Simon v Commissioner

"Simon v. Commissioner", 103 T.C. 247(1994), is a decision by the United States Tax Court relating to the deductibility of expensive items or tools that may increase in value as a collectible but decrease in value if used in the course of a business or trade.

Facts

Who are the Simons?

The plaintiffs in this case are Richard and Fiona Simon. The Simons are two full-time professional violinists who are performers with the New York Philharmonic Orchestra. The Simons believe that old violins played with old bows produce superior sounds to newer violins played with new bows. In 1985, the Simons purchased two bows made by François Tourte in the 19th Century, one for $30,000 and the second for $21,500. Both bows were regularly used during their employment as violinists.

"'What is the Tax Issue?"'

When the Simons did their taxes for the year of 1989, they claimed a $6,300 and $4,515 depreciation deduction on the first and second bow respectively. The basis for this deduction was the under §167 of the US Tax Code as calculated based on §168 of the US Tax Code. The Tax Commissioner objected to this deduction based on the increased fair market value of the bows. When the first bow was appraised for tax purposes in 1985 it had a value of $35,000. Based on a 1990 appraisal, the value had risen to $45,000. The value of the second bow increased as well from $25,000 to $35,000. Because of these increases in value, the Commissioner did not feel that the useful life could be determined and therefore the deduction couldn't be taken.

Holding of the Court

The Tax Court determined that the Simons' deduction for the depreciated value of the violins was proper for the 1989 tax year under § 168 of the Tax Code.

Rationale of the Majority

The majority of the court found that the deduction should be allowed. The court pointed out that “taxpayers have long been allowed asset depreciation deductions in order to allow them to allocate their expense of using an income-producing asset to the periods that are benefited by that asset”. The reason for this is so depreciation taken in a given year represents that year’s reduction of the asset through wear and tear.

Prior to the passage of the Economic Recovery Tax Act of 1981 (ERTA), the depreciation of personal property was solely determined by § 167 of the Interval Revenue Code of 1954. Calculating depreciation under this part of the code required the taxpayer to determine the “useful life” of property which was difficult and often led to disagreements. After ERTA, Congress simplified the process by reducing the number of years over which a taxpayer could depreciate property to 4 periods (3, 5, 10, and 15 year periods) and basing the depreciation on these statutory year periods rather than useful life.

Under § 168(a), a taxpayer may deduct depreciations of “recovery property” which is property that is (1) tangible, (2) placed in service after 1980, (3) of a character subject to the allowance for depreciation, and (4) used in the trade or business, or held for the production of income. The court defined subsection (3) to mean that the “property must suffer exhaustion, wear and tear, or obsolescence in order to be depreciated”. Because of the frequent wear and tear of the bows, the court found that the bows fit in the parameters of depreciable personal property under § 168.

Even though the fair market value of bows may have increased, the court notes that for it to look into determining whether an asset has a “separate, non business” value for depreciation purposes would be contrary to Congress’s intent to simply this concept.

Dissent

The dissent believes that the majority decision gives an improper “tax shelter” for musicians. They state that the Internal Revenue Services, in accordance with congressional intent, meant for these “works of art” to be nondepreciable property since instruments and other collectibles have an indeterminable useful life.

Significance of the Case

The court finds that § 168 of the Tax Code does not prevent a taxpayer from depreciating a business asset solely due to its age, or because the asset may have appreciated in value over time.

The potential consequence of this simplification is that § 168 may “allow an asset to be written off over a period much shorter than its actual useful life and that the entire cost might be deducted despite the fact that there might be no actual economic decrease in value”.

References

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* [http://caselaw.lp.findlaw.com/cgi-bin/getcase.pl?court=2nd&navby=case&no=944237 Full Text of Opinion, Findlaw]