Alexander v. Internal Revenue Service of the United States

UNITED STATES COURT OF APPEALS
FOR THE FIRST CIRCUIT

No. 95-1451

J. KENNETH ALEXANDER AND JOANNE M. ALEXANDER,

Petitioners - Appellants,

v.

INTERNAL REVENUE SERVICE OF
THE UNITED STATES OF AMERICA,

Respondent - Appellee.

ON APPEAL FROM A DECISION OF
THE UNITED STATES TAX COURT

Before

Torruella, Chief Judge,

Aldrich and Coffin, Senior Circuit Judges.

Philip J. Ryan, with whom Ryan, Martin, Costello, Leiter,

Steiger & Cass, P.C. was on brief for appellants.

William J. Patton, Attorney, Tax Division, Department of

Justice, Loretta C. Argrett, Assistant Attorney General, Gary R.

Allen, Attorney, and Richard Farber, Attorney, Tax Division,

Department of Justice, were on brief for appellee.

December 22, 1995

TORRUELLA, Chief Judge. Respondent-Appellee, the
TORRUELLA, Chief Judge

Commissioner of Internal Revenue (the "Commissioner"), determined

a deficiency of $57,441 in the 1989 Federal income tax filed by

J. Kenneth Alexander (the "Taxpayer") and Joanne M. Alexander

(together, the "Appellants" or the "Petitioners"). The Tax Court

upheld the Commissioner's determination and the Petitioners now

seek review of that decision. For the reasons stated below, we

affirm.

I. BACKGROUND
I. BACKGROUND

The pertinent facts, some of which have been stipulated

and incorporated in the district court's findings, are not in

dispute, and are recapitulated here. Unless otherwise indicated,

all section references are to the Internal Revenue Code in effect

for 1989. Internal Revenue Code, 26 U.S.C. 1 et seq. (1988 &

Supp. 1991).

In 1983, Taxpayer entered into an employment agreement

with his employer, W. F. Young, Inc. ("Young"), according to

which Taxpayer would remain in the capacities of Executive Vice

President, Treasurer, and Chief Executive Officer until he

reached the age of seventy (70), on December 13, 1993. On

October 15, 1987, when Taxpayer was sixty-four (64) years old,

Young terminated Taxpayer's employment. Subsequent to his

termination, Taxpayer offered management consulting services for

a fee, and in 1989 obtained a management consulting contract with

the Hanson Group of Ludlow, Massachusetts.

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On February 10, 1988, Taxpayer filed a civil lawsuit

against Young (the "lawsuit"), in which Taxpayer was represented

by the law firm of Ryan & White, P.C. ("Ryan & White").1 In his

complaint, Taxpayer alleged a breach of the express 1983

employment contract (or "Count I"), a breach of an implied

pension benefits contract (or "Count II"), and age discrimination

under Massachusetts General Law, Chapter 151B, Section 1 (1976)

(or "Count III").

On May 1, 1989, Taxpayer and Young executed a written

settlement agreement (the "Settlement Agreement"), according to

which Young was to pay Taxpayer $350,000, of which $100,000 was

allocated to Count III, and $250,000 to Counts I and II.2 On

May 5, 1989, as per the Settlement Agreement, Young issued two

checks payable to "J. Kenneth Alexander and Ryan & White,

Attorneys for J. Kenneth Alexander," one in the amount of

$100,000 (for Count III), and the other in the amount of

$225,395.20 (for Counts I and II, less taxes withheld).

On the 1989 Federal income tax return, Taxpayer's tax

preparer deducted $245,100 from the settlement proceeds

attributable to Counts I and II. This deduction was explained in

1 J. Kenneth Alexander v. W. F. Young, Inc., Civil Action No.

82-243 (Mass. Superior Court, Hampden County 1988).

2 The Settlement Agreement also provided that (i) Taxpayer would
be deemed to have retired from Young effective October 15, 1987;
(ii) Taxpayer would receive monthly payments commencing on May
15, 1989, and continuing for the duration of Taxpayer's life,
which total over $70,000 per year; and (iii) Taxpayer and Young
executed releases, according to which Alexander surrendered all
claims arising out of his employment and its termination.

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an attached statement, which stated that Taxpayer paid Ryan &

White $258,000 in legal fees (the "Legal Fee").3 It also stated

that according to Ryan & White's time allocations, 5% of the

Legal Fee was attributable to settlement of Count III, and 95% to

settlement of Counts I and II. Accordingly, $245,100 (95% of the

$258,000 Legal Fee) was deducted from the settlement proceeds

attributable to Counts I and II.

The Commissioner sent a notice of deficiency

disallowing Taxpayer's direct deduction of the Legal Fee from the

settlement proceeds. The Commissioner determined that the

$250,000 received from Young in settlement of Counts I and II was

gross income to Taxpayer, and that the Legal Fee associated with

Counts I and II were miscellaneous itemized deductions.

Accordingly, the Commissioner reduced the $245,100 deduction

reported on the 1989 return to $240,198, due to the increase in

Taxpayer's adjusted gross income and the two percent (2-percent)

adjusted gross income limitation for miscellaneous deductions.

In addition, the Commissioner determined that, due to these

adjustments, Taxpayer was liable for the Alternative Minimum Tax

("AMT") under Section 55 of the Code, which resulted in a

deficiency of $57,441.

Petitioners filed a petition in the United States Tax

Court for redetermination of the deficiency. The Tax Court

3 The additional information included in the statement attached
to Petitioners' 1989 return, entitled "Disclosure Under Reg. Sec.
1.6661," is not included here because it is not essential for the
disposition of the issue on appeal.

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rejected Petitioners' arguments, entering a final judgment on

January 31, 1995, upholding the Commissioner's determination of

Petitioners' tax deficiency. This appeal followed. We have

jurisdiction pursuant to 26 U.S.C. 7482(a)(1).

II. DISCUSSION
II. DISCUSSION

The only issue on appeal is the proper tax treatment of

the Legal Fee. We must determine whether the Petitioners

properly deducted the Legal Fee from the settlement proceeds

under Section 1001. If we find that they did not, then we must

determine whether to treat the Legal Fee as an "above the line"4

trade or business deduction under Section 162 of the Code, or as

a miscellaneous itemized deduction "below the line."5

On appeal, Petitioners essentially contend that the Tax

Court's decision to uphold the Commissioner's deficiency finding

is caused by the erroneous determination that Taxpayer was in the

trade or business of "the performance of services as an employee

during 1989." Petitioners correctly assert that the defining

issue is whether Taxpayer was Young's "employee" for purposes of

classifying the settlement proceeds and for determining the

deductibility of the Legal Fee under Section 62(a)(1). Although

4 We make reference to the "line" on the federal income tax form
where adjusted gross income is calculated.

5 Petitioners do not dispute that by treating the Legal Fee
"below the line" the amounts involved trigger the AMT and, thus,
their tax deficiency. We recognize that it is this ramification
which drives Petitioners' challenge to the Commissioner's
determination that the Legal Fee is to be treated as a
miscellaneous itemized deduction.

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we agree with Petitioners' formulation of the defining issue, we

reject their arguments and affirm the court below.

A. Standard of Review
A. Standard of Review

We review the Tax Court's decision "in the same manner

and to the same extent as decisions of the district courts in

civil actions tried without a jury." 26 U.S.C. 7482(a). The

treatment of the Legal Fee is purely a question of law and,

therefore, subject to de novo review. Estate of Robertson v.

Commissioner, 15 F.3d 779, 781 (8th Cir. 1994); see also First

National Bank in Albuquerque v. C.I.R., 921 F.2d 1081, 1086 (10th

Cir. 1990) (stating that de novo review is applied to tax court's

findings of law and of ultimate fact derived from applying legal

principles to subsidiary facts). The Tax Court's findings of

fact will only be disturbed for clear error. Manzoli v.

Commissioner, 904 F.2d 101, 103 (1st Cir. 1990); U.S. v.

Thompson, 406 F.2d 1006, 1009 (9th Cir. 1969); see also Conner v.

Commissioner, 847 F.2d 985 (1st Cir. 1988) (emphasizing

appropriateness of giving weight to Commissioner's well-

established views).

B. Characterization of the Legal Fee
B. Characterization of the Legal Fee

Petitioners argue that the Legal Fee was properly

subtracted from the amount realized in the settlement, as per

Sections 1001 and 1016,6 in order to determine the "gain" from

6 Section 1001(a) provides, in relevant part,

The gain from the sale or other
disposition of property shall be the
excess of the amount realized therefrom

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the disposition of Taxpayer's "valuable intangible assets," the

express and implied contracts and resulting lawsuit. In support

of their position, Petitioners contend that the Legal Fee was the

"cost of the disposition" of Taxpayer's assets because it was

incurred after Taxpayer's employment was terminated for the "sole

purpose" of enhancing their value and disposing of them by

obtaining either a settlement or judgment. Petitioners further

contend that, because Sections 1001 and 1016 make no distinction

between the basis and gain rules for capital or ordinary assets,

"there is a 'capital account' for all assets, whether those

assets are considered capital or ordinary." Thus, Petitioners

over the adjusted basis provided in
[S]ection 1011 for determining gain . . .
.

Section 1011(a) provides, in relevant part,

The adjusted basis for determining the
gain or loss from the sale or other
disposition of property, whenever
acquired, shall be the basis (determined
under [S]ection 1012 . . .) adjusted as
provided in [S]ection 1016.

Section 1012 provides, in relevant part,

The basis of property shall be the cost
of such property . . . .

Section 1016 provides, in relevant part,

(a) General rule. Proper adjustment in
respect of the property shall in all
cases be made

(1) for expenditures, receipts, losses,
or other items, properly chargeable to
capital account . . . .

26 U.S.C. 1001(a), 1011(a), 1012, 1016 (1988 & Supp. 1991).

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conclude, the Legal Fee is an "expenditure . . . properly charged

to [the assets'] capital account" within the meaning of Section

1016 to be offset against the settlement proceeds in order to

determine the "gain" under Section 1001.

Upon de novo review, we reject Petitioners' arguments

invoking treatment under Section 1001, and their contention that

the Tax Court erred when it rejected them.

In determining the tax treatment of the Legal Fee, we

take as our point of departure Section 61(a), which defines gross

income as "all income from whatever source derived," subject to

certain exclusions provided in the Code. It includes, and is not

limited to, "[c]ompensation for services, including fees,

commissions, fringe benefits, and similar items." See Helvering

v. Clifford, 309 U.S. 331, 334 (1940) (finding that Congress

intended to exert the "full measure of its taxing power" through

Section 61(a)). Next, we take into consideration the well-

settled rule that the classification of amounts received in

settlement of litigation is to be determined by the nature and

basis of the action settled, and amounts received in compromise

of a claim must be considered as having the same nature as the

right compromised. Parker v. United States, 573 F.2d 42, 49, 215

Ct.Cl. 773 (quoting Carter's Estate v. Commissioner, 298 F.2d

192, 194 (8th Cir. 1962)), cert. denied, 439 U.S. 1046 (1978);

see Furrer v. Commissioner, 566 F.2d 1115, 1116 (9th Cir. 1977),

cert. denied, 437 U.S. 903 (1978); Clark v. Commissioner, 67

T.C.M. (CCH) 3105 (1994).

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These two considerations lead us to our test: it "is

not whether the action was one in tort or contract but rather the

question to be asked is 'In lieu of what were the damages

awarded?'" Raytheon Production Corp. v. Commissioner, 144 F.2d

110, 113 (1st Cir.) (citation omitted), cert. denied, 323 U.S.

779 (1944); see Getty v. Commissioner, 913 F.2d 1486, 1490 (9th

Cir. 1990) (applying Raytheon test in characterizing settlement

payment for tax purposes). An amount received in lieu of

compensation under an employment contract constitutes gross

income to the recipient in the year in which it was received.

See Furrer v. Commissioner, 566 F.2d at 1117 (holding lump sum

payment for termination of an agency relationship is ordinary

income); Heyn v. Commissioner, 39 T.C. 719, 720 (1963) (holding

amount received in consideration of an employment contract is

ordinary income); Clark v. Commissioner, 67 T.C.M. (CCH) at

(finding that lump sum payment received upon termination of

employment contract is ordinary income); Rev. Rul. 58-301, 1958-1

C.B. 23, 24 (holding lump sum payment received by an employee as

consideration for the cancellation of his employment contract

constitutes gross income to the recipient in the taxable year of

receipt); cf. Rev. Rul. 80-364, 1980-2 C.B. 294 (illustrating by

way of three hypothetical examples the income and employment tax

consequences of interest and attorney's fees awarded in

connection with claims for back wages).

Under this rubric, whether Taxpayer's employment

contracts are "property" or "intangible assets" in the abstract

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is irrelevant to the proper analysis of the characterization of

the settlement proceeds and, thus, the proper tax treatment of

the Legal Fee. The Supreme Court's decision in Hort v.

Commissioner, 313 U.S. 28 (1941), is particularly instructive:

Where, as in this case, the disputed
amount was essentially a substitute for
rental payments which 22(a) [of the
1932 Act] expressly characterizes as
gross income, it must be regarded as
ordinary income, and it is immaterial
that for some purposes the contract
creating right to such payments may be
treated as "property" or "capital."

Id. at 31. The cancellation of the lease in Hort "involved

nothing more than the relinquishment of the right to future

rental payments in return for a present substitute payment and

possession of the leased premises." Id. at 32. Because those

future rents would have been taxed as ordinary income had they

been received in the ordinary course of the lease, the

"substitute" payment should be treated no differently. Id.

Similarly, here, assuming the settlement was a "cancellation" of

Taxpayer's contractual rights, what Taxpayer fought for, and

received, is merely a substitute payment for the compensation and

retirement benefits due him under his express and implied

employment contracts. Because his salary and benefits would have

been taxed as ordinary income without any offsetting basis if

received in the ordinary course under Taxpayer's employment

contract, the "substitute" payments can be treated no

differently. See Henry v. Commissioner, 62 T.C. 605, 606 (1974)

(holding that amounts received in settlement of breach of

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employment contract must be held impressed with the same

compensatory, taxable character); cf. Hodge v. Commissioner, 64

T.C. 616 (1975) (addressing suit for back wages); Sterns v.

Commissioner, 14 T.C. 420 (1950), affd. per curiam 189 F.2d 259

(6th Cir. 1951) (same).7

Similarly, Petitioners' argument that, because the

settlement was a "cancellation" of his contractual rights, it was

a "disposition" within the meaning of Section 1001(a), is

7 In support of their claim that Taxpayer's express and implied
contracts were "intangible assets," Petitioners rely on a Fifth
Circuit case and two revenue rulings holding that professional
football or baseball player contracts were assets with distinct
values that could be depreciated by the team owners. Laird v.

U.S., 556 F.2d 1224 (5th Cir. 1977) (discussing professional

football player contracts), cert. denied, 434 U.S. 1014 (1978);

Rev. Rul. 77-137, 1971-C.B. 104 (same); and Rev. Rul. 67-379,
1967-2 C.B. 127 (same, baseball). Petitioners' reliance is
clearly inapposite and unpersuasive. As the Tax Court noted, and
as Petitioners concede, Taxpayer's employment contract with Young
was neither a depreciable nor a capital asset in his hands.

Moreover, while Petitioners correctly maintain that Taxpayer's
contract claims were ordinary, not capital, assets, Furrer v.

Commissioner, 566 F.2d at 1117 (noting that "[i]f all contracts

granting rights could be considered capital assets, without
inquiry into the nature of the rights granted, almost all
ordinary income from salaries, wages, or commissions could be
transformed into capital gain"), they nonetheless urge us to
apply here the rationale adopted in a line of cases addressing
the deductibility of legal fees incurred in the disposition of a
capital asset. See United States v. Hilton Hotels Corp., 397

U.S. 580 (1970); Woodward v. Commissioner, 397 U.S. 572 (1970);

Helgerson v. United States, 426 F.2d 1293 (8th Cir. 1970); Baier

v. Commissioner, 63 T.C. 513 (1975), aff'd, 553 F.2d 117 (3d Cir.

1976); see also A.E. Staley Manufacturing Co. and Subsidiaries v.

Commissioner, 1995 WL 535269 at *46-48, 105 T.C. (CCH) 14 (1995)

(providing a recent discussion of the "origin of the claim"
analysis in the context of capital assets). These cases simply
do not persuade us that Taxpayer's Legal Fee should be offset
against the settlement proceeds because, as we have already
explained, Taxpayer's Legal Fee was incurred to obtain damages in
the nature of compensation due him under the express and implied
employment contracts.

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unpersuasive. As the Tax Court correctly noted, assuming the

settlement was a "cancellation" of Taxpayer's rights, it does not

necessarily follow that the settlement constituted a

"disposition" of "property" warranting an offsetting of basis.

See Herbert's Estate v. Commissioner, 139 F.2d 756 (3d Cir. 1943)

(discussing meaning of "disposition" and holding extinguishment

of decedent's debt, represented by readily transferable notes and

open accounts, was a disposition), cert. denied, 322 U.S. 752

(1944).8 More importantly, to permit Taxpayer to offset his

"cost of disposition" or basis -- the Legal Fee -- would be

fundamentally inapposite in light of the controlling fact that

the settlement proceeds are clearly in the nature of compensation

as Young's employee.9

To recapitulate, what is relevant is that, as the Tax

Court found, Taxpayer in substance was suing for damages suffered

by the loss of his employment with Young -- his loss of

compensation in terms of salary and retirement benefits. This is

8 As the Tax Court correctly noted, Petitioners' reliance on
Herbert's Estate is inapposite. Petitioners fail to recognize

that the nature of the claim involved proved an important factor
in the court's finding of a "disposition." Unlike the executors
in Herbert's Estate, Taxpayer did not hold a claim against Young

in the sense of a "debt," that was readily transferable or
liquidated prior to settlement; nor, was he in any way Young's
"creditor."

9 One might intuitively argue that some sort of "basis" should
be recognized when one has to litigate to receive one's due
compensation. The fact remains, however, that the Code simply
does not provide for the offsetting of basis in such
circumstances except in limited cases involving capital assets.
Instead, the Code permits litigation expenses to be taken into
account by way of a deduction. See Section C, infra.

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a factual determination and, indeed, is one with respect to which

we find no clear error. In fact, the claim giving rise to the

Legal Fee is inexorably rooted in Taxpayer's employment with

Young -- indeed, in his status as Young's "employee."10

Because the damages Taxpayer received are essentially a

substitute for the salary and benefits he would have received

under the employment contract, they are fully included as

ordinary income in Taxpayer's gross income under Section 61,

without regard to whether Taxpayer's employment contracts

constituted "property" or "intangible assets." Hort, 313 U.S. at

31-32.11

Thus, upon de novo review, we find no error of law in

the Tax Court's rejection of Petitioners' arguments in favor of

Section 1001 treatment, because the settlement proceeds were

10 We note also that under this rubric it is irrelevant that at
the time of the lawsuit, Taxpayer was no longer on Young's
payroll. See footnote 14, supra, and related text. Equally

irrelevant is Taxpayer's stated purpose for incurring the Legal
Fee, namely "to add value to [Taxpayer's] contract claims, and to
dispose of those assets by means of either a settlement or a
courtroom victory." See Woodward, 397 U.S. at 578 (rejecting

purpose test and noting that it would encourage a resort to
formalisms and artificial distinctions); U.S. v. Gilmore, 372

U.S. 39, 49 (1963) (rejecting purpose test in favor of origin of
claim test). Taxpayer's desire to obtain the salary and benefits
due under the employment contracts was clearly the "origin" of
the lawsuit - not his alleged desire to "dispose" of "intangible
assets."

11 We note that we need not address the merits of Petitioners'
claim regarding Sections 1001 and 1016, namely that because those
two sections make no distinction between the basis and gain rules
for capital or ordinary assets, "there is a 'capital account' for
all assets."

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received in lieu of compensation and, as such, are fully included

as gross income under Section 61.

C. Deductibility of the Legal Fee
C. Deductibility of the Legal Fee

Having determined that the Legal Fee is included in

gross income under Section 61, we turn to the question of its

deductibility. It is well-settled that any accessions to wealth

received by a taxpayer are included in his gross income, unless

the taxpayer can demonstrate that the amount received falls

within a specific statutory exclusion. Commissioner v. Glenshaw

Glass, 348 U.S. 426, 431, reh'g denied, 349 U.S. 925 (1955).

Section 162(a) provides that 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." Section 62(a)(1) adds that expenses falling within

Section 162(a) are deducted from gross income to arrive at

"adjusted gross income," explicitly excluding expenses incurred

by a taxpayer engaged in the trade or business of the performance

of services as an employee.12

Petitioners argue that, if the entire settlement

proceeds allocable to Counts I and II constitute gross income to

12 Section 62(a)(1) provides in pertinent part,

The deductions allowed by this chapter
(other than by part VII of this
subchapter) which are attributable to a
trade or business carried on by the
taxpayer, if such trade or business does

not consist of the performance of

services by the taxpayer as an employee.

26 U.S.C. Section 62(a)(1) (1988 & Supp. 1991) (emphasis added).

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him under Section 61(a) of the Code, the Legal Fee should be

treated as an "above the line" trade or business expense under

Section 162(a) of the Code, rather than a "miscellaneous itemized

deduction" under Section 63, as the Commissioner found and the

Tax Court held. The crux of Petitioners' argument is that the

"employee" limitations of Section 62(a)(1) do not apply, because

Taxpayer was not Young's employee during 1989. Pointing to the

fact that Taxpayer was employed in 1989 as an independent

management consultant, they maintain that the Tax Court's

application of Section 62(a)(1) is based on its erroneous finding

that Taxpayer was "in the business of performing services of an

employee" during 1989.

We disagree with Petitioners. First, we reiterate that

we find no clear error in the Tax Court's determination finding

that Taxpayer was "in the business of performing services of an

employee" during 1989.13 Second, we look to the plain language

of Section 62(a)(1). As the Tax Court correctly noted, no

distinction is made in Section 62(a)(1) between present and

former employees if the expenses originated in the trade or

business of being an employee.14 Thus, the fact that Taxpayer

13 It is well-settled that an individual may engage in the trade
or business of rendering services as an employee. McKay v.

Commissioner, 102 T.C. 465, 489 (1994), appeal docketed, No. 94-

41189 (5th Cir. 1995) (collecting cases).

14 See McKay, 102 T.C. at 489 (holding corporate executive's

post-employment litigation expenses incurred in suit against
former employer were incurred in trade or business, and were
deductible, if at all, under Section 162); McKeague v. United

States, 12 Cl. Ct. 671, 674-77 (1987) (finding, inter alia, that

former employee's litigation expenses which originated in trade

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was not in actuality Young's employee in 1989 does not alter the

controlling fact that the lawsuit and the ensuing settlement

directly resulted from his employment with Young. Petitioners

argue in vain that Taxpayer should not be "saddled with employee

status" because his new trade or business as an independent

management consultant indicates a "break" from his former

employment with Young (Appellants' Brief, p. 40). Equally in

vain, they argue that the "[l]awsuit should be looked at as the

ordinary and necessary expense incurred by an independent

businessman to bring suit when contracts are breached."

(Appellants' Brief, p. 40). As the Tax Court correctly found,

there is absolutely no connection between Taxpayer's lawsuit and

his independent management consulting business. Instead,

Taxpayer's lawsuit was "directly connected with, or . . .

proximately resulted from" his employment at Young.15

Kornhauser, 276 U.S. at 153. It is under this rubric that

or business were deductible as ordinary expenses under Section
162), aff'd without published opinion, 852 F.2d 1294 (Fed. Cir.

1988); cf. Kornhauser v. United States, 276 U.S. 145, 153 (1928)

(stating that where suit against a taxpayer is directly connected
with, or proximately resulted from, his business, expense
incurred is a business expense).

15 We note also that on the "Disclosure Under Reg. Sec. 1.6661,"
Petitioners' tax preparer describes the lawsuit against Young as
being for "age discrimination, back wages and retirement
benefits." (Appellants' Appendix, p. 68). We also note that the
releases executed pursuant to the Settlement Agreement regard
"[a]ll claims arising out of [Taxpayer's] employment by [Young]
and the cessation of [Taxpayer's] employment" and "[a]ll claims
which were or could have been asserted by [Taxpayer] in the
Lawsuit entitled J. Kenneth Alexander v. W.F. Young, Inc.,

Hampden Superior Court Civil Action No. 88-243." (Appellants'
Appendix, p. 98).

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Taxpayer is considered to be in the business of being Young's

"employee" for purposes of falling within the Section 62(a)(1)

limitation.16

In another attempt to circumvent the application of

Section 62(a)(1), Petitioners argue that, if we attribute

employee status to Taxpayer, we should find that Young's direct

payment of the settlement proceeds to R&W (by way of joint checks

payable to Taxpayer and R&W as joint payees) qualifies as a

reimbursement arrangement within the meaning of Section

62(a)(2)(A). That section provides that reimbursed employee

expenses are permitted to be deducted from gross income when

arriving at adjusted gross income.17 Petitioners contend that

16 Similarly irrelevant is Petitioners' argument that the Legal
Fee was not expended for the benefit of Young's business and was
in fact detrimental to Young. See McKay, 102 T.C. at 488, n.23

(noting that "[i]t makes no difference whether the employee is
defending himself in actions that challenge his activities as a
corporate officer or the employee is bringing a suit against his
former employer."); see also McKeague, 12 Cl. Ct. 671 (involving

litigation expenses which were not incurred for benefit of
taxpayer's employer).

17 Section 62(a)(2)(A) provides, in pertinent part, that in
determining adjusted gross income there will be allowed,

[t]he deductions allowed by part VI
(section 161 and following) which consist
of expenses paid or incurred by the
taxpayer, in connection with the
performance by him of services as an
employee, under a reimbursement or other

expense allowance arrangement with his

employer. The fact that the

reimbursement may be provided by a third
party shall not be determinative of
whether or not the preceding sentence
applies.

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Young's direct payment arrangement was effectively providing for

the payment of the Legal Fee pursuant to Section 62(a)(2)(A) in

light of the fact that R&W had a statutory lien under

Massachusetts law for the payment of the Legal Fee. See Mass.

Gen. L. ch. 221, sec. 50 (1986). This argument fails because it

is utterly without support in the record. As the Tax Court

correctly found, Petitioners have not proven that Taxpayer was

under a "reimbursement or other expense allowance arrangement"

with Young for Taxpayer's Legal Fee. Contrary to Petitioners'

insistence, the fact that the record shows Young's direct and

joint payment is "standard operating procedure" in all types of

litigation does not support the requisite finding of a

reimbursement or other "arrangement" or alter the fact that both

Young and Taxpayer were responsible for their respective legal

costs. Finally, we also note that the settlement agreement

itself makes no mention of attorney's fees and the Taxpayer's

lawsuit was dismissed "without prejudice and without costs."

Thus, we reject Petitioners' argument that Section 62(a)(2)(A)

applies, and reaffirm our conclusion that the Legal Fee falls

squarely within Section 62(a)(1).

Having determined that Section 62's employee limitation

applies, we turn to its effect on Taxpayer's Legal Fee. Expenses

26 U.S.C. 62 (1988 & Supp. 1991) (emphasis added); see H.R.

Conf. Rep. No. 998, 100th Cong., 2d Sess. at 204. (allowing
reimbursed expenses only if incurred pursuant to a reimbursement
or other expense allowance arrangement requiring employees
substantiate expenses covered thereunder to the person providing
the reimbursement).

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excluded under the Section 62(a)(1) limitation are treated as

"itemized deductions" under Section 63, such that they are

subtracted from adjusted gross income in computing the taxpayer's

"taxable income." See I.R.C. 63(d) (stating that "itemized

deductions" include all deductions not "allowable in arriving at

adjusted gross income" and the deduction for personal exemptions

provided by Section 151). In turn, under Section 67(b)

"miscellaneous itemized deductions" -- which are defined as all

itemized deductions other than those specifically enumerated

therein -- are subject to a 2-percent floor, such that they are

allowable "only to the extent that the aggregate of such

deductions exceeds 2 percent of adjusted gross income." Because

trade or business expenses subject to Section 62(a)(1), such as

Taxpayer's Legal Fee, are not among the deductions listed in

Section 67(b), statutory construction leads to the conclusion

that they are miscellaneous itemized deductions subject to the 2-

percent floor. See McKay, 102 T.C. at 493;18 cf. In Re Black,

131 B.R. 106, 108 (E.D. Ark. 1991) (discussing the deductibility

of non-reimbursed employee business expenses).

Upon de novo review, and finding no merit to

Petitioners' other arguments, we therefore affirm the Tax Court's

determination that the Legal Fee is properly deducted "below the

line."

18 We note that, without advancing much by way of argument,
Petitioners urge us not to follow McKay (and its statutory

analysis), claiming that it is wrongly decided. We merely add
that, upon de novo review, we agree with McKay's statutory

analysis, and find the case on point.

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D. Applicability of Alternative Minimum Tax
D. Applicability of Alternative Minimum Tax

Petitioners do not dispute that the treatment of

Taxpayer's Legal Fee as a miscellaneous itemized deduction

triggers the application of the Alternative Minimum Tax (the

"AMT") under Sections 55 and 56;19 nor do they deny that, under

Section 56(b)(1)(A)(i), they are not permitted to deduct the

Legal Fee as a miscellaneous itemized deduction (as defined in

Section 67(b)) in computing the AMT. Petitioners do argue,

however, that the Commissioner's "stretching" interpretation of

Section 62(a)(1), adopted by the Tax Court and, now, this Court,

results in "gross injustice, inequity and lack of uniformity in

the treatment of taxpayers similarly situated." (Appellants'

Brief, p. 24).

We recognize that, because the amounts involved trigger

the AMT and, thus, Taxpayer's deficiency, the outcome smacks of

injustice because Taxpayer is effectively robbed of any benefit

of the Legal Fee's below the line treatment. While unfortunate

for Petitioners here, we disagree that there is inequality of

treatment as compared to similarly situated taxpayers. Although

it may seem otherwise, in reality Petitioners have not been

denied their below the line deduction of the Legal Fee.

The AMT was enacted to "ensure that no taxpayer with

substantial economic income can avoid significant tax liability

by using exclusions, deductions, and credits." S. Rep. No. 313,

99th Cong., 2d Sess. at 518, 1986-3 C.B. (Vol. 3) v., 518; see

19 26 U.S.C. 55 and 56 (1988 & Supp. 1991).

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also S. Rep. No. 1263, 95th Cong., 2d Sess., 1978-1 C.B. (Vol. 1)

315, 499. It is well established that equitable arguments cannot

overcome the plain meaning of the statute. See Okin v.

Commissioner, 808 F.2d 1338, 1340-42 (discussing the purpose and

constitutionality of the AMT), cert. denied, 484 U.S. 802 (1987);

Warfield v. Commissioner, 84 T.C. 179, 184 (1985) (rejecting

argument that imposition of the AMT was unfair because income-

producing transaction was only a "one-time deal;" "[t]here is no

justification for creating such an exception to the express

terms" of Section 55); see also Rawlins v. Commissioner, 1995 WL

610605, at *5-8, 70 T.C.M. (CCH) 1046, (1995). Petitioners

are bound by the tax consequences of the settlement as it

actually occurred. Id. at 184.

III. CONCLUSION
III. CONCLUSION

For the foregoing reasons, we affirm the Tax Court's

decision and uphold the Commissioner's finding of Petitioners'

deficiency. The judgment of the Tax Court is affirmed.
affirmed.

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