Rassenfoss v. Commissioner of Internal Revenue

• Decision Date: 18 December 1946
• Docket Number: No. 9078.,9078.
• Citation: 158 F.2d 764
• Parties: RASSENFOSS v. COMMISSIONER OF INTERNAL REVENUE.
• Court: U.S. Court of Appeals — Seventh Circuit

158 F.2d 764 (1946)

RASSENFOSS v. COMMISSIONER OF INTERNAL REVENUE.

No. 9078.

Circuit Court of Appeals, Seventh Circuit.

December 18, 1946.

M. Lester Reinwald, of Chicago, Ill., for petitioner.

Douglas W. McGregor, Asst. Atty. Gen., Sewall Key, A. F. Prescott, S. D. Hanson and Helen Goodner, Asst. to the Atty. Gen., J. P. Wenchel and Bernard D. Daniels, both of Washington, D. C., Bureau of Internal Revenue, for respondent.

Before MAJOR and MINTON, Circuit Judges, and LINDLEY, District Judge.

MAJOR, Circuit Judge.

This is a petition to review a decision of the Tax Court sustaining respondent's determination of deficiencies in the income tax of petitioner for the years 1940 and 1941. Such deficiencies were determined by disallowing deductions taken by petitioner in the sums of $2,087.37 and $4,467.06, representing money paid by him for legal fees and expenses in defending certain litigation affecting his co-partnership business interest.

Petitioner contended before the Tax Court, as here, that the deductions were proper either as ordinary and necessary business expenses under the provisions of Sec. 23(a) (1) or as a non-business expense under Sec. 23(a) (2) of the Internal Revenue Code as amended, 26 U.S.C.A. Int.Rev. Code, § 23(a) (1) and (2). Respondent contends that the expenditures thus made were for the purpose of protecting and defending his right and title to partnership business and property and therefore not deductible.

A statement of facts sufficient to show the nature and character of the expenditure in question is required. Petitioner, Julian Richmond and William R. Kohl, Jr. in 1928 formed a co-partnership known as the Lincoln Bag Company, and have since been engaged in the manufacture and sale of paper bags used principally by the dry cleaning industry. In 1933, Richmond sold his partnership interest to petitioner and Kohl, and as a result each became the owner of a 50% interest in said co-partnership. They so reported their respective interests in tax returns filed by the co-partnership from year to year. Petitioner reported substantial income from his one-half interest in the partnership, as is evidenced by the fact that he reported $59,809.65 for the year 1940, and $67,157.44 for the year 1941.

In 1928, Lawson V. Campbell, a friend of Kohl, was brought into the business to act as superintendent. The exact terms of his entry into the business are not clear and perhaps not important. With reference thereto the Tax Court found: "The partners and Campbell had a rather vague and indefinite oral understanding at that time that he would be allowed to participate in some way in the earnings of the business." (The question as to Campbell's position in the business gave rise to the litigation, for the defense of which petitioner made the expenditures sought to be deducted.) Shortly after Richmond's sale of his interest in the partnership, an unfriendly relationship developed between petitioner and Kohl which resulted on one occasion in a fight.

Campbell in 1934, some six years after he became associated with the partnership, asserted for the first time that he was a general partner rather than an employee. His assertion was disputed by petitioner and supported by Kohl. On December 29, 1939, Campbell filed his complaint in Chancery in the Superior Court of Cook County, Illinois, naming as defendants petitioner, Kohl, and Lincoln Bag Company, a co-partnership composed of petitioner, Kohl and Campbell. By his complaint Campbell sought the following relief: (a) that a receiver be appointed to take over the partnership business; (b) that an accounting be had, and that the court should decree that he should receive such amount as such accounting would disclose he would be entitled to; (c) that a decree be entered determining and adjudicating his right in and to the partnership and its assets, and (d) that the co-partnership be dissolved.

Kohl filed an answer to said complaint, substantially admitting the allegations thereof. Petitioner employed attorneys for the purpose of contesting the suit. An answer was filed, denying substantially all the allegations of the complaint and particularly that Campbell had any interest in the copartnership, was entitled to an accounting, the appointment of a receiver or to have the partnership dissolved. The matter was referred to a Master in Chancery who, after hearing the testimony of all the parties, made a report finding that Campbell was entitled to a 1.75% interest in the partnership as against the 33 1/3% interest claimed by him. Petitioner excepted to the Master's report, but subsequently the controversy was compromised and the report was neither approved nor disapproved. By the terms of the compromise Campbell was given a limited 1.75% interest in the partnership earnings and assets commencing the first day of November 1943, and in addition thereto the sum of $14,346.78, in full settlement against the partnership up to November 1, 1943.

Petitioner incurred and paid his attorneys in defense of the aforesaid suit the sum of $2,087.37 for the year 1940, and the sum of $4,467.06 for the year 1941. No question is raised as to the reasonableness of such fees. These are the items which the respondent, sustained by the Tax Court, held to be non-deductible.

The findings of fact as made by the Tax Court follow in the main those which we have recited. We think it is not inaccurate to state that there is no dispute concerning the facts as found except as to the finding that "the amounts paid in 1940 and 1941 were not ordinary and necessary expenses of carrying on the petitioner's trade or business." Obviously, if we are bound by this finding there is nothing to review for the reason that a taxpayer is not entitled to a deduction under either Sec. 23(a) (1) or (2) unless the expenditure is an "ordinary and necessary expense."

On the authority of Trust of Bingham v. Commissioner, 325 U.S. 365, 65 S. Ct. 1232, 1235, 89 L.Ed. 1670, we are of the view that this so-called finding of the Tax Court presents a reviewable question. The question in the Bingham case was whether certain expenditures in connection with the "management * * * of property held for the production of income" were deductible under Sec. 23(a) (2). The court held that the question for decision involved the meaning of the words found in the statutory provision, and that (325 U.S. page 371, 65 S.Ct. 1235, 89 L.Ed. 1670) "They are therefore questions of law, decision of which is unembarrassed by any disputed question of fact or any necessity to draw an inference of fact from the basic findings," and that "Decision of which by the Tax Court does not foreclose their decision by appellate courts * * * although their decision by the Tax Court is entitled to great weight."

Both petitioner and respondent cite a number of cases in support of their respective contentions, a study of which reveals that the line of demarcation between an "ordinary and necessary expense" as a deductible item and an expenditure incurred in defense of title to property and therefore not deductible is extremely narrow. In fact, in some of the cases it appears to have been drawn on an arbitrary rather than on a basis of reason or logic.

Petitioner places much reliance upon Kornhauser v. United States, 276 U.S. 145, 48 S.Ct. 219, 72 L.Ed. 505, wherein the taxpayer claimed as a deduction money spent for legal services. The situation before the court was so strikingly similar to that of the instant case that it seems pertinent to quote 276 U.S. page 151, 48 S.Ct. 220, 72 L.Ed. 505: "The petition alleges that the latter sum was paid by petitioner for attorney's fees incurred in the defense of a suit against him for an accounting instituted by his former co-partner, said suit growing directly out of the conduct of the partnership business, it being alleged by the copartner that petitioner had collected fees or compensation for professional services performed during the existence of the partnership to a division to which the co-partner was entitled; that the alleged fees in fact consisted of stock in a corporation acquired subsequently to the dissolution of the partnership and not for services performed during its existence; that the defense to the suit was successful and the amount paid was a necessary expense incurred in connection with petitioner's business * * *."

In that case the deduction was sought under a provision of the Revenue Act identical with the present Sec. 23(a) (1). The government contended (276 U.S. footnote page 147, 48 S.Ct. 219, 220, 72 L.Ed. 505), as the Commissioner does here, that the expenditures were not "ordinary and necessary expenses paid or incurred in carrying on any trade or business," that they were in defense of an accounting suit for the purpose of protecting property and that they were capital expenses. The Court of Claims sustained the government's theory. In reversing, the Supreme Court stated (276 U.S. page 152, 48 S.Ct. 220, 72 L.Ed. 505): "And it was an `ordinary and necessary' expense, since a suit ordinarily and, as a general thing at least, necessarily requires the employment of counsel and payment of his charges." The court, referring to certain opinions of the Revenue Department, stated (276 U.S. page 153, 48 S.Ct. 220, 72 L.Ed. 505): "The basis of these holdings seems to be that where a suit or action against a taxpayer is directly connected with, or, as otherwise stated, * * * proximately resulted from, his business, the expense incurred is a business expense within the meaning * * * of the act. These rulings seem to us to be sound and the principle upon which they rest covers the present case." The court also noted (276 U.S. page 152, 48 S.Ct. 220, 72 L.Ed. 505) that it made no difference...