Nickell v. C.I.R.
| Decision Date | 27 October 1987 |
| Docket Number | No. 86-1010,86-1010 |
| Citation | 831 F.2d 1265 |
| Parties | -5873, 56 USLW 2276, 87-2 USTC P 9585 Jane K. NICKELL, now Jane K. Johnson by marriage, and Joan D. Kincaid, Petitioners-Appellants, v. COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellee. |
| Court | U.S. Court of Appeals — Sixth Circuit |
Fred T. Goldberg, Jr., Chief Counsel, I.R.S., Washington, D.C., Michael L. Paup (Lead Counsel), Roger M. Olsen, Tax Div. Dept. of Justice, Ann Belanger Durney, Steven W. Parks, argued, Washington, D.C., Marlene Gross, Washington, D.C., for respondent-appellee.
Paul E. Sullivan, Brown, Todd & Heyburn, Lexington, Ky., C. Christopher Trower, argued, Scott W. Dolson, Brown, Todd & Heyburn, Louisville, Ky., for petitioners-appellants.
Before NELSON and RYAN, Circuit Judges, and ENSLEN, District Judge. *
The taxpayers, Jane Johnson and Joan Kincaid, appeal a Tax Court decision rejecting the deduction of certain legal expenses. The central issue in the case is whether Treas.Reg. Sec. 1.212-1(k) should be read to create an exception to the general rule of nondeductibility of expenses incurred to "recover" property. The proposed exception would render deductible, under I.R.C. Sec. 212, the expense of litigation to recover title or possession of stock.
We conclude that the Tax Court's holding denying the deductibility of these expenses should be affirmed. We hold, however, that the taxpayers are entitled to a deduction for the portion of expenses allocable to the recovery of dividends and interest.
The taxpayers, two sisters, owned stock in a finance company and several banks. Both taxpayers granted their father options to buy various of these stocks at more or less advantageous prices. Their father died without exercising the options. The executor of the father's estate then sought to exercise the options. The daughters refused to accept the tendered payment, and litigation ensued.
The daughters argued that the options were personal and therefore did not survive their father's death, that the options were void for lack of consideration, and that the options were revocable and had in fact been revoked before the executor sought to exercise them.
Title to the finance company stock had passed to the executor prior to the litigation. Joan, who owned the finance company stock, prevailed in the Kentucky Court of Appeals, and the judgment was affirmed by the Kentucky Supreme Court. She was declared to be the owner of the stock and, in response to a supplemental complaint filed after the first case had been affirmed on appeal, she was also awarded a large sum of money, representing dividends and interest received by the executor while he held the stock.
The bank stocks, meanwhile, which were owned by both sisters, were held by the executor as the litigation went forward. Title to the bank stocks did not pass to the executor prior to the litigation, so the sisters continued to receive dividend income from their bank shares. The sisters lost their separate suits concerning the bank stocks, and the executor paid each of them for their bank stocks according to the terms of the options the sisters had granted to their father.
Both sisters deducted the legal expenses associated with all of this litigation on their 1977 tax returns. The Internal Revenue Commissioner audited their returns and determined that the expenses were not deductible. Subsequently, the Tax Court held that the expenses were nondeductible capital expenditures.
This appeal presents a narrow legal issue, but one which implicates the highly artificial and thus continually vexed problem of distinguishing capital from ordinary expenditures. I.R.C. Sec. 212 provides in part that:
In the case of an individual, there shall be allowed as a deduction all the ordinary and necessary expenses paid or incurred during the taxable year--
(1) for the production or collection of income; [or]
(2) for the management, conservation, or maintenance of property held for the production of income....
I.R.C. Sec. 263(a) makes capital expenditures nondeductible. Capital expenditures are defined as "[a]ny amount paid out for new buildings or for permanent improvements or betterments made to increase the value of any property or estate." As explained in Treas.Reg. Sec. 1.263(a)-2(c), one example of a capital expenditure is "[t]he cost of defending or perfecting title to property."
Taxpayers' argument for the deductibility of their legal expenses rests almost solely upon the language of Treas.Reg. Sec. 1.212-1(k), which reads as follows:
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: but if the suit is also to collect accrued rents thereon, that portion of such fees is deductible which is properly allocable to the services rendered in collecting such rents. Expenses paid or incurred in protecting or asserting one's right to property of a decedent as heir or legatee, or as beneficiary under a testamentary trust, are not deductible.
Id. (emphasis added).
Taxpayers contend that:
Expenses paid to acquire or dispose of property or to defend or perfect title to property (which is simply a subcategory of acquiring or disposing of property) are also capital expenditures. Woodward v. Commissioner, 379 U.S. 572, 90 S.Ct. 1302, 25 L.Ed.2d 577 (1970). Expenses paid to recover property are within this category of capital expenditures unless the expenses are paid to recover investment property. Treas.Reg. Sec. 1.212-1(k). The exception for recovering investment property is a recognition that recovery expenses are paid for the production of income under I.R.C. Sec. 212(1), and the conservation and maintenance of property held for the production of income under I.R.C. Sec. 212(2), rather than enhancing the value of or title to property.
Treas.Reg. Sec. 1.212-1(k) has never been authoritatively held to have the effect attributed to it by the taxpayers. Two cases cited by the taxpayers lend only slight credence to their argument. Loyd v. United States, 153 F.Supp. 416, 139 Ct.Cl. 626 (1957), cited the predecessor to Sec. 1.212-1(k) only as an alternative basis for its holding. The Tax Court in Cruttenden v. Commissioner, 70 T.C. 191 (1978), aff'd on other grounds, 644 F.2d 1368 (9th Cir.1981), construed the regulation to allow "a deduction for expenses paid or incurred for the recovery of investment property which by its very nature is held for the production of income." Id. at 202. However, the Ninth Circuit, in affirming the result in Cruttenden, expressly disavowed the Tax Court's reading of this regulation and based its affirmance upon a conclusion that the regulation did not apply. Cruttenden v. Comm'r., 644 F.2d 1368, 1378 (9th Cir.1981).
The Tax Court, in this case, has held that the "linchpin" of the litigation was title to the stock.
Consistently since 1916 the Treasury Regulations have provided that the cost of defending or perfecting title to property constitutes a part of the cost of the property and is not a deductible expense. Congressional approval of this interpretation by reenactment of the applicable revenue statutes in successive acts in identical language gives to the regulation the efficacy of law.
Jones' Estate v. Comm'r., 127 F.2d 231, 232 (5th Cir.1942). This circuit has acknowledged since at least 1948 that the regulations making the cost of defending or perfecting title nondeductible have "the effect of law." Porter Royalty Pool, Inc. v. Comm'r., 165 F.2d 933, 936 (6th Cir.1948). See also Safety Tube Corp. v. Comm'r., 168 F.2d 787, 789 (6th Cir.1948).
In both Loyd and Cruttenden, the courts found that the legal expenses in question were not attributable to disputes over title. In Loyd,
The primary purpose, or at least the motivating force, of the litigation was not the question of who had title to the property, rather it was that the proper distribution of the estate's assets could not have been had without a prior determination by the court of the validity of the gift.
153 F.Supp. at 421. In Cruttenden, the Tax Court found that "the legal expenses paid by petitioners in no manner related to the title of the securities." The subject of the litigation was the right to the possession of the securities.
The Court of Claims in Loyd and the Tax Court in Cruttenden presumed that construing Treas.Reg. Sec. 1.212-1(k) to create a deduction for the expense of "recovering" investment property would not conflict with the well-established rule that costs of "defending or perfecting title" are not deductible. In the instant case, however, the taxpayers adopt as their definition of "recovering" the Ninth Circuit's language in Cruttenden, which confines "recovering property" to "instances where ownership, having been lost or relinquished, has been restored." 644 F.2d at 1378. Thus, the taxpayers apparently contend that "recovering" property is a subset of "defending or perfecting title," and that the regulation makes recoveries of investment property an exception to the rule of nondeductibility. Even if these cases may be considered precedential, the precedent they represent is much narrower than the rule taxpayers would have us adopt.
Taxpayers do not contend that their rule is necessarily implicit in the Code itself. Thus, in the absence of case authority, taxpayers are left with only the regulation in apparent support of their position.
The taxpayers propose that we adopt a sort of "plain meaning" approach to the language of Treas.Reg. Sec. 1.212-1(k). The regulation provides in part that:
Expenses paid ... in recovering property (other...
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