Gale v. Commissioner, Docket No. 4448-97.

CourtUnited States Tax Court
Writing for the CourtBeghe
Citation83 T.C.M. 1270
PartiesLee G. Gale v. Commissioner. Lee Gale v. Commissioner.
Docket NumberDocket No. 1422-98.,Docket No. 4448-97.
Decision Date27 February 2002
83 T.C.M. 1270
T.C. Memo. 2002-54
Lee G. Gale
Lee Gale
Docket No. 4448-97.
Docket No. 1422-98.
United States Tax Court.
Filed February 27, 2002.

[83 T.C.M. 1272]

Lee G. Gale, pro se.1

Ramon Estrada and Christine V. Olsen, for the respondent.1a*


BEGHE, Judge:

Respondent determined the following deficiencies, late-filing additions, and accuracy-related penalties with respect to petitioner's Federal income tax:

 Addition to Tax Penalty
                 Docket No. Year Deficiency Sec. 6651(a)(1) Sec. 6662
                 4448-97 ......................... 1992 $244,563 $12,228 $48,913
                 1422-98 ......................... 1993 247,317 12,366 49,463
                 1422-98 ......................... 1994 61,965 -- 12,393

After concessions, the following issues are to be decided:

(1) Whether litigation settlement proceeds of $797,225 paid to and placed in petitioner's attorney's trust account in 1992, pending resolution of a fee dispute between petitioner and his attorney, should be reported as income on petitioner's 1992 individual income tax return, or whether the amounts should be reported as income only when paid from the trust account in later years. We hold that the settlement proceeds were income to petitioner in 1992.

(2) Whether petitioner is entitled to deduct under section 461(f)2 amounts placed in his attorney's trust account pending resolution of the fee dispute between petitioner and his attorney. We hold that petitioner is entitled to deduct the amounts placed in his attorney's trust account pending resolution of the fee dispute, but only to the extent that the amounts would have been deductible if the attorney's claims had been undisputed and the amounts held in trust had been paid to the attorney in satisfaction of the attorney's claims. Because it has been established that only $65,685.34 claimed by the attorney for handling petitioner's divorce would not have been deductible if paid, we hold that petitioner is entitled to deduct in 1992, under section 461(f), $729,220.21.

(3) Whether petitioner is entitled to treat any portion of the additional $128,275 claimed on his 1992 return as cost of goods sold. We hold that he is not.

(4) Whether petitioner is entitled to deduct as a business expense any portion of the additional $128,275 that he wrongly claimed as a cost of goods sold on his 1992 return. We uphold respondent's determination allowing a deduction for $35,000 and disallowing any deduction for the balance of $93,275.

(5) Whether petitioner may carry forward total net operating losses of $148,367 from 1990 and 1991 to 1992 and $323,352 from 1992 to 1994. We hold that he may not.

(6) Whether petitioner may deduct depreciation in 1992 that exceeds the amount allowed by respondent. We hold that he may not.

(7) Whether petitioner failed to report various items of income on his 1992, 1993, and 1994 individual income tax returns. We hold that he did, although in lesser amounts than determined by respondent.

(8) Whether petitioner is liable for additions to tax and accuracy-related penalties under sections 6651(a)(1) and 6662(a), respectively. We hold that he is liable for both, although in lesser amounts than determined by respondent.

Respondent's additional adjustments to petitioner's exemptions, itemized deductions, self-employment taxes, and taxable Social Security benefits are computational and will be resolved by our holdings on the foregoing issues.


Some of the facts have been stipulated and are so found. The stipulation of facts, first through third supplemental stipulations of facts, associated exhibits, and oral stipulations are incorporated by this reference. Petitioner resided in Newport Beach, California, at the times he filed the petitions in these cases, which have been consolidated for the purposes of trial, briefing, and opinion.

Petitioner's Business and Estate Planning Activities

Over the years, petitioner engaged in several business activities, including cement hauling, retail gasoline sales, residential real estate rentals, and truck and equipment rentals. Petitioner conducted his hauling business both individually and as president and sole shareholder of Pyramid Commodities, Inc. (Pyramid), an S corporation incorporated in California and licensed by the California Public Utilities Commission (PUC) to haul cement, rock, and sand in Southern California. Petitioner's retail gasoline business was organized as a sole proprietorship and operated under the name Sherrys Exxon. Petitioner's

83 T.C.M. 1273

residential real estate and equipment rental activities also were unincorporated businesses. Petitioner used the cash receipts and disbursements method of accounting to compute taxable income for all these activities.

In December 1986, petitioner created the Lee G. Gale Living Trust (living trust) as part of his estate plan. Petitioner's primary purpose in creating the living trust was to avoid or minimize probate costs. Petitioner had exclusive power to revoke or amend the living trust during his lifetime. The living trust instrument designated petitioner as the initial trustee, to be succeeded by Bruce J. Lurie and/or Ronald Foster if petitioner became unable or unwilling to serve. Petitioner purported to fund the living trust by contemporaneously executing a document entitled "Assignment of Assets to Living Trust" (assignment document). In the assignment document, petitioner declared that he assigned to the living trust, without consideration, all the right, title, and interest that he owned or would thereafter acquire in all of his property, whether tangible or intangible, real, personal, or mixed.

United Ready Mixed Hauling Contract and Subsequent Litigation

In June 1986, petitioner entered into a 5-year contract to haul cement, rock, and sand (hauling contract) for United Ready Mixed Concrete Co., Inc., and its affiliates (United Ready Mixed) on an exclusive basis. The hauling contract contemplated that Pyramid, as a PUC-licensed hauler, would do the actual hauling. Petitioner and Pyramid rented office space, purchased or rented additional trucks and other equipment, and hired and trained new employees to meet the requirements of the hauling contract. Petitioner and Pyramid performed hauling services for United Ready Mixed beginning in June 1986. Later in 1986, United Ready Mixed refused to allow further performance of the hauling contract, refused to pay for hauling services previously received, and terminated the hauling contract.

In 1987, petitioner and Pyramid filed suit against United Ready Mixed for unpaid receivables and for breach of the hauling contract (among other things). Judgment was entered in favor of petitioner and Pyramid in May 1992. In July 1992, there was a settlement agreement whereby United Ready Mixed agreed to pay petitioner and Pyramid $782,500 plus interest. Under the terms of the settlement agreement, United Ready Mixed was required to make payment by check or wire transfer payable to a trust account created by petitioner's counsel, then Lurie & Hertzberg, and later Lurie & Zepeda (collectively, Lurie & Zepeda).

In late 1992, Lurie & Zepeda received total settlement proceeds of $794,905.55 from United Ready Mixed, and deposited the funds in a client trust account pending resolution of the fee dispute between Lurie & Zepeda and petitioner, described below. United Ready Mixed reported the settlement payment as a payment to petitioner on a 1992 Form 1099-MISC.

Fee Agreement and Dispute Between Petitioner and Lurie & Zepeda

In the 1980s and early 1990s, Lurie & Zepeda represented petitioner in numerous litigation matters, including the United Ready Mixed litigation, various lawsuits initiated by the FDIC against petitioner and others for default on a construction loan, a joint action by petitioner and others against another law firm for legal malpractice, lawsuits arising out of a real estate investment, a divorce proceeding against petitioner's former wife, and litigation involving petitioner's family members.

In 1987, petitioner entered into an hourly written fee agreement with Lurie & Zepeda. In August 1988, petitioner and Lurie & Zepeda modified the agreement (as modified, the fee agreement). In the fee agreement, petitioner agreed to pay Lurie & Zepeda an amount to cover legal fees and expenses incurred through June 30, 1988, and Lurie & Zepeda agreed to bill all fees incurred thereafter at one-half the firm's normal hourly rate. In exchange for the reduced hourly rate, petitioner agreed to pay a graduated contingency fee that would apply to any recoveries from petitioner's various litigation matters in excess of a specified minimum amount. For a recovery of less than $1 million, Lurie & Zepeda would be entitled to a contingency fee of 25 percent of the amount recovered in excess of $400,000. Petitioner also granted Lurie & Zepeda a lien against his recoveries to secure his obligations under the fee agreement.

Shortly after the fee agreement was executed, a fee dispute arose between petitioner and Lurie & Zepeda. In 1990, to secure payment of $750,000 in disputed fees then owed to Lurie & Zepeda, petitioner granted Lurie & Zepeda a lien against some rental real property he owned.

On the basis of its claims for unpaid legal fees and costs in connection with the various matters on which it represented petitioner, Lurie & Zepeda refused to release any of the United Ready Mixed settlement proceeds to petitioner during 1992. Lurie & Zepeda released the following amounts from the trust account in 1993 and 1994: (1) $5,500 paid on behalf of petitioner to Max Binswenger in 1993; (2) $200,000 paid to Lurie & Zepeda for legal fees in 1993; and (3) $250,000 and $5,391.94 paid to petitioner directly in 1993 and 1994, respectively. Lurie & Zepeda released other amounts in later years not at issue in these cases.

In May 1994, petitioner filed a complaint for legal malpractice,...

To continue reading

Request your trial

VLEX uses login cookies to provide you with a better browsing experience. If you click on 'Accept' or continue browsing this site we consider that you accept our cookie policy. ACCEPT