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GALE v. UNITED STATES

June 27, 1991

SEYMOUR L. GALE and ETHEL G. GALE, Plaintiffs,
v.
UNITED STATES OF AMERICA, Defendant


John A. Nordberg, United States District Judge.


The opinion of the court was delivered by: NORDBERG

JOHN A. NORDBERG, UNITED STATES DISTRICT JUDGE

 The plaintiffs, Seymour and Ethel Gale, have brought this action pursuant to § 7422 of the Internal Revenue Code of 1986, 26 U.S.C. § 7422, seeking recovery of taxes erroneously assessed and collected. The United States moves to dismiss the plaintiffs' complaint. Because an answer to the complaint has already been filed, and the pleadings are, therefore, closed, the motion is properly styled a motion for judgment on the pleadings pursuant to Rule 12(c) of the Federal Rules of Civil Procedure. No evidence outside the pleadings has been submitted in conjunction with this motion, however. Thus the standards of a Rule 12(b)(6) motion apply. See Republic Steel Corp. v. Penn. Engineering Corp., 785 F.2d 174, 182-83 (7th Cir. 1986). For the reasons set forth below, the court grants the government's motion.

 BACKGROUND

 This action involves the taxable year ending December 31, 1984. During that year, Seymour Gale was self-employed, with gross income from his business of $ 21,000. Gale contributed $ 7,031 to the Seymour L. Gale Defined Benefit Pension Plan, a retirement plan qualified under § 401(a) of the code as a Keogh (or H.R. 10) retirement plan. *fn1"

 Prior to April 15, 1985, the plaintiffs filed a joint federal income tax return for the year 1984 and paid in full the taxes calculated to be due and owing. In determining their tax liability, the plaintiffs followed the instructions accompanying Form 1040 and its schedules. Accordingly, Gale included the $ 7,031 pension contribution on Line 27 of Form 1040 as an adjustment to income. In addition to Form 1040, the plaintiffs filed Schedule C detailing the profit from Gale's business. While he claimed deductions for various expenses totalling $ 11,004, Gale did not include his pension contribution as a deduction from the gross income of his business or profession on Schedule C. Consequently, Gale reported business income of $ 9,996 (Form 1040, Line 12; Schedule C, Line 32) and paid Social Security self-employment taxes of $ 1,130 (Form SE, Line 14), based on that income.

 On April 15, 1988, the plaintiffs timely filed a joint amended federal income tax return for the taxable year ending December 31, 1984. On the amended return, Gale included his $ 7,031 pension contribution on Schedule C, as a deduction from the income of his trade or profession (Schedule C, Line 21); that is, as a business expense, rather than on Line 27 of Form 1040 as an adjustment to income. As a result of this change, the amended return indicated that Gale's business or professional income for the year was $ 2,965, and his Social Security self-employment tax was $ 335. *fn2" The plaintiffs sought a refund in the amount of $ 795 to reflect the difference in the self-employment tax originally paid and the amended figure.

 By letter dated June 30, 1988, the Internal Revenue Service disallowed the plaintiffs' claim for a refund, explaining that contributions to a Keogh plan are adjustments to gross income, not self-employment income. It is this disallowance that the plaintiffs challenge in their complaint.

 ANALYSIS

 The plaintiffs argue that Seymour Gale's contribution to his Keogh plan reduced his "net earnings from self-employment" under 26 U.S.C. § 1402(a), and, therefore, that contribution should also serve to reduce the business income that was subject to the self-employment tax. *fn3" Because the self-employment taxes collected on Gale's 1984 business income were not reduced by the amount of his pension contribution, the plaintiffs claim they were taxed excessively. They seek a refund of the $ 795 difference between the self-employment tax paid initially and the amount calculated in the plaintiffs' amended return.

 Section 1402 is part of Subtitle A of the Code, which covers income taxes. Among the deductions allowed under Subtitle A is the deduction under § 404(a) for contributions to certain retirement plans, including Keogh plans. Therefore, the plaintiffs conclude, the "net earnings from self-employment" under § 1402 may be reduced by the deduction under § 404(a), so long as that deduction is "attributable to [the taxpayer's] trade or business," as specified under § 1402(a). The success of the plaintiffs' argument, therefore, turns on the question of whether Gale's contribution to his Keogh plan can be treated as an expense attributable to his trade or business.

 The government contends that a Keogh contribution is not a business expense, but is a transfer of business profits from the business to the owner. This is not a business expense, under the government's analysis, because its benefit redounds to the self-employed individual, not his business. The government challenges the plaintiffs' assumption that because Congress permitted self-employed individuals to deduct contributions to Keogh plans in computing ordinary income tax, these contributions are ordinary and necessary business expenses.

 According to the government, the deductions allowed under § 1402(a) are those ordinary and necessary business expenses allowed as deductions under § 162. If the contributions do not fall within that rubric, they may not be deducted under § 1402(a). A self-employed individual's contributions to a Keogh plan are not ordinary and necessary business expenses, the government contends, although they are treated as such by virtue of certain fictions ...


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