Mazzei v. Commissioner
61 T.C. No. 55, 61 T.C. 497, 1974 U.S. Tax Ct. LEXIS 167 (1974)
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Rule of Law:
A loss incurred from being defrauded in a scheme to reproduce counterfeit United States currency is not deductible under Section 165(c)(2) or (3) of the Internal Revenue Code, as allowing such a deduction would severely and immediately frustrate clearly defined public policy against counterfeiting.
Facts:
- In March 1965, Vernon Blick was introduced by Cousins to Collins and Joe, who demonstrated a 'black box' that appeared capable of reproducing a $10 bill.
- In April or May 1965, Blick recounted the demonstration to his business partner, Raymond Mazzei, leading to discussions with Cousins, Collins, and Joe about a 'deal' to reproduce money.
- In May 1965, Mazzei, Blick, and Cousins traveled to New York City, where Collins and Joe used the 'black box' to seemingly reproduce a $100 bill from Mazzei's money.
- Mazzei later gave $700 to Cousins, who supposedly reproduced it in New York, returning Mazzei's original $700 plus an additional $300.
- In June 1965, Joe requested Mazzei to obtain $20,000 in large denominations for a larger reproduction deal, and Blick obtained an additional $5,000.
- On June 3, 1965, Mazzei and Blick flew to New York City with $25,000 cash and met Cousins, Collins, and Joe at an apartment.
- Collins took Mazzei's $20,000 and Blick's $5,000, placed the money in water, then between white papers, and finally into an electric oven, claiming the 'black box' was broken.
- While the money was in the oven, two armed men broke into the apartment impersonating law enforcement officers, handcuffed Joe, and, along with Collins and Joe, fled with all $25,000.
Procedural Posture:
- Raymond and Elizabeth Mazzei filed a joint Federal income tax return for the calendar year 1965, claiming a theft loss deduction of $19,900 based on a $20,000 loss.
- The Commissioner of Internal Revenue (respondent) issued a statutory notice of deficiency, disallowing the deduction under section 165(c)(2) or (3) on grounds of lack of adequate substantiation of the loss and that allowance of the deduction would be contrary to public policy.
- Petitioners Raymond and Elizabeth Mazzei filed a petition with the United States Tax Court challenging the deficiency.
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Issue:
Does public policy against counterfeiting United States currency preclude a taxpayer from deducting a loss under IRC Section 165(c)(2) or (3) when they were defrauded in a scheme they believed was to reproduce counterfeit currency?
Opinions:
Majority - Quealy, Judge
No, public policy precludes a taxpayer from deducting a loss under IRC Section 165(c)(2) or (3) when they were defrauded in a scheme they believed was to reproduce counterfeit currency, because allowing such a deduction would severely and immediately frustrate the clearly defined policy against counterfeiting. The Court found that Mazzei did incur a $20,000 loss as a result of being defrauded. However, its deductibility is precluded by the precedent set in Luther M. Richey, Jr., 33 T.C. 272 (1959). In Richey, a taxpayer involved in a counterfeiting scheme who was swindled was denied a deduction because it would severely and immediately frustrate the clearly defined policy against counterfeiting U.S. obligations (18 U.S.C. sec. 471). The present case is indistinguishable; the fact that Mazzei was ultimately victimized in what he believed was a criminal act does not make his participation in the perceived criminal act any less violative of public policy. The conspiracy itself, regardless of its factual impossibility, constituted a violation of law (18 U.S.C. sec. 371). The loss was directly related to the purported illegal act that Mazzei conspired to commit. The Court distinguished Commissioner v. Tellier, 383 U.S. 687 (1966), noting it concerned business expenses under section 162(a) and a different public policy context. The Court also declined to follow Edwards v. Bromberg, 232 F. 2d 107 (C.A. 5, 1956).
Concurring - Dawson, Judge
No, a theft loss deduction should not be sanctioned where the petitioner clearly intended to conspire with others in a scheme to counterfeit United States currency because it would frustrate a sharply defined national policy. Judge Dawson agreed with the majority and Judge Tannenwald, affirming Luther M. Richey, Jr. as viable precedent. He distinguished Commissioner v. Tellier by explaining that it concerned business expenses under Section 162(a) and deductions for legal fees for past conduct, whereas this case involves a loss of capital invested in the intended initiation of a criminal enterprise. The test for nondeductibility, as established in Tank Truck Rentals v. Commissioner, 356 U.S. 30, 35 (1958), is the 'severity and immediacy of the frustration' to public policy, which is clearly met here given the strong national policy against counterfeiting.
Concurring - Tannenwald, Judge
No, a taxpayer should not be allowed to deduct a payment voluntarily made that is part and parcel of an act they believed to constitute a crime, particularly when it involves conduct proscribed by sharply defined national policy. Judge Tannenwald emphasized that it is 'inconceivable' for Congress to intend such a deduction. He drew a sharp distinction between payments 'so interwoven with the purported criminal act' and 'inherently innocent character' payments like rent or utilities, which Commissioner v. Sullivan, 356 U.S. 27 (1958), allowed due to their 'remote relation to an illegal act.' He stated that the factual impossibility of the black box working is irrelevant because Mazzei was unaware of it. He also clarified that Tellier did not preclude public policy considerations under all circumstances, and that counterfeiting is a serious crime under declared national policy (U.S. Constitution, Art. 1, Sec. 8, Cl. 6; 18 U.S.C. sec. 471). He argued that applying the 'narrow delineation of the standard of non-deductibility' from Tellier should consider the seriousness of the purported crime.
Dissenting - Featherston, Judge
Yes, the deduction should be allowed because there was no actual conspiracy to counterfeit, as no party involved truly intended to or could counterfeit currency. Judge Featherston argued that Mazzei was not a party to any conspiracy to counterfeit because neither he nor his co-victim (Blick) could counterfeit, and the other parties (Cousins, Collins, Joe) only pretended they could. The entire scheme was designed solely to defraud Mazzei, not to counterfeit. He believed Mazzei’s intentions, though perhaps evil, should not be a ground for denying a tax deduction. He asserted that Edwards v. Bromberg, 232 F. 2d 107 (C.A. 5, 1956), which allowed a deduction for money stolen in a 'fixed' race scheme, should control the outcome, especially given subsequent Supreme Court decisions.
Dissenting - Sterrett, Judge
Yes, the deduction should be allowed because denying it does not severely and immediately frustrate a sharply defined national policy, and Congress intended to control the specific categories of nondeductible expenditures. Judge Sterrett applied the test from Tank Truck Rentals v. Commissioner, 356 U.S. 30 (1958), requiring a deduction denial to 'severely and immediately' frustrate 'sharply defined national or State policies.' He noted that Congress, in the Tax Reform Acts of 1969 and 1971, attempted to set forth specific categories of nondeductible expenditures under Section 162, suggesting a call for judicial restraint. He argued that the majority failed to explain how allowing a theft loss, where the victim involuntarily parted with property, would severely and immediately encourage counterfeiting. He contrasted this with direct fines or bribes where the government directly underwrites illegal activity. He found the relationship between the loss and the illegal activity too remote, similar to Commissioner v. Sullivan, 356 U.S. 27 (1958). He warned against imposing a 'clean hands doctrine' or making the tax statute an unwarranted instrument of further punishment.
Analysis:
This case reinforces the 'public policy doctrine' in tax law, particularly for loss deductions under IRC Section 165. It clarifies that a taxpayer's intent to commit an illegal act, even if the act is factually impossible to complete or results in them being defrauded, can be sufficient to invoke public policy grounds to deny a deduction. The ruling significantly broadens the application of public policy beyond direct fines or penalties, extending it to losses directly connected to a taxpayer's participation (even if deceived) in a scheme that violates clearly defined national policies like anti-counterfeiting laws. It highlights the tension between judicial and legislative roles in defining what expenditures or losses are against public policy, with the majority adopting a broader judicial interpretation based on the intent to engage in criminal activity.
