## Facts

- John Manocchio, an airline pilot and Air Force veteran, took VA-approved flight-training courses in 1977.
- The training cost approximately $4,162 and maintained and improved skills required in his trade or business.
- Under a VA educational assistance program, Manocchio received tax-exempt payments equal to 90% of the training cost; he endorsed the checks over to the school.
- He did not include the VA payments in gross income.
- He deducted 100% of the training cost as a business/educational expense under I.R.C. § 162.
- The IRS disallowed the deduction to the extent of the 90% tax-exempt reimbursement under I.R.C. § 265(1) and determined a $924 deficiency for 1977.
- Manocchio challenged the deficiency in the Tax Court; the case was submitted fully stipulated.

## Issues

1. Whether I.R.C. § 265(1) disallows a deduction for the portion of otherwise deductible flight-training expenses that was reimbursed by tax-exempt VA educational benefits because the expenses are “allocable to” tax-exempt income.
2. Whether the Commissioner was estopped from disallowing the deduction based on prior IRS guidance indicating VA educational benefits did not require reducing education-expense deductions.

## Decision

- The Tax Court held that the reimbursed 90% portion of the flight-training expense was allocable to tax-exempt VA benefits and was nondeductible under I.R.C. § 265(1).
- The Tax Court allowed deductibility only for the unreimbursed portion of the expense.
- The Tax Court held the Commissioner was not estopped from applying § 265(1) despite earlier IRS publications and rulings suggesting a contrary result.
- The deficiency was sustained to the extent attributable to disallowing the reimbursed portion of the deduction.

## Legal Principles

- I.R.C. § 265(1) disallows deductions for amounts otherwise deductible to the extent they are allocable to a class of income wholly exempt from federal income tax.
- When a tax-exempt reimbursement is computed as a percentage of, and conditioned on incurring, a specific expense, the reimbursed portion of that expense is allocable to the tax-exempt income.
- Section 265(1) applies by objective allocation; taxpayer motivation for incurring the expense (e.g., skill maintenance rather than obtaining benefits) does not control.
- A taxpayer may not claim both tax-exempt reimbursement and a deduction for the same reimbursed costs; the statute prevents a double tax benefit.
- Estoppel against the government in tax administration is applied narrowly; reliance on prior administrative guidance does not bar the Commissioner from enforcing the statute and changing interpretive positions.

## Conclusion

The Tax Court held that flight-training expenses otherwise deductible as business education costs must be reduced by the amount reimbursed with tax-exempt VA benefits because the reimbursed portion is allocable to exempt income under § 265(1), and prior IRS statements did not estop the Commissioner from disallowing the deduction.


Manocchio v. Commissioner, 78 T.C. 989 (1982)