Opinion
No. CV-08-170-FVS.
November 25, 2009
Gary C. Randall, Eric James Sachtjen, James Joseph Workland, Workland Witherspoon PLLC, Spokane, WA, for Plaintiff.
Jennifer D. Auchterlonie, W. Carl Hankla, U.S. Department of Justice, Washington, DC, for Defendant.
ORDER RE CROSS MOTIONS FOR SUMMARY JUDGMENT
THIS MATTER comes before the Court based upon cross motions for summary judgment. The plaintiff is represented by Gary C. Randall, James J. Workland, and Eric J. Sachtjen. The defendant is represented by Jennifer D. Auchterlonie and W. Carl Hankla.
The Court has determined oral argument will not be helpful. Local Rule 7.1(h)(3).
A.
John Stahl belongs to a religious corporation whose members live communally and hold their property in common. The corporation is not required to pay federal income tax. 26 U.S.C. § 501(d) (establishing an exemption for "[r]eligious . . . corporations . . . [that] . . . have a common treasury"). Instead, the corporation's members pay tax on its income. Members may reduce their tax liability by invoking deductions the corporation is entitled to take ("corporate-level" deductions). In addition, members may reduce their tax liability by invoking deductions they, as individuals, are entitled to take ("individuallevel" deductions). Mr. Stahl argues the religious corporation to which he belongs may deduct from its gross income the value of food and medical care it provided to him during tax years 1997, 1998, and 1999. Not only that, but also he argues he may deduct from his gross income the value of meals he receives on the corporation's premises for the corporation's convenience during those same years.B.
John Stahl paid his federal income taxes for tax years 1997, 1998, and 1999. Thereafter, he submitted timely claims for refund with the Internal Revenue Service ("IRS"). The IRS denied his claims. Consequently, he filed an action against the United States. He alleges he overpaid his income taxes for the years in question, and the IRS has improperly refused to refund his overpayments. He seeks judgment against the United States in the amount of his alleged overpayments, together with interest, attorney's fees, and costs. The Court has jurisdiction over the subject matter of his action. 28 U.S.C. § 1346(a)(1); 26 U.S.C. § 7422.
Mr. Stahl is a founding member of the Stahl Hutterian Brethren ("SHB"). The latter is nonprofit corporation that was organized in order to enable its members to live in accordance with the tenets of the Hutterite tradition. Hutterites are a branch of the Anabaptist movement, which began in 16th century Europe. They live in colonies; emphasizing communal life. The SHB is like an extended family. Its core is composed of eight brothers, two sisters and their respective spouses. Those ten couples have produced children. As a result, the colony now numbers about 65 men, women, and children.
Like other Hutterite colonies, the SHB recognizes the spiritual authority of the elders of the Hutterian church. Nevertheless, the SHB is an independent corporation that exists under the laws of the State of Washington. Active members of the SHB elect the corporation's directors who, in turn, elect and supervise its officers. Mr. Stahl is the SHB's current president. He is accountable to the active members of the SHB for the colony's spiritual and material well being.
A person transfers his property to the SHB when he becomes a member. Members hold their property in common through the SHB as long as they are members. However, a member may sever his relationship with the SHB, or his fellow members may expel him. Should either contingency occur, the person forfeits his interest in the SHB's property. In the event he leaves the community, he takes the clothing he's wearing, and that's about it.
The SHB's approach to property is illustrated, in part, by its policy regarding credit cards. Individual members are not allowed to maintain separate accounts with credit card companies. However, the SHB has a corporate account. The president has issued copies of the SHB card to approximately 20 members. A member may use the SHB credit card to purchase an item in a store, but he must obtain the president's approval before doing so. For the most part, members use the SHB credit card when they are traveling.
The SHB farms approximately 30,000 acres of land. The SHB has appointed eight managers to oversee the various parts of the operation. Each member works to the extent he's able; typically, at a job that interests him. Children perform age-appropriate tasks. Members are expected to be self-motivated. Each works until he's completed his responsibilities for that day. When a member becomes sick, he stays home. He doesn't need to ask anyone's permission to miss work; although, if he has pressing responsibilities, he would notify his manager so the work is performed.
The SHB hires nonmembers to perform a limited number of jobs within the colony. Some of the jobs that are performed by nonmembers are short-term jobs. For example, the SHB pays an employment agency to provide seasonal workers. By contrast, some of the jobs that are performed by nonmembers are long-term jobs. For example, the SHB hires four nonmember school teachers to help educate its families' children. Not only does the SHB pay wages to its long-term, nonmember employees, but also the SHB makes contributions to government-mandated benefit programs such as the State of Washington's Industrial Insurance Act.
The SHB does not pay wages to its members; but it does take care of their needs. By way of illustration only, the SHB provides each family with a residence in the colony. The residences are like "condos." Furthermore, the SHB feeds its members. They typically share meals together in the colony's dining hall. Finally, the SHB pays for the medical care its members need. It is medical care and meals that lie at the heart of this action. SHB president John Stahl and the IRS disagree with respect to whether the value of those items is deductible. Their disagreement has its genesis in 26 U.S.C. § 501(d).
Section 501(d) creates an exemption from federal income tax for "[r]eligious . . . corporations . . . [that] . . . have a common treasury[.]" The reason for the exemption is this:
Without § 501(d), the income of a religious corporation such as the [SHB] would be subject to the regular corporate income tax at the corporate level, and, if distributed to organization members, the individual income tax at the shareholder level. If the corporate income were not distributed, the corporation would pay both the corporate income tax and the accumulated earnings tax.Kleinsasser v. United States, 707 F.2d 1024, 1025-26 (9th Cir. 1983). Congress decided it was unfair to require both a § 501(d) corporation and its members to pay federal income taxes. Id. at 1026. Consequently, Congress eliminated the corporate level of taxation and left "a single tier of individual income taxation." Id.
An individual member's federal income tax liability is determined by application of partnership accounting principles. Kleinsasser, 707 F.2d at 1026. The § 501(d) corporation files a partnership tax return. Id. at 1025 (citing Treas. Reg. (26 C.F.R.) § 1.6033-2(e)). "The partnership tax return allows the Internal Revenue Service to determine how much income must be reported by organization members." Id. at 1026. Each member files an individual tax return in which he declares his pro rata share of the corporation's income as his personal gross income. 26 U.S.C. § 501(d). For tax purposes, each member's share is treated as though it were a dividend received. Id. Individual members "pay income tax on their pro rata shares of organization income." Kleinsasser, 707 F.2d at 1025.
Given the structure of § 501(d), Mr. Stahl must calculate the SHB's taxable income before he can determine the amount of federal income tax he must pay. Corporate deductions play an important role in the process. A corporate deduction reduces the SHB's taxable income. This means the SHB reports less income on its tax return. The benefit to Mr. Stahl is obvious. His personal gross income is his pro rata share of the SHB's taxable income. As the SHB's annual taxable income goes down, so does his individual gross income. Once he has calculated his gross income, he can begin looking for deductions to which he, as an individual, is entitled.
Mr. Stahl seeks to invoke two deductions: one at the corporate level; the other at the individual member level. At the corporate level, the issue is whether the SHB may deduct, as business expenses, the value of meals and medical care it furnished to Mr. Stahl during tax years 1997, 1998, and 1999. 26 U.S.C. § 162(a) ("[t]here shall be allowed as a deduction all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business"). At the individual level, the issue is whether Mr. Stahl may deduct from his gross income the value of meals he received from the SHB on its premises for its convenience during tax years 1997, 1998, and 1999. 26 U.S.C. § 119(a) ("[t]here shall be excluded from gross income of an employee the value of any meals . . . furnished to him . . . by . . . his employer for the convenience of the employer, but only if . . . the meals are furnished on the business premises of the employer"). Mr. Stahl bears the burden of proving he is correct with respect to both deductions. See Smith v. Comm'r of Internal Revenue, 300 F.3d 1023, 1029 (9th Cir. 2002) ("`In general, an income tax deduction is a matter of legislative grace and . . . the burden of clearly showing the right to the claimed deduction is on the taxpayer.'") ((alterations in the original) (quoting Interstate Transit Lines v. Comm'r, 319 U.S. 590, 593, 63 S.Ct. 1279, 87 L.Ed. 1607 (1943))). The IRS argues Mr. Stahl cannot satisfy his burden of proof.
The parties have filed cross motions for summary judgment. "[J]udgment . . . should be rendered if the pleadings, the discovery and disclosure materials on file, and any affidavits show that there is no genuine issue as to any material fact and that the movant is entitled to a judgment as a matter of law." Fed.R.Civ.P. 56(c). In order for Mr. Stahl to defeat the United States' motion for summary judgment, he must present evidence from which a rational fact-finder could conclude the SHB is entitled to the corporate deduction (§ 162(a)) and he's entitled to the individual deduction (§ 119(a)). See Nissan Fire Marine Ins. Co., Ltd. v. Fritz Companies, Inc., 210 F.3d 1099, 1103 (9th Cir. 2000). In order for Mr. Stahl to prevail upon his motion for summary judgment, he must demonstrate a rational fact-finder would be compelled to accept his position with respect to one or both of the deductions at issue here. See Soremekun v. Thrifty Payless, Inc., 509 F.3d 978, 984 (9th Cir. 2007).
C.
Mr. Stahl contends he may deduct from his gross income the value of meals he receives on the SHB's premises for the SHB's convenience. 26 U.S.C. § 119(a). "The value of meals furnished to an employee by his employer shall be excluded from the employee's gross income if two tests are met: (i) The meals are furnished on the business premises of the employer, and (ii) the meals are furnished for the convenience of the employer." Treas. Reg. (26 C.F.R.) § 1.119-1(a). The IRS objects to Mr. Stahl's effort to invoke § 119(a). In its opinion, Mr. Stahl is not an employee of the SHB. If the IRS is correct, he is not entitled to take the deduction.
The first step is to identify the test for determining when a member of a § 501(d) corporation is also an employee of the corporation. The Ninth Circuit has not addressed that specific issue. Nor has any other circuit court of appeals. Some guidance may be drawn from Israelite House of David v. United States, 58 F.Supp. 862 (W.D.Mich. 1945). There, a district court applied a "right to control test" in a case that is similar to this one in important respects. Id. at 862. The Ninth Circuit has used much the same test in tax cases, although none involved § 501(d). See, e.g., Professional Executive Leasing v. Commissioner, 862 F.2d 751, 753 (9th Cir. 1988); General Investment Corp. v. United States, 823 F.2d 337, 341 (9th Cir. 1987). In General Investment Corp., the Ninth Circuit observed the basic test is whether the employer has the right to control the manner in which work is performed. 823 F.2d at 341. However, the Ninth Circuit listed other factors that profitably may be considered:
(1) whether the business has the right to discharge the worker; (2) whether the business furnishes tools to the person rendering the service; (3) whether the business provides the worker with a place to work; and (4) whether the work is performed in the course of the individual's business rather than in some ancillary capacity.Id. at 342 (citations omitted). The list in Professional Executive Leasing is virtually the same. The only factor it adds is whether the purported employer withholds "taxes, workmen's compensation and unemployment insurance funds[.]" Professional Executive Leasing, 862 F.2d at 753.
Viewed from a distance, the relationship between the SHB and its members resembles that of employer and employee. The SHB has the authority to determine which job a member will perform and how he will perform it. The SHB provides its members with places to work and the tools they need to perform their jobs; and the relationship between the SHB and its members is a permanent relationship, although the members have the authority to expel a wayward brother or sister. Thus, Mr. Stahl can argue plausibly he is an employee of the SHB. However, upon closer examination, it is clear his relationship to the SHB is very different from the typical employee/employer relationship.
An employer hires an employee to perform some job that will benefit the employer. The employee's value lies principally in what he can do for his employer. An employee can be replaced when it suits his employer's interests. Not so a member of the SHB. He is part of a body of believers. No member of the SHB has the authority to say to another member, "I don't need you anymore. Be gone." Such statements are unthinkable. Rather, the members of the SHB are distinguished by their devotion to one another.
At the same time, the SHB is a disciplined body. Members elect leaders and agree to submit to their leaders' authority, much of which is vested in the office of the president. For example, he may correct a member who is failing to perform his job. In theory, the president could remove the delinquent member from his job and ask him to perform some other job. However, the SHB would not expel a delinquent member from the colony because he performed a job incompetently. Only the member who breaks faith with his fellow members will be expelled.
The faith-based nature of the relationship between the SHB and its members is further reflected by the absence of wages. Employees work to earn wages, and the wages they receive are their own property. The members of the SHB work, and they work hard, but they neither expect to receive, nor do they receive, wages for their efforts. Instead, they hold all property in common and use it to provide for each other's needs. Unlike employees, they are not rewarded based upon skill, or productivity, or rank. To the contrary, each receives according to his needs. These are met by the colony. The SHB does not look to the government for support for its members. As a matter of religious principle, Hutterites refuse to participate in either the Social Security system or any other government-benefit program.
If any doubt remains regarding Mr. Stahl's status, it is removed by comparing it to the status of the nonmembers who work at the colony. They bear all the characteristics of true employees. The SHB hires each one to perform a specific task. It controls the manner in which he performs the task. It pays him wages for the work he performs, and it makes contributions on his behalf to government-mandated benefit programs. His relationship with the SHB lasts only as long the SHB needs his services and he performs his job to the satisfaction of the SHB.
In conclusion, the SHB knows how to hire employees when it needs them. Mr. Stahl's relationship to the SHB is substantially different from that of its nonmember employees. His relationship is based upon shared religious commitments, not upon job performance. Thus, were he totally disabled in an accident, his relationship with the SHB would continue indefinitely despite his inability to contribute materially to the life of the SHB. He would not seek assistance from the government, but would be supported by his fellow members. In view of the preceding circumstances, a rational fact-finder would be unable to determine Mr. Stahl is an employee of the SHB. This means he, as an individual member of the SHB, may not deduct from his gross income the value of meals he received on the SHB's premises for the SHB's convenience during tax years 1997, 1998, and 1999. The United States is entitled to summary judgment with respect to Mr. Stahl's claim for a deduction under 26 U.S.C. § 119(a).
D.
Mr. Stahl contends the SHB may deduct from its gross income the value of medical care and food it provided to him during tax years 1997, 1998, and 1999. The IRS disagrees. In its opinion, he is seeking a deduction for personal, living, or family expenses. The IRS argues such expenses are not deductible. 26 U.S.C. § 262(a) ("Except as otherwise expressly provided in this chapter, no deduction shall be allowed for personal, living, or family expenses.").
The parties' dispute over the deductibility of medical care may be resolved quickly. Mr. Stahl acknowledges the SHB is entitled to the deduction only if he is its employee. Waterfall Farms, Inc. v. Comm'r, 86 T.C. 648, 2003 WL 22838540, at *7 (2003) ("When payments for medical care are properly excludable from an employee's income because they are made under a `plan for employees,' they are deductible by the employer as ordinary and necessary business expenses under section 162(a)." (quoting Treas. Reg. (26 C.F.R.) § 1.162-10(a))). As explained above, Mr. Stahl is not an employee of the SHB. Thus, the corporation may not deduct the cost of his medical care under § 162(a).
The parties' dispute over the existence of a § 162(a) deduction for the cost of food is more difficult to resolve. Mr. Stahl relies upon Harrison v. Commissioner, 41 T.C. 1384 (1981). There, a judge allowed a company to deduct, as a business expense, the cost of food it provided to seasonal employees. The judge found that the company needed to furnish meals to seasonal employees in order to induce them to work on the company's farm. Id. He decided that the company's expenditures for employee meals were "`appropriate and helpful'" to the operation of the farm. Id. (quoting Welch v. Helvering, 290 U.S. 111, 115, 54 S.Ct. 8, 78 L.Ed. 212 (1933)). Consequently, he ruled that the company was entitled to deduct the cost of groceries as a business expense. Id.
This case is distinguishable from Harrison. In this case (unlike Harrison), the issue is whether a § 501(d) corporation may deduct the cost of meals it provides to a member who is not one of its employees. Harrison does not address that issue. As a result, Harrison does not help Mr. Stahl. He must seek some other rationale for the § 162(a) deduction he is attempting to invoke.
Mr. Stahl attempts to bolster his position by drawing upon the concept of "unrelated business taxable income." That he should rely upon the concept is surprising; for it is associated with organizations which are exempt from income tax pursuant to 26 U.S.C. § 501(c)(3). A § 501(c)(3) organization "must pay tax on income that it earns by carrying on a business not `substantially related' to the purposes for which the organization has received its exemption from federal taxation." United States v. American College of Physicians, 475 U.S. 834, 835, 106 S.Ct. 1591, 89 L.Ed.2d 841 (1986). The preceding case is instructive. The American College of Physicians ("ACP") publishes a journal named "The Annals of Internal Medicine." 475 U.S. at 836, 106 S.Ct. 1591. At one time, the ACP sold advertising space in the journal. The advertisements typically involved "pharmaceuticals, medical supplies, and equipment useful in the practice of internal medicine, as well as notices of positions available in that field." Id. The advertisements generated income for the ACP. Id. It paid tax on the net income and filed a claim for a refund, which the IRS denied. The ACP filed an action in the United States Claims Court. Id. at 837, 475 U.S. 834, 106 S.Ct. 1591, 89 L.Ed.2d 841. The latter rejected the ACP's request for a refund because it found the ACP's editorial policy concerning advertising was driven by financial considerations rather than by educational considerations. Id. at 849, 475 U.S. 834, 106 S.Ct. 1591, 89 L.Ed.2d 841. "`Those companies willing to pay for advertising space got it; others did not.'" Id. (quoting American College of Physicians v. United States, 3 Cl.Ct. 531, 534 (1983)). The Supreme Court agreed the advertising in question was not substantially related to the ACP's educational purpose. Id. at 849-150, 106 S.Ct. 1591. Consequently, it upheld the Claims Court's decision to deny a refund.
He has submitted a copy of a private letter ruling that applied the concept to the agricultural operations of a monastery. The monastery was not a § 501(d) organization; it had been granted a tax exemption under 26 U.S.C. § 501(c)(3).
Unlike the American College of Physicians, the SHB is not a § 501(c)(3) organization. It is a § 501(d) organization. Thus, the SHB does not have to worry about unrelated business taxable income:
[A § 501(d)] organization is granted its exemption not because of function, but because of form. It is totally unrestricted in function. Indeed, § 501(d) specifically allows the organizations it exempts to engage in business and thus compete with nonexempt entities. The only requirements for the exemption are that there be a common treasury, that the members of the organization include pro rata shares of organization income when reporting taxable income and, implicitly, that the organization have a religious or apostolic character. Once this requirement of form is fulfilled, the exempt organization is unlimited as to function. It can farm, as the Milford Colony does, or engage in manufacturing, or any other business or combination of businesses. It is definitionally impossible for a § 501(d) organization to have unrelated trade or business income. If the organization had income that it failed to allocate to its members, it would simply lose its exemption altogether.Kleinsasser, 707 F.2d at 1029. Given the preceding observations, it is clear the SHB cannot have unrelated business taxable income. Mr. Stahl's reliance upon the concept is misplaced. Since he has no other arguments to support his position, all that remains is to sum up.
As a result, the Court need not consider the private letter ruling he cites.
This section began with Mr. Stahl's contention the SHB may deduct from its gross income, as business expenses, the value of medical care and food it provided to him during tax years 1997, 1998, and 1999. The IRS denies the SHB may take § 162(a) deductions for the cost of medical care and meals it provided to Mr. Stahl. The IRS argues § 162(a) is trumped by § 262(a), which prohibits deductions for personal, living, or family expenses. It is unnecessary to determine whether the IRS is correct. If a § 501(d) organization is entitled to take a § 162(a) deduction for food and medical care it provides to its members (and its far from clear whether such a deduction is ever available), the § 501(d) organization may take the deduction only if, at a minimum, the member is an employee of the organization. Mr. Stahl is not an employee of the SHB. Consequently, the United States is entitled to summary judgment with respect to Mr. Stahl's contention the SHB may deduct from its gross income the value of medical care and food it provided to him during tax years 1997, 1998, and 1999.
IT IS HEREBY ORDERED:
1. The plaintiff's motion for summary judgment (Ct. Rec. 15) is denied.
2. The defendant's motion for summary judgment (Ct. Rec. 10) is granted.
3. The plaintiff's claims against the defendant are dismissed with prejudice.
IT IS SO ORDERED. The District Court Executive is hereby directed to file this order, enter judgment accordingly, furnish copies to counsel, and close the case.