Brown v. U.S., 75--1364

• Citation: 526 F.2d 135
• Decision Date: 09 December 1975
• Docket Number: No. 75--1364,75--1364
• Parties: , 76-1 USTC P 9109 Prentiss M. BROWN, Jr., and Margaret D. Brown, Plaintiffs-Appellees, v. UNITED STATES of America, Defendant-Appellant.
• Court: United States Courts of Appeals. United States Court of Appeals (6th Circuit)

Page 135

526 F.2d 135

39 A.L.R.Fed. 214, 76-1 USTC P 9109

Prentiss M. BROWN, Jr., and Margaret D. Brown, Plaintiffs-Appellees, v. UNITED STATES of America, Defendant-Appellant.

No. 75--1364.

United States Court of Appeals, Sixth Circuit.

Argued Oct. 13, 1975.

Decided Dec. 9, 1975.

Ralph B. Guy, Jr., U.S. Atty., Samuel J. Behringer, Jr., Asst. U.S. Atty., Detroit, Mich., Scott P. Crampton, Asst. Atty. Gen., Gilbert E. Andrews, Ernest J. Brown, Richard Farber, Tax Div., Dept. of Justice, Washington, D.C., for defendant-appellant

Edward B. Harrison, Fischer, Sprague, Franklin & Ford, Detroit, Mich., for plaintiffs-appellees.

Before PHILLIPS, Chief Judge, MARKEY, ^* Chief Judge, United States Court of Customs and Patent Appeals, and LIVELY, Circuit Judge.

LIVELY, Circuit Judge.

This case is concerned with the deductibility of legal fees and expenses incurred and paid by a taxpayer who brought a derivative action as a shareholder of a close corporation. Margaret D. Brown (taxpayer) and her sister first consulted attorneys concerning their interests in a family business (Dolese Brothers) after receiving an offer from their brother, Roger Dolese, for purchase of their stock in the corporation in August 1955. Taxpayer was disturbed by some of the statements contained in the offer, particularly the statement that Dolese Company was wholly owned by Roger. Dolese Company had been formed as a separate corporation in 1946, avowedly for the purpose of enabling Dolese Brothers to purchase the stock held by another branch of the Dolese family. Counsel was initially retained to advise on '. . . the overall advisability of accepting Roger's offer' to purchase, and the status of Dolese Company was discussed at the first meeting with taxpayer's attorneys.

Following an investigation, taxpayer and her sister were advised by their attorneys that the transactions carried out by Roger Dolese in 1946 by which the newly formed Dolese Company acquired some of the most valuable assets and the most lucrative operations of Dolese Brothers were a fraud upon their rights as shareholders of Dolese Brothers. Upon the refusal of Roger Dolese to disclose any information about the assets or earnings of Dolese Company, taxpayer and her sister instituted a shareholder's derivative action in the Chancery Court of New Castle County, Delaware, the legal domicile of both corporations. A motion to dismiss the action was denied, and the Supreme Court of Delaware affirmed.

While the case was pending in the Supreme Court of Delaware settlement discussions were initiated by the attorneys for Roger Dolese. The outcome of the negotiations was a settlement by which taxpayer and her sister disposed of their stock in exchange for debentures of Dolese Brothers at a value eighty percent above the offer in the 1955 letter from Roger Dolese. In addition taxpayer's annual income from her investment in Dolese Brothers was increased from $10,000 to $86,400 and she and her sister were guaranteed two seats on the board of directors as long as they held the debentures. The settlement agreement also provided for the payment by Dolese Brothers of '. . . the attorney fees and disbursements of the plaintiffs incurred by them and their attorneys in said Civil Action No. 989 in the Court of Chancery in the State of Delaware . . . in the aggregate amount of $100,000.00.'

When all conditions of the settlement had been satisfied in 1962 taxpayer paid her attorneys $54,910.65 for legal service rendered to her during the preceding seven years. On their income tax return for 1962 taxpayer and her husband (who is a plaintiff because a joint return was filed) reported a capital gain on the sale of the stock, but deducted the legal fees from ordinary income as being incurred and '. . . paid for the production or collection of income and for the management, conservation and maintenance of property held for the production of income.' The deduction was disallowed, an additional assessment was paid under protest and this action for refund was filed. Taxpayer also filed claims for refund of taxes based on smaller amounts of legal fees she had paid in 1959, 1960 and 1961.

Following some discovery each party moved for summary judgment. These motions were overruled by District Judge Theodore Levin in a reported opinion and order, Brown v. United States, 312 F.Supp. 286 (E.D.Mich.1970). There was no appeal from Judge Levin's order or the findings and conclusions set out in the opinion, which also contains a detailed statement of the facts. After ruling against the government on two of its asserted bases for summary judgment, the district court held that the remaining issue involved factual determinations and that summary judgment was not proper at that time. The district court defined the legal issue as whether the legal expenses were incurred in the production of income or for the management, conservation or maintenance of income-producing property, as claimed by the taxpayer; or were incurred as an incident to the sale of stock, as claimed by the government.

Thereafter the parties entered into a lengthy stipulation, referred to herein, which resolved all factual issues. On the basis of the stipulation and other evidence in the case, including depositions of the taxpayer and one of her attorneys, the district court granted judgment to the taxpayer for the full amount of the refund sought with interest. District Judge Robert E. DeMascio, to whom the case was reassigned following the death of Judge Levin, filed an unreported memorandum opinion with the judgment. His ultimate conclusion was that the origin of the claim litigated by the taxpayer in which the legal expenses were incurred was the conservation of income-producing property and that she had satisfied all requirements of Section 212 of the Internal Revenue Code of 1954, 26 U.S.C. § 212, for deduction of such expenses. This conclusion was based upon the finding that taxpayer's claim '. . . originated in the 1946 transaction that resulted in the transfer of income-producing assets from (Dolese) Brothers to Dolese (Company).'

The district court relied principally upon the opinion of the Supreme Court in Woodward v. Commissioner of Internal Revenue, 397 U.S. 572, 90 S.Ct. 1302, 25 L.Ed.2d 577 (1970). There a minority stockholder was outvoted on a proposal to extend perpetually the life of a corporation. Under controlling state law those shareholders voting for the proposal were required to purchase the stock voted against the proposal 'at its real value.' When negotiations for the sale of the stock failed to produce an agreement on its value, the majority stockholders brought an action in the state court to appraise the value of the minority stock interest. The minority stock interest was eventually purchased at the price fixed by the court and the majority shareholders sought to deduct attorneys', accountants' and appraisers' fees paid in connection with the appraisal litigation. The Tax Court and the Eighth Circuit held that the expenses were not deductible, and the Supreme Court granted certiorari '. . . to resolve the conflict over the deductibility of the costs of appraisal proceedings . . .' between two courts of appeals. Id. at 574, 90 S.Ct. at 1304.

In affirming the holding of the lower courts in Woodward the...