Standing v. Comm'r of Internal Revenue, Docket No. 57030.

• Decision Date: 28 June 1957
• Docket Number: Docket No. 57030.
• Citation: 28 T.C. 789
• Parties: JAMES J. STANDING AND MARIE S. STANDING, PETITIONERS, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
• Court: U.S. Tax Court

28 T.C. 789

JAMES J. STANDING AND MARIE S. STANDING, PETITIONERS,

v.COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

Docket No. 57030.

Tax Court of the United States.

Filed June 28, 1957.

Charles A. G. Dawe, Esq., and Leroy T. Canoles, Jr., Esq., for the petitioners.

James A. Scott, Esq., for the respondent.

Held, taxpayer James J. Standing was on an accrual method for reporting business income and held, further, items representing interest on income tax deficiencies for prior years and expenses incurred in settling the deficiencies were properly accrued under section 22(n)(1), I.R.C. 1939, as deductions allowed by section 23 attributable to the business carried on by James J. Standing.

MULRONEY, Judge:

The respondent determined a deficiency in the income tax of James J. Standing and Marie S. Standing for the taxable year 1951 in the amount of $23,542.96. Some of the adjustments made by respondent were not put in issue by petitioners and other have been conceded. The only issue presented here is whether petitioners were entitled to deduct as expenses in arriving at adjusted gross income (under sec. 22 (n(1), I.R.C. 1939) for the year 1951 the sum of $29,043.32 representing interest on income tax deficiencies and other expenses incurred in settling the deficiencies, which items were accrued by them in their Federal income tax return for 1951.

FINDINGS OF FACT.

Some of the facts are stipulated and are found accordingly.

James J. Standing and Marie S. Standing are husband and wife, residing at Virginia Beach, Virginia, and their tax return for the year involved was filed with the then collector of internal revenue in Richmond, Virginia.

From 1944 until sometime during the year 1952, petitioner James J. Standing operated as sole proprietorships a retail lumber and building supply business and a business of building and selling houses. The individual income tax liabilities of petitioner James J. Standing, for the taxable years 1945, 1946, and 1947, and the joint individual income tax liabilities of both petitioners for the taxable years 1948 and 1949 were made the subject of investigation by respondent's agents. As a result of this investigation, the respondent, in July 1951, sent to petitioner James J. Standing proposed adjustments for the years 1944 to 1949, inclusive, showing total deficiencies and additions to the tax amounting to $160,566.46. The transmittal letter in the usual form stated if taxpayer did not agree with the adjustments he could file a protest and have opportunity for a hearing. There was attached to the transmittal letter the report of the revenue agent, which report worked up Standing's income on the specific item basis, and it stated: ‘The additional tax is due to increase in business income.’

The agent's report shows that the items of asserted deficiencies consisted of finding various errors, including failure to report some rents, failure to use a proper basis in reporting a capital gain for sale of a parcel of realty, improperly reporting gains realized from sales of realty as capital gains and not ordinary income, improperly reporting Standing's withdrawals from the business as a salary deduction, inventory variances, improperly charging capital improvements to cost of sales or charging them off as repairs, and improperly reporting the business income on the cash basis when it should have been reported on the accrual basis.

On July 26, 1951, petitioners entered into a contingent fee contract with Charles A. G. Dawe, an attorney, and Leroy T. Canoles, Sr., a certified public accountant, whereby the attorney and accountant agreed to represent petitioners before the Bureau of Internal Revenue or other departments or courts in connection with the proposed deficiencies, and petitioners agreed to pay them one-fourth of any saving effected in the total proposed tax and penalty of $160,566.46 not to exceed the sum of $15,000. The contract also provided for the payment of $1,500 by petitioners to the attorney and accountant upon the execution of the contract, and this sum was paid on that date.

After their employment the attorney and accountant had various meetings with respondent's agents and it seems to have been agreed taxpayer's records failed properly to reflect his income.

In December 1951 the accountant and attorney and the revenue agents jointly worked up a net worth statement which eliminated the year 1944 but which showed a deficiency for the years 1945 through 1949 of $63,601.32, with additions for fraud (for the years 1945 to 1948) of $26,074.87, and an addition for negligence (for the year 1949) of $762.76, or a total of $90,438.95. This net worth statement was made the basis of settlement and respondent proceeded to determine the above total deficiencies and taxpayers executed Treasury Forms 870 for the pertinent years waiving the restrictions on, and agreeing to, the assessment and collection of the foregoing total deficiency in income tax, additions to the tax, and interest. These Forms 870 were received at the Richmond office by the then internal revenue agent in charge on December 20, 1951. All of the foregoing assessments, plus interest, were paid during the calendar year 1952.

In their joint Federal income tax return for 1951, petitioners claimed a deduction for interest in the amount of $16,861.02, of which $14,676.16 pertained to the foregoing interest assessed with respect to the deficiencies for prior years. Petitioners accrued the unpaid interest under the heading of ‘General Expense’ as a business deduction in arriving at their net profit from business operations, and, in turn, in arriving at their individual adjusted gross income.

Petitioners were billed under the contingent fee contract by the attorney and accountant for $13,591.53, the bill being received by the petitioner James J. Standing on or about December 21, 1951. In computing their net profit from business operations in 1951, and, in turn, in arriving at their individual adjusted gross income for 1951, petitioners deducted under the heading of ‘General Expense’ legal fees in the amount of $14,367.16, only $1,500 of which was paid in 1951.

Petitioners elected to take the optional standard deduction of $1,000. Petitioners also took as a deduction a nonbusiness donation in the sum of $59.80 but they admit this was improper after electing to take the standard deduction.

In the statement attached to the notice of deficiency, the following explanations, insofar as material herein, were made:

(b) The business deductions claimed for accrued interest, donations and legal expenses in the respective amounts of $14,676.16, $59.80 and $14,367.16 have been disallowed for the reason that such expenses are held to be nonbusiness expenses.

(d) The standard deduction claimed in the amount of $1,000.00 has been disallowed because itemized deductions have been allowed in lieu thereof.

(f) and (g) Deductions have been allowed for the legal expenses and contributions paid in 1951 in the respective amounts of $1,500.00 and $59.80. Your contention that you are entitled to the use of the accrual basis of claiming nonbusiness expenses has been denied.

The records for the business operations of James J. Standing were substantially accrual in nature. Items such as accounts receivable, accounts payable, sales, and purchases were accrued. Inventories were used in computing profit and loss of the business. Some other items such as salaries were not accrued. Apparently no records, cash or accrual, were kept for nonbusiness income and expenses of petitioners. The income tax return of petitioners for 1951 reflected the accounting method or methods described above.

The expenses of interest on the deficiency for prior years, and the attorney's and accountant's fees incurred for settling said deficiency, were business expenses.

OPINION.

The basic question here is whether the interest on the deficiency and the attorney's and accountant's fees were deductible as business expenses. Petitioners took the deductions under section 22(n)(1), Internal Revenue Code of 1939, in order to arrive at their adjusted gross income. The cited section allows deductions in arriving at adjusted gross income if they are ‘deductions allowed by section 23 which are attributable to a trade or business carried on by the taxpayer * * * .’ And section 23 provides, in part:

SEC. 23. DEDUCTIONS FROM GROSS INCOME.

In computing net income there shall be allowed as deductions:

(a) EXPENSES.—

(1) TRADE OR BUSINESS EXPENSES.—

(A) In General.— All the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business. * * *

(2) 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.

(b) INTEREST.— All interest paid or accrued within the taxable year on indebtedness, * * *

The question comes down to whether or not the deductions are such as are allowed under section 23 which are attributable to Standing's business.

Respondent states the question in the case is: ‘Were the petitioners during the year 1951 on the cash basis for the purpose of claiming deductions for interest on federal income tax deficiencies and fees in connection with contesting asserted deficiencies in income taxes and fraud penalties for prior years, with the result that petitioners may not accrue those expenses which were not paid during the year 1951?’ The single proposition argued in respondent's brief is that Standing was...