Wagner v. Comm'r of Internal Revenue , Docket Nos. 6290-79
| Decision Date | 09 June 1982 |
| Docket Number | 13865-79.,Docket Nos. 6290-79 |
| Citation | 78 T.C. 910 |
| Parties | WILLIAM WAGNER and EVELYN WAGNER, PETITIONERS v. COMMISSIONER of INTERNAL REVENUE, RESPONDENT |
| Court | U.S. Tax Court |
OPINION TEXT STARTS HERE
In 1972, petitioner sold certain stock for $2,400,000, payable $700,000 down with the balance to be paid in 12 quarterly installments. Petitioner reported his gain on the transaction as long-term capital gain on the installment basis. In 1974, the buyer brought suit against petitioner for damages alleging that petitioner violated sec. 10 of the Securities Act of 1934 and rule 10(b)-5 of the SEC in failing to disclose certain information affecting the value of the stock. Petitioner incurred litigation expenses in defending the suit in 1975, 1976, and 1977, which he deducted as expenses deductible under sec. 212, I.R.C. 1954. Held, the “origin-of-the-claim” test is applicable to determine whether the litigation expenses were capital expenditures or sec. 212 expenses. Held, further, the litigation originated with respect to a capital transaction, and the litigation expenses incurred were capital expenditures. Sidney A. Soltz, for the petitioners.
David R. Smith, for the respondent.
Respondent determined deficiencies in petitioners' Federal income taxes as follows:
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¦Docket No. ¦TYE Dec. 31— ¦Deficiency ¦
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¦ ¦ ¦ ¦
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¦6290-79 ¦1975 ¦$15,394 ¦
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¦13865-79 ¦1976 ¦7,510 ¦
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¦13865-79 ¦1977 ¦10,136 ¦
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These cases have been consolidated for purposes of trial, briefing, and opinion.
After concessions by petitioners, the only issue is whether attorney's and accountant's fees and other legal expenses paid by petitioner in connection with certain litigation are deductible expenses pursuant to section 212 1 or are nondeductible capital expenditures.
The cases were submitted on facts that were fully stipulated. The stipulation of facts and exhibits attached thereto are incorporated herein by reference. The pertinent facts are as follows.
Petitioners William Wagner (hereinafter petitioner) and Evelyn Wagner, husband and wife, resided in Miami Beach, Fla., at the time they filed their petitions herein. Petitioners filed a joint Federal income tax return for each of the taxable years in issue with the Internal Revenue Service Center, Chamblee, Ga. Evelyn Wagner is a party herein solely by reason of filing a joint return for each of the taxable years in issue with her husband.
Prior to November 27, 1972, petitioner owned 349,000 shares of common stock of Watsco, Inc. (hereinafter Watsco), a Florida corporation. Watsco was engaged in the design, manufacture, and sale of refrigeration components and tools, professional hair spraying systems, and roller bearings and wheels. Watsco stock was traded on the American Stock Exchange.
On November 27, 1972, petitioner agreed to sell 300,000 shares2 of his Watsco stock to Albert H. Nahmad (hereinafter Nahmad) for $2,400,000. Of this amount, $700,000 was to be paid at the time of closing by certified check, while the remaining $1,700,000 was to be paid in 12 substantially equal quarterly installments of $141,674, plus interest at 6 percent per annum on the outstanding principal balance. The first of these payments was due 3 months from the date of closing. Nahmad thereafter assigned his interest in the November 27, 1972, purchase agreement to Alna Corp., a Panamanian corporation of which Nahmad was the principal officer. The closing date was specified in the purchase agreement to be no later than December 29, 1972, and in fact was closed on that date.3
Prior to December 29, 1972, petitioner was the chief executive officer of Watsco. On that date, he resigned as chief executive officer, and entered into a consulting agreement with Watsco for a period of 6 years at an annual rate of compensation of $50,000 per year plus certain fringe benefits. In addition, petitioner agreed not to compete with Watsco for a period of 5 years.
On December 31, 1974, Alna Corp. and Alna Capital Associates, a limited partnership formed under the laws of the State of New York4 (hereinafter the plaintiffs), filed a lawsuit in the U.S. District Court for the Southern District of Florida naming petitioner and several others as defendants (hereinafter sometimes referred to as the lawsuit). The complaint filed in connection with this lawsuit charged generally that the defendants had made material misleading statements to the plaintiffs and to Nahmad, and had failed to disclose certain other information in connection with the sale of the Watsco stock. The complaint alleged that the acts, misrepresentations, and failure to disclose, complained of therein, constituted a violation by petitioner of section 10 of the Securities Act of 1934, and rule 10(b)-5, of the Securities and Exchange Commission (hereinafter SEC). The remedies sought in the lawsuit included, inter alia, (1) a complete recision of the purchase of stock from petitioner, and (2) compensatory damages of at least $1,500,000 and punitive damages of $1 million.
On January 31, 1975, petitioner filed an answer to the above complaint, including therein affirmative defenses and counterclaims. The counterclaims were (1) for the amount of $131,593.81, which petitioner alleged was the installment payment due on January 1, 1975, in respect of his Watsco stock sale, and (2) for the amount of $566,670, which he alleged to be the remaining unpaid balance of the purchase price due in respect of such sale5 (not including the amount claimed in count 1).
The plaintiffs filed an amended complaint and demand for jury trial on July 1, 1975. Petitioner filed his answer to the amended complaint on July 14, 1975, including therein affirmative defenses and counterclaims, which were essentially the same as in his original answer, filed on January 31, 1975.
On November 30, 1975, the district judge required the plaintiffs to make an election between the remedies sought in the pleadings. The plaintiffs elected to pursue their claim for money damages and waived their prayer for recision.
On December 23, 1977, Watsco terminated the December 29, 1972, consulting agreement with petitioner. Thereafter, on or about December 28, 1977, Watsco filed a lawsuit against petitioner in the Circuit Court for the Eleventh Judicial Circuit, Dade County, Fla., alleging fraud, misrepresentation, and deceit in connection with their consulting agreement. Watsco sought recision of that agreement as well as compensatory and punitive damages.6
During the taxable years 1975, 1976, and 1977, petitioner paid and deducted attorney's fees and other legal expenses incurred in connection with the lawsuit in the amounts of $61,431, $13,335, and $18,139, respectively.7
Respondent has disallowed these deductions in their entirety because he determined that the legal expenses were incurred as a result of a capital transaction rather than in a trade or business.8
The issue for decision is whether expenses incurred in defending a lawsuit wherein it was alleged that petitioner had made fraudulent representations and concealed certain information with respect to the sale of stock, in violation of the Securities Act of 1934 and rule 10(b)-5 of the SEC, are deductible expenses pursuant to section 212 or are nondeductible capital expenditures. 9
Petitioner claims that the legal expenses, and attorney's and accountant's fees (hereinafter collectively referred to as the litigation expenses) were paid for the “production or collection of income” within the meaning of section 212(1).10 He asserts that the stock sale to the plaintiffs was a completed transaction, and that in order to protect and collect his income, both from the sale of his stock and from his consulting fees from Watsco, he had no recourse other than to defend the lawsuit.
Respondent claims that the litigation expenses were incurred in a dispute having its origin in the disposition of a capital asset, and are therefore nondeductible capital expenditures. He maintains that the real dispute in the lawsuit centered around what price the plaintiffs would ultimately have to pay for the 300,000 shares of Watsco stock purchased.
Section 212 provides for the deduction of all ordinary and necessary expenses paid or incurred during a taxable year, inter alia, “for the production or collection of income.” The purpose of this section is to extend deductions previously allowed only in a “trade or business” context to certain nonbusiness situations. See Baier v. Commissioner, 63 T.C. 513, 517 (1975), affd. 533 F.2d 117 (3d Cir. 1976); Boagni v. Commissioner, 59 T.C. 708, 712 (1973). Likewise, the restrictions and limitations applicable to the deductibility of trade or business expenses are also applicable to the expenses covered by section 212. United States v. Gilmore, 372 U.S. 39, 45 (1963).
One of the limitations to deductibility of expenses under section 212 is that capital expenditures are nondeductible. Sec. 263;11 see Woodward v. Commissioner, 397 U.S. 572, 575 (1970); United States v. Hilton Hotels, 397 U.S. 580 (1970); sec. 1.212-1(n), Income Tax Regs. These expenditures are added to “the basis of the capital asset with respect to which they were incurred, and are taken into account for tax purposes either through depreciation or by reducing the capital gain * * * when the asset is sold.” ( Woodward v. Commissioner, supra at 574-575; see sec. 1016(a)).
Expenses which are incurred in either the acquisition or disposition of a capital asset are considered capital expenditures. Woodward v. Commissioner, supra at 575; United States v. Hilton Hotels, supra at 585; sec. 1.263(a)-2(a), Income Tax Regs....
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