Tax season is upon us, and most people will not start filing their tax return until the very last moment. Statistics show that the majority of people file in April or even the week of April 15, the usual filing deadline. Sound familiar? In such a case, it helps to be organized and have all your receipts for possible itemized deductions ready and in order. And who could be more organized than a German? (As a German myself, I will allow myself to freely reinforce stereotypes about Germans.) I recently came across a 2004 tax case from the German Federal Fiscal Court (Bundesfinanzhof, BFH) which I could not resist sharing. (BFH, docket no. III R 31/02)
Facts of the Case
The plaintiff and his wife had been married since 1964. Unbeknownst to his wife, the plaintiff also entertained two extramarital affairs, one of which was with the former housekeeper of the couple. He kept his affairs hidden from his wife, because she had a heart condition and had previously suffered a heart attack and was therefore not supposed to be subjected to any unnecessary excitement. A friend of the housekeeper learned of the affairs and started blackmailing the plaintiff. Afraid that she would expose him to his wife, he paid her a total of Deutsche Mark 191,000 (around US$ 103,253) over the course of four years from 1994 until 1997. (BFH, supra at paras. 1, 2).
Ever the proper German, the plaintiff kept meticulous records of the time and amount of the payments, collected the bank transfer forms, copied checks and money orders, and even had his blackmailer sign receipts for received money. (Id. at 3).
So at what point in the story do taxes come into play? In April of 1998, his wife died of a heart attack (without discovering her husband’s infidelity) and the plaintiff reported the friend of the housekeeper to the police. She was subsequently tried and convicted for extortion to a prison sentence of two years and three months. Attempts to get her to repay the money proved unsuccessful. Not willing to give up just yet, the husband submitted his receipts and other paperwork to his local tax authority and claimed the blackmail money as a deduction for “extraordinary expenses.” The tax authority rejected his claim, and, obviously, he sued. (Id. at 3-6)
The Applicable Law
The German Income Tax Act provides that expenses are “extraordinary” and, therefore, deductible if the taxpayer inevitably incurs higher expenses than the majority of taxpayers with the same income level, the same financial situation, and the same marital status. Expenses are inevitable if the taxpayer cannot avoid them because of legal, actual, or moral reasons and if the expenses were necessary given the circumstances and did not exceed a reasonable amount. (Income Tax Act, § 33)
The Court Decisions
The Fiscal Court in Cologne (Finanzgericht Köln, FG Köln) was sympathetic to the plaintiff’s claim and ruled in his favor. (FG Köln, docket no. 4 K 2149/00). It held that the expenses were inevitable, because extortion is not a common occurrence and the plaintiff had no choice but to pay the money in order to ensure his wife’s life or health were not in peril. In the Court’s opinion, it was irrelevant that the plaintiff could have confessed the affair to his wife or that he consciously or unconsciously incurred the expenses by entering into an extramarital affair. A person that starts an extramarital affair does not necessarily anticipate that he or she will be extorted because of it.
The Federal Fiscal Court reversed the decision of the lower court on appeal. It stated that the Income Tax Code provides that expenses that the taxpayer incurred because of voluntary decisions regarding his lifestyle are generally not deductible as “extraordinary expenses.” (Income Tax Code, § 12) Such costs are only deductible as an exception on grounds of equity or when the expenses concern a part of the taxpayer’s way of living that he or she cannot influence. (BFH, supra at 13) According to the Court, the reason that led to the expense is therefore essential. It added that it is irrelevant whether the taxpayer subjectively felt that he or she was forced to perform an act; only objective reasons,as mentioned in the Income Tax Code, are relevant. (Id. at 14, 15) In the case of extortion, it matters whether the taxpayer had influence over the fact that caused the extortion. For example, a person who gets extorted because of his or her wealth had no influence over that fact. (Id. at 16, 17)
The Court held that even though the expenses were “extraordinary,” because not everyone who has an extramarital affair will be extorted, they were not “inevitable.” (Id. at 20) The plaintiff voluntarily entered into an affair even though his wife’s health was already fragile. He himself created the reason for the later extortion. (Id. at 21) The Court added that the plaintiff had different options at his disposal to avoid paying. He could have gone to the police right away, or he could have confessed the affair to his wife. Even though she had a heart problem, and eventually died of a heart attack, there was no indication that every excitement would have threatened her life. In the opinion of the Court, the plaintiff could have consulted her doctor, had a doctor present while he confessed the affair, or given her medication to avoid any danger. (Id. at 22, 23)
And the moral of the story? Is there one? Let us know in the comments section!
Bundesfinanzhof (BFH) (Federal Fiscal Court), Mar. 18, 2004, docket no. III R 31/02
Finanzgericht Köln (FG Köln) (Fiscal Court Cologne), Dec. 19, 2001, docket no. 4 K 2149/00