T.C. Memo. 2000-120
UNITED STATES TAX COURT
SHARON PURCELL DILEONARDO, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 5508-97. Filed April 5, 2000.
P is a one-sixth income beneficiary of a trust. In
State court, P filed objections to an accounting by the
trustee. The State court (1) ruled against P, (2) required
P to compensate the trustee, the other beneficiaries, and a
guardian ad litem for their expenses in dealing with P’s
objections, and (3) directed the trustee to use P’s share of
the trust distributions to accomplish this compensation. P
reported as income her share of the trust’s income and
deducted the court-ordered payments.
Held: The origin and character of the claim resulting
in P’s payments was the trustee’s filing of an accounting,
proposing a distribution, and acknowledging that an argument
could be made for a different apportionment of the proposed
distribution; P’s payments are deductible under sec. 212(1)
and (2), I.R.C. 1986.
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Sharon Purcell DiLeonardo, pro se.
Alan E. Staines, for respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
CHABOT, Judge: Respondent determined deficiencies in
Federal individual income tax and an addition to tax under
section 6651(a)(1)1 (late filing of tax return) against
petitioner as follows:
Addition to Tax
Year Deficiency Sec. 6651(a)
1993 $3,517 $879
1994 18,887 0
1
Unless indicated otherwise, all section and chapter
references are to sections and chapters of the Internal Revenue
Code of 1986 as in effect for the years in issue.
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After concessions by both sides,2 the issue for decision is
whether under section 212 petitioner may deduct payments she made
as ordered by a California court.
FINDINGS OF FACT
Some of the facts have been stipulated; the stipulations and
the stipulated exhibits are incorporated herein by this
reference.
When the petition was filed in the instant case, petitioner
resided in Santa Rosa, California.
The Trust
Petitioner is an income beneficiary of a testamentary trust
established by the will of petitioner’s grandfather, L.O. Ivey.
This testamentary trust is hereinafter sometimes referred to as
the Trust. L.O. Ivey’s will was admitted to probate in 1978.
2
Petitioner concedes that she is liable for an addition to
tax under sec. 6651(a) for 1993, except insofar as our
redetermination of the deficiency for that year reduces or
eliminates the base for calculation of this addition to tax.
Petitioner also concedes that she is not entitled to deductions
under sec. 162.
Respondent concedes that, if petitioner’s expenditures are
qualitatively deductible, then the amounts that petitioner
deducted are the correct amounts. In the pleadings respondent
suggested, and in the opening statement respondent plainly
contended, that allowance of the claimed deduction would
frustrate California public policy. On opening brief, however,
respondent concedes this issue.
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By July 1, 1991, the other income beneficiaries of the Trust were
petitioner’s mother, Helen True Purcell, hereinafter sometimes
referred to as Purcell, and petitioner’s two siblings. Purcell
and petitioner’s two siblings are hereinafter sometimes
collectively referred to as the other beneficiaries3. Purcell
was entitled to receive 50 percent of the Trust’s income.
Petitioner and her two siblings were each entitled to receive
one-sixth of the Trust’s income. See infra note 3.
Crocker National Bank acted as trustee for the Trust until
May 31, 1986, when Crocker National Bank was acquired by Wells
Fargo Bank. Wells Fargo Bank, hereinafter sometimes referred to
as the Trustee, has acted as the Trust’s Trustee since May 31,
1986.
Petitioner’s husband, Joseph DiLeonardo, hereinafter
sometimes referred to as DiLeonardo, is licensed by California as
both an attorney and a real estate broker.
The Third Account and the Objections
On July 5, 1991, the Trustee filed with the Superior Court
of the State of California for the County of Los Angeles
(hereinafter sometimes referred to as the California Court), its
3
There also was a lifetime annuitant, who was entitled to
receive $100 per month. This annuitant did not play a role in
the proceedings described infra; her interest was sufficiently
insignificant so that we join the parties in ignoring it for
purposes of analyzing the parties’ dispute in the instant case.
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third accounting (hereinafter sometimes referred to as the Third
Account), covering the period October 1, 1987, through April 15,
1991. Petitioner and DiLeonardo each received a copy of the
Third Account.
Among other matters in the Third Account, the Trustee
recommended a distribution of “delayed income” with respect to
the sale of L.O. Ivey’s residence after the death of L.O. Ivey’s
widow, who had lived in the residence rent-free pursuant to a
court-ordered probate homestead. The Trustee calculated the
amount payable to each of the income beneficiaries, but
acknowledged that a different formula would result in a
different, smaller, current distribution. The Trustee asked the
California Court to provide instructions on this matter and, in
connection therewith, to appoint a guardian ad litem to represent
minor and unborn contingent remainder beneficiaries. The Trustee
also proposed that the net profit from the sale of that residence
be allocated half to income and half to principal.
After reviewing the Third Account, DiLeonardo advised
petitioner to contact an attorney specializing in probate matters
to review the Third Account, make recommendations, and represent
petitioner as needed. DiLeonardo contacted several attorneys on
petitioner’s behalf.
Two attorneys, John D. Burroughs, hereinafter sometimes
referred to as Burroughs, and Evan W. Field, hereinafter
sometimes referred to as Field, from the law firm of Burroughs,
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Froneberger & Field, reviewed the Third Account. Burroughs and
Field agreed to represent petitioner if any action were necessary
regarding the Third Account. Petitioner paid a small amount to
Field and Burroughs to do some investigative and preliminary
work. Field and Burroughs agreed to a contingency fee
arrangement for their representation of petitioner concerning the
Third Account.
Field told petitioner that he had spoken with his father-in-
law, Professor Halbach, regarding the Third Account. Field told
petitioner that Professor Halbach was the former Dean of Boalt
Hall School of Law at the University of California and a foremost
expert on trusts in the United States. Field also told
petitioner that Professor Halbach recommended that petitioner be
very aggressive in objecting to the Third Account.
Thereafter, DiLeonardo, Burroughs, and Field recommended
that petitioner object to the Third Account in two ways: (1)
Object to the actions of the Trustee during the period covered by
the Third Account and ask for reductions in the Trustee’s fees or
that the Trustee be surcharged, and (2) object to the Trustee’s
request for authority regarding new actions. Burroughs prepared
Objections to the Third Account and Report of the Trustee,
hereinafter sometimes referred to as the Objections, for
petitioner. Two meetings between DiLeonardo, Burroughs, Field,
and petitioner were held before petitioner signed the Objections.
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It appears that, after the Trustee’s first account,
petitioner filed objections to that account, and those objections
resulted in substantial reductions in the Trustee’s fees. At
that time, the Trustee tried to have sanctions imposed on
petitioner but was unsuccessful in that attempt. With this
experience in mind, DiLeonardo, Burroughs, Field, and petitioner
discussed whether the Trustee would move for sanctions or an
award of litigation costs against petitioner if she filed the
Objections. DiLeonardo, Field, and Burroughs represented to
petitioner that this would not happen because the Objections were
good on their face and would not subject petitioner to any kind
of sanction, penalty, or litigation costs award. After
consultation with DiLeonardo, Field, and Burroughs, and after
assurances that the Objections were reviewed by Professor Halbach
and investigated by another law firm, petitioner signed the
Objections.
On August 7, 1991, petitioner filed the Objections with the
California Court. Petitioner made several Objections to the
Third Account, including the following:
Guardian ad litem. Petitioner agreed that a guardian ad
litem should be appointed, but objected to the Third Account by
asking the California Court to delay authorizing the distribution
until the guardian was appointed and had sufficient time to
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review the Third Account, appear before the California Court, and
make appropriate objections.
Insufficiently productive assets. Petitioner contended that
the Trustee failed to earn a normal rate of return on trust
assets, focusing on two of these assets. One asset was the
residence which had been occupied by L.O. Ivey’s widow after his
death. Petitioner contended that the Trustee failed to make the
property productive after the death of L.O. Ivey’s widow and that
the Trustee sold the residence for only $3.5 million, although
the residence had been appraised at $5.2 million and there had
been offers to buy the residence for more than $3.5 million. The
other asset was a series of gypsum mining claims located in
Nevada. L.O. Ivey owned the claims for 10 to 12 years before his
death. For nearly 15 years the Trust did not receive income from
the claims but did incur expenses associated with them. The
Trustee disposed of the claims after petitioner filed the
Objections.
Charges of bias and fraud. Petitioner charged that the
Trustee failed to protect the interests of income beneficiaries
with regard to the residence that had been occupied by L.O.
Ivey’s widow, and that, to make up for this, the Trustee proposed
to distribute the proceeds of the sale of that residence in a way
that would fail to protect the interests of the remainder
beneficiaries. Petitioner proposed that the income
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beneficiaries’ lost income be made up for out of the Trustee’s
assets and not by taking away what should go to remainder
beneficiaries. Petitioner charged that the Trustee should have
opposed homestead status for the residence of L.O. Ivey’s widow,
and that the Trustee’s failure to oppose homestead status was a
breach of fiduciary duty which may have resulted from “an
extrinsic fraud”. The asserted extrinsic fraud involved a
conflict of interest in that the conservator for L.O. Ivey’s
widow (the conservator also was a residual beneficiary of the
widow’s estate) was married to a partner in the law firm that
represented the Trustee, as a result of which the Trustee acted,
or failed to act, in a manner that favored L.O. Ivey’s widow over
the other beneficiaries of the Trust.
Investments too aggressive. Petitioner charged that there
was a large turnover in the Trust’s investment portfolio, and
contended that she should be given the opportunity to investigate
the situation.
Self-dealing. Petitioner charged that the Trustee
improperly deposited substantial cash amounts in the Trustee’s
own money market accounts and contended that there should be an
examination of comparative interest rates and costs to determine
whether income beneficiaries were disadvantaged by these
deposits.
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The Litigation, Award of Costs.
On November 8, 1991, the California Court granted summary
adjudication in favor of the Trustee on most of the Objections.
On November 12, 1991, the remaining Objections were withdrawn by
Burroughs.
After the remaining Objections were withdrawn, the Third
Account was approved by the California Court. The California
Court also ordered that the extraordinary distributions provided
for in the Third Account be held pending the other beneficiaries’
motion for litigation costs. In December 1991, the other
beneficiaries moved against petitioner for litigation costs.
The California Court awarded litigation costs to the other
beneficiaries, the Trustee, and the guardian ad litem, stating as
follows:
F. Based upon all of the evidence presented at
trial, Sharon DiLeonardo’s failure to explain or deny
by her testimony the evidence in the case against her,
the matters of which judicial notice was taken, and the
Court’s prior issue-preclusion sanction, the Court
finds: each and all of Sharon DiLeonardo’s Objections
to the Third Account were frivolous; she knew that her
Objections to the Third Account were frivolous; she
knew that the Third Account was proper; she would have
objected to essentially anything that was included
within the Third Account; that each and all of her
Objections to the Third Account were totally and
completely without merit; that each and all of her
Objections to the Third Account were made in bad faith;
that each and all of her Objections to the Third
Account were made for the sole purpose of harassing
opposing parties; that each and all of her Objections
to the Third account were made willfully and
maliciously to injure the trustee or the beneficiaries
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of the Trust; that each and all of her Objections to
the Third Account were intended by her to be punishment
and vindictive; that Sharon DiLeonardo’s bad faith was
compounded by her stonewalling on discovery; and that
she willfully suppressed material evidence.
The California Court ordered petitioner to pay the
litigation costs, plus interest, of the other beneficiaries, the
Trustee, and the guardian ad litem. Petitioner’s obligations
under this order are hereinafter sometimes referred to as the
Payments. The California Court further ordered that the Payments
be paid out of petitioner’s portion of distributions from the
Trust. The amounts the Trustee was directed by the California
Court to pay, and the payees, are summarized in Table 1.
Table 1
Payee Amount
Other beneficiaries $203,474.91
Trustee and guardian ad litem 147,040.75
Total 350,515.66
The California Court’s order was affirmed by the California
Court of Appeal for the Second District. Estate of Ivey v.
DiLeonardo, 28 Cal. Rptr. 2d 16 (Ct. App. 1994).
Tax returns
Table 2 shows selected items from petitioner’s tax returns.
Table 2
1993 1994
Income from the Trust $49,546.00 $113,478.00
Adjusted gross income 50,571.93 120,540.70
Litigation cost deduction 53,000.00 159,718.00
(before 2-percent floor)
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No part of the Payments constitutes a capital expenditure.
No part of the Payments is allocable to a class of income wholly
exempt from income taxes. No part of the Payments is interest on
indebtedness incurred or continued to purchase or carry
obligations the interest on which is wholly exempt from income
taxes.
Petitioner’s obligation to make the Payments arose from the
Trustee’s filing of the Third Account. The Payments were
incurred in entirety for, and are proximately related to, the
production or collection of income, or for the management,
conservation, or maintenance of property held for the production
of income.
OPINION
Petitioner contends that the Payments are deductible under
section 212 as expenses arising from an attempt to produce income
or to preserve, maintain, and conserve property held for the
production of income.
Respondent contends that the Payments are not deductible
under section 212 because they were not ordinary and necessary
–-in particular, respondent states that the Payments were not
made “with the purpose and reasonable expectation that income
would flow directly therefrom to” petitioner (sec. 212(1)), and
that petitioner’s “immediate purpose” for making the Payments was
not “the management, conservation, or maintenance of property
held for the production of income”, sec. 212(2). In addition,
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respondent contends that, under the “‘origin of the claim’ test”,
the Objections did “not constitute the relevant litigation”, but
that--
The relevant litigation is that which was initiated by
those persons who opposed petitioner’s Objections to
the Third Account and who prosecuted both a motion for
monetary sanctions and a petition to charge
petitioner’s share of the trust’s income with the
payment of such monetary sanctions.
In addition, respondent contends that the California Court--
determined that the underlying reasons for petitioner’s
objections to the trustee’s accounting were vindictive,
intended as punishment, initiated in bad faith, and
based on petitioner’s animosity with respect to the law
firm representing the trustee.
Respondent concludes from this that section 262 prohibits
deductions for petitioner’s Payments. In the alternative,
respondent states that if the payments meet the “ordinary and
necessary requirement” of section 212, then they are nevertheless
not deductible because petitioner failed to carry her burden of
allocating the payments between deductible and nondeductible
portions.
Petitioner responds that (1) she had to make the payments in
order to receive income from the Trust, thus meeting the
“ordinary and necessary” requirement; (2) the origin of the claim
is petitioner’s filing of the Objections, an income-focused act
that does not fall under section 262; and (3) the entire
obligation to make the Payments arose from the one document-–the
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Objections–-“and therefore all fees arose from the litigation and
are deductible.”
We agree with petitioner’s conclusions and part of
petitioner’s analysis.
Section 2124 allows a deduction for expenses to produce or
collect income or to manage, etc., property held for the
production of income.
Section 212 is coextensive in most respects with section
162(a), and taxpayers may not deduct expenses under section 212
that could not be deducted under section 162(a) were the expenses
connected to a trade or business. See Trust of Bingham v.
Commissioner, 325 U.S. 365, 373-376 (1945) (discussing the
predecessors of secs. 212 and 162(a)); Guill v. Commissioner, 112
T.C. 325, 328 (1999). As we have noted:
“[E]xcept for the requirement of being incurred in
connection with a trade or business,” however, a deduction
under section 212 “is subject * * * to all the restrictions
and limitations that apply in the case of the deduction
4
Sec. 212 provides, in pertinent part, as follows:
SEC. 212. EXPENSES FOR PRODUCTION OF INCOME.
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;
(2) for the management, conservation, or
maintenance of property held for the production of
income; * * *
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under * * * [section 162(a)] of an expense paid or incurred
in carrying on any trade or business.” [Estate of Davis v.
Commissioner, 79 T.C. 503, 507 (1982) (quoting from H. Rept.
2333, 77th Cong., 2d Sess. (1942), 1942-2 C.B. 372, 430; S.
Rept. 1631, 77th Cong., 2d Sess. (1942), 1942-2 C.B. 504,
571, the legislative history to the predecessor of section
212).
For purposes of the instant case, section 212 must be
applied in the light of section 262(a),5 which generally
disallows deductions for personal expenses. In United States v.
Gilmore, 372 U.S. 39, 44, 45-46 (1963), the Supreme Court
described as follows the relevant relationships between the 1939
Code predecessors of sections 162(a) (sec. 23(a)(1)), 212 (sec.
23(a)(2)), and 262(a) (sec. 24(a)(1)):
I.
For income tax purposes Congress has seen fit to regard
an individual as having two personalities: “one is [as] a
seeker after profit who can deduct the expenses incurred in
that search; the other is [as] a creature satisfying his
needs as a human and those of his family but who cannot
deduct such consumption and related expenditures.”11 The
Government regards § 23(a)(2) as embodying a category of the
expenses embraced in the first of these roles.
* * * * * * *
A basic restriction upon the availability of a
§ 23(a)(1) deduction is that the expense item involved must
be one that has a business origin. That restriction not
only inheres in the language of § 23(a)(1) itself, confining
5
SEC. 262. PERSONAL, LIVING, AND FAMILY EXPENSES.
(a) General Rule.--Except as otherwise expressly
provided in this chapter [chapter 1, relating to normal
taxes and surtaxes], no deduction shall be allowed for
personal, living, or family expenses.
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such deductions to “expenses * * * incurred * * * in
carrying on any trade or business,” but also follows from
§ 24(a)(1), expressly rendering nondeductible “in any case
* * * [p]ersonal, living, or family expenses.” See note 9,
supra. In light of what has already been said with respect
to the advent and thrust of § 23(a)(2), it is clear that the
“[p]ersonal * * * or family expenses” restriction of
§ 24(a)(1) must impose the same limitation upon the reach of
§ 23(a)(2)–-in other words that the only kind of expenses
deductible under § 23(a)(2) are those that relate to a
“business,” that is, profit-seeking, purpose. The pivotal
issue in this case then becomes: was this part of
respondent’s litigation costs a “business” rather than a
“personal” or “family” expense?
11
Surrey & Warren, Cases on Federal Income Taxation, 272
(1960).
We consider first the origin-and-character-of-the-claim test
to determine whether the Payments stemmed from petitioner’s
personality as “a seeker after profit” or from petitioner’s
personality as “a creature satisfying * * * [her] needs as a
human”. United States v. Gilmore, 372 U.S. at 44. We then
consider whether the Payments are ordinary and necessary expenses
of her profit-seeking activity. Finally, we consider
respondent’s contention about apportionment.
A. Origin and Character of the Claim
In the instant case it may be helpful to begin by analyzing
United States v. Gilmore, supra, and its companion case, United
States v. Patrick, 372 U.S. 53 (1963).
In United States v. Gilmore, supra at 41, the taxpayer
claimed a deduction for certain litigation expenses arising out
of the taxpayer’s and his wife’s divorce suit. The taxpayer’s
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“overriding concern in the divorce litigation was to protect * *
* [certain] assets against the claim of his wife.” Ibid. The
assets were controlling stock interests in certain corporations,
the dividends and salaries from which amounted to substantially
all of the taxpayer’s income. Ibid. The taxpayer won a complete
victory in his divorce case. Id. at 42. The Court of Claims
allocated 80 percent of the taxpayer’s legal expenses to the
taxpayer’s focus on protecting his assets and 20 percent to all
other aspects of the divorce litigation, and allowed deductions
for the 80 percent under sections 23(a)(2), I.R.C. 1939, and
212(2), ruling that deductions for the remaining 20 percent were
barred by sections 24(a)(1), I.R.C. 1939, and 262. See id. at
40, 43. In United States v. Gilmore, 372 U.S. at 49, the Supreme
Court described its conclusion as to the legal standard to be
used in analyzing such situations:
we resolve the conflict among the lower courts on the
question before us * * * in favor of the view that the
origin and character of the claim with respect to which an
expense was incurred, rather than its potential consequences
upon the fortunes of the taxpayer, is the controlling basic
test of whether the expense was “business” or “personal” and
hence whether it is deductible or not under § 23(a)(2). * *
* [Emphasis added.]
Although in Gilmore the taxpayer’s focus was (and, according
to the Court of Claims, 80 percent of his expenditures were
spent) on protecting the assets that clearly were the source of
substantially all of his income, the Supreme Court directed its
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analysis to what gave rise to the threat that the taxpayer sought
to overcome. That threat was the wife’s claim. The wife’s
claim, the Supreme Court determined, “stemmed entirely from the
marital relationship, and not, under any tenable view of things,
from income-producing activity.” Id. at 51. Applying this to
the search for “the origin and character of the claim with
respect to which an expense was incurred,” (id. at 49) the
Supreme Court concluded as follows: “Thus none of respondent’s
[Gilmore’s] expenditures in resisting these claims can be deemed
‘business’ expenses, and they are therefore not deductible under
§ 23(a)(2).” [Id. at 52.]
In a companion case, United States v. Patrick, 372 U.S. 53
(1963), the taxpayer’s wife sued for divorce. See id. at 54.
Negotiations resulted in a property settlement agreement. See
ibid. The divorce court then granted an absolute divorce to the
wife, approved the property settlement, and ordered the taxpayer
to pay the attorney’s fees for both parties. See ibid. The
taxpayer and his wife allocated the total fees as follows:
$4,000 for handling the divorce itself, $16,000 for rearranging
the stock interests in a family corporation that the taxpayer
headed, and $4,000 for dealing with certain leases and
transferring property to a trust. See id. at 54-56. The
taxpayer claimed deductions for those portions of the attorney’s
fees allocable to the property settlement and not to the divorce
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as such. See id. at 56. The Supreme Court pointed out that
Patrick is similar to Gilmore, summarizing its analysis (ibid.)
as follows:
The principles held governing in that case are equally
applicable here. It is evident that the claims asserted by
the wife in the divorce action arose from respondent’s [the
taxpayer’s] marital relationship with her and were thus the
product of respondent’s personal or family life, not profit-
seeking activity. As we have held in Gilmore, payments made
for the purpose of discharging such claims are not
deductible as “business” [i.e., sec. 212(2)] expenses.
The Supreme Court in Patrick then commented as follows (id.
at 57):
We find no significant distinction in the fact that the
legal fees for which deduction is claimed were paid for
arranging a transfer of stock interests, leasing real
property, and creating a trust [in Patrick] rather than for
conducting litigation [as in Gilmore]. These matters were
incidental to litigation brought by respondent’s wife, whose
claims arising from respondent’s personal and family life
were the origin of the property arrangements. * * *
We note that the Supreme Court in Patrick did not even
bother to discuss another difference between Patrick and
Gilmore–-in Gilmore, the taxpayer won his divorce case and his
sought-for deductions were only for his expenses; in Patrick,
half of the taxpayer’s sought-for deductions were for expenses of
his wife, which the taxpayer paid under compulsion of the local
court order.
In the instant case, petitioner’s claimed deductions arose
from her payment of the relevant expenses of the other
beneficiaries, the Trustee, and the guardian ad litem.
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Petitioner made the Payments because the California Court ordered
her to make them. The California Court’s order directing
petitioner to make these Payments came in response to a petition
for equitable allocation and a motion for sanctions filed
separately by the other beneficiaries. That petition and that
motion arose from petitioner’s Objections to the Third Account.
We do not continue to follow the steps all the way back to L.O.
Ivey’s will, establishing the Trust. See Boagni v. Commissioner,
59 T.C. 708, 713 (1973). Rather, we look for “‘the kind of
transaction out of which the obligation arose’”. United States
v. Gilmore, 372 U.S. at 48 (quoting Deputy v. du Pont, 308 U.S.
488, 494 (1940)).
After examining the record in the instant case we conclude,
and we have found, that petitioner’s obligation to make the
Payments arose from the Trustee’s filing of the Third Account.
The context of the Third Account is distributions from the Trust.
The distributions to petitioner arose from her status as an
income beneficiary. Thus, after examining the origin and
character of the claim in the instant case, we conclude that
petitioner made the Payments in her personality of a “seeker
after profit”, United State v. Gilmore, 372 U.S. at 44, and
petitioner’s entitlement to deductions therefor is not barred by
section 262(a).
Respondent contends as follows:
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Under this test, petitioner’s Objections to the Third
Account do not constitute the relevant litigation for
purposes of Section 212(1) and (2). The relevant litigation
is that which was initiated by those persons who opposed
petitioner’s Objections to the Third Account and who
prosecuted both a motion for monetary sanctions and a
petition to charge petitioner’s share of the trust’s income
with the payment of such monetary sanctions.
We disagree. The motion and petition were no more than responses
to petitioner’s Objections to the Third Account. The motion and
petition would be pointless in the absence of petitioner’s
Objections and the Third Account. Indeed, even the California
Court’s decree, requiring petitioner’s Payments to be made solely
out of petitioner’s current income from her income interest in
the Trust, confirms that the California Court regarded the
consideration and resolution of the motion and petition as being
part of a dispute about petitioner’s income from the Trust.
Respondent contends as follows:
In addition, those sanctions were imposed to compensate the
victims of petitioner’s bad faith and vindictive actions.
Such sanctions bear no relation to the production or
collection of income or to the management, conservation, or
maintenance of income producing property.
We disagree.
In general, if the origin and character of the claim arise
out of a taxpayer’s personality as a seeker after profit rather
than satisfier of human needs, it does not matter that the
taxpayer’s expenditures are made because of the imposition of a
sanction to compensate the victims of the taxpayer’s improper
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actions. See, e.g., Ostrom v. Commissioner, 77 T.C. 608 (1981),
in which the taxpayer was allowed to deduct his payment of a jury
award of damages imposed on account of the taxpayer’s fraudulent
misrepresentation on which the plaintiff had relied to his
detriment. To the same effect are the cases described in Ostrom
v. Commissioner, 77 T.C. at 611-613. In the instant case, the
origin and character of the claim from which the liability arose
are petitioner’s personality as a seeker after profit. This is
not affected by whether petitioner won or lost the underlying
litigation or even by whether the California Court imposed the
obligation on petitioner because that Court concluded that
petitioner had acted in bad faith and out of vindictiveness.
The rule is otherwise in certain statutorily defined areas
(see, e.g., Huff v. Commissioner, 80 T.C. 804 (1983), dealing
with sec. 162(f)) and in the “public policy doctrine.” See,
e.g., Commissioner v. Tellier, 383 U.S. 687 (1966). As to what
remains of the public policy doctrine, see the opinions in
Stephens v. Commissioner, 93 T.C. 108 (1989), revd. 905 F.2d 667
(2d Cir. 1990). However, as noted supra note 2, respondent has
conceded the public policy doctrine issue. Also, clearly,
section 162(f) does not apply. Thus, we return to our conclusion
that respondent’s argument about the Payments constituting
sanctions does not change our analysis or conclusions.
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Respondent notes opinions of this Court and other courts
indicating that “If the origin of the underlying suit is a
personal vendetta against others, the related expenses are not
deductible.” Respondent contends that the California Court has,
in effect determined that petitioner’s filing of the Objections
is “the result of her personal vendetta”.
Respondent does not contend that the California Court’s
findings should be given collateral estoppel or other preclusive
effect. See Rule 39 of the Tax Court Rules of Practice and
Procedure. Petitioner does not contend that those findings
should be excluded. See generally 5 Weinstein, Weinstein’s
Federal Evidence sec. 803.28 [2] (2d Ed. 1997); 1 Weinstein, sec.
201.12 [3]. Thus, we are presented with a record that includes
the California Court’s findings and testimony before this Court
from petitioner and DiLeonardo. At trial, we explained our role
vis-a-vis the California Court’s ruling, as follows:
THE COURT: Mrs. DiLeonardo, as I had said before, we
took the recess. We’re not here to re-try those
proceedings. We’re not here to second-guess the wisdom of
what was done in those proceedings. We’re here only to
understand them to the extent necessary to decide whether or
not these expense are deductible.
The California Court reached the conclusions it stated in
the context of determining whether petitioner’s actions in the
proceeding before it justified punishment and, if so, then what
was the nature and extent of the justified punishment. Our
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context is different, as we noted in our discussion of Ostrom v.
Commissioner, supra. The California Court imposed punishment and
explained its determination. Its explanation and determination
are not in substantive conflict with our conclusion that
petitioner’s actions arose out of her efforts to produce or
collect income, or to manage, conserve, or maintain property held
for the production of income. Meredith v. Commissioner, 47 T.C.
441 (1967), which respondent cites for the proposition that the
expenses of a personal vendetta are not deductible, illustrates
why we have concluded that the instant case had not yet
progressed to the vendetta stage.
In Meredith the sequence was as follow:
1949--taxpayer sued John Deere Plow Co. for breech of an
oral agency sales contract. Taxpayer’s suit was
dismissed. 89 F. Supp. 787 (SD Ia. 1950), affd. 185
F.2d 451 (8th Cir. 1950).
1952--taxpayer sued Deere to enforce an association
agreement. Taxpayer’s suit was dismissed by order;
affd. 206 F.2d 196 (8th Cir. 1953).
--taxpayer sued Deere to enforce a contract.
Taxpayer’s suit was dismissed by order; affd. 244 F.2d
9 (8 Cir., 1957).
--Deere sued taxpayer for injunction to prevent more
suits. Judgment for Deere, granting injunction;
affd. 261 F.2d 121 (8th Cir. 1958).
1960--taxpayer sued Federal Judge involved in 1957 and 1958
affirmances noted supra. Order granting summary
judgment to that Judge; affd. 286 F.2d 216 (8th Cir.
1960).
1960--taxpayer sued Deere and Deere’s former counsel.
Taxpayer held in contempt for violating injunction.
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In Meredith, the taxpayer sought deductions for 1961
expenditures in connection with the 1960 suits. We summarized
the situation as follows (47 T.C. at 447):
While the petitioner’s first action undoubtedly arose
out of his business relationship with Deere, and the costs
of that suit were ordinary and necessary expenses of his
business, by the time he initiated the action against the
judge and filed the last suit against Deere, in violation of
the injunction, the original cause of action had ceased to
have significance. The controversy had become a personal
struggle, a vendetta, and the expenses incurred had no
proper relationship to the petitioner’s business.
The action brought against Judge Van Oosterhout related
to decisions of the Court of Appeals made in the
petitioner’s third suit against Deere and in Deere’s suit
for an injunction. The business issue had been decided
against petitioner long before these cases were initiated.
There was no business relationship to the expenses of the
action against the judge, which was a personal accusation
completely without merit.
For the reasons stated, we sustain the respondent’s
determination.
In contrast, the instant case is only the second one in
which petitioner has filed objections to the Trustee’s
accounting; petitioner proceeded only by way of the Objections
and only after the Trustee initiated an action; and the Trustee’s
accounting directly affected petitioner’s income from the Ivey
Trust. Our analysis and conclusions are not inconsistent with
the determinations of the California Court.
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B. Ordinary and Necessary
In Trust of Bingham v. Commissioner, 325 U.S. 365, 373-374
(1945), the Supreme Court described section 23(a)(2), I.R.C.
1939,6 as follows:
Section 23(a)(2) is comparable and in pari materia with
§ 23(a)(1), authorizing the deduction of business or trade
expenses. Such expenses need not relate directly to the
production of income for the business. It is enough that
the expense, if “ordinary and necessary,” is directly
connected with or proximately results from the conduct of
the business. The effect of § 23(a)(2) was to provide for a
class of nonbusiness deductions coextensive with the
business deductions allowed by § 23(a)(1), except for the
fact that, since they were not incurred in connection with a
business, the section made it necessary that they be
incurred for the production of income or in the management
or conservation of property held for the production of
income. [Emphasis added; citations omitted.]
We have concluded supra that there is the necessary proximate
relationship between the Payments and petitioner’s efforts to
produce or collect income or to manage, conserve, or maintain her
income beneficiary interest.
We will not attempt to comprehensively summarize the
meanings of “ordinary” and “necessary” in the contexts of
sections 162(a) and 212. See Carbine v. Commissioner, 83 T.C.
356, 362-364 (1984), affd. 777 F.2d 662 (11th Cir. 1985).
Suffice it to observe that generally a taxpayer’s payment of a
6
The year before the Court in Trust of Bingham v.
Commissioner, 325 U.S. 365 (1945), was 1940. Sec. 23(a)(2),
I.R.C. 1939, was enacted in 1942; it applied to Trust of Bingham
because of the retroactive effective date of the 1942 enactment.
This is briefly described in Trust of Bingham v. Commissioner, 2
T.C. 853, 857-858 (1943), the Tax Court’s Court-reviewed opinion
that was affirmed by the Supreme Court.
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judgment which arose out of the taxpayer’s trade or business is
an ordinary and necessary expense of the trade or business. See
Ostrom v. Commissioner, 77 T.C. 608 (1981). Section 212 is, in
this regard, in pari materia with section 162(a). See Trust of
Bingham v. Commissioner, 325 U.S. at 373. Petitioner’s Payments
of the judgment arose out of petitioner’s profit-seeking section
212 activity. It was ordinary for a person in that situation to
make the Payments, and it was necessary for petitioner to make
the Payments.
We conclude that petitioner’s Payments satisfy the
“ordinary” and “necessary” requirements of section 212.
C. Allocation
Respondent contends that, even if a portion of petitioner’s
Payments satisfies the requirements of section 212(1) or (2)--
Petitioner has presented no evidence which would enable
the Court to allocate the total sanctions claimed between
those amounts which purportedly qualify under Section 212(1)
or (2) and those amounts which are strictly personal and
therefore nondeductible under Section 262(a). Accordingly,
petitioner is entitled to no deduction for the court-imposed
sanctions at issue.
We recently summarized the law in this area as follows:
We recognized that, when appropriate, litigation costs
must be apportioned between business and personal claims,
and that business litigation costs are nondeductible to the
extent that they constitute capital expenditures. See, e.g.
Kurkjian v. Commissioner, 65 T.C. 862 (1976) (deduction
disallowed for portion of attorney’s fees attributable to
personal matters); Buddy Schoellkopf Prods., Inc. v.
Commissioner, 65 T.C. 640, 646-647 (1975) (deduction
disallowed for portion of attorney’s fees attributable to
acquisition of intangible assets); Merians v. Commissioner,
60 T.C. 187 (1973) (deduction disallowed for portion of
attorney’s fees attributable to personal matters); see also
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Boagni v. Commissioner, supra [59 T.C. 708 (1973)]
(recognizing that litigation costs can be characterized as
both deductible and nondeductible when the litigation is
rooted in situations giving rise to both types of
expenditures). * * * [Guill v. Commissioner, 112 T.C. 325,
331 (1999).]
Respondent supports the apportionment contention by citing
Pozzo di Borgo v. Commissioner, 23 T.C. 76 (1954); Looby v.
Commissioner, T.C. Memo. 1996-207; Page v. Commissioner, T.C.
Memo. 1970-112. The common thread of distinction between those
cases on the one hand and the instant case on the other, is that
in each of the cases cited by respondent the Court concluded or
assumed arguendo that at least some part of the disputed expenses
had been incurred for a nondeductible purpose, while in the
instant case we conclude-–and we have found–-that the disputed
expenses were incurred in entirety for section 212(1) or (2)
purposes. Also, in Pozzo di Borgo, the taxpayer merely lost in
her effort to claim at trial a deduction in excess of what she
had claimed on her tax return. The taxpayer’s tax return claim
of a deduction for 63.4864 percent of the commission payments she
made apparently was not challenged, and so the taxpayer “face[d]
the burden of establishing that commissions in excess of the
amount deducted on her income tax return are not within the
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limiting provisions of section 24(a)(5).”7 Pozzo di Borgo v.
Commissioner, 23 T.C. at 78. (Emphasis added.) The taxpayer
failed to establish the factual underpinnings for her contention
that some or all of the remaining 36.5136 percent of her
commission payments were not allocable to income or interest
wholly exempt from tax, and so we held for the Commissioner. Id.
at 78, 81.8
Thus, the cases that respondent cites to us do not provide
any instructions relevant to the instant case. Respondent has
not suggested that the instant case involves any other
consideration, such as capital expenditures, or exempt income,
that might require apportionment, and our Findings of Fact
dispose of these theoretical possibilities.
7
Sec. 24(a)(5), I.R.C. 1939, is the predecessor of sec.
265(a)(1) of present law, relating to disallowance of deductions
for expenses allocable to income or interest wholly exempt from
income taxes.
8
We noted that the taxpayer’s contention as to the commission
payments, if proven, would transform that case into an
overpayment–-or refund-–case. See Pozzo di Borgo v.
Commissioner, 23 T.C. 76 (1954). For a discussion of the
differences between a taxpayer’s burden in a refund case and that
taxpayer’s burden in a deficiency case, see Helvering v. Taylor,
293 U.S. 507, 514-516 (1935), affg. Taylor v. Commissioner, 70
F.2d 619, 620-621 (2d Cir. 1934).
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We hold for petitioner.
To reflect the foregoing,9
Decision will be
entered for petitioner.
9
From the notice of deficiency and petitioner’s 1993 income
tax return, it is apparent that, as a result of our holding for
petitioner on the disputed issue, she does not have a 1993
Federal income tax liability. As a result, under paragraph (1)
and the last sentence of sec. 6651(a), the addition to tax
resulting from petitioner’s conceded failure to timely file her
1993 tax return is zero.