Cruttenden v. Comm'r of Internal Revenue

• Decision Date: 03 January 1978
• Docket Number: Docket No. 9037-75.
• Citation: 1978 PH TC Memo 78004,70 T.C. 191,37 T.C.M. (CCH) 8
• Parties: WALTER W. CRUTTENDEN and FAY T. CRUTTENDEN, PETITIONERS1 v. COMMISSIONER of INTERNAL REVENUE, RESPONDENT
• Court: U.S. Tax Court

1978 PH TC Memo 78,004

37 T.C.M. (CCH) 8

70 T.C. 191

WALTER W. CRUTTENDEN and FAY T. CRUTTENDEN, PETITIONERS1

v.COMMISSIONER of INTERNAL REVENUE, RESPONDENT

Docket No. 9037-75.

United States Tax Court

Filed January 3, 1978.

Petitioners lent corporate stocks to a corporation (Command) in which they owned a minority interest to be used as collateral by Command to borrow funds from a bank. Title to the stocks remained in petitioners and they continued to receive all of the dividends. The agreement between petitioners and Command permitted petitioners to withdraw the stocks, substituting other securities or cash, and upon termination of the agreement, if Command no longer had possession of petitioners' stocks, Command agreed to deliver to petitioners securities acceptable to them of quality and value comparable to the shares delivered to Command. Command pledged petitioners' stocks as collateral for loans but the shares were never sold and title remained in petitioners. Following a corporate reorganization of Command petitioners employed an attorney to recover the stocks from Command. After protracted negotiations the stocks were recovered. Held, sec. 212(2), I.R.C. 1954, as amended, and sec. 1.212-1(k), Income Tax Regs., permit deductibility of the attorney's fees relating to recovery of the stocks.

Petitioner husband paid attorneys for advice as to a possible conflict of interest as a securities broker and his participation in lending stock to Command. Held, such attorneys' fees are personal and nondeductible. Lewis M. Porter, Jr., for the petitioners.

Harmon B. Dow, for the respondent.

GOFFE, Judge:

The Commissioner determined deficiencies in Federal income tax for the taxable year 1971 in the amount of $12,644. The issues for decision are as follows:

(1) Whether legal expenses paid by petitioner Fay T. Cruttenden to recover securities from a brokerage firm of which she was a shareholder represent a loss on a transaction entered into for profit under section 165(c)(2),² or were ordinary and necessary expenses paid for the management, conservation, or maintenance of property held for the production of income under section 212(2);

(2) Whether legal expenses paid by petitioner Fay T. Cruttenden to recover interest on a loan to the corporation were ordinary and necessary expenses paid for the collection of income under section 212(1); and

(3) Whether expenses for legal advice in connection with making a loan of securities is an ordinary and necessary expense for the management, conservation, or maintenance of property held for the production of income under section 212(2).

FINDINGS OF FACT

Some of the facts have been stipulated. The stipulation of facts and supplemental stipulation of facts and attached exhibits are incorporated herein by reference.

Mr. Walter W. Cruttenden, Sr. (hereinafter referred to as Walter, Sr.), and Mrs. Fay T. Cruttenden (hereinafter referred to as petitioner) are husband and wife and at the time of filing their petition were legal residents of Corona del Mar, Calif. In 1971 petitioner and her husband filed a joint U.S. Individual Income Tax Return with the Internal Revenue Service Center at Fresno, Calif.

On January 3, 1963, petitioner lent $100,000 to Command Securities, Inc. (Command), at 6-percent interest under a loan agreement which subordinated the debt to other obligations of the corporation.³ On March 1, 1963, petitioner acquired 500 shares of Command for $50,000 cash. Command, formerly Cruttenden and Co., Inc., was a California corporation engaged as a broker-dealer in securities. Command was a member of the Midwest Stock Exchange and the Pacific Coast Stock Exchange at all times involved in the instant case. Mr. Walter W. Cruttenden, Jr. (Walter, Jr.), and Mr. James R. Cruttenden (James), are the sons of petitioner and Walter, Sr., and along with petitioner owned the controlling interest in Command. As of January 30, 1970, they held over 83 percent of Command's voting stock and approximately 70 percent of all Command stock. Petitioner owned 18 percent of Command voting stock.

Petitioner and Command entered into another loan agreement on December 7, 1964, under which petitioner lent certain securities and cash to Command. ⁴ The agreement provided that Command could use the securities and cash in its business and allowed Command to hypothecate the securities to secure loans from banks or other lenders. Petitioner could withdraw any of the securities upon substituting cash or other securities of comparable quality and value. Upon termination of the loan any cash or securities belonging to petitioner would be returned to her and if the exact securities were not available Command agreed to deliver to petitioner securities which were acceptable to her and of a comparable quality and value. The agreement also provided that the right to demand or receive payment or return of the borrowed securities, whether in the form of securities or cash, was expressly subordinated to the claims of all present and future general creditors of Command.

In May 1969, Walter, Jr., and Mr. Anthony K. Nex discussed an idea (Command concept) which was designed to provide certain services to independent broker-dealers, in order to eliminate a substantial portion of the independent broker-dealers' overhead. The Command concept included providing computerized account services, handling certain mutual fund transactions, providing research ideas, and providing the opportunity for independent broker-dealers to handle underwritings in coordination with other broker-dealers. As a result of this discussion Mr. Nex was employed by Command to implement the Command concept. Two additional corporations were organized (Command Group, Inc., and Command Management, Inc.). Command Group, Inc., was organized to own the computer that would be used in accomplishing the back office customer accounting operations. Command Management, Inc., was organized to provide managed account services. Its function was to offer the broker-dealer an opportunity to place large individual accounts under professional management.

The management of the three Command companies anticipated operations in 11 Western States. To operate a block trading department (Command concept) successfully, a substantial amount of working capital was required. However, Command's financial condition was inadequate to implement the Command concept and, therefore, it was necessary to obtain the necessary working capital from outside sources.

Walter, Sr.,⁵ was the owner of 4,000 shares of ARA Services stock during 1969. He consulted with his attorney, Mr. Donnelly, to examine the possibilities of lending his shares of ARA Services stock to Command. Walter, Sr., was an officer of Walston & Co. He sought legal advice concerning the transfer of his ARA Services stock because he was concerned about possible conflicts of interest and SEC violations due to his position with Walston & Co. On September 16, 1969, he lent the 4,000 shares to Command pursuant to the December 7, 1964, loan agreement between petitioner and Command. No evidence was introduced to show the terms of this transfer regarding the date of repayment, interest charged, if any, or what agreement, if any, existed between petitioner and Walter, Sr., or petitioner and Command (all dividends of ARA stock were delivered to petitioner by Command). On December 19, 1969, Command borrowed $730,000 from the First National Bank of Chicago, Chicago, Ill. Command pledged certain securities as collateral for this loan which included Walter, Sr.‘s 4,000 shares of ARA Services stock. In addition, Command borrowed $91,000 from the Harris Trust & Savings Bank, Chicago, Ill. The collateral used for this loan was comprised of stock which petitioner transferred to Command pursuant to the loan agreements.

The loan obtained from the First National Bank of Chicago was an “in-transit” loan.⁶ Walter, Sr., who at the time of the loan negotiations lived in California, agreed to send the ARA Services stock to the bank if it would agree to lend Command $730,000. The bank did in fact lend the money to Command but did not receive the ARA stock and proposed to terminate the agreement with Command and call the loan if it did not receive the ARA stock as collateral. Mr. Donnelly conferred with bank officials to resolve this problem. Pursuant to this conference, the ARA stock was delivered to the bank.

During December 1969, officers of Command discussed the possibilities of selling Command to Systems Capital Corp. (Systems). Mr. Nex, who was Command's executive vice president, was working in Command's Chicago office and was in the process of promoting the Command concept. He became aware of these discussions with Systems and was in favor of selling only a part of the Command companies.

In December 1969, Mr. Nex went to Phoenix to meet with the board of directors of Systems to further discuss the acquisition by Systems of the Command companies and to explain the Command concept. At that meeting, Mr. Nex told Don L. Benscoter, president of Systems, that before Systems decided to acquire the Command companies he should wait until Command's audit was completed. Mr. Benscoter expressed an interest in the Command concept and was not primarily concerned with Command's upcoming audit.⁷

On January 6, 1970, Mr. Benscoter issued a news release announcing that Systems had entered into negotiations to acquire the three Command corporations. Systems eventually entered into an agreement with the shareholders of Command to acquire all of Command's outstanding capital stock in exchange solely for voting shares of its own stock. This agreement, entitled “Stock Exchange Agreement and Plan of Reorganization Between Systems Capital Corporation and the Shareholders of Command Securities, Inc.,” was dated January 30, 1970. Systems also entered into similar acquisition agreements with the shareholders of Command Group, Inc., and Command...