Cobb v. Comm'r of Internal Revenue, Docket No. 12617.

• Decision Date: 25 February 1948
• Docket Number: Docket No. 12617.
• Citation: 10 T.C. 380
• Parties: FRANK M. COBB, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
• Court: U.S. Tax Court

10 T.C. 380

FRANK M. COBB, PETITIONER,

v.COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

Docket No. 12617.

Tax Court of the United States.

Promulgated February 25, 1948.

Taxpayer in 1941 made certain gifts, thereafter filed a gift tax return, and paid the tax as disclosed by the return. In 1942 he was notified that a proposed adjustment would result in a gift tax deficiency of $13,840.52. Thereupon taxpayer employed attorneys, upon whose advice a protest was filed. Upon receipt of notice of deficiency a proceeding was brought in this Court. Thereafter, pursuant to settlement, taxpayer paid a deficiency of $6,000 in gift tax, together with interest of $643.80. In 1944 he paid his attorneys for their services $2,260. Held, that the amount paid to his attorneys by taxpayer is not allowable as a deduction under section 23(a)(2), Internal Revenue Code. W. Dean Hopkins, Esq., for the petitioner.

Philip J. Wolf, Esq., for the respondent.

The Commissioner determined a deficiency of $360.32 in income tax for the year 1944. The only issue to be determined is whether attorneys' fees in the amount of $2,260 are deductible under section 23(a)(2) of the Internal Revenue Code. The respondent conceded error in disallowing deductions aggregating $241 for dues to bar associations and a law library, subscription to legal periodicals, and expenses for telephone service, stationery, and stamps. Two other issues raised in the petition were conceded by petitioner.

FINDINGS OF FACT.

Most of the facts were stipulated and are found by us to be as stipulated. Those material to the issue are as follows:

The petitioner resides in Cleveland, Ohio, and filed his income tax return for 1944 on January 15, 1945, with the collector for the eighteenth district of Ohio, at Cleveland. During 1944 petitioner was employed as general counsel by the Cleveland Electric Illuminating Co. and received $16,380.32 from real estate rentals and $10,790.25 from dividends and interest.

Prior to December 1, 1941, the petitioner owned an undivided one-half interest in a certain parcel of real estate located at 234-236 Euclid Avenue, Cleveland, Ohio. On or about December 1, 1941, petitioner delivered to each of his four daughters a deed of gift transferring to each of them an undivided one-twelfth interest in fee simple of such real estate.

The petitioner filed a gift tax return for 1941 in which he listed such gifts to his daughters and other gifts, and paid a gift tax of $18,943.65 with the return.

Thereafter, on July 29, 1942, the internal revenue agent in charge in Cleveland sent a letter to petitioner proposing an adjustment of his 1941 gift tax liability which would result in a gift tax deficiency of $13,840.52.

On or about August 6, 1942, petitioner employed reputable attorneys to advise him as to the merits of the proposed adjustment and to protect his interests in the matter. The attorneys prepared and filed on petitioner's behalf a protest against the proposed adjustment. By an appropriate notice, dated November 23, 1942, the Commissioner of Internal Revenue notified petitioner that a determination of his gift tax liability for 1941 disclosed a deficiency of $13,840.52. At petitioner's request his attorneys prepared and filed in the Tax Court of the United States a petition for redetermination of such deficiency. After petitioner's attorneys had prepared for trial before the Tax Court, a settlement was reached and on December 14, 1943, the Tax Court, pursuant to stipulation of the parties, found a deficiency in such gift tax in the amount of $6,000. On or about December 29, 1943, petitioner paid such deficiency, together with interest of $643.80.

On January 12, 1944, petitioner paid his attorneys the sum of $2,260 as fees for their advice and services as attorneys in connection with such gift tax dispute, which amount was reasonable for the services rendered.

The record discloses the following additional facts:

The petitioner's books were kept and his 1944 return was made on a cash receipts and disbursements basis.

Petitioner's income in 1940 was more than $51,000. In 1940 the Euclid Avenue property yielded rent to petitioner of approximately $20,000. In 1941 the property was occupied for the whole year and petitioner's share of the rental was $33,500. In 1940 petitioner was constructing a building on other property he owned, which was leased subsequently to Marshall Drug Co. The indications were that his annual income would increase considerably over the amount received in 1940.

In order to aid his daughters and their families financially and to reduce his income taxes, petitioner made the above mentioned gifts to his daughters.

Prior to making the gifts he consulted with one of his attorneys especially experienced in valuation matters with respect to the value of the four one-twelfth interests in the Euclid Avenue property to be reported in his gift tax return.

In order to pay the 1941 gift tax deficiency of $6,000, the petitioner sold at a loss income-producing securities. If petitioner had been required to pay the original deficiency claimed, it would have been necessary for him to sell additional income-producing securities.

OPINION.

KERN, Judge:

The sole question presented herein is whether petitioner may deduct from gross income the amount of attorneys' fees paid by him in the taxable year in connection with litigation arising out of a dispute with regard to Federal gift taxes under the facts detailed in our findings. Petitioner contends that they are deductible under the provisions of section 23(a)(2) of the Internal Revenue Code.¹ Respondent contends that they are not deductible pursuant to his construction of the statute in Regulations 111, section 29.23(a)-15(b), as amended by T.D. 5513.²

It has been held that when expenses have been incurred by reason of contesting income taxes, and these taxes were a proximate result of the holding of property for the production of income, then such expenses are deductible under section 23(a)(2). Bingham v. Commissioner, 325 U.S. 365; Howard E. Cammack, 5 T.C. 467. It has also been held that expenses incurred in litigation involving Federal income tax liability are deductible without regard to whether the income out of which the dispute has arisen is derived from property. Herbert Marshall, 5 T.C. 1032. But it has never been held that expenses incurred in litigation involving the Federal gift tax liability of a taxpayer are deductible from gross income by reason of section 23(a)(2).

In our opinion such expenses can not be deducted. They are not expenses directly connected with or proximately resulting from the production or collection of income, as it might be said concerning expenses incident to disputes involving income tax liability. Cf. Herbert Marshall, supra. It is also impossible to conclude that the giving away of property for the purpose of reducing income is embraced by the phrase ‘The management, conservation, or maintenance of property held for the production of income,‘ and, therefore, expenses incident to such a gift are not those to which this part of section 23(a)(2) applies. We have already held this as to expenses incurred incident to a gift of income-producing property, but before the gift was actually made. Nancy Reynolds Bagley, 8 T.C. 130. A fortiori, when the expenses incident to a gift are incurred at or after the the time the property given passes from the donor, it can not be said that the expenses have ‘a proximate connection with the management, conservation, or maintenance of such property. ‘ Nancy Reynolds Bagley, supra, p. 135.

However, the contention is made that any liability of petitioner on account of gift taxes would result in a lien upon his income-producing property, that the payment of attorneys' fees in the gift tax litigation was necessary in order to protect the taxpayer's property from such a lien, and that the satisfaction of the liability asserted on account of gift taxes and the payment of expenses incurred in defending him against the assertion of that liability resulted in petitioner's being forced to sell a part of his income-producing property. Therefore, petitioner reasons, payment of these expenses was directly connected with the management and conservation of income-producing property.

This argument, to paraphrase our language in John W. Willmott, 2 T.C. 321, would result in a conclusion that the expenses of defending any type of litigation, even actions for slander or for alienation of affections, would be deductible by any taxpayer who owned property held for the production of income. We reiterate our conclusion reached in that case that section 23(a)(2) does not go, and was not intended to go, so far.

As we said in Don A. Davis, 4 T.C. 329, 334, section 23(a)(2) ‘was intended to give a deduction for ordinary and necessary expenses to one no engaged in carrying on a business, limited, however, to the extent set forth in this subsection and under circumstances where such expenditures would be allowable to one engaged in carrying on a trade or business.‘ And in Harold K. Hochschild, 7 T.C. 81, 87 (reversed on another ground, 161 Fed.(2d) 817), we said: ‘The test accordingly seems to us to be whether prior to the amendment (sec. 121, Revenue Act of 1942) such a deduction as that now in controversy would have been permitted to a taxpayer admittedly engaged in carrying on a trade business.‘ Stated another way, section 23(a)(2) treats the activities of producing or collecting income, and of managing, conserving, or maintaining property held for the production of aging, conserving, or maintaining property held for the production of income as a business for the purpose of permitting the deduction of the ordinary and necessary expenses incident to these activities in the same manner and to the same extent as trade or business expenses. A taxpayer actually engaged in business and owning property devoted to that business may not deduct as...