Tellier v. CIR

• Decision Date: 16 February 1965
• Docket Number: No. 29,Docket 28823.,29
• Citation: 342 F.2d 690
• Parties: Walter F. TELLIER and Evelyn H. Tellier, Petitioners, v. COMMISSIONER OF INTERNAL REVENUE, Respondent.
• Court: U.S. Court of Appeals — Second Circuit

342 F.2d 690 (1965)

Walter F. TELLIER and Evelyn H. Tellier, Petitioners, v. COMMISSIONER OF INTERNAL REVENUE, Respondent.

No. 29, Docket 28823.

United States Court of Appeals Second Circuit.

Argued October 8, 1964.

Decided February 16, 1965.

Michael Kaminsky, New York City (Whitman, Ransom & Coulson, New York City, on the brief), for petitioners.

Robert A. Bernstein, Atty., Dept. of Justice, Washington, D. C. (Louis F. Oberdorfer, Asst. Atty. Gen., Lee A. Jackson, Harry Baum, Attys., Dept. of Justice, of counsel), for respondent.

First issue before LUMBARD, Chief Judge, and HAYS and ANDERSON, Circuit Judges.

Second issue before LUMBARD, Chief Judge, and WATERMAN, FRIENDLY, SMITH, KAUFMAN, HAYS, MARSHALL and ANDERSON, Circuit Judges.

HAYS, Circuit Judge.

I.

The first issue in this case is whether the profits realized from the sale by the taxpayer (Evelyn H. Tellier is a party only because she and her husband filed a joint return) of certain securities during the years 1952-1956 were taxable as ordinary income rather than as capital gain. The resolution of this issue turns upon whether the securities were held by the taxpayer for sale to customers in the ordinary course of his business of underwriting and selling securities. If they were so held, then under Section 117(a) (1) (A) of the Internal Revenue Code of 1939 (Section 1221(1) of the 1954 Code)¹ the profits were taxable as ordinary income.

There is ample evidence to support the Tax Court's finding that the taxpayer held the securities for sale in the ordinary course of business. The taxpayer was engaged through Tellier and Company, in form a partnership but in fact wholly controlled by the taxpayer, in the business of underwriting the public sale of stock offerings and in purchasing securities for resale to customers. In connection with the underwriting agreements the taxpayer himself received stock or stock warrants which he sold, frequently through Tellier and Company.

There were seventy separate transactions of this kind during the years in question and the net gains from these sales were:

                  1952 ........................ $74,755.33
                  1953 ........................  74,089.23
                  1954 ........................  49,184.05
                  1955 ........................  97,864.12
                  1956 ........................  13,277.42
                

On some occasions as an inducement to make more sales of the publicly issued shares, taxpayer would give Tellier and Company's salesmen a part of his stock warrants. Tellier and Company had at all times free call upon the securities which taxpayer kept in an "investment account." The cashier of Tellier and Company had authority to borrow any security it might need either because of a short sale or because a security was not received.

In the words of the Tax Court:

"The volume of sales, petitioner\'s activities with respect to the securities, and the close relationship between petitioner\'s investment accounts and the dealing activities of Tellier and Company support the conclusion that the securities here involved were being held by petitioners for sale to customers in the ordinary course of their trade or business."²

Affirmed.

HAYS, Circuit Judge (with whom LUMBARD, Chief Judge, and WATERMAN, FRIENDLY, SMITH, KAUFMAN, MARSHALL and ANDERSON, Circuit Judges, concur).

II.

The second issue presented in this case is whether legal expenses for the unsuccessful defense of a criminal action are deductible. We have decided that this problem, though long considered as authoritatively answered in this Circuit, should be reexamined.³

Taxpayer was tried and convicted on a thirty-six count indictment charging him with violations of the fraud section of the Securities Act of 1933,⁴ with violations of the mail fraud statute,⁵ and with conspiracy to violate these statutes.⁶ He was sentenced to four and one-half years of imprisonment on each count, the sentences to run concurrently, and was fined $18,000. He claimed a deduction in 1956 in the amount of $22,964.20, representing expenditures during that year incurred in his defense in the criminal proceeding. The Commissioner disallowed this deduction and his ruling was sustained by the Tax Court.

In disallowing a deduction for the expenses of an unsuccessful defense of a criminal action the tax authorities are following a purely judge-made rule. There is nothing in the statute which dictates or even suggests such a result. The applicable provision is Section 162 of the 1954 Code which provides:

"There shall be allowed as a deduction all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business * * *."

There is no provision which expressly prohibits the deduction of the expenses of an unsuccessful defense. The general prohibition on deductions, Section 262, reads:

"Except as otherwise expressly provided in this chapter, no deduction shall be allowed for personal, living, or family expenses."

That the framers of the legislation did not intend that it should be used for moral reform is indicated by the following bit of legislative history: In the Senate debate over the provision with respect to business losses, objection was raised to its liberality. It was suggested that deductions for losses be permitted only when incurred in a "legitimate" trade or business. The suggestion was rejected. Senator Williams, who was in charge of the income tax sections of the bill, explained that the object of the bill was

"to tax a man\'s net income; that is to say, what he has at the end of the year after deducting from his receipts his expenditures or losses. It is not to reform men\'s moral characters, that is not the object of the bill at all. The tax is not levied for the purpose of restraining people from betting on horse races or upon `futures,\' but the tax is framed for the purpose of making a man pay upon his net income, his actual profit during the year." 50 Cong.Rec. 3849 (1913).

In 1951 Congress rejected a proposal for disallowing deductions under Section 162 "for any expense paid or incurred in or as a result of illegal wagering" on the ground that the Internal Revenue Code was not intended to penalize or prohibit unlawful activities.⁷

Randolph Paul said:

"As exploration of relevant Congressional debates indicates, Section 23(a) (1) (A) Section 162(a) is not an essay in morality, designed to encourage virtue and discourage sin. It `was not contrived as an arm of the law to enforce State criminal statutes by augmenting the punishment which the State inflicts.\' Nor was it contrived to implement the various regulatory statutes which Congress has from time to time enacted. The provision is more modestly concerned with `commercial net income\' — a businessman\'s net accretion in wealth during the taxable year after due allowance for the operating costs of the business. * * There is no evidence in the Section of an attempt to punish taxpayers * * * when the Commissioner feels that a state or federal statute has been flouted. The statute hardly operates `in a vacuum,\' if it serves its own vital function and leaves other problems to other statutes. When Congress has wished to deny tax deductions as a means of reinforcing the sanctions of other federal statutes, it has done so deliberately and explicitly."⁸

No Supreme Court case lends any support to the rule that the legal expenses of an unsuccessful criminal defense when paid or incurred in connection with the carrying on of a trade or business are not deductible. In fact the Court has cast doubt on the rule by what it has said with respect to the reasons ordinarily given to justify the existence of the rule. These reasons are: first, that the expenses occasioned by unlawful activities are not ordinary and necessary in the conduct of a business⁹ and second that the allowance of a deduction for such expenses would be contrary to public policy.¹⁰

Of the legal expenses of resisting issuance by the Postmaster General of a fraud order, the Court said in Commissioner v. Heininger, 320 U.S. 467, 470, 471, 472, 64 S.Ct. 249, 252, 253, 88 L.Ed. 171 (1943):

"There can be no doubt that the legal expenses of respondent were directly connected with `carrying on\' his business. * * *

"It is plain that respondent\'s legal expenses were both `ordinary and necessary\' if those words be given their commonly accepted meaning. For respondent to employ a lawyer to defend his business from threatened destruction was `normal\'; it was the response ordinarily to be expected. Cf. Deputy v. du Pont, 308 U.S. 488, 495 60 S.Ct. 363, 467, 84 L.Ed. 416 (1940); Welch v. Helvering, 290 U.S. 111, 114 54 S.Ct. 8, 9, 78 L.Ed. 212 (1933); Kornhauser v. United States 276 U.S. 145, 48 S.Ct. 219, 72 L.Ed. 505 (1928). * * * Since the record contains no suggestion that the defense was in bad faith or that the attorney\'s fees were unreasonable, the expenses incurred in defending the business can also be assumed appropriate and helpful, and therefore `necessary.\' * * * "To say that * * * the expenses * * * were extraordinary or unnecessary would be to ignore the ways of conduct and the forms of speech prevailing in the business world."

To the extent that the equation of illegality with extraordinary and unnecessary is not question begging, it is applying special meanings to "ordinary and necessary" which are not applied in other connections. So long as the expense arises out of the conduct of the business and is a required outlay it ought to be considered ordinary and necessary.

As to public policy the Supreme Court held in Lilly v. Commissioner, 343 U.S. 90, 96-97, 72 S.Ct. 497, 501, 96 L.Ed. 769 (1952):

"Assuming for the sake of argument that, under some circumstances, business expenditures which are ordinary and necessary in the generally accepted meanings of those words may not be deductible as `ordinary and necessary\' expenses under § 23(a) (1) (A) Section 162(a) when they `frustrate sharply defined national or state policies

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