Opinion
Case No. 99-CV-76369, Case No. 00-74575
September 6, 2001
OPINION AND ORDER DENYING DEFENDANT'S MOTION FOR SUMMARY JUDGMENT
INTRODUCTION
Plaintiff taxpayers in this matter, Laurence and Kathryn Mohn and Keith and Lisa Mohn, have filed two lawsuits against defendant United States of America under 28 U.S.C. § 1346, claiming tax improperly, illegally, and erroneously assessed, and seeking a refund of tax paid. The two lawsuits were consolidated upon the plaintiffs' request. The dispute concerns the deductibility of payments made by plaintiffs to reimburse a group of investors from whom the Mohns solicited funds for a failed investment in prime bank instruments. Defendant government now moves for summary judgment. Because the court has determined that material questions of fact exist concerning plaintiffs' motives in making the payments and the relationship of those payments to the plaintiffs' financial services businesses, defendant's motion is denied.
This matter concerns acts taken by Laurence and Keith Mohn; Kathryn and Lisa Mohn are plaintiffs in this lawsuit solely due to their joint taxpayer status with their spouses.
BACKGROUND
Laurence Mohn, who retired in June 1999, owned a John Hancock Mutual Life Insurance franchise called L.F. Mohn General Agent; his son, Keith Mohn, is in the financial services industry, and at the time of the payments in question, sold John Hancock insurance and mutual fund products through L.F. Mohn General Agent. Both Laurence and Keith Mohn reported business income to the Internal Revenue Service on Schedule C, Profit or Loss from Business. In 1993, Laurence and Keith Mohn were informed about an investment possibility through a Seattle, Washington group called Rosette Partners. The opportunity involved the trading of "prime bank" instruments (Laurence Mohn testified at his deposition that these are bank notes bought at a discount and sold at higher prices in the foreign banking market, Laurence Mohn deposition, pp. 14-15). The investment required an initial deposit of $600,000; the Mohns believed that this investment could produce a return on investment in the amount of 300-600 percent in a 10 day period.
Apparently Laurence Mohn believed the return could be in the range of 300-400% (Laurence Mohn deposition p. 25), and Keith Mohn believed the return could be as great as 500-600% (Keith Mohn deposition pp. 32, 58-59).
The Mohns, anxious to be involved in such an opportunity, solicited other investors (family members, friends, and fellow Oakland Hills Country Club members) to participate. The Mohns told potential investors they could expect a 400-500 percent return in a ten day period; the Mohns were to keep twenty percent of the profits made on the investment. Nine individuals agreed to participate in the prime bank investment opportunity. Concerning the nine individuals, defendant asserts that only one, Michael Baratta (Laurence Mohn's son-in-law) was shown to be a client of the Mohns' businesses. Plaintiffs dispute this assertion, contending that the company owned by Michael and Joe (now deceased) Baratta did business with plaintiffs, as did Michael Baratta on a personal basis, and that Earl Schwartz was also plaintiffs' client prior to the prime bank instrument investment. (Laurence Mohn deposition, p. 44, Keith Mohn deposition, p. 51-52).
On January 12, 1994, plaintiffs (through M M Trading Company Ltd., a company which was not otherwise activated, according to plaintiffs) entered into an agreement with Rosette Partners concerning the financial transaction. The $600,000 acquired from the investors was put in escrow with a Mr. Plowman, an attorney in Seattle, and was to be released upon the meeting of certain conditions. According to the Mohns, a telex was sent to Mr. Plowman in May 1994, indicating the bank had the bonds available for the transaction; Mr. Plowman believed the telex related to the financial transaction and that all of the conditions required for release of the escrowed funds had been met. Mr. Plowman then released the $600,000 to a Mr. Morgan (who the Mohns expected would broker the deal). However, soon after the release of the funds, the Mohns discovered that Mr. Morgan had not acquired the notes. Moreover, it was learned that Mr. Plowman did not have malpractice insurance and that Mr. Morgan had no assets in the U.S. to attach. Attorneys at the law firm in Seattle to which the Mohns were referred came to a conclusion that the $600,000 was unrecoverable.
The Mohns, after cashing in personal investments and taking bank loans, repaid the investors $520,000 in 1994 and $100,000 in 1995. Each Mohn paid $300,000. Plaintiffs assert that the investors were very upset and that some threatened to sue the Mohns if they did not receive repayment, so the Mohns decided to repay the investors to protect their business reputation. (Laurence Mohn deposition, pp. 70-71, 84-85, 130-34; Keith Mohn deposition, pp. 68-70, 74-77, 89, 93-94). Plaintiffs also offer the affidavit of Bruce McClelland, one of the investors, who attests he would have consulted with an attorney concerning a lawsuit against the Mohns if he had not been repaid. (McClelland May 22, 2001 affidavit, ¶ 5).
Although it appears that $620,000 was repaid, this dispute concerns $600,000.
The dispute with the government arises out of the Mohns' contention that each was entitled to a $300,000 business deduction in 1994 for the reimbursements made to their investors. Defendant's position is that the Mohns' solicitation of funds and the investment in prime bank instruments did not arise out of the Mohns' businesses, so business deductions are not permitted.
court notes defendant's position that only those reimbursements made in 1994 would be deductible expenses for the tax year of 1994.
Plaintiffs Laurence and Kathryn Mohn filed suit, action no. 99-76369, in 1999; Keith and Lisa Mohn filed action no. 00-74575 in 2000, and the two lawsuits were consolidated by the court upon the plaintiffs' request in December 2000. Defendant United States has moved the court for summary judgment on all of the plaintiffs' claims, concerning which the court heard oral argument on July 2, 2001.
STANDARD FOR SUMMARY JUDGMENT
Federal Rule of Civil Procedure 56(c) empowers the court to render summary judgment "forthwith if the pleadings, depositions, answers to interrogatories and admissions on file, together with the affidavits, if any, show that there is no genuine issue as to any material fact and that the moving party is entitled to judgment as a matter of law." See FDIC v. Alexander, 78 F.3d 1103, 1106 (6th Cir. 1996). The Supreme Court has affirmed the court's use of summary judgment as an integral part of the fair and efficient administration of justice. The procedure is not a disfavored procedural shortcut. Celotex Corp. v. Catrett, 477 U.S. 317, 327 (1986); see also Kutrom Corp. v. City of Center Line, 979 F.2d 1171, 1174 (6th Cir. 1992).
The standard for determining if summary judgment is appropriate is "`whether the evidence presents a sufficient disagreement to require submission to a jury or whether it is so one-sided that one party must prevail as a matter of law.'" Winningham v. North Am. Resources Corp., 42 F.3d 981, 984 (6th Cir. 1994) (citing Booker v. Brown Williamson Tobacco Co., 879 F.2d 1304, 1310 (6th Cir. 1989)). The evidence and all inferences therefrom must be construed in the light most favorable to the non-moving party. Matsushita Elec. Indus. Co., Ltd. v. Zenith Radio Corp., 475 U.S. 574, 587 (1986); Enertech Elec., Inc. v. Mahoning County Comm'r, 85 F.3d 257, 259 (6th Cir. 1996); Wilson v. Stroh Co., Inc., 952 F.2d 942, 945 (6th Cir. 1992). "[T]he mere existence of some alleged factual dispute between the parties will not defeat an otherwise properly supported motion for summary judgment; the requirement is that there be no genuine issue of material fact." Anderson v. Liberty Lobby, Inc., 477 U.S. 242, 247-48 (1986); see also Hartleip v. McNeilab, Inc., 83 F.3d 767, 774 (6th Cir. 1996).
If the movant establishes by use of the material specified in Rule 56(c) that there is no genuine issue of material fact and that it is entitled to judgment as a matter of law, the opposing party must come forward with "specific facts showing that there is a genuine issue for trial." First Nat'l Bank v. Cities Serv. Co., 391 U.S. 253, 270 (1968); see also Adams v. Philip Morris, Inc., 67 F.3d 580, 583 (6th Cir. 1995). Mere allegations or denials in the non-movant's pleadings will not meet this burden. Anderson, 477 U.S. at 248. Further, the nonmoving party cannot rest on its pleadings to avoid summary judgment. It must support its claim with some probative evidence. Kraft v. United States, 991 F.2d 292, 296 (6th Cir.), cert. denied, 510 U.S. 976 (1993).
ANALYSIS
The parties agree that the Internal Revenue Code ("Code") general rule, under 26 U.S.C. § 162, is that a taxpayer is allowed to deduct "all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business," and that to qualify as an allowable deduction under § 162, "an item must 1) be `paid or incurred during the taxable year,' 2) be for `carrying on any trade or business,' 3) be an `expense,' 4) be a `necessary' expense, and 5) be an `ordinary' expense. Commissioner v. Lincoln Savings and Loan Assoc., 403 U.S. 345, 352 (1971).
Plaintiffs contend that the reimbursements are allowable as an expense under § 162 pursuant to an exception to the general rule that a payment by one taxpayer of the obligation of another taxpayer is not an § 162 expense. Plaintiffs cite to Lohrke v. Commissioner, 48 T.C. 679, 684-85 (1967) (citing C. Doris H. Pepper, 36 T.C. 886 (1961)); Cubbedge Snow, 31 T.C. 585 (1958); and Charles J. Dinardo, 22 T.C. 430 (1954), to support their position that deductions are allowed when the taxpayer makes expenditures to protect or promote his own business, even though the transaction calling for the expenditures originated with another person or entity, that would have been deductible by that person or entity if payment had been made by it. Plaintiffs assert that their motive for repaying the investors was to protect their existing businesses, not M M Trading, the existence of which the investors were not even aware. Plaintiffs assert that they are entitled to a jury trial, so that a jury can make the determination that plaintiffs' purpose in making the reimbursement payments was to protect their business reputations, placing them squarely within the exception to the general rule of non-deductibility for payments on behalf of another taxpayer.
Defendant states in its motion that the Mohns' solicitation of funds and prime bank instrument investments did not arise out of the Mohns' businesses, and that the reimbursements are not ordinary and necessary expenses under 26 U.S.C. § 162. Defendant quotes from a stipulation entered into by the parties, which states "the solicitation of funds from the investors and the investment in prime bank instruments through Rosette Partners was a transaction that did not arise out of either Laurence's business, L.F. Mohn General Agent, or Keith's financial services business."
At oral argument, counsel for defendant asserted that the stipulation was entered into by plaintiffs in lieu of taking the deposition of a John Hancock representative concerning the prime bank investment.
In response to this argument, plaintiffs assert that the stipulation meant the investment in prime bank instruments was not a John Hancock product, and that it did not arise out of their John Hancock businesses. Plaintiffs also counter defendant's argument that the investors were not clients of plaintiffs' businesses, stating that at least two of the investors were pre-existing clients. Plaintiffs argue that the investors were repaid in order to protect their existing John Hancock businesses, and that the reimbursement expenditures were connected to those businesses as they were made exclusively to protect those businesses.
In a case relied on by defendant, Dietrick v. Commissioner, 881 F.2d 336 (6th Cir. 1989), the Sixth Circuit affirmed the tax court's denial of deductions to taxpayer, the owner of a filtration equipment business. The Dietrick court cited Lohrke in stating the test for determining whether a taxpayer falls within the narrow "protect or promote" exception to the general rule against a taxpayer deducting expenses incurred on behalf of the business of another. The court stated that test as follows:
First, the taxpayer must demonstrate that his "ultimate purpose in paying [the other taxpayer's] obligation was [not] to keep [the other taxpayer] in existence, thereby perhaps realizing a return on his payment through corporate profits, . . . [but rather] his purpose was to protect or promote his own business realizing a return on his payment through continued profits in that business. . . . The taxpayer must also show that the expense is an ordinary and necessary expenditure in furtherance of his trade or business—not in furtherance of the trade or business of the other taxpayer.Dietrick, 881 F.2d at 339, citing Lohrke, 48 T.C. at 688. In that case, the court found that the taxpayer had introduced no evidence showing that the failure of the business to which he made advances would have had an adverse impact on his business reputation or filtration business. Dietrick, 881 F.2d at 339-40. The Dietrick court specifically distinguished the case of Jenkins v. Commissioner, 47 T.C.M. 238 (1983), acknowledging that
[T]he Tax Court has recognized that where a taxpayer has demonstrated a proximate relationship between the failure of a corporate enterprise and the "possibility of extensive adverse publicity concerning petitioner's involvement in the defunct corporation" which has the potential to harm the taxpayer's business, payment of the corporation's debts may serve to "protect or promote" the taxpayer's business and thus may be deducted.Dietrick, 881 F.2d at 339, citing Jenkins, 47 T.C.M. at 246.
In Jenkins v. Commissioner, T.C. Memo 1983-667, 47 T.C.M. 238 (1983), referred to above, petitioner Jenkins (a/k/a Conway Twitty), opened a chain of restaurants, soliciting funds from friends and business associates. The restaurants failed, and petitioner repaid investors from his future earnings by checks drawn on his personal accounts. Petitioner deducted the amount of these reimbursements as bad debts, or alternatively, as ordinary and necessary business expenses under § 162. The Commissioner determined the amounts were not deductible under either theory and disallowed the deductions. In a memo, the Tax Court reviewed the Lohrke two prong test, 1) ascertaining the purpose or motive of the taxpayer in making the payments and 2) determining whether there is a sufficient connection between the expenditures and the taxpayer's trade or business. The Tax Court was convinced that the taxpayer repaid the investors "with the primary motive of protecting his personal business reputation (singer/songwriter)." Jenkins, 47 T.C.M. 238. The court considered the similarity of the restaurant name to the taxpayer's stage name, and the fact that many of the investors were connected with the country music industry, and found that although part of the taxpayer's motivation for making payments was a "personal sense of morality," it did not believe that this ethical consideration was "paramount." The court held that there was a proximate relationship between the payments made to the investors and petitioner's trade or business as a country music entertainer, and that the payments were deductible expenses of that trade or business under § 162.
As in the Jenkins case, where there was no suggestion made that the payments made by taxpayer were to protect or revitalize the taxpayer's interest in Twitty Burgers, and it was the taxpayer's contention that the investors were repaid to protect his personal business reputation, taxpayers in the instant matter certainly did not make the payments to "fix" M M Trading. In the case sub judice, plaintiffs assert that their business reputations were on the line. Although some of the investors were family members, it appears that the Mohns also solicited friends and fellow country club members, concerning whom they have testified at least two were former clients of their existing businesses. Further, the Mohns have offered evidence that at least one investor would have sued had he had not been repaid. It is certainly reasonable to infer that the Mohns made the payments either to protect their personal reputations or to protect their John Hancock business reputations, or with a combination of the two motives. A question of material fact also exists as to the nexus between the payments and the plaintiffs' financial services businesses. The court is convinced that the answer to those questions should lie in the hands of the jury requested by the plaintiffs and will deny defendant's motion for summary judgment.
the deductibility of voluntary reimbursement, which apparently was not guaranteed by MM or personally by the plaintiffs, the court notes that the same issue was addressed in Jenkins, citing Milbank v. Commissioner, 51 T.C. 805 (1969), and Lohrke:
In making these payments petitioner was furthering his business as a country music artist and protecting his business reputation for integrity. The mere fact that they were voluntary does not deprive them of their character as ordinary and necessary business expenses.
Milbank, 51 T.C. at 808.
CONCLUSION
For the foregoing reasons, the court hereby DENIES defendant's motion for summary judgment as to plaintiffs' claims in actions no. 99-76369 and 00-74575.