259 F.2d 450 (4th Cir. 1958), 7638, C.I.R. v. Standing

Docket Nº:7638.
Citation:259 F.2d 450
Party Name:COMMISSIONER OF INTERNAL REVENUE, Petitioner, v. James J. STANDING and Marie S. Standing, Respondents.
Case Date:September 20, 1958
Court:United States Courts of Appeals, Court of Appeals for the Fourth Circuit
 
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Page 450

259 F.2d 450 (4th Cir. 1958)

COMMISSIONER OF INTERNAL REVENUE, Petitioner,

v.

James J. STANDING and Marie S. Standing, Respondents.

No. 7638.

United States Court of Appeals, Fourth Circuit.

September 20, 1958

Argued June 9, 1958.

Page 451

Carter Bledsoe, Atty., Dept. of Justice, Bethesda, Md. (Charles K. Rice, Asst. Atty. Gen., Lee A. Jackson and Harry Baum, Attys., Dept. of Justice, Washington, D.C., on the brief), for petitioner.

Dudley DuB. Cocke, Norfolk, Va., for respondents.

Before SOBELOFF, Chief Judge, HAYNSWORTH, Circuit Judge, and BARKSDALE, District Judge.

BARKSDALE, District Judge.

This is an appeal from a decision of the Tax Court involving a deficiency in income Tax in the amount of $18, 634.40, the opinion of the Tax Court being reported at 28 T.C. 789. The facts, so far as pertinent, may be briefly stated as follows:

Taxpayer James J. Standing, during all the times here pertinent, was sole proprietor of two businesses, a retail lumber concern and an organization engaged in building and selling houses. Taxpayer Marie S. Standing was and is his wife. In july 1951, the Commissioner proposed adjustments in the joint income tax liability of the Standings for the years 1944 through 1949 resulting in total deficiencies and penalties of $160, 566.46. These deficiencies were caused by increases in the business income of the taxpayers for these years.

The taxpayers engaged an attorney, and an accountant, on a contingent fee basis to represent them in connection with the proposed deficiencies. In December of 1951, a compromise was reached, the taxpayers signing a Form 870 agreement whereby they agreed to pay a total of $90, 438.95 in full settlement of the asserted taxes, interest and penalties. For service rendered in reaching this settlement, the taxpayers incurred attorneys' and accountants' fees and expenses (for simplification hereinafter referred to as 'legal fees') of $14, 367.16. All of this amount became due and accruable in December 1951, although only $1, 500 of it was actually paid in that year. Also, in the settlement reached in December 1951, taxpayers agreed to pay $14, 676.16 as interest assessed on the agreed tax deficiency for prior years. None of this amount of interest was actually paid, but the entire sum was accruable in 1951. Taxpayers were on the accrual basis for reporting business income and expense,

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and on a cash basis for reporting non-business deductions.

In computing 'adjusted gross income' in their joint income tax return for 1951, the taxpayers claimed as business deductions both the interest assessed on the tax deficiency agreed to for prior years, and the legal fees incurred in contesting the deficiency assessment. Also they elected to and did take the optional standard deduction of $1, 000.

The Commissioner determined that the legal fees and interest were not allowable as 'business' deductions for the purpose of arriving at adjusted gross income. Instead, he allowed the $1, 500 actually paid in 1951 on account of legal fees as a 'non-business' itemized deduction from adjusted gross income, in lieu of the standard deduction taken by the taxpayers. The Commissioner's explanation for his action was that the interest and expenses involved were not business deductions, and that since the taxpayers were on a cash basis for reporting non-business deductions, the unpaid portion of these items could not be accrued and deducted in the year 1951. However, the Tax Court held that both the interest and legal fees were 'business deductions' and that since the taxpayers were on an accrual basis for the purpose of reporting business income, the entire amount of these items was properly accrued in 1951, and was deductible in arriving at adjusted gross income.

The Commissioner admits that both the legal fees and interest items are deductible, but contends that the legal fees are a non-business deduction under section 23(a)(2), 26 U.S.C.A. § 23(a)(2), which is as follows:

'Non-trade or non-business expenses. In the case 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.'

And the Commissioner further contends that the item of interest is deductible as a non-business deduction under Section 23(b), the pertinent part of which is,

'Interest. All interest paid or accrued within the taxable year on indebtedness, * * *'

On the contrary, taxpayers contend that both the item of legal fees and the item of interest are deductible under the provisions of 22(n)(1) and 23(a)(1) (A), which, so far as pertinent here, are as follows:

'§ 22. Gross income. * * *

'(n) Definition of 'adjusted gross income'. As used in this chapter the term 'adjusted gross income' means the gross income minus--

'(1) Trade and business...

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