Mazzei v. Commissioner
61 T.C. No. 55, 1974 U.S. Tax Ct. LEXIS 167, 61 T.C. 497 (1974)
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Rule of Law:
A loss incurred by a taxpayer from being defrauded in a scheme they believed to be a criminal act, such as counterfeiting U.S. currency, is not deductible under Section 165(c)(2) or (3) of the Internal Revenue Code due to public policy considerations.
Facts:
- In March 1965, Vernon Blick learned of a money-reproduction scheme from a man named Cousins, who introduced him to Collins and Joe, who demonstrated a 'black box' that appeared to reproduce a $10 bill.
- Blick informed his employer, Raymond Mazzei, about the scheme, and Mazzei, Blick, and Cousins subsequently discussed a 'deal' to reproduce money using Mazzei's cash.
- In May 1965, Mazzei provided $10,000 in cash for a demonstration in New York City, where Collins appeared to reproduce a $100 bill using the black box.
- Later, Mazzei gave Cousins $700, which Cousins supposedly reproduced and returned with an additional $300, attributing limits on reproduction to a lack of special paper.
- In June 1965, Joe requested Mazzei obtain $20,000 in large denominations, and Mazzei cashed a company check for that amount, while Blick obtained $5,000 from Mazzei's brother.
- On June 3, 1965, Mazzei and Blick flew to New York City and met Collins and Joe, to whom Mazzei handed over his $20,000 and Blick's $5,000, totaling $25,000, for reproduction.
- After Collins placed all the money in an electric oven, two armed men broke into the apartment, impersonating law enforcement officers conducting a counterfeiting raid, and seized the money at gunpoint.
- Collins, Joe, and the two armed intruders then left the apartment with the $25,000, and the 'black box' was later found to be an empty tin box with a buzzer, incapable of reproducing money.
Procedural Posture:
- Petitioners Raymond and Elizabeth Mazzei filed a joint Federal income tax return for the calendar year 1965.
- The Commissioner of Internal Revenue determined a deficiency in income tax against petitioners for the taxable year 1965, disallowing a claimed theft loss deduction of $20,000.
- Petitioners Raymond and Elizabeth Mazzei filed a petition with the United States Tax Court challenging the determined deficiency.
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Issue:
Does public policy preclude a taxpayer from deducting a loss, specifically a theft loss under Section 165(c)(3) or a loss from a transaction entered into for profit under Section 165(c)(2), when the loss resulted from the taxpayer being defrauded in a scheme they believed to be a criminal enterprise, such as counterfeiting United States currency?
Opinions:
Majority - Quealy, Jvdge
Yes, public policy precludes such a deduction. The court found that Raymond Mazzei did incur a loss of $20,000, but its deductibility is barred by the precedent established in Luther M. Richey, Jr. In Richey, a taxpayer involved in an actual counterfeiting scheme was denied a loss deduction when he was swindled. The present case is indistinguishable because Mazzei's participation in what he believed to be a criminal act (conspiracy to counterfeit U.S. currency) is no less violative of clearly declared public policy against counterfeiting, even if the scheme was a fraud from the start and no actual counterfeiting was possible. The loss was directly related to this purported illegal act. The court explicitly declined to follow Edwards v. Bromberg, which allowed a deduction for money lost in a fixed race scam where the taxpayer never intended to participate in fixing the race.
Concurring - Dawson, J.
Yes, public policy precludes such a deduction. Judge Dawson agreed, emphasizing that this is not the type of case where a theft loss deduction for an intended criminal conspiracy should be sanctioned, reinforcing Luther M. Richey, Jr. as a viable precedent. He distinguished Commissioner v. Tellier, noting that Tellier allowed deduction of legal fees as business expenses for past criminal conduct defense, whereas here, the loss was capital 'invested' in the initiation of a criminal enterprise. Allowing the deduction would 'severely and immediately' frustrate the sharply defined national policy against counterfeiting.
Concurring - Tannenwald, J.
Yes, public policy precludes such a deduction. Judge Tannenwald fully agreed, finding it inconceivable that Congress intended to allow a deduction for a payment 'voluntarily made, which is part and parcel of the very act believed by him to constitute a crime and involving a type of conduct proscribed by sharply defined 'national or state policies.'' He provided a hypothetical of paying a hitman who pockets the money, arguing no deduction would be allowed. He distinguished Commissioner v. Sullivan (rent/wage expenses in illegal bookmaking) because those payments were 'inherently innocent' and only remotely related to the illegal act, unlike the payment here which was 'interwoven' with the purported criminal act. The factual impossibility of the crime was irrelevant because Mazzei was unaware of it.
Dissenting - Featherston, J.
No, public policy does not preclude such a deduction. Judge Featherston disagreed with the majority and joined Judge Sterrett's dissent. He argued that Raymond Mazzei was not part of a conspiracy to counterfeit because neither he nor the other 'conspirators' (Cousins, Collins, Joe) intended to counterfeit; the latter only pretended they could. Therefore, the entire scheme was designed solely to defraud Mazzei, making him a victim. He asserted that Mazzei's intentions, even if evil, are not grounds to deny a tax deduction and that Edwards v. Bromberg should control.
Dissenting - Sterrett, J.
No, public policy does not preclude such a deduction. Judge Sterrett argued that an otherwise allowable deduction should only be denied if its allowance would 'severely and immediately' frustrate 'sharply defined national or State policies,' as established by Tank Truck Rentals v. Commissioner and reiterated in Commissioner v. Tellier. He criticized the majority for not explaining how allowing a theft loss, which assumes the victim did not voluntarily part with the money, would encourage counterfeiting. He contended that the relationship between the theft loss and the illegal activity was more remote than in Sullivan and that Congress, through the Tax Reform Acts, intended to control the public policy exceptions to deductions, suggesting judicial restraint. He warned against imposing a 'clean hands doctrine' that would make the tax statute an instrument of further punishment.
Analysis:
This case reinforces the 'public policy' exception to tax deductions, particularly when a taxpayer's loss is directly intertwined with their intent to commit a criminal act, even if they are ultimately the victim of a separate fraud. It highlights the tension between allowing deductions for legitimate losses (like theft) and the judicial desire to avoid incentivizing illegal behavior. The split among the judges reveals the difficulty in applying the 'severely and immediately frustrate' standard, especially when a criminal act is intended but factually impossible, or when the taxpayer is defrauded. This decision has implications for cases where individuals suffer losses in illegal enterprises or in schemes they believe to be illegal, potentially extending the denial of deductions beyond purely criminal activities to those involving criminal intent.
