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Miller v. Quinn

June 12, 1986


On Appeal from the District Court of the Virgin Islands Division of St. Croix D.C. Civil No. 82-0211

Author: Hunter

Before HUNTER, WEIS, and MANSMANN, Circuit Judges


JAMES HUNTER, III, Circuit Judge:

Leroy A. Quinn, the Director of the Virgin Islands Bureau of Internal Revenue ("Director"), appeals the district court's grant of a petition to redetermine a tax deficiency brought by joint filers Gregory E. Miller and Doris D. Miller. Subject matter jurisdiction before the District Court of the Virgin Islands was based on V.I. Code Ann. tit. 33, § 944(a) (1967). Appellate jurisdiction over the court's redetermination obtained by virtue of 28 U.S.C. § 1291 (1982).

This appeal presents the question whether Virgin Islands lottery dealers may deduct the cost of unsold lottery tickets as an "ordinary and necessary" business expense under § 162(a) of the Internal Revenue Code of 1954, 26 U.S.C. § 1-9602 (1982) ("Code" or "I.R.C."). We conclude that such losses may be deducted only under the gambling loss provision, 26 U.S.C. § 165(d), and consequently reverse.


Like many of its mainland counterparts, the Virgin Islands legislature created a government-managed lottery to increase the Territory's revenues. See V.I. Code Ann. tit. 32, §§ 241-261 (Supp. 1985). All lottery winnings are tax free. Id. § 261. Unlike many mainland state lotteries, however, Virgin Islands lottery dealers do not purchase only those tickets that they sell. Instead, dealers purchase "sheets" of tickets at a twenty-percent discount from their retail price. If a dealer is unable to sell all his tickets prior to the drawing, he cannot return them. Under the lottery's rules, the dealer becomes the owner of all unsold tickets.

In late 1975, while he set up his legal practice after graduating from law school, Gregory Miller obtained a license as a Virgin Islands lottery dealer. His wife Doris assisted him in selling the tickets. On their tax returns for 1976 and 1977, the Millers deducted the cost of unsold tickets as an ordinary and necessary business expense incurred in Miller's lottery dealership. This figure amounted to slightly more than eight thousand dollars for the two years.

The Director disallowed the Millers' treatment of the unsold tickets, taking the position that they could be deducted only under the Code's less favorable gambling loss provision. The Director consequently sent the Millers a notice of deficiency for the claimed losses. The Millers then petitioned the district court for a redetermination of the deficiency pursuant to V.I. Code Ann. tit. 33, § 943(a) (1967).

The court granted the Millers' petition. The court observed that the lottery ticket distribution system created by the Virgin Islands legislature required dealers to retain unsold tickets. From this finding, the court reasoned that unsold tickets were a foreseeable and necessary incident of his dealership. Therefore, the court held that the losses should be treated as ordinary and necessary business expenses under I.R.C. § 162(a) like Miller's other overhead costs in running the dealership.


Through the Naval Appropriation Act of July 12, 1921, Congress made the United States income tax laws applicable to the Virgin Islands.*fn1 All income taxes collected from Virgin Islands residents, and income taxes collected from United States citizens not residing in the Virgin Islands but earning income in the Islands, are paid into the Islands' treasury. See 48 U.S.C. §§ 1397, 1642 (1982); Great Cruz Bay, Inc., St. John, Virgin Islands v. Wheatley, 495 F.2d 301, 303 (3d Cir. 1974). Because the Naval Appropriation Act establishes the Virgin Islands as a separate taxing jurisdiction, the administration of the Code requires the substitution of the term "Virgin Islands" for "United States" where appropriate. See Chicago Bridge and Iron Company v. Wheatley, 430 F.2d 973, 975-76 (3d Cir. 1970), cert. denied, 401 U.S. 910, 91 S. Ct. 873, 27 L. Ed. 2d 809 (1971). We have previously described the Virgin Islands income tax as a "mirror system" of the income tax structure in place on the mainland. See Vitco, Inc. v. Government of the Virgin Islands, 560 F.2d 180, 181-82 (3d Cir. 1977), cert. denied, 435 U.S. 980, 56 L. Ed. 2d 72, 98 S. Ct. 1630 (1978); HMW Industries, Inc. v. Wheatley, 504 F.2d 146, 150-51 (3d Cir. 1974); Dudley v. Commissioner of Internal Revenue, 258 F.2d 182, 184-87 (3d Cir. 1958). Although ...

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