during such uninterrupted

period. The amount excluded under this paragraph for any

taxable year shall be computed by applying the special rules

contained in subsection (c).

* * *

An individual shall not be allowed, as a deduction from his gross

income, any deductions (other than those allowed by section 151,

relating to personal exemptions) properly allocable to or

chargeable against amounts excluded from gross income under

this subsection.

(b) DEFINITION OF EARNED INCOME.—For purposes of this

section, the term “earned income” means wages, salaries, or

professional fees, and other amounts received as compensation

for personal services actually rendered, but does not include that

part of the compensation derived by the taxpayer for personal

services rendered by him to a corporation which represents a

distribution of earnings or profits rather than a reasonable

allowance as compensation for the personal services actually ren-

dered. In the case of a taxpayer engaged in a trade or business in

which both personal services and capital are material income-

producing factors, under regulations prescribed by the Secretary

or his delegate, a reasonable allowance as compensation for the

personal services rendered by the taxpayer, not in excess of 30

percent of his share of the net profits of such trade or business,

shall be considered as earned income.

(Emphasis added.)

28a

rendered by the taxpayer, not in excess of 30 percent

of his share of the net profits of such trade or busi-

ness, shall be considered as earned income.”

On a prior occasion, this same taxpayer asked us to

decide the identical question initially before us here-

in, namely, whether, under section 911, a citizen

residing outside of the United States can have exclud-

able ‘earned income” from a farming proprietorship

in which both capital and personal services are mate-

rial income-producing factors (service-capital busi-

ness) when such proprietorship operates at a loss. In

a Court-reviewed opinion, we answered that question

affirmatively. Anne Moen Bullitt Brewster, 55 T.C.

251 (1970), affd. 473 F.2d 160 (D.C. Cir. 1972). We

reasoned that the 30-percent limitation on the amount

of net profits deemed to be earned income only

applies to a business realizing net profits, since the

limitation is expressed in terms of a percentage of net

profits. Based upon this approach and because the

benefit conferred takes the statutory form of an ex-

clusion from gross income, we held that the excluda-

ble compensation factor was to be determined with

reference to gross income. 55 T.C. at 254. Our deci-

sion was affirmed by the Court of Appeals for the Dis-

trict of Columbia in a per curiam opinion (473 F.2d

160 (D.C. Cir. 1972)), which rather extensively ana-

lyzed the issue involved and the views expressed by

this Court.

Petitioner herein renews her contention that a pro-

prietor of a foreign service-capital business generat-

ing losses cannot have any earned income within the

meaning of section 911(b) and urges us to reexamine

and abandon our position to the contrary. Respondent

counters with the assertion that the rule established

29a

in Jack E. Golsen, 54 T.C. 742 (1970), affd. on the sub-

stantive issue 445 F.2d 985 (10th Cir. 1971), requires

us to follow our prior decision in view of its affir-

mance by the Court of Appeals for the District of

Columbia, to which an appeal from a decision herein

would lie.

It is clear that a decision herein for respondent on

this threshold issue is required under Golsen. Such

being the case, we reject petitioner’s renewed con-

tention.’

We turn to the questions as to how the amounts of

excludable gross income and related expenses should

be calculated—questions which did not have to be

dealt with in the previous case because such amounts

were stipulated by the parties.

Petitioner contends that if she had realized “earned

income” from her farming operations, it was not de-

terminable as a flat percentage of gross income.

Rather, she maintains that the proper measure of her

earned income is the amount she would have had to

pay employees as reasonable compensation to per-

form all of the services she performed.

In making her argument, petitioner suggests that if

we apply the prior decision in Anne Moen Bullitt

Brewster, supra, then the 30-percent figure in the net

profits limitation contained in the second sentence of

7 We are cognizant of the intervening decision of the Court of

Claims in Vogt v. T/nited States, 537 F.2d 405 (Ct. Cl. 1976). But

the issue in Vogt \,as an entirely different one, i.e., whether the

dollar limitation of sec. 911 should be applied to a partner’s share

of the gross income or net income of a profitable personal service

partnership, and the Court of Claims carefully distinguished

Brewster v. Commissioner, 473 F.2d 160 (D.C. Cir. 1972), affg. 55

T.C. 251 (1970).

30a

section 911(b) should not be imposed in determining

what portion of gross income constitutes ‘‘a reason-

able allowance as compensation for the personal ser-

vices rendered” as provided in the preceding portion of

that sentence. To the extent that petitioner's argu-

ment is based upon the assertion that the 30-percent

argument is based upon the assertion that the 30-

percent figure should not be mechanically applied, we

agree with her position. Given the theory of the deci-

sion in Anne Moen Bullitt Brewster, supra, we think

that the amount of reasonable compensation can, de-

pending upon the facts and circumstances of each

case, be found to be above or below 30 percent of

gross income.® From this point on, however, peti-

tioner’s approach misses the mark.

In the first place, we are not convinced, as peti-

tioner urges, that we should adopt precisely the same

test for determining reasonable compensation under

section 911(b) as is utilized in the cases involving the

allowance of a deduction for compensation paid or

accrued under section 162(a)(1), although we recog-

nize that the two sections use substantially the same

language.® There are numerous factors which enter

into the determination of reasonableness under sec-

tion 162(a)(1). See, e.g., Pepsi-Cola Bottling Co. of

Salina, Inc., 61 T.C. 564, 567-568 (1974), affd. 528 F.2d

*Indeed, even if a 30-percent limitation applied under the

gross income theory, it is clear from the second sentence of sec.

911(b) that it only provides a ceiling and would not preclude a

finding of less than 30 percent. That situation does not exist

herein because neither party is contending for a lesser amount.

*Sec. 162(a)(1) allows a deduction, as an ordinary and

necessary business expense, of “a reasonable allowance for

salaries or other compensation for personal services actually ren-

dered.”

3la

176 (10th Cir. 1975); 4A Mertens, Law of Federal In-

come Taxation secs. 25.69-25.81 (Malone rev.). Some

of these factors are not present in a situation, such as

is involved herein, where there is no compensation

actually paid or accrued; rather the determination

herein requires the construction of an imputed “rea-

sonable compensation” geared directly to the portion

of petitioner's gross receipts attributable to her ser-

vices as opposed to her capital input. As we view the

situation, only a combination ef capital and personal

services permits any receipts and this necessitates an

inquiry as to the portion of the receipts which should

be deemed attributable to each of such elements. Cf.

Mark Tobey, 60 T.C. 227 (1973).

Thus, while it cannot be gainsaid that there are

similarities in the decisional process under section

162(a)(1) and section 911(b), the latter situation has a

somewhat different cast and the difficulties are per-

haps even greater than those confronted in the former

situation where, as has been observed, there is “no

definite formula” (see Jones Bros. Bakery, Inc. v.

United States, 411 F.2d 1282, 1291 (Ct. Cl. 1969)) or

“universal rule” (see Charles McCandless Tile Service

v. United States, 422 F.2d 1336, 1338 (Ct. Cl. 1970)).

Compare D. & N. Auto Parts Co., 8 T.C. 1192,

1196-1197 (1947).

In the second place, even if we were to agree that

section 911(b) completely tracks section 162(a)(1), we

would be unable to accept petitioner’s argument here-

in. The bulk of that argument is based upon the con-

tention that ‘the proper measure of petitioner’s com-

pensation is the amount she would have had to pay

someone to replace her.” Concededly, this is one of

the elements to be taken into account but it cannot be

32a

the sole element. If the latter were the case, the

degree of profitability of the business (or, more accur-

ately, the existence of continual losses) would be

eliminated from our consideration, a clearly unaccept-

able consequence (see The Barto Co., 21 B.T.A. 1197,

1199 (1931))—and one which also assumes that peti-

tioner would be willing to expend the additional sums

to compensate such replacement personnel notwith-

standing the already large losses being incurred by

the business (see Crescent Bed Co., a Memorandum

Opinion of this Court dated April 6, 1942, affd. 133

F.2d 424 (5th Cir. 1943)). Moreover, we would be un-

able to consider the degree to which petitioner’s em-

ployees, such as the stud groom, the head lad, and the

accountant (who discharged operational responsibili-

ties), in fact performed services which would other-

wise have been performed by the claimed replace-

ment personnel and which lessened the extent of the

activity demanded of petitioner. Finally, the standard

suggested by petitioner would preclude consideration

of the fact that petitioner’s role was of a dual nature,

consisting of contributions to the business not only in

terms of the performance of services in a quasi-

employee role but also in terms of her role as owner,

i.e., using her resources to generate a return on her

investment. Cf. Charles McCandless Tile Service v.

United States, supra at 1338.

The ultimate question is what was the worth of

petitioner’s services in the generation of gross income

of the business.'® Although there is testimony as to

how long and hard petitioner worked, we have been

Congress, the test as applied to a service-capital business was ar-

ticulated as one “to determine what the man’s own personal ser-

vices are worth.” See 65 Cong. Rec. 2850 (1924).

33a

furnished with no evidence as to the value thereof,

aside from the amount which purportedly would have

had to be paid for replacement personnel. Such being

the case, we are compelled to conclude that petitioner

has failed to carry her burden of proof in overcoming

respondent’s determination that 30 percent of gross

farm income constitutes “a reasonable allowance as

compensation for the personal services rendered”

within the meaning of section 911(b). In so concluding,

we again emphasize that we are not adopting a

mechanical formula for all cases. See pp. 358-359,

supra. We are merely holding that, under the cir-

cumstances of this case, respondent’s determination

should not be overturned. In the foregoing context,

any.attempt by petitioner to upset respondent's deter-

mination on the ground that a flat percentage allow-

ance will produce varying amounts of reasonable com-

pensation from year to year falls by the wayside.

Petitioner further contends that, in computing the

amount of her excludable earned income, the dollar

limitations contained in section 911(c)(1), applicable to

taxable years 1963 through 1965, should be increased

in accordance with section 911(c)(7)"" by the amount

'! That paragraph provides:

(7) CERTAIN NONCASH REMUNERATION.—If an individual

who qualifies under subsection (a)(1) receives compensation from

sources without the United States (except from the United

States or any agency thereof) in the form of the right to use

property or facilities, the limitation under paragraph (1) ap-

plicable with respect to such individual —

(A) for a taxable year ending in 1963, shall be increased by

an amount equal to the amount of such compensation so

received during such taxable year;

(B) for a taxable year ending in 1964, shall be increased by

an amount equal to two-thirds of such compensation so

received during such taxable year; and

34a

representing the value of the facilities of the business

which she used. Under our holding, the dollar limita-

tions applies only to the taxable year 1963. See p. 355,

supra. Petitioner’s argument is without merit. Al-

though petitioner utilized the facilities of the business

for personal purposes, e.g., the house and the automo-

biles, we know of no theory pursuant to which the

value of such use or the deduction of the portion of

the expenses allocable thereto could enter into the

calculation of petitioner’s taxable income from her

sole proprietorship.'*” Even if some such theory could

be constructed, it could not be said that such allocable

portion of expenses was received as “compensation

* * * in the form of the right to use.” Sec. 911(c)(7).

Compare Challenge Manufacturing Co., 37 T.C. 650,

663 (1962) (disallowed expenses paid on behalf of a

shareholder-employee not treated as compensation

because not paid as such), and Rapid Electric Co., 61

T.C. 232, 241 (1973) (to the same effect). Indeed,

given this statutory language, there is a serious ques-

tion whether it has any applicability with respect to

the excludable gross income of sole proprietors.

We now turn to the deduction side of the section

911 computations. The governing provision is con-

tained in section 911(a) and reads as follows:

An individual shall not be allowed, as a deduction

from his gross income, any deductions (other

than those allowed by section 151, relating to

an amount equal to one-third of such compensation so received

during such taxable year.

In point of fact, petitioner herself allocated a portion of such

expenses attributable to those facilities as personal and excluded

them from the deductions claimed on her return.

35a

personal exemptions) properly allocable to or

chargeable against amounts excluded from gross

income under this subsection.

Petitioner first asserts that, since earned income

should be determined by equating reasonable compen-

sation with the amount she would have paid others to

perform her services, nondeductible expenses alloca-

ble to earned income should only be those that such

hypothetical other employees would have incurred.

Since, according to petitioner, they would have in-

curred none of the expenses claimed by petitioner as

a proprietor of a service-capital business, the ex-

cluded income should not be charged with any such

expenses. Our rejection of the “employee approach”

in respect of income disposes of this argument. The

invalidity of petitioner’s position is further revealed

by the fact that such an approach, an exclusion from

income without any disallowance of expenses, would

produce a tax loss in excess of petitioner’s actual

loss.'*

Petitioner next focuses on the statutory language

disallowing deductions “allocable to or chargeable

against” excludable income and argues that such lan-

guage requires an item-by-item analysis of each farm

expense to determine which expenses are definitely

related to, or identified with, earned income. In this

vein, petitioner takes the position that only four types

of her farm expenses bore the requisite factual rela-

tionship to her personal services. Of these four ex-

penses (motor car expense, motor car depreciation,

travel and entertainment, and periodicals), petitioner

‘8 This result would not obtain where it was possible to con-

clude that there were hypothetical employee expenses in an

amount at least as great as the amount of excluded gross income.

36a

claims only one-third of the costs was attributable to

her personal services and the balance was «:tributa-

ble to her employees.

While it is true that a good portion of petitioner’s

total farming expenses appears to be capital-related

(e.g., feed, seed, saddlery, repairs, etc.), the nature of

this service-capital business is such that even these

expenses are related to earned income since without

them earned income could not have been realized. See

George Rousku, 56 T.C. 548, 552 (1971); Fred J.

Sperapani, 42 T.C. 308, 334 (1964).'* Moreover, disal-

lowed deductions are statutorily keyed to “amounts

excludable from gross income,” not to the personal

services rendered per se, so that the standard urged

by petitioner has no statutory foundation. In fact,

petitioner’s argument seeks to impart a definite iden-

tification of expenses with personal services on the

deduction side, although as petitioner herself recog-

nizes, the assignment of a portion of receipts to per-

sonal services on the income side is not based upon

any definite identification of a particular item of gross

income with the rendition of personal services."

Petitioner attempts to attach some special signifi-

cance to the words used by Congress in disallowing

‘See also Frieda Hempel, a Memorandum Opinion of this

Court dated June 23, 1947, in which all expenses of a business

where capital was not a material income-producing factor were

chargeable against earned income, although some of the expenses

were of the type petitioner herein would allocate solely to capital

(e.g., office supplies, managerial and secretarial expenses, etc.).

'® We do not accept petitioner’s suggestion that the comment of

the Court of Appeals for the District of Columbia in the prior

Brewster case (see 473 F.2d at 164 n. 6) requires an item-by-item

analysis. That comment was made in the context of a stipulation

in which the parties agreed as to which expenses were deductible

and which were not, a situation which does not obtain herein.

37a

expenses “allocable to or chargeable against” ex-

cluded income in section 911(a). She argues that these

words require the disallowance of only those expenses

as to which there is a definite factual relationship to

her services, with all other expenses to be allowed as

deductions, and that, had Congress intended to disal-

low expenses in the same ratio that excluded income

bears to gross foreign-source income, as respondent

has done, it would have instead chosen the word “ap-

portionment.” We see no reason to conclude that Con-

gress intended that the standard to be applied on the

deduction side of section 911 should operate in such a

beneficial fashion for the taxpayer. Indeed, if peti-

tioner’s interpretation is correct, it can be argued

that she has read the word “allocate” out of the

statute, since the existence of a definite factual rela-

tionship would seem to be encompassed within the

phrase “chargeable against.” Cf. Carstairs v. United

States, 75 F.Supp. 683, 685 (E.D. Pa. 1936).

Nor are we disposed to engage in a semantic exer-

cise so as to divine shadings of legislative intention

based on the use of the word “allocation” rather than

“apportionment.” It is of some significance that the

dictionary defines “allocation” in terms of “apportion-

ment.” See Webster’s Third’ New International Dic-

tionary (Unabridged) (1965). Whatever may be the

interpretation of these words in other sections of the

Code,'* we are not persuaded that we should adopt a

narrow interpretation of the phrase “allocable to or

chargeable against” used in section 911. Cf. Carstairs

16 E.g., secs. 861 and 862 and the regulations thereunder, which

were dealt with on a basis seemingly favorable to the taxpayer in

F. W. Woolworth Co., 54 T.C. 1233, 1269 et seq. (1970), although

we are constrained to note that respondent had the burden of

proof. See 54 T.C. at 1264.

38a

v. United States, supra. In this connection, we note

that, as in the case of petitioner’s first argument re-

lating to her deductions (see p. 362, supra), her “allo-

cation vs. apportionment” theory could produce enti-

tlement of a taxpayer to a loss in excess of the actual

loss."”

We see no reason to construe a provision of the

Code excluding amounts from gross income in a fash-

ion so favorable to the taxpayer when the language of

the provision does not compel this result. Perhaps

there will be situations where the deductible items

can be sufficiently identified as solely capital-related

so as to justify the conclusion that they should not be

disallowed under section 911(a). But such is not the

case herein and consequently we sustain respondent’s

use of an allocation of 30 percent of expenses (except

with respect to 1963, see p. 355 and n. 4, supra) to

petitioner’s excludable earned income. Here again we

are constrained to note, as we did on the income side,

that we are not putting our stamp of approv.! on the

unvarying use of a percentage figure, much less a

uniform 30 percent, on the deduction side, although we

recognize that, in the usual situation, the use of the

same percentage on the income and deduction sides is

likely to be appropriate.

Perhaps because petitioner recognizes that her

first two theories could produce situations where the

deductible loss for tax purposes would exceed the

'7 Assume total gross income of $1,000, expenses of $1,500, of

which only $100 are clearly identified with earned income. On the

basis of a 30-percent exclusion from gross income, the taxpayer

would report $700 of gross income and, under petitioner's theory,

would be entitled to deduct $1,400. This produces a tax loss of

$700, although the actual loss is only $500.

39a

actual loss, she makes a still further argument that in

no event should the amount of the disallowed deduc-

tions exceed the amount of excluded earned income.

The basis for petitioner’s contention is that such an

approach is all that is necessary to avoid the double

tax benefit against which the deduction provision in

section 911 was presumably directed. Clearly there is

no language in the statutory provision which provides

any basis whatsoever for importing the suggested

limitation. Moreover, the arithmetic of petitioner's

proposal is such that it eliminates the same dollar

amount on the income side and deduction side, there-

by producing the same loss as is produced by using

the gross figures on both sides. Obviously, adoption of

such a proposal would render entirely nugatory the

prior decision in Anne Moen Bullitt Brewster, supra.

It is no doubt for this reason that the Court of Ap-

peals specifically rejected this position, although such

rejection can arguably be characterized as dictum.

See 473 F.2d at 164 n.6.'*

Respondent determined that the amount of gross

farm expenses to be disallowed is—

Excluded earned income x Gross farm expenses

Gross farm income

Petitioner argues that even if this formula is cor-

rect, the amount of gross farm expenses to be plugged

in should not include an amount attributable to gain

'8 Moreover, the allowance of excess deductions (which is the

other side of the same coin) was specifically rejected in Frieda

Hempel (n. 14 supra). Compare also the discussion in [vor Corn-

man, 63 T.C. 653, 660 (1975), with respect to the failure to obtain

legislative sanction of this position in connection with excess

deductions related to tax-exempt income under sec. 265.

40a

from the sale of horses.'® Petitioner reasons that be-

cause such gain, subject to beneficial capital gain

treatment under section 1231, was not included in the

gross farm income for purposes of computing earned

income, no part of the expenses attributable to the

horses sold should be disallowed as being allocable to

the excluded earned income. Because petitioner can-

not identify the expenses relating to the horses sold,

which she would insulate from the proportional disal-

lowance, she seeks to accomplish her objective by

arguing that the amount of section 1231 gain realized

each year should be added to the amount of gross

farm income used by respondent in the denominator

ot the fraction previously noted.

The fact that the amount of such gain was not

treated as part of gross income for purposes of com-

puting excludable earned income is of no relevance in

light of our rejection of the mechanical application of

any percentage of gross income in arriving at such

computation and our conclusion that petitioner has

'* Petitioner also argues that the gross expenses should be

reduced by expenses attributable to horserace winnings. It

would appear that this argument is addressed to an error in

respondent's deficiency notice calculations which netted gross

race winnings and expenses. Respondent has conceded his error

in this regard and the necessary corrections are reflected in the

figures shown in our findings of fact. See pp. 354-355, supra. It

would appear that this disposes of petitioner’s contention in

respect of this item.

Although this adjustment results in the disallowance of more

expenses than were disallowed in the notice of deficiency, it also

results in the exclusion of more income. Thus, but for the

operation of the dollar limitation on earned income in 1963,

respondent's adjustment, like his deficiency notice, results in the

same amount of reduction of petitioner's claimed losses. For 1963,

the reduction in petitioner's allowable loss is less than that in the

deficiency notice.

4la

failed to carry her burden of proof that the amount

excluded did not represent “reasonable allowance as

compensation for [petitioner’s] personal services.”

As for petitioner's contention that a certain portion

of her gross farm expenses should be immune from

the operation of the disallowance because a portion of

such expenses was attributable to horses sold, we dis-

agree. On her tax returns, petitioner offset the gain

from such sales with expenses clearly identifiable

therewith (e.g., commissions). Other expenses relat-

ing to such horses were basically breeding, racing, or

maintenance costs and the fact of the matter is that

petitioner maintained many, if not all, of the horses

sold for breeding and racing, activities generating or-

dinary gross farm income through the combination of

capital input and petitioner’s personal services. Com-

pare Mark Tobey, supra; George Rousku, supra.

Thus, we find no basis for adjusting respondent's for-

mula (either by directly reducing the gross farm ex-

pense element or by increasing the gross farm income

denominator, with a consequent reduction in the

amount of expenses disallowed) to reflect the fact

that some of petitioner’s ordinary farm expenses re-

lated to horses eventually sold.

It cannot be gainsaid that the legislative and judi-

cial situation relating to the treatment of earned in-

come abroad is far from satisfactory. It has, as the

Court of Appeals for the District of Columbia has

observed in its opinion in the prior Brewster case,

produced “certain incongruities” and a condition

which “is not welcomed.” See 473 F.2d at 163-164.

Any remedy of such “incongruities” and “unwelcome

condition” must, in our opinion, emanate from the

Congress.

42a

Reviewed by the Court.

Decision will be entered under Rule 155.

Sterrett and Quealy, JJ., did not participate in the

consideration and disposition of this case.

Hall, J. concurring: I agree with Judge Goffe on the

merits but think Golsen requires a decision for

respondent.

Goeffe, J., dissenting: I respectfully dissent. The

majority opinion is cast in terms of exclusions from

gross income but the end result is to deny the full

losses petitioner sustained in the operation of her

farm. This result is produced by holding that Jack E.

Golsen, 54 T.C. 742 (1970), affd. 445 F.2d 985 (10th Cir.

1971), precludes examination of our prior decision and

requires a decision in favor of respondent.

Our holding in Jack E. Golsen, supra, recognized

that if a party losing a case in the Tax Court appealed

to a Court of Appeals which previously held a position

contrary to ours, that he would win on appeal.

Therefore, in the interest of efficient and harmonious

judicial administration we held that in such instances

we would apply the holding of that Court of Appeals.

We stated that “We shall remain able to foster unifor-

mity by giving effect to our own views in cases ap-

pealable to courts whose views have not yet been ex-

pressed, and, even where the relevant Court of Ap-

peals has already made its views known, by explaining

why we agree or disagree with the precedent that we

feel constrained to follow.” 54 T.C. at 757. Golsen in-

volved a position of the Court of Appeals that arose

from an appeal from the District Court not the Tax

Court. Golsen requires us to follow the position of the

Court of Appeals for the circuit in which the taxpayer

43a

resided at the time he filed his petition in the Tax

Court. All appeals from cases initiated in the Tax

Court by United States citizens residing abroad lie in

the United States Court of Appeals for the District of

Columbia. If the Golsen rule is applied to the instant

case, therefore, a whole class of taxpayers (U.S.

citizens residing abroad), are precluded from having us

reexamine our holding in the first Brewster case

unless such taxpayers pay the tax and sue in the Court

of Claims or unless they change their residence to the

United States, except to the District of Columbia. The

Golsen rule is solely a rule of law of the Tax Court. !t is

not etched in stone. It has been neither commended

nor criticized by a Court of Appeals or the Supreme

Court. It has never been extended to apply to the same

taxpayer. Application of the Golsen rule in this case

makes our prior opinion virtually “review-proof.” I

conclude, therefore, that Golsen should not compel a

decision for respondent but we should, instead, freely

examine our holding in the first Brewster case.

Moreover, the recent holding of the Court of Claims in

Vogt v. United States, 537 F.2d 405 (Ct. Cl. 1976),

severely undermines the rationale of our prior

Brewster decision and that of the Court of Appeals in

the first Brewster case.

The majority in the instant case disallows 30 percent

of petitioner’s deductions from the operations of her

farm in Ireland under section 911(a) of the Code. This

section is not a general section of the Code. It provides

only for disallowance of deductions properly allocable

to or chargeable against amounts excluded from gross

income. The sole purpose of disallowing deductions so

“allocable or chargeable” is to prevent a double

benefit; i.e., excluding the income and deducting the

expenses relating to such income. There is no

44a

statutory prohibition against offsetting foreign deduc-

tions against income from U.S. sources. Even the

majority permits petitioner to offset the remaining 70

percent of her Ireland farm deductions against income

from U.S. sources.

The disallowance of petitioner’s deductions comes

about by requiring petitioner to exclude 30 percent of

the gross income from operations of her farm in

Ireland. On her returns petitioner excluded no income

from the operation of the farm because it operated at a

loss. In the first Brewster case we held that she must

exclude 30 percent of the gross profits from the farm

although section 911(b) allows an exclusion not to ex-

ceed 30 percent of net profits. The exclusion is

designed to permit a U.S. citizen residing abroad to ex-

clude from income a portion of the net income from a

trade or business attributable to the personal services

rendered by such a taxpayer as distinguished from the

portion of net income produced by invested capital. We

held in the first Brewster case that the 30-percent

limitation on the amount of income excludable was ap-

plicable only if there were net profits from the

business; because there were only losses, not profits,

the limitation did not come into play; and, therefore,

petitioner must exclude 30 percent of gross profit. Ac-

cordingly, under section 911(a), we required that a por-

tion of petitioner’s deductions be disallowed (the

amount to be disallowed was stipulated in the first-

Brewster case but not in the instant case).

The exclusion provided in section 911(a) is for

“earned income” as that term is defined in section

911(b). The definition of earned income which is em-

bodied in section 911(b) originated in the Revenue Act

of 1924. It had nothing to do with income earned from

45a

foreign sources but, instead, was defined in order to

impose a lower rate of tax on all earned income. Sec.

209(a)(1), Revenue Act of 1924, ch. 234, 43 Stat. 263,

264. The limitation was enacted to facilitate adminis-

tration of the Act. H. Rept. No. 179, 68th Cong., 1st

Sess. (1924), 1939-1 C.B. (Part 2) 241, 245. S. Rept. No.

398, 68th Cong., 1st Sess. (1924), 1939-1 C.B. (Part 2)

266, 281; 65 Cong. Rec. 2850. The concept of earned in-

come as distinguished from income derived from in-

vested capital in the case of unincorporated businesses

resulted from a floor amendment to the bill designed

to aid farmers (as is petitioner here) and small

businessmen. 65 Cong. Rec. 2849. The application of

the “earned income” concept to exclude income earned

outside the U.S. was first enacted in the Revenue Act

of 1926. Sec. 213(b)(14), Revenue Act of 1926, ch. 27, 44

Stat. 26. At that time Congress also provided that

deductions properly allocable to or chargeable against

such excluded income were not allowable (now sec.

911(a)). Although Congress has changed the per-

centage and has otherwise modified the percentage

limitation on exclusion of earned income it has never

expressed the limitation in terms other than as a per-

centage of net profits. The effect of our prior decision,

the decision of the Court of Appeals, and now, the

majority, is to nullify the language of the percentage

limitation when the business suffers a net loss. Such an

interpretation is erroneous. There is no legislative

history to support our prior conclusion. Moreover, it is

fundamental in statutory construction to give effect to

all of the language of the statute. Hellmich v. Hellman,

276 U.S. 233 (1928); Larkin v. United States, 78 F.2d

951 (8th Cir. 1935); Stanford v. Commissioner, 297

F.2d 298, 308 (9th Cir. 1961); William C. Stolk, 40 T.C.

345 (1963), affd. per curiam 326 F.2d 760 (2d Cir. 1964).

46a

The limitation of 30 percent of net profits should be

applied in all cases, regardless of the existence of net

profits. Therefore, applying the limitation literally, to

a net loss as we have here, 30 percent of zero is zero

and the limitation of section 911(b) precludes exclusion

of any portion of petitioner’s income as “earned in-

come.” Because no income is excluded, no deductions

are disallowed under section 911(a). Moreover, our in-

terpretation in the first Brewster case is not consonant

with the taxation of proprietorships generally; i.e., no

income is realized by virtue of the efforts of the

proprietor unless a net profit results.

In the first Brewster case the Court of Appeals held

that the statutory concept of “earned income” was

structured in terms of gross income not net profits.

Brewster v. Commissioner, 473 F.2d 160, 162 (D.C.

Cir. 1972). That conclusion has since been rejected by

the Court of Claims. Vogt v. United States, 5387 F.2d

405 (Ct. Cl. 1976). That case involved the method of

computing the amount excludable from income under

section 911(a) received from a partnership which oper-

ated outside the U.S. It did not involve an allocation

between the income attributable to the taxpayer's

personal services and the income attributable to the in-

vested capital but, instead, whether the dollar limita-

tion on the amount excludable applied to the part-

ner’s distributive share of the gross profit of the part-

nership or its net profit. Relying in part on our decision

in Warren R. Miller, Sr., 51 T.C. 755 (1969), the Court

exhaustively examined all of the interpretations of sec-

tion 911 and concluded that the taxpayer demon-

strated that there was a long-standing administrative

interpretation that a partner’s “earned income” from a

pertnership is his share of net profits. The net profits

concept, so aptly explored by the Court of Claims, in

47a

the partnership context should apply here to a sole

proprietorship. In both cases a taxpayer includes in his

gross income his net profit from a proprietorship or

his distributive share of the profits of a partnership

(except for items upon which the Code imposes limi-

tations). By the same token, he deducts the net loss

of his sole proprietorship or his distributive share of

the net loss of the partnership.

The net profits concept is the only rationale that is

consistent with taxation generally. Requiring pe-

titioner to exclude 30 percent of the gross profits of

the proprietorship is not consistent with the general

scheme of taxation of sole proprietorships or part-

nerships. Expression of the exclusion in terms of an ex-

clusion from gross income in section 911(a) does not

make the exclusion a gross income concept. It merely

identifies the point in the computation of the tax-

payer’s overall tax liability at which the exclusion ap-

plies. All exclusion provisions are expressed in terms

of exclusion from gross income.

The reliance by the Court of Claims on Warren R.

Miller, Sr., supra, requires an examination of our

holding in that case. We had before us the meaning of

the term “earned income” for purposes of reduction of

retirement income in connection with the retirement

income credit. We were called upon to interpret that

term as it is used in section 911(b), the identical section

involved herein. We thoroughly analyzed the term and

concluded that earned income was keyed to net profits,

not gross profits. 51 T.C. at 762. In the first Brewster

case we admitted that Miller “gave us pause”;

however, we dismissed petitioner’s contention that

Miller applied by pointing out that in Miller we were

coordinating two sections of the Code which we were

48a

not doing in Brewster. That is a distinction without a

difference. Section 37, which allowed the retirement

income credit, incorporated by reference section

911(b). We may have so lightly dismissed our prior in-

terpretation of section 911(b) in Miller when we

decided the first Brewster case but the Court of

Claims considered it viable enough to quote from our-

Miller opinion in its opinion.

I conclude that our interpretation of “earned in-

come” in section 911(b) as being a net profits concept

as fully developed in Miller, was correct as is the

opinion of the Court of Claims in Vogt, relying on

Miller, and we erred in holding to the contrary in the

first Brewster case which, in turn, led the Court of Ap-

peals in Brewster to an erroneous conclusion. I would,

therefore, hold that the 30-percent limitation of section

911(b) means exactly what it clearly says without any

“court made” limitation; “30 percent of his share of the

net profits of such trade or business.” Applying the un-

mistakable language of section 911(b) to the “net

profits” of petitioner’s trade or business; i.e., a net

loss, 30 percent of zero is zero and petitioner had no

earned income and no deductions should be disallowed

under section 911(a).

Featherston, Irwin, and Wiles, JJ., agree with this

dissent.

APPENDIX

49a

APPENDIX C

(Filed June 28, 1979)

UNITED STATES COURT OF APPEALS

FOR THE DISTRICT OF COLUMBIA CIRCUIT

No. 77-2010

ANNE MOEN BULLITT BIDDLE BREWSTER, Appellant

COMMISSIONER OF INTERNAL REVENUE, Appellee

BEFORE: MacKinnon and Robb, Circuit Judges; and

Richey*, Judge, United States District

Court for the District of Columbia

ORDER

Upon consideration of appellant’s petition for

rehearing or remand, it is

ORDERED, by the Court, that appellant’s aforesaid

petition is denied.

Per Curiam

For the Court,

/s/ George A. Fisher

Clerk

*Sitting by designation pursuant to Title 28 U.S.C. §292(a).

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(Filed June 28, 1979)

UNITED STATES COURT OF APPEALS

FOR THE DISTRICT OF COLUMBIA CIRCUIT

No. 77-2010

ANNE MOEN BULLITT BIDDLE BREWSTER, Appellant

COMMISSIONER OF INTERNAL REVENUE, Appellee

BEFORE: Wright, Chief Judge; Bazelon, McGowan,

Tamm, Leventhal, Robinson, MacKinnon,

Robb, and Wilkey, Circuit Judges

ORDER

The suggestion for rehearing en banc filed by

appellant Anne Moen Bullitt Biddle Brewster, having

been transmitted to the full Court and no judge in

regular active service having requested a vote with

respect thereto, it is

ORDERED, by the Court, that appellant’s aforesaid

suggestion for rehearing en banc is denied.

Per Curiam

For the Court:

/s/George A. Fisher

Clerk

Circuit Judge Leventhal did not participate in the foregoing

order.

APPENDIX [)

5la

APPENDIX D

Internal Revenue Code of 1954 (26 U.S.C.):*

SEC. 911. EARNED INCOME FROM SOURCES

WITHOUT THE UNITED STATES.

(a) [as amended by Sec. 11(a), Revenue Act of

1962, P.L. 87-834, 76 Stat. 960] General Rule.—The

following items shall not be included in gross in-

come and shall be exempt from taxation under this

subtitle:

(1) Bona fide resident of foreign country.—In

the case of an individual citizen of the United

States who establishes to the satisfaction of the

Secretary or his delegate that he has been a bona

fide resident of a foreign country or countries for

an uninterrupted period which includes an entire

taxable year, amounts received from sources

without the United States (except amounts paid

by the United States or any agency thereof)

which constitute earned income attributable to

services performed during such uninterrupted

period.*** ;

* * a

An individual shall not be allowed, as a deduction

from his gross income, any deductions (other than

those allowed by section 151, relating to personal

exemptions) properly allocable to or chargeable

against amounts excluded from gross income under

this subsection.

* The provisions of section 911 set forth here are as they were

during the 1962-1969 periud in question.

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(b) Definition of Earned Income.—For purposes

of this section, the term ‘earned income’ means

wages, salaries, or professional fees, and other

amounts received as compensation for personal

services actually rendered, but does not include

that part of the compensation derived by the tax-

payer for personal services rendered by him to a

corporation which represents a distribution of

earnings or profits rather than a reasonable allow-

ance aS compensation for the personal services

actually rendered. In the case of a taxpayer en-

gaged in a trade or business in which both personal

services and capital are material income-producing

factors, under regulations prescribed by the Secre-

tary or his delegate, a reasonable allowance as com-

pensation for the personal services rendered by the

taxpayer, not in excess of 30 percent of his share of

the net profits of such trade or business, shall be

considered as earned income.

* * *

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