                        T.C. Memo. 1997-499



                      UNITED STATES TAX COURT



              BERGER CHEVROLET, INC., Petitioner v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent

           TIMOTHY M. & HELEN L. PETTY, Petitioners v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket Nos. 5882-96, 16336-96.          Filed November 6, 1997.



     Ray Foresman, for petitioners.

     Elizabeth Patino, for respondent.



                        MEMORANDUM OPINION

     RAUM, Judge:   The Commissioner determined deficiencies in

petitioners' Federal income taxes as follows:

     Petitioner                       Year      Deficiency

     Berger Chevrolet, Inc.           1990        $13,087

     Timothy and Helen Petty          1987         21,908
                               - 2 -

The issue is whether, on the facts set forth hereinafter,

commissions paid to a car dealership's finance and insurance

manager for selling credit insurance are ordinary and necessary

business expenses of the dealership deductible under section

162(a)1.   The case was submitted on the basis of a stipulation of

facts.

     Petitioners are Timothy M. and Helen L. Petty and Berger

Chevrolet, Inc. (Berger).   The Pettys, husband and wife, lived in

Ada, Michigan, when their petition in this case was filed.    They

filed joint returns for the years involved.   Berger was located

in Grand Rapids, Michigan, when its petition in this case was

filed.

     Timothy Petty is the sole shareholder of Classic Chevrolet,

Inc. (Classic), an S corporation.   The Petty deficiency for 1987

is the result of the disallowance of deductions for commissions

paid by Classic to its employees in 1989 and 1990.2   The Berger

deficiency is the result of the disallowance of deductions for

commissions paid in 1990.   Unless otherwise indicated, the

following events occurred in 1989 and 1990 in the case of

Classic, and 1990 in the case of Berger.




     1
        Unless otherwise indicated, all section references are to
the Internal Revenue Code in effect for the years in issue.
     2
       As a result of the disallowances, Classic's net operating
losses for 1989 and 1990 were reduced. Consequently, the net
operating loss carryback to 1987 was correspondingly adjusted,
resulting in the deficiency.
                               - 3 -

     Classic and Berger are Michigan motor vehicle dealerships,

licensed as new motor vehicle dealerships by the Michigan

Department of State.   They are also licensed as "installment

sellers" by the State of Michigan, Financial Institutions Bureau.

An installment seller is authorized by the Michigan Motor Vehicle

Sales Finance Act to enter into installment sales contracts with

any of its customers who desire and qualify for financing.

     Installment sales contracts are written by dealers on behalf

of a variety of financial institutions and assigned to the

financial institution without recourse against the dealer.

Dealers use the financial institution's forms when arranging the

financing.   When a buyer of a motor vehicle finances the vehicle,

the buyer completes a credit application.    After the buyer's

credit is approved, the buyer enters into an installment sale

purchase agreement for the vehicle.    The installment sale

purchase agreement is immediately assigned to the financial

institution through which the dealer has arranged financing.

Upon assignment, the dealer receives payment from the financial

institution for the installment sale purchase agreement that was

assigned to it.

     During 1990, Classic sold a total of 3,112 new and used

motor vehicles; 1,888 of those vehicles were financed with

dealer-arranged financing.   Classic received gross income from

dealer-arranged financing of $280,529.    Berger sold a total of

5,290 motor vehicles; 2,561 of those were financed with dealer-
                                - 4 -

arranged financing.    Berger received gross income from dealer-

arranged financing of $261,926.

     Virtually all new motor vehicle dealers in Michigan and

other states offer credit life and disability insurance (credit

insurance) to their customers who buy vehicles with dealer-

arranged financing.    Credit insurance is also available from

banks, credit unions, and other lenders.    Credit insurance is

available to installment buyers under the age of 70 years without

a physical examination, provided the buyer's answers to a health

questionnaire are satisfactory.

     To purchase credit disability insurance, the buyer must be

actively employed and not on leave at the time of application for

the insurance.   Benefits from the credit insurance policies, in

the event of disability or death, are payable to the financial

institution that holds the installment sale purchase agreement,

not the buyer.   Benefits that exceed the outstanding

indebtedness, if any, are payable to the second beneficiary or

the estate of the buyer.    Disability payments are prorated for

each day the buyer is disabled and paid to the creditor up to a

maximum of the full monthly vehicle installment payment.    Only

the buyer, not any co-obligor, is eligible for disability

insurance.

     Credit life and credit disability programs are written as

group policies in which the buyer enrolls, rather than as

individual policies.    The group policy is issued to the dealer.
                                - 5 -

The group policy explains the insurance coverage in detail.      When

insurance is issued to a buyer he receives a certificate of

enrollment.    The certificate contains an outline of the benefits

included in the group policy.

     To provide credit insurance to its customers, Classic

contracted with Western Diversified Life Insurance Company

(Western).    Western issued certain group credit insurance

policies to Classic.    Berger contracted with American Way Life

Insurance Company (American Way).    American Way issued certain

group credit insurance policies to Berger.

     Installment buyers may finance the cost of credit insurance

as part of the installment sales contract.    If financed, the

premiums for credit insurance are included as a specific item in

the contract.    Berger and Classic each collected the full

insurance premium as part of the remittance from the financial

institution after assignment of the installment sale agreement to

that financial institution.    In 1990, Berger and Classic made a

single remittance each month of all premiums they collected to

Western and American Way, respectively.    The dealers did not

retain any portion of the premiums and were not reimbursed by

either Western or American Way for any of their direct or

indirect costs in connection with offering and marketing group

credit insurance.

     Western paid a commission on each premium collected by

Classic to the Woodcliff Agency, Inc. (Woodcliff), a duly
                                - 6 -

licensed insurance agency in Michigan.    Woodcliff is an S

corporation whose sole shareholder and director was petitioner

Helen L. Petty.    Woodcliff's sole income was the commissions

received from the sale of credit insurance under Classic's group

policy.   Woodcliff's sole expenses were for accounting fees.

Woodcliff did not have any employees.

     American Way paid a commission on each premium collected by

Berger to the Corsa Agency, Inc. (Corsa), a duly licensed

insurance agency in Michigan.    Corsa is a subchapter S

corporation whose shareholders were R. Dale Berger, Sr., and Lynn

Berger, each of whom held 50 percent of the stock.    R. Dale

Berger Sr. is Matt Berger's grandfather.    Lynn Berger is Matt

Berger's wife.    Matt Berger held 16 percent of the stock of

Berger.   The remaining 84 percent was held by R. Dale Berger, Jr.

The stipulation of the parties does not disclose the relationship

between Matt Berger and R. Dale Berger, Jr.    Corsa received

$510,163 from the sale of credit insurance under Berger's group

policy.   Corsa's sole income was the commissions received from

the sale of credit insurance under Berger's group policy.

Corsa's sole expenses were taxes, professional fees, and

administrative fees which totaled less than 10 percent of Corsa's

gross income.    Corsa did not have any employees.   Woodcliff and

Corsa are referred to as "dealer-related agencies" by the State

of Michigan Financial Institutions Bureau because such agencies

are established for the purpose of selling credit insurance to a
                                 - 7 -

single dealership or related dealerships and are normally owned

by a relative of the shareholders of the dealership.

     For the entire year of 1990, Berger and Classic each

employed a finance and insurance manager and certain

salespersons.   The responsibilities of the managers and

salespersons included offering group credit insurance to

installment buyers.   If an installment buyer purchased credit

insurance, the manager and/or salesperson calculated the amount

of the premiums, completed insurance disclosures on the

installment sale contract, obtained the buyer's signature,

explained the coverages, ensured that enrollment certificates

were provided to the buyer, and documented the transaction for

Western or American Way.

     Berger paid manager commissions of $38,490 for selling

credit insurance.   Classic paid manager commissions of $26,060 in

1989 and $29,025 in 1990 for selling credit insurance.     Neither

Berger nor Classic paid commissions to salespersons other than

managers for selling credit insurance.

     Under Michigan law, motor vehicle installment sellers are

prohibited from receiving, directly or indirectly, any portion of

the credit insurance premiums.    Mich. Stat. Ann. sec. 23.628(31)

(Law. Co-op. 1991).   Because of this law, insurance agencies were

created to collect the commissions paid by the insurance

companies.   Such agencies, although closely related to the

dealerships, were legally separate from them under Michigan law.
                                - 8 -

Realistically, however, the sale of credit insurance is part of

the dealership's function.    Dealerships perform a variety of

services, including selling cars, arranging financing, and

fulfilling warranty obligations as defined in service contracts.

Among these services, offering credit insurance is a subservice

of arranging financing.

     Credit insurance is offered on the installment sale purchase

agreement filled out by employees of the dealerships.    Since the

installment agreement offers credit insurance, the dealerships,

through their employees, must be able to explain the purpose of

credit insurance and calculate its cost.    Moreover, the dealers

collect payment for credit insurance when the dealer-arranged

financing is completed.   Although the commissions paid by the

insurance companies are paid to the dealer-related agencies, it

is clear from the record that the dealerships earn such

commissions.   And those commissions are paid to the dealer-

related agencies only because Michigan law mandates that result.

However, the agencies have no employees and take no initiative in

selling the credit insurance.    The only role the dealer-related

agencies play is as repositories of commissions paid by the

insurance companies.   There is nothing in the record to indicate

that the agencies played any part whatsoever in earning the

commissions paid to them.    The agencies are owned (directly or

indirectly, e.g., through a corporation) by relatives of the

dealerships' owners with the result that the dealerships'
                               - 9 -

earnings go to, or for the benefit of, the natural objects of the

owners' bounty.

     Because the earnings of the dealerships are diverted to the

dealer-related agencies, it may be questioned why the

Commissioner did not impute the agencies' earnings to the

dealerships.   In Lucas v. Earl, 281 U.S. 111 (1930), the Supreme

Court held that income must be taxed to the person who earns it;

see Commissioner v. Culbertson, 337 U.S. 733, 739-740 (1949)

("the first principle of income taxation:   that income must be

taxed to him who earns it").   However, the Commissioner did not

take that approach here.3   Instead, the Commissioner denied the

dealerships' deductions for commissions paid to their managers on

the theory that the commissions are an expense of the dealer-

related agencies.

     The record is clear that the dealerships, not the insurance

agencies, in fact offer credit insurance, notwithstanding that

under Michigan law the dealerships are not permitted to receive

commissions for selling credit insurance and that in accord with

Michigan law the commissions are channeled to their related

insurance agencies.   However, the issue presented to us by the

pleadings is not whether the commissions4 paid by the insurance

     3
       Conceivably, the Commissioner may have been deterred by
Commissioner v. First Security Bank, 405 U.S. 394 (1972).
     4
       Unfortunately, the word "commissions" is used in two
different contexts with potential for confusion: (1) Commissions
paid by the insurance companies for the sale of policies, which
                                                   (continued...)
                                - 10 -

companies should be included in the gross income of the

dealerships, but rather whether the dealerships are entitled to

deduct under section 162(a) the commissions that they paid to

their managers for selling credit insurance.

     The Government urges us to decide in its favor on the ground

that the compensation (or commissions) paid to the dealerships'

managers for selling the credit insurance is not deductible under

section 162(a) as claimed by petitioners.      In that posture of the

case, we hold for petitioners that such compensation (or

commissions) is deductible as a business expense under section

162(a).

     Section 162(a) allows "as a deduction all the ordinary and

necessary expenses paid or incurred during the taxable year in

carrying on any trade or business".      An ordinary expense is one

that is "normal, usual, or customary" in a particular business,

even if it occurs only once.    Deputy v. du Pont, 308 U.S. 488,

495 (1940).   "One of the extremely relevant circumstances is the

nature and scope of the particular business out of which the

expense in question accrued."    Id. at 496.    A necessary expense

is one that is "appropriate and helpful."      Welch v. Helvering,

290 U.S. 111, 113 (1933).   Whether the expense meets the




     4
      (...continued)
they paid to the dealer-related agencies; and (2) commissions
paid by the dealerships to their managers for their role in the
sale of insurance.
                                - 11 -

requirement of being ordinary and necessary is a question of

fact.     Id. at 115.

        A dealership's business encompasses a wide range of

activities beyond the mere sale of a vehicle.     The arrangement of

financing of sales on an installment plan is a familiar aspect of

a dealership's business and the offer of credit insurance with

respect to such sales is proximately related thereto.     Of the

3,112 new and used cars purchased from Classic, 1,888 were

financed with dealer-arranged financing.     Of the 5,290 cars sold

by Berger, 2,561 were financed with dealer-arranged financing.

With each car financed, the dealer uses the financial

institution's installment sales contract forms.     Of four

installment sales contracts in the record, all offer the option

of credit insurance.     Credit insurance is not always purchased by

the customer and is available for purchase elsewhere.

Nevertheless, it is clear from the record that both the

dealerships and the financial institutions expect someone at the

dealership to be able to explain and offer credit insurance to

the customer while the customer is filling out the installment

sale purchase agreement.

        The commissions for credit insurance are an "ordinary"

expense.     The parties have stipulated that virtually all new

motor vehicle dealerships in Michigan and other states offer

credit insurance to their customers who finance their

automobiles.     We have noted that the offering of credit insurance
                               - 12 -

on the installment agreement requires its explanation by a

salesman or a manager.    And it seems clear that a dealership

offering credit insurance would take such service into account in

some manner in compensating an employee for explaining to

customers the nature of the insurance coverage and calculating

its cost for customers, as well as arranging for the financing of

the very cost of the credit insurance itself.

     The expenses are also "necessary".   As we have noted,

virtually all motor vehicle dealerships offer credit insurance.

And, as we have also noted, the installment sale purchase

agreements offer the option for credit insurance.    To keep up

with their competitors, and to offer one stop service for

financing, the dealerships must have employees who can explain

the function of credit insurance to customers and who are able to

calculate the premiums.    Paying commissions to the managers is an

"appropriate and helpful" step in achieving those objectives.

Cf. Nichols Loan Corp. v. Commissioner, 321 F.2d 905 (7th Cir.

1963), revg. T.C. Memo. 1962-149.

     The Government relies on an artificial distinction between

the dealerships and the related agencies.    According to the

Government, the compensation (or commissions) paid to the

managers constitutes an expense of the dealer-related agencies,

not of the dealerships.    Accordingly, the argument continues, the

dealerships are not entitled to a deduction unless they can show

that compensating the managers results in a direct and tangible
                                - 13 -

benefit to the dealerships.   The Government further contends that

the dealerships are not in the insurance business and should not

be allowed to deduct insurance expenses.

     First, the Government is mistaken in treating the

dealerships and the dealer-related agencies as separate,

autonomous organizations.   As we indicated earlier, the

dealerships provide the service of offering, explaining, and

calculating credit insurance.    The agencies have no employees and

are merely shadow entities; they do not in fact sell insurance.

The agencies receive the commissions on the premiums, but that

result is required by Michigan law.      To be sure, Michigan law

governs as to the rights created and the relationships involved,

but Federal law is determinative as to tax consequences.      Morgan

v. Commissioner, 309 U.S. 78, 80-81 (1940).      See United States v.

National Bank of Commerce, 472 U.S. 713, 722 (1985); United

States v. Mitchell, 403 U.S. 190, 197 (1971); Bank One Ohio Trust

Co., N.A. v. United States, 80 F.3d 173, 175 (6th Cir. 1996);

Estate of Agnello v. Commissioner, 103 T.C. 605, 614 (1994).

     Second, the Government contends that the dealerships should

be denied the deductions because they are not in the insurance

business.   The Government fails to recognize the dealerships'

role in fact in the sale of credit insurance and in that

connection the breadth of a dealership's business.      A motor

vehicle dealership does much more than merely sell vehicles.

Among other things, it arranges for financing of installment
                              - 14 -

sales and offers credit insurance in respect of such sales.

Although the dealerships are not engaged generally in the

insurance business, they do deal with credit insurance to the

limited extent that it relates to dealer-arranged financing.    As

the record indicates, credit insurance is a small but

nevertheless an integral part of a dealership's business.   As a

result, the manager commissions are an ordinary and necessary

expense of the dealerships.

                              Decisions will be entered

                         for petitioners.
