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Diamond v. Commissioner of Internal Revenue, 56 T.C. 530

Facts

Sol Diamond, a mortgage broker, received $145,186.37 in commissions from borrowers in 1961 for obtaining loans from Marshall Savings & Loan, controlled by the Moravec family. He also made secret payments totaling $39,398.50 to the Moravecs, which he claimed as deductible business expenses. In 1962, Diamond received a $40,000 interest in a venture with Philip Kargman for obtaining a mortgage loan, which he later sold. The IRS disallowed the deductions and reclassified the income.

During 1961 petitioner received the following payments as commissions from borrowers with respect to loans which he had placed with Marshall: … At about the time that petitioner received each of the four foregoing commissions identified by an asterisk, he made a payment or payments by check for the benefit of the Moravecs which was equal to approximately 50 percent of the amount of the commission payment.

Issue

Whether the commissions received by Sol Diamond in 1961 must be included in gross income and whether the payments made to the Moravecs are deductible as ordinary and necessary business expenses.

Whether certain commissions received by petitioner Sol Diamond in 1961 must be included in petitioners' gross income for that year under section 61, I.R.C . 1954, and if so, whether purported ‘consultants fees' paid by him in respect of such commissions during that year are deductible as ordinary and necessary business expenses under section 162, I.R.C . 1954.

Rule

Under Section 61 of the Internal Revenue Code, all income from whatever source derived is included in gross income. Section 162 allows deductions for all ordinary and necessary expenses paid or incurred in carrying on any trade or business.

Sec. 61(a)(1), I.R.C . 1954. Sec. 721, as interpreted by regs. sec. 1.721-1(b)(1), relied upon by petitioners, is inapplicable here to remove such income from the otherwise operative provisions of sec. 61(a)(1).

Analysis

The court found that the commissions received by Diamond were indeed income under Section 61, as they were received under a claim of right. The payments to the Moravecs were deemed not deductible under Section 162 because they were not ordinary and necessary business expenses, and the secretive nature of the payments raised concerns about their legitimacy.

We conclude that they cannot prevail on either theory. (a) Exclusion from gross income.— We note at the outset that petitioners' alternative position is inconsistent not only with their 1961 income tax return, which reported the full $145,186.37 mortgage loan commissions (unreduced by the payments to the Moravecs), but also with the original petition filed in this Court.

Conclusion

The court concluded that all commissions received by Sol Diamond in 1961 were includable in gross income, and the payments to the Moravecs were not deductible. Additionally, the $40,000 received in 1962 was classified as ordinary income.

The payments were not deductible. Cf. United Draperies, Inc., 41 T.C. 457.

Who won?

The Commissioner of Internal Revenue prevailed in the case, as the court upheld the inclusion of the commissions in gross income and disallowed the deductions for payments to the Moravecs.

The Commissioner disallowed the claimed deduction. He ruled that the ‘Consultants fees' item was ‘not deductible under the provisions of section 162 of the Internal Revenue Code of 1954, or any other section thereof.’

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