Estate of Meade v. CIR

• Citation: 489 F.2d 161
• Decision Date: 05 March 1974
• Docket Number: No. 73-1456.,73-1456.
• Parties: ESTATE of Joseph M. MEADE, Deceased, First National Bank of Florence, Executor, and Hazel B. Meade, Petitioners-Appellees, v. COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellant. William S. and Elizabeth KING, Petitioners-Appellees, v. COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellant.
• Court: U.S. Court of Appeals — Fifth Circuit

489 F.2d 161 (1974) ESTATE of Joseph M. MEADE, Deceased, First National Bank of Florence, Executor, and Hazel B. Meade, Petitioners-Appellees, v. COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellant.

William S. and Elizabeth KING, Petitioners-Appellees, v. COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellant.

No. 73-1456.

United States Court of Appeals, Fifth Circuit.

February 7, 1974.

Rehearing Denied March 5, 1974.

Scott P. Crampton, Asst. Atty. Gen., Meyer Rothwacks, Donald H. Olson, Attys., Tax Div., U. S. Dept. of Justice, Lee H. Henkel, Jr., Chief Counsel, I. R. S., Washington, D. C., for respondent-appellant.

J. Gilmer Blackburn, Decatur, Ala., for petitioners-appellees.

Before GEWIN, AINSWORTH and MORGAN, Circuit Judges.

AINSWORTH, Circuit Judge:

Taxpayers¹ incurred legal expenses in connection with the settlement of a civil antitrust claim that had been assigned to them in pro rata shares as distributees in a corporate liquidation. These cases present the question whether the legal expenses are deductible from ordinary income under section 212 of the Internal Revenue Code of 1954, or whether, under section 263 of the Code, they must be capitalized and offset against long-term capital gain realized by taxpayers from the settlement.

The pertinent facts have been fully stipulated. Joseph M. Meade and William S. King were the sole shareholders of the Alabama Wire Company, Inc. In 1963, that corporation and its wholly owned subsidiary employed an Atlanta, Georgia, law firm to advise whether Kaiser Aluminum and Chemical Corporation, in connection with its dealings with Alabama Wire and its subsidiary, had violated the federal antitrust laws. For this initial employment, which ceased in early 1964, the Atlanta firm was paid legal fees by Alabama Wire and its subsidiary.

The name of Alabama Wire was thereafter changed to Terrace Corporation, and, on February 15, 1965, the corporation was liquidated. Among the proceeds of the liquidation was the potential claim against Kaiser Aluminum, which, the parties have stipulated, had no ascertainable value at that time. Meade and King, individually, thus acquired ownership of the potential antitrust claim. Meade received a one-third interest in the claim, and King received a two-thirds interest, in accordance with their proportionate ownership of the distributing corporation.²

Based upon a later opinion of Atlanta counsel, Meade and King, in 1965, retained the firm to pursue the antitrust claim on their personal behalf. An agreement was entered whereby the firm would be paid a monthly retainer fee plus 20 per cent of any amount recovered. When it was subsequently determined that San Francisco counsel should be employed to bring the suit against Kaiser Aluminum in California, the agreement was modified to provide that a retainer of $10,000 would be paid to San Francisco counsel (which amount was to be credited against future retainer charges due Atlanta counsel), and that both counsel would share a 33 per cent participation in any amount recovered.

Suit was brought against Kaiser Aluminum in 1965 in the names of Meade and King, individually, as assignees of the cause of action of Alabama Wire and its subsidiary. Treble damages of $9,000,000 were sought. The case was settled in 1966 for $900,000, of which Meade received $300,000, and King, $600,000. On his respective 1966 income tax return, each reported the proceeds of the settlement as additional long-term capital gain from the liquidation of Terrace Corporation.

Pursuant to the aforementioned agreement with counsel, Meade and King, in 1966, paid legal fees and litigation expenses totaling $320,993.67.³ Meade paid one third of that amount, and King paid two thirds. Each claimed the full amount so paid by him as a deduction against ordinary income on his 1966 tax return. The Commissioner disallowed these deductions and treated the entire amount of legal expenses as an offset against the long-term capital gain realized by taxpayers from their antitrust claim. This resulted in an asserted deficiency for the taxable year 1966 in the amount of $29,991.37 for Meade and $65,221.26 for King. Taxpayers filed petitions with the Tax Court for a redetermination of their deficiencies. Upon the consolidation of the cases, the Tax Court held that the attorneys' fees and expenses are properly deductible under section 212(1) as payments for the production of income. 31 CCH Tax Ct. Mem. 935 (1972). This Court has jurisdiction under section 7482 of the Internal Revenue Code of 1954. We reverse the decision of the Tax Court.

The stock of Terrace Corporation constituted a capital asset in the hands of the taxpayers of Terrace Corporation. Thus, the proceeds of the liquidation of Terrace Corporation, received in exchange for their Terrace stock, constituted capital gain to taxpayers. Since the antitrust claim was included as part of the proceeds of the liquidation, the fair market value of the claim ordinarily would have entered into the computation — made at that time — of taxpayers' capital gain from the liquidation. See section 331 of Internal Revenue Code of 1954. In this instance, however, the potential claim had no ascertainable fair market value at the time of distribution, and no value was assigned to it for purposes of computing taxpayers' capital gain from the liquidation. The liquidation therefore remained an "open transaction," and, for tax purposes, the amounts subsequently received from the antitrust claim related back to the initial exchange. See Burnet v. Logan, 283 U.S. 404, 51 S.Ct. 550, 75 L.Ed. 1143 (1931); Dennis v. C.I.R., 5 Cir., 1973, 473 F.2d 274, 285; C.I.R. v. Carter, 2 Cir., 1948, 170 F.2d 911; Westover v. Smith, 9 Cir., 1949, 173 F.2d 90. It being undisputed that the Terrace stock was a capital asset in taxpayers' hands, taxpayers and the Commissioner agree that taxpayers had long-term capital gain upon the settlement with Kaiser Aluminum in 1966.

This appeal involves the treatment of taxpayers' legal expenses in connection with the settlement of the anti-trust claim. Taxpayers contend that these legal expenses are deductible from ordinary income as expenses incurred "for the collection of income" under section 212(1). The Commissioner argues that the legal expenses must be capitalized and offset against taxpayers' capital gain because they were incurred in connection with the disposition of a capital asset, the Terrace Corporation stock, within the meaning of section 263.

Section 162(a) of the Code permits an individual or corporate taxpayer to deduct all ordinary and necessary expenses paid or incurred in carrying on a trade or business.⁴ Section 212 permits an individual not engaged in a trade or business to deduct similar expenses paid or incurred "for the production or collection of income" and "for the management, conservation, or maintenance of property held for the production of income."⁵ The concept of capital expenditures, on the other hand, limits the deductions permitted for such gain-seeking expenses under sections 162 and 212.⁶ Although section 263, which deals with capital expenditures, explicitly denies a deduction only for certain types of expenditures,⁷ it is clear that the section does not provide an exclusive list. C.I.R. v. Lincoln Savings and Loan Association, 403 U.S. 345, 358, 91 S.Ct. 1893, 1901, 29 L.Ed.2d 519 (1971). The limits of nondeductibility for capital expenditures are found in the case law. Here, we are guided by fundamental doctrine recently noted by the Supreme Court in Woodward v. C.I.R., 397 U.S. 572, 575, 90 S.Ct. 1302, 1305, 25 L.Ed.2d 577 (1970): "It has long been recognized, as a general matter, that costs incurred in the acquisition or disposition of a capital asset are to be treated as capital expenditures."⁸ More specifically, expenses incurred by shareholders in effecting the liquidation of their corporation — our concern in this case — ordinarily constitute capital expenditures, which enter into the computation of gain or loss arising from the distribution. See, e. g., Third National Bank v. United States, 6 Cir., 1970, 427 F.2d 343; Helgerson v. United States, 8 Cir., 1970, 426 F.2d 1293; Estate of McGlothlin v. C.I. R., 5 Cir., 1967, 370 F.2d 729.

The Supreme Court's recent decisions in Woodward v. C.I.R., supra, and its companion case, United States v. Hilton Hotels Corporation, 397 U.S. 580, 90 S. Ct. 1307, 25 L.Ed.2d 585 (1970), shed further light on the principles applicable to this appeal. In those cases, the Court unanimously held that expenses of litigation that arise out of the acquisition of a capital asset are capital expenses. The cases presented two substantially identical situations. Taxpayers incurred legal expenses in appraisal proceedings in connection with a purchase of dissenting shareholders' stock that was required under local law. Taxpayers argued that the "primary purpose" test should be applied in determining the deductibility of the costs of acquiring or disposing of property. That rule, developed in the context of expenditures to defend or perfect title to property, provides that such expenditures are capital in nature only where the taxpayer's primary purpose in incurring them is to defend or perfect title. See, e. g., Treas.Reg. on Income Tax § 1.263(a)-2(c); Rassenfoss v. C.I.R., 7 Cir., 1946, 158 F.2d 764; Industrial Aggregate Co. v. United States, 8 Cir., 1960, 284 F.2d 639, 645. The primary purpose of their expenditures in the appraisal proceedings, taxpayers argued, related not to the acquisition of title, but to the price to be paid for the stock, and, therefore, their expenditures should not be characterized as acquisition costs.

In rejecting the taxpayers' claims in Woodward and Hilton Hotels, the Supreme Court found the primary purpose test inapplicable to the situations before it: "A test based upon the taxpayer's `purpose' in undertaking or defending a particular piece of litigation would encourage...