Some provisions of the Internal Revenue Code aren’t referenced very often and even though they may have existed for years have never actually had a court analyze in depth.  One such provision in the Code was the subject in the case of Jones v. Commissioner, 146 TC No. 3.

Generally the expenses of employee are required to be deducted as an itemized deduction which poses several disadvantages vs. other business expenses which are deducted in computing adjusted gross income.  If the taxpayer must itemize a deduction, the deduction is subject to the 2% floor on miscellaneous itemized deductions before any benefit can be received and entirely nondeductible in computing the alternative minimum tax.

The Code does provide a few exceptions to the “below the line” treatment for an employee, and the one in question today is found at IRC §62(a)(2)(C).  That provision allows such business expenses to be deducted above the line for those who meet the definition below:

(C) Certain expenses of officials

The deductions allowed by section 162 which consist of expenses paid or incurred with respect to services performed by an official as an employee of a State or a political subdivision thereof in a position compensated in whole or in part on a fee basis.

The case in question involves a judge in Arizona who sat on the Maricopa County Superior Court, which is a trial court of general jurisdiction in Arizona.  Judges in the court are paid a salary by the county, but the court itself is funded in part by the collection of fees from members of the public (such as for case filings, licenses, etc.).  However, the county does not receive fees for wedding ceremonies, rather the judges are allowed to collect those fees directly.

In this case the judge had taken the deductions above the line, relying on the fact that his salary, paid from the Maricopa County Superior court budget, was partially funded by fees.  The IRS contended that this was not a proper reading of the provision—that, rather, the public needed to pay fees directly to the judge to trigger this provision.  The only fee available to the judge were wedding fees—but this judge had never actually collected such a fee, waiving the fee for each wedding he performed.

When the County ran into budget troubles, many of the expenses previously reimbursed by the County to the judge were no longer reimbursable.  The judge continued to incur many of these fees as well spending personal funds to upgrade his office and replace equipment and even paying for gift cards for his staff after they were no longer able to receive bonuses.

The judge consulted with a CPA when it came time to prepare his 2008 returns, and the CPA in question determined that his deduction should go above the line in 2008 based on that provision.  The CPA did the same in 2009, but died before he prepared the judge’s 2010 return.  Another CPA took over the return preparation for 2010 and arrived at the same conclusion.

The fundamental distinction in the positions of the taxpayer and the IRS is presented in the opinion as follows:

The Commissioner wants us to interpret “compensated on a fee basis” to mean something like “paid by a member of the public for a service rendered by a judge who receives the fee.” Judge Jones argues that “in a position compensated in whole or in part on a fee basis” means something like “a position funded in whole or in part by fees paid by members of the public for services rendered by judges.”

Unfortunately, as the opinion continues, “[n]either the Code nor the regulations define what “fee basis” means, and the case law is similarly stubborn in its silence.”  Thus the Tax Court judge embarked on his own voyage to resolve this matter.

The Court first turns to determine what should be the proper definition of “fee basis” and “compensation” for these purposes. 

For purposes of determining what is meant by compensation the Court consults not just the dictionary but continues on with citations from Henry Thoreau and Ralph Waldo Emerson to determine the general meaning of compensation is “something of value given in exchange for” some service.

The Court then notes that a “fee basis” test [1] also exists in the self-employment tax provisions of IRC §1402(c)(1).  While the Code contains no definition, Revenue Ruling 74-608 does look to define this.  The Court references this definition noting:

It says that a public official is compensated by “fees” if he receives them directly from members of the public, but not if he is paid from a government fund. Id. If the “public official receives his remuneration or salary from a government fund and no portion of the monies collected by him belongs to or can be retained by him as compensation, the remuneration is not ‘fees’ under section 1402(c)(1).” Id., 1974-2 C.B. at 276.

The opinion goes on to note that a similar distinction is found in Reg. §31.3401(a)-2(b)(1) when defining payments that aren’t subject to withholding vs. those which are, again looking again at a difference between fees paid directly for services to the public official vs. receiving a salary from the government.  The Court goes on to cite similar distinctions found in the Social Security Act and the Fair Labor Standards Act.

Thus the Court concludes the IRS’s reading is the more reasonable one—the fact that the Court collected fees that may have been partially used to pay his salary did not mean, for these purposes, that the judge was “compensated in whole or in part on a fee basis.”

But what about those marriage fees the judge could have, but did not, collect?  The judge argues that while he may not have collected fees, his position is one that is allowed to collect fees and so if any Superior Court judge collected fees then he can make use of this provision. 

However the opinion determined this is not the proper way to read the statute.  The Court determined:

We think that the possibility that one of his colleagues was more mercenary than he at weddings can’t convert his own position into one “compensated in whole or in part on a fee basis” any more than the collection of even one filing fee by the clerk of his court would

Section 62(a)(2)(C) tells us to look at the particular situation of individual taxpayers. Is he “an official?” Is he “an employee of a State * * * in a position compensated in whole or in part on a fee basis?” Singular terms in the Code can include their plural form unless “the context indicates otherwise.” See Commissioner v. Driscoll, 669 F.3d 1309, 1311 (11th Cir. 2012) (quoting United States v. Hayes, 555 U.S. 415, 422 n.5 (2009)), rev’g and remanding 135 T.C. 557 (2010). But, as in Driscoll, we think “a” and “an” are function words used before singular nouns and indicate a singular meaning here. See id. at 1312.

No portion of Judge Jones’s compensation for his role as a public officer was provided on a fee basis. Rather, he was an employee of the State of Arizona and paid a salary for his work. Thus, his expenses are deductible as unreimbursed employee expenses under section 162 and should be reported as miscellaneous itemized deductions subject to a 2% floor.

[1] Under this provision the compensation must be solely on a fee basis but, as the Court notes, a fee basis would arguably be the same definition even though for the provision in question here the compensation only needs to be “in part” on a fee basis.