Manufacturers Hanover Trust Co. v. United States

• Decision Date: 06 February 1963
• Docket Number: No. 311-61.,311-61.
• Citation: 312 F.2d 785
• Parties: MANUFACTURERS HANOVER TRUST COMPANY, as Trustee Under Indenture Dated November 15, 1927, Made by Henry H. Rogers, Deceased v. The UNITED STATES.
• Court: U.S. Claims Court

312 F.2d 785 (1963)

MANUFACTURERS HANOVER TRUST COMPANY, as Trustee Under Indenture Dated November 15, 1927, Made by Henry H. Rogers, Deceased v. The UNITED STATES.

No. 311-61.

United States Court of Claims.

February 6, 1963.

Hewitt A. Conway, New York City, for plaintiff. Kelley, Drye, Newhall, Maginnes & Warren, New York City, were on the brief.

David D. Rosenstein, Chicago, Ill., with whom was Louis F. Oberdorfer, Asst. Atty. Gen., for defendant. Edward S. Smith, Lyle M. Turner and Philip R. Miller, Washington, D. C., were on the briefs.

DAVIS, Judge.

This is a suit brought by plaintiff, as trustee under a trust indenture executed by Henry H. Rogers on November 5, 1927, to obtain a refund of income taxes and interest in the amount of $23,008.89, which was paid by the trust for calendar year 1954. The case is before the court on plaintiff's motion and defendant's cross-motion for summary judgment, and presents three issues which call for resolution: (1) whether attorneys' fees incurred by the taxpayer in certain trust litigation are deductible as ordinary and necessary expenses for the management, conservation, or maintenance of property held for the production of income, or whether the expenses were capital expenditures incurred in defending or perfecting title to property; (2) whether capital gains and other gross income allocated to trust principal are to be taken into account in determining the amount of expenses, otherwise deductible by the trust, which are rendered nondeductible because allocable to tax-exempt income; and (3) whether taxpayer, in its claim for refund, made a sufficient demand for a deduction for the amount of income which it was required to distribute currently to the beneficiaries.

Plaintiff is a corporation organized under New York law for the conduct of a banking and trust business. On November 5, 1927, Henry H. Rogers executed an indenture transferring property in trust to an individual trustee, since deceased, and to plaintiff's predecessor, in contemplation of his daughter Millicent's forthcoming marriage to Arturo Peralta Ramos. The marriage took place two days later. Under the terms of the indenture, the net income of the trust was payable to Millicent for life, and at her death the trust was to be divided into equal shares (after making provision for her husband, if he survived her and had the marriage not terminated in divorce — as it did), one share to be held in trust for and the net income paid for life to each surviving child of the marriage.¹ Thereafter, the corpus was to be paid to that child's issue per stirpes; or, in default of issue, to his brothers or sisters or their issue; and in case of default of such beneficiaries, to the grantor or those entitled to take under his will. The indenture also contained reservations of reversionary interests in the event that Millicent might be survived by only one child, or by no children, but these provisions never came into effect, for at her death on January 1, 1953, she was survived by two sons of her marriage to Ramos — Arturo Henry Peralta Ramos and Paul Jaime Peralta Ramos, who were born on November 14, 1928, and February 18, 1931, respectively. The grantor, Henry H. Rogers, died testate on July 25, 1935, leaving a part of his residuary estate in trust for his widow, Pauline. She survived him, and by remarriage became Pauline V. Hoving.

After the death of Millicent, early in 1953, there was uncertainty as to the validity of the continuing trusts to Arturo Henry and Paul under Section 11 of the New York Personal Property Law, McKinney's Consol. Laws, c. 41, which prohibits suspension of the absolute power of alienation for more than two lives in being. On January 7, 1954, the plaintiff filed a petition in the Supreme Court of the State of New York for an order settling its account as trustee and fixing and allowing its commissions, and also construing the trust indenture and the grantor's will and instructing plaintiff as to the disposition of the trust assets. Millicent's executors, her two sons born of the marriage with Ramos, the infant son of Arturo Henry Ramos, another son of Millicent by a later marriage, and Mrs. Hoving were among those made parties to the proceeding, and they, as well as plaintiff, participated and prepared briefs on the issue of the validity of the trust. The position of Mrs. Hoving, residuary legatee of Henry Rogers, was that under New York law the continuing trusts for Arturo Henry and Paul were illegal and void, and she may also have attacked the entire inter vivos trust indenture of November 5, 1927. The other participants, opposing the interpretation advanced by Mrs. Hoving, contended that the trust indenture was wholly valid.

On November 29, 1954, before the cause was decided by the state court, the parties settled the proceeding by stipulation, after extended negotiations. Under the terms of this agreement, Mrs. Hoving withdrew her answer, consented that an order be entered construing the secondary trusts as valid, and assigned any rights of hers to the assets of these trusts to Arturo Henry and Paul in return for their paying her from their own funds the sum of $40,000. The parties also stipulated, subject to court approval, the various allowances to be paid to the different attorneys (and to the guardian ad litem of the infant respondent), and that all such allowances should be paid by the trust. The court entered a final order on December 6, 1954, in conformity with the stipulations, that plaintiff's accounts as trustee were approved and settled; that the trusts to commence upon the death of Millicent for the benefit of Arturo Henry and Paul were valid and enforceable; and that the trustee was to pay out of the trust corpus $49,000 in attorneys' fees and $15.25 as disbursements.

When it filed its fiduciary income tax return for 1954, plaintiff claimed a deduction of the entire $49,015.25 paid out in the trust litigation. Upon audit, the Commissioner of Internal Revenue disallowed the deduction "to the extent of $35,315.25 for the reason that to that extent the expenditures were not deductible under section 212 of the Internal Revenue Code of 1954 but should be capitalized under section 263 as an expenditure to perfect title." The $13,700 allowed by the Commissioner was attributed by him to the accounting aspect of the litigation and therefore allowable as an ordinary and necessary expense of the trust. Plaintiff paid the deficiency and then filed a refund claim asserting that the entire amount of attorneys' fees was deductible (except to the extent, if any, allocable to tax-exempt income) as an ordinary and necessary expense. Rejection of the refund claim brings the matter before us.

There is no dispute as to the allocation of these litigation fees between the accounting and the trust-construction phases. Plaintiff's position is the broader one that the sums attributable to the construction aspect of the suit must also be allowed as a deduction under Section 212 of the Internal Revenue Code of 1954 (26 U.S.C. § 212 (1958 ed.)), authorizing the deduction of "all the ordinary and necessary expenses paid or incurred during the taxable year * * * for the production or collection of income * * * or for the management, conservation, or maintenance of property held for the production of income * * *², and more particularly by Treasury Regulation § 1.212-1(i), which says that "reasonable amounts paid or incurred by the fiduciary of an estate or trust on account of administration expenses, including fiduciaries' fees and expenses of litigation, which are ordinary and necessary in connection with the performance of the duties of administration are deductible under section 212 * *" (emphasis added). On the other hand, defendant relies, of course, on Treasury Regulation § 1.212-1(k):

"Expenses paid or incurred in defending or perfecting title to property, in recovering property (other than investment property and amounts of income which, if and when recovered, must be included in gross income), or in developing or improving property, constitute a part of the cost of the property and are not deductible expenses. Attorneys\' fees paid in a suit to quiet title to lands are not deductible * * *" (emphasis added).³

As we have recently noted with respect to comparable provisions under the 1939 Code, these sections of the statute and the regulations, taken together, require that, before the expenditures can be deductible, they must be (a) "ordinary and necessary"; (b) "paid or incurred during the taxable year"; (c) "for the production or collection of income," or "for the management, conservation, or maintenance of property held for the production of income"; and (d) other than capital expenditures, including expenditures incurred in "defending or perfecting title to property." See California and Hawaiian Sugar Refining Corp. v. United States, Ct.Cl., 311 F.2d 235, 241, 242, decided December 5, 1962; Industrial Aggregate Co. v. United States, 284 F.2d 639, 644 (C.A.8, 1960). In this case the critical question is whether the expenditures were incurred in the defense or perfection of title.⁴

The binding effect of the rule that expenditures incurred in defending or perfecting title must be capitalized has long been recognized, and often applied. See, for example, Bowers v. Lumpkin, 140 F.2d 927, 151 A.L.R. 1336 (C.A.4, 1944); Roberts v. United States, 87 F.Supp. 935, 115 Ct.Cl. 428 (1950); Vernor v. United States, 23 F.Supp. 532, 87 Ct.Cl. 435 (1938); United States v. St. Joe Paper Co., 284 F.2d 430 (C.A.5, 1960); Brown v. Commissioner, 215 F.2d 697 (C.A.5, 1954); Safety Tube Corp. v. Commissioner, 168 F.2d 787 (C.A.6, 1948); Johnson v. Commissioner, 162 F.2d 844 (C.A.5, 1947); Jones' Estate v. Commissioner, 127 F.2d 231 (C.A.5, 1942); Boulder Building Corp. v. United States, 125 F.Supp. 512 (W.D.Okla. 1954); Coughlin v. Commissioner, 3 T.C. 420 (1944). The validity of the rule is settled,...