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Charles W. v. Commissioner of Internal Revenue

decided: December 1, 1988.


On Appeal from the United States Tax Court, Nos. 5229-84, 5230-84, 5231-84--L.W. Hamlen, Jr., Judge.

Flaum, Manion, Circuit Judges, and Will, Senior District Judge.*fn*

Author: Will

WILL, Senior District Judge.

Charles W. Decker and Darrell E. Lauderdale*fn1 appeal from the decision of the United States Tax Court disallowing their deductions for depreciation of purchased insurance expirations. We affirm the decision of the Tax Court.

I. Factual background.

In 1975, appellants Charles W. Decker and Darrell E. Lauderdale formed a corporation known as the Lauderdale Insurance Agency, Ltd. (the "Lauderdale Agency"). The agency was located in Carbondale, Illinois and specialized in commercial lines of property and casualty insurance. In August of 1978, Lauderdale and Decker entered into a partnership agreement to operate an insurance brokerage business which they named Comprehensive Insurance Services ("Comprehensive").

Wm. J. Cunningham, Inc. ("WJC") was a corporation wholly owned by William Cunningham which operated an insurance agency in Pinckneyville, Illinois, thirty-five miles away from Carbondale. Comprehensive entered into negotiations with Cunningham to purchase the insurance expirations of WJC. Insurance expirations are policyholder files which contain the customers' names and addresses and other information including the expiration date of each policy. The expirations are valuable, because they show the most advantageous time to seek a renewal. Although the Lauderdale Agency already did some business in the Pinckneyville area out of its Carbondale location, the purchase of the expirations permitted Comprehensive to expand its market there more quickly and economically.

On August 30, 1978, Comprehensive, WJC, and Cunningham entered into a purchase agreement for the acquisition by Comprehensive of all of WJC's insurance accounts, lists, renewals, insurance records and papers. By agreement, Comprehensive was not entitled to any accounts receivable on or before the date of closing. In addition, Comprehensive was prohibited from using the name "Wm. J. Cunningham, Inc." Comprehensive, however, was to receive all commission income due WJC after September 1, 1978 except from policies having an effective date, anniversary date or renewal date on or before August 31, 1978. Additionally, WJC and Cunningham covenanted not to compete with Comprehensive in the insurance business within a twenty-five-mile radius of Pinckneyville for five years. WJC and Cunningham also agreed to assist Comprehensive in securing the renewal of transfer of WJC's contracts with all insurance companies for which WJC had been the agent. Finally, WJC and Cunningham assigned to the Lauderdale Agency WJC's lease to its Pinckneyville office.

As required by the purchase agreement, Cunningham entered into an employment agreement to work as an insurance agent and broker for Comprehensive during a three-year period. This agreement was terminated one year later, on August 10, 1979, and was replaced by an agreement that Cunningham serve as an independent contractor for the Lauderdale Agency. During his period of employment by Comprehensive, Cunningham went with appellants to meet with the policyholders whose commercial accounts were due to expire in order to solicit their renewal. In addition to Cunningham, Comprehensive retained WJC's two clerical employees and operated from WJC's office.

Comprehensive began its business in Pinckneyville under the name "Lauderdale Insurance Agency, Ltd." In 1980, the name was changed to "Lauderdale and Decker Insurance, Ltd." The telephone directory listed "Cunningham Insurance" with a reference "See Lauderdale Insurance Agency, Ltd." Lauderdale and Decker Insurance, Ltd. had an advertisement in the yellow pages for approximately one year which included a parenthetic reference "formerly the Cunningham Agency."

During the period from September 1978 through December 1983, 503 of the 1,107 accounts Comprehensive acquired from WJC were terminated. During this same period, Comprehensive wrote 240 insurance policies on accounts it acquired from WJC and acquired 339 new accounts. The record does not indicate whether or not any of these new accounts were attributable to referrals from WJC's original customers.

Comprehensive claimed on its 1978 partnership tax return a depreciable basis in the acquired insurance expirations of $287,216. On its returns for 1979 and 1980, Comprehensive claimed a depreciable basis of $258,040. Comprehensive claimed depreciation deductions with respect to the insurance expirations using the straight-line method of depreciation over a seven-year useful life. The IRS issued notices of deficiency to Charles W. and Susan D. Decker and Darrell E. and Velma J. Lauderdale, disallowing these partnership depreciation deductions because the taxpayers had not shown that the expirations were separable from WJC's goodwill, a nondepreciable asset, or that the expirations had a reasonably ascertainable limited useful life.

In the Tax Court, the taxpayers presented the testimony of Decker, a report prepared by a consulting firm, the Middleton Group, and the testimony of a principal of Middleton, William K. Lee, to establish that the insurance expirations in question had value separate from goodwill and an ascertainable limited useful life. Mr. Lee testified that the figures chosed by Comprehensive-a useful life of seven years for the insurance expirations and a value of approximately $250,000-were reasonable estimates. On the basis of this analysis, Mr. Lee concluded that Comprehensive acquired little, if any, good will or going concern value when it purchased WJC's insurance expirations.

The Tax Court disagreed. It found that the taxpayers purchase of the insurance expirations and the related agreements was in effect the purchase of a going concern and that the expirations were so inextricably linked to goodwill that a limited useful life for them could not be determined apart from goodwill. The Tax Court noted that Comprehensive had acquired WJC's office facilities, clerical staff, principal salesman, and telephone number. The court found that Comprehensive's hiring of Cunningham to solicit renewal business from WJC's policyholders and obtaining from him a covenant not to compete ...

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