United States v. Lykes

• Citation: 188 F.2d 964
• Decision Date: 27 April 1951
• Docket Number: No. 13156.,13156.
• Parties: UNITED STATES v. LYKES.
• Court: United States Courts of Appeals. United States Court of Appeals (5th Circuit)

188 F.2d 964 (1951)

UNITED STATES v. LYKES.

No. 13156.

United States Court of Appeals Fifth Circuit.

April 27, 1951.

Francis W. Sams, Ellis N. Slack, Sp. Assts. to Atty. Gen., Theron Lamar Caudle, Asst. Atty. Gen., Herbert S. Phillips, U. S. Atty., Tampa, Fla., for appellant.

George W. Ericksen, Chester H. Ferguson, Tampa, Fla., for appellee.

Before HOLMES, McCORD and STRUM, Circuit Judges.

STRUM, Circuit Judge.

This is a suit to recover an alleged overpayment of income tax for the year 1944. The controlling question is whether, in computing the plaintiff-taxpayer's income tax for 1944, he is entitled under 26 U.S.C.A. § 23(a) (2) to deduct from gross income the amount he paid in that year as attorney's fees in contesting with the Commissioner of Internal Revenue the amount of plaintiff's gift tax liability for 1940. Judgment below was for the taxpayer.

In 1940, plaintiff Joseph T. Lykes was the principal stockholder in Lykes Brothers, Inc., a closely held family corporation organized in 1910 by his elder brothers, engaged in the cattle and meat packing business. Through a subsidiary it also operates extensive steamship lines. In 1940, plaintiff made gifts aggregating 1000 shares of stock in said corporation to his wife, two daughters and a son, giving to each 250 shares. The gifts represented about one-third of plaintiff's holdings in the company. He retained the remaining two-thirds. The son and one daughter were minors. The other daughter had reached her majority. The three children were unmarried and lived with plaintiff. Previous to the gifts, they had taken no active interest in the management of the corporation's affairs. Whether they did so thereafter, does not appear.

As the stock was closely held by the Lykes' family, it had no established market value. In his gift tax return plaintiff valued it at $120 per share, which he considered a fair value, and paid thereon a gift tax of $13,032.75. The Commissioner disagreed, and on March 3, 1944 entered a deficiency assessment of $145,276.50, based upon the Commissioner's valuation. Plaintiff testified that had he been required to pay the deficiency, it would have been necessary for him to raise the money by disposing of a large part of his remaining holdings in the company, property which he held for the production of income.

Plaintiff engaged the services of an attorney who contested the deficiency assessment in the Tax Court of the United States, with the result that the assessment was settled before trial for $15,612.75, about eleven per cent of the sum originally demanded. In 1944, plaintiff paid his attorney $7,263.83 for these services, but did not deduct this sum from gross income in reporting his income tax liability for that year. He later submitted a claim for refund, based upon a re-computation with the attorney's fees deducted, which claim was denied. If the fee is deductible, plaintiff's income tax for 1944 has been over paid by $5,665.78, which he would be entitled to recover.

At the trial, plaintiff testified that his motive for the gifts was not only "love," as stated in the gift tax return, but an additional motive was to fortify the value of his retained stock by giving the younger generation an interest in the corporation, thus ensuring continuity in family ownership and management of the corporation, a practice followed by his elder brothers who organized the corporation.

Plaintiff contends that the attorney's fee is deductible from gross income, first, because the gifts were not a mere distribution of property in the ordinary sense but involved calculated business considerations, one of the purposes of the gifts being the strengthening and enhancement of the stock retained by plaintiff, so that the attorney's fee paid for contesting the deficiency assessment was an ordinary and necessary expense incurred in the "conservation" of his income producing property. Second, that the controversy between the Commissioner and plaintiff arose out of an effort by the United States to collect a deficiency assessment which was so disproportionate as to have no reasonable relation to the gifts, but was essentially a hazard to plaintiff's remaining stock in the corporation, a substantial part of which he would have had to dispose of in order to raise the money to pay the assessment.

Plaintiff relies upon section 23(a) (2) of the Internal Revenue Code, 26 U.S.C.A. § 23(a) (2), which provides that in computing net income for income tax purposes, there may be deducted from the gross income of an individual "all the ordinary and necessary expenses paid or incurred during the taxable year for the production or collection of income, or for the management, conservation, or maintenance of property held for the production of income." If plaintiff is entitled to deduct these fees from his gross income, he must establish that right under the statutory provisions just quoted, as there is no specific statutory provision on the subject.

The subject is dealt with, however, in Treasury Regulation 111, section 29.23 (a)-15(b), as amended,¹ which has the force and effect of law unless in conflict with the statute itself,² and which holds that the deduction here sought is unauthorized. The trial court held that insofar as this regulation purports to deny the deduction here in question it is in conflict with the statute, and hence invalid.

As section 23(a) (2), supra, deals with exemptions, it is to be strictly construed. New Colonial Ice Company v. Helvering, 292 U.S. 435, 440, 54 S.Ct. 788, 78 L.Ed. 1348, 1352.

The questions here involved were recently considered in Cobb v. Commissioner, 6 Cir., 173 F.2d 711, and determined adversely to plaintiff's contentions here. There is no tenable distinction in principle between this and the Cobb case, with which we are in accord. The Cobb case also clearly distinguishes the Bingham case, Bingham's Trust v. C. I. R., 325 U.S. 365, 65 S.Ct. 1232, 89 L.Ed. 1670, here relied upon by plaintiff which involved the deductibility of legal fees and expenses paid by the trustee of the Bingham trust estate in contesting a deficiency assessment of income tax which was a direct lien against the corpus of the trust, and for legal...