Lilly v. Commissioner

Background

Thomas B. Lilly and his wife Helen ran optical shops in North Carolina and Virginia. They paid the doctors who prescribed eyeglasses one-third of the retail price, following a long-standing local and nationwide custom. The opticians deducted those payments as ordinary business expenses. The Commissioner of Internal Revenue disallowed the deductions for 1943 and 1944, the Tax Court and the Court of Appeals agreed with the Commissioner, and the opticians were taxed on the unpaid amounts.

Reasoning

The Court considered whether these routine payments were ordinary and necessary business expenses. It found the payments were customary, regular, and essential to keeping the opticians in business because doctors often referred patients to sellers who shared profits. The Court rejected the argument that the payments were non-deductible on public policy grounds because, in 1943–44, there was no sharply defined national or state policy forbidding the practice. Earlier cases that limited deductions did not apply here. The Court reversed and directed the lower courts to allow the deductions consistent with this opinion.

Real world impact

The decision lets the opticians deduct customary commission payments to prescribing doctors for the years at issue and requires the Tax Court to change its prior ruling. The opinion also makes clear that payments actually illegal under state or federal law, or barred by a clear government policy, could be non-deductible in other circumstances. Later state legislation banning the practice can change its tax treatment going forward.

Dissents or concurrances

A single judge in the Tax Court dissented below, and Justice Douglas did not participate in this decision.