Elrick v. CIR

Decision Date10 September 1973
Docket NumberNo. 72-1366.,72-1366.
PartiesMarianne Crocker ELRICK v. COMMISSIONER OF INTERNAL REENUE, Appellant.
CourtU.S. Court of Appeals — District of Columbia Circuit

Keith A. Jones, Atty., Dept. of Justice, of the bar of the Supreme Judicial Court of Massachusetts, pro hac vice by special leave of Court, for appellant. Scott P. Crampton, Asst. Atty. Gen., and Leonard J. Henzke, Jr., Atty., Dept. of Justice, were on the brief for appellant. William A. Friedlander, Atty., Tax Div., Dept. of Justice, also entered an appearance for appellant.

Sidney D. Rosoff, Washington, D. C., of the bar of the Court of Appeals of New York, pro hac vice, by special leave of Court, for appellee.

Before BAZELON, Chief Judge, TUTTLE,* Senior Circuit Judge for the Fifth Circuit, and MacKINNON, Circuit Judge.

MacKINNON, Circuit Judge:

This appeal involves certain claimed deficiencies in federal income taxes for the taxable years 1965 and 1966 in the amounts of $17,267.63 and $11,829.28 respectively. The decision of the United States Tax Court in favor of taxpayer-appellee1 is under attack here on appeal by the Commissioner.

The facts of the case are undisputed.2 On October 25, 1937, when taxpayer was four years old, her parents entered into a separation agreement which survived their divorce several months thereafter. Under the terms of the agreement, taxpayer's father, on November 1, 1937, created for her benefit an inter vivos trust consisting of 5,000 shares of capital stock of Provident Securities Company, a closely held California corporation. The terms of the trust provided that, during the joint lives of taxpayer and her father, all of the net income of the trust was to be paid over to the father until taxpayer reached her twenty-first birthday. At that time, taxpayer was to receive annually the first $10,000 of annual net income if unmarried and so long as she remained unmarried. However, if married at the time of her twenty-first birthday, of if married subsequent to that time, she was to receive annually $6,000 of the trust's annual net income. In each instance, the balance of the net income was to be paid to the settlor, taxpayer's father. The trust indenture also provided that, upon the death of taxpayer's father, taxpayer would receive annually the entire net income of the trust. In addition, upon the death of her father she would receive one-third of the trust corpus upon reaching the age of twenty-one, and one-half of the remaining corpus upon attaining the age of thirty-five. The corpus remaining at taxpayer's death was to be divided equally among her surviving issue, if any. Finally, taxpayer's father retained the right to revoke the trust agreement with the consent of the taxpayer's mother.

In 1955, taxpayer, who was then married and twenty-one years of age, was entitled to trust income of $6,000 a year. However, with the consent of taxpayer's mother (who had consulted with the taxpayer), her father, on February 15, 1955, revoked the trust agreement of November 1, 1937. In place of the first trust, and as consideration for taxpayer's mother's consent to the revocation, taxpayer's father created a second trust for taxpayer's benefit, with a corpus consisting of 2,200 shares of capital stock of Provident. Under the terms of the new trust indenture, taxpayer was to receive the entire annual net income from the trust during her lifetime and was to have a testamentary power of appointment over the corpus which could not be exercised in favor of the taxpayer, her estate, her creditors, or the creditors of her estate. Taxpayer's annual income increased substantially as a result of the revocation of the first trust and the creation of the second trust. Where her income from the first trust would have been limited to $6,000, her taxable income from the second trust averaged approximately $31,000 for the years 1955 through 1961.

On March 13, 1961, taxpayer's father died testate, his will expressly providing that taxpayer should not share in his estate. Taxpayer immediately retained counsel to contest the will on various grounds. In addition, taxpayer filed suit for quasi-specific performance of a contract to make a will, or in the alternative, for a rescission of both the revocation and trust agreements of February 15, 1955. In this claim, taxpayer alleged that in return for her mother's consent to the revocation of the 1937 trust agreement, her father had promised to provide equally for taxpayer and the other two children in his will, after taking into account what taxpayer received under the trust agreement of 1955.

Taxpayer's legal actions were settled by agreement of the parties on May 13, 1963. Taxpayer agreed to dismiss her suits and the other parties agreed to pay her $250,000 in settlement of her claim for specific performance of a contract to make a will. The agreement provided that payment should be made by transferring 909 shares of the capital stock of Provident (valued at $275 a share) to the 1955 trust, the stock to be held, administered, and distributed in accordance with the provisions of that trust. Taxpayer was also given the option to receive in cash, free of any trust, any amount not to exceed $275 for each share of Provident stock up to 227 shares which would not be placed in trust. Taxpayer opted to have all 909 shares of the Provident stock placed in the trust, thereby increasing its corpus to 3,109 shares. As a result, the annual income received by taxpayer from the trust increased by about 50 percent, and constituted her main source of income.

Pursuant to the contingent fee agreement between taxpayer and her attorneys, she paid legal fees of $52,500 in 1963 and 1964, $22,536.70 in 1965, and $20,000 in 1966 in asserting and settling her claim against her father's estate. Taxpayer deducted these expenditures in full as ordinary and necessary expenses for the production of income on her income tax returns for the respective years in which the fees were paid. After the Commissioner of Internal Revenue disallowed these deductions for 1965 and 1966, taxpayer filed a petition in the Tax Court in which she abandoned her original position and conceded that the legal fees were capital expenditures and not deductible as ordinary and necessary expenses. She argued rather that the legal fees were amortizable over the useful life of the income-producing asset (i. e., the life estate in the 909 shares of Provident stock) which the legal fees were expended in acquiring. The Commissioner argued that the fees were not deductible under any theory but must simply be added to taxpayer's basis in the life estate. The Tax Court agreed with the taxpayer's new position and this appeal ensued. We reverse.

To begin with, however, we agree completely with the Tax Court that taxpayer-appellee's original contention that the legal expenses in question were fully deductible under § 212 as ordinary and necessary expenses for the production of income is wholly without merit. Marianne Crocker Elrick, 56 T. C. 903, 908 (1971). Under recent Supreme Court decisions there can be no question that such legal expenses incurred in the acquisition of property having a useful life to the taxpayer substantially beyond the taxable years in issue are capital in nature and become part of taxpayer's basis in the asset. Woodward v. Commissioner, 397 U.S. 572, 90 S.Ct. 1302, 25 L.Ed.2d 577 (1970); United States v. Hilton Hotels Corp., 397 U.S. 580, 90 S.Ct. 1307, 25 L. Ed.2d 585 (1970).

Taxpayer's principal claim is that she is entitled to a depreciation deduction under § 167(a)(2)3 for the amortization of these legal fees over the useful life of the income producing asset, here the life estate in the 909 shares of Provident stock. An intangible asset may be the subject of such a deduction4 and it is well established that the purchaser of a life estate in income producing property is entitled to amortize the cost basis of his acquisition5 over the period of the life expectancy of the beneficiary (in this case the taxpayer herself) by ratable annual deductions. Gist v. United States, 296 F.Supp. 526 (D.C. 1969) aff'd 423 F.2d 1118 (9th Cir. 1970); Commissioner v. Fry, 283 F.2d 869 (6th Cir. 1960) aff'g 31 T.C. 522 (1958); Bell v. Harrison, 212 F.2d 253 (7th Cir. 1954); Estate of Daisy F. Christ, 54 T.C. 493 (1970); May T. Hrobon, 41 T.C. 476, 503 (1964); Elmer J. Keitel, 15 B.T.A. 903 (1929); see also, 4 J. Mertens, Law of Federal Income Taxation § 23.63a (1966 rev.). However where the life estate was not purchased in an exchange transaction for good and sufficient consideration, § 273 of the Internal Revenue Code denies the depreciation deduction. Section 273 provides that income generated by a life interest that was acquired by gift, bequest or inheritance shall not be reduced by any deduction for depreciation (or amortization or any other name for the same concept).6 Thus if the life estate in issue in this case was acquired by gift, inheritance or bequest, no depreciation deduction would be allowable and taxpayer's claim must fail.

Taxpayer's interest in the life estate which is here in question arose in settlement of certain claims against her father's estate. Taxpayer claimed, and the Tax Court agreed, that the transaction should be characterized not as a settlement of a will contest, but rather of an action for "quasi-specific performance of a contract to make a will." Marianne Crocker Elrick, 56 T.C. 903, 909 (1971). "Any interest she acquired as a result of the settlement of this claim flowed from her standing as a third-party beneficiary and not from her standing as an heir, devisee, donee, or legatee." Id.

In determining the correctness of this characterization, attention must be directed to the Supreme Court's decision in Lyeth v. Hoey, 305 U.S. 188, 59 S.Ct. 155, 83 L.Ed. 119 (1938) holding that recoveries in compromise or settlement are of the same nature for tax...

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