1956 U.S. Tax Ct. LEXIS 148">*148 Decision will be entered under Rule 50.
Certain attorneys rendered services for decedent prior to 1941, and in 1948 they obtained a judgment against decedent for the value of their services plus expenses. In 1945 decedent had disposed of his stock in a corporation, and in 1949 he became entitled to a partial payment for this stock. The court ordered that $ 225,000 of the amount to which decedent was entitled be paid to the clerk of the court as security pending decedent's appeal of the judgment for the attorneys. The judgment was affirmed, and in 1951 the sum of $ 190,355.82 was paid to the attorneys in satisfaction of their judgment and the balance of the $ 225,000 was paid to the decedent. Held, at least $ 33,000 of the judgment represented that portion of the cost of the attorneys' services and expenses which was a capital expenditure allocable to the stock for which the $ 225,000 was paid. Held, further, decedent realized capital gain in 1949 in the amount of $ 192,000. Held, further, any capital losses on other stock and nonbusiness expense deductions to which decedent was entitled on the payment of the judgment in 1951 cannot be related back to 1949.
26 T.C. 600">*601 Respondent determined a deficiency in the income tax of A. P. Steckel for the year 1949 in the amount of $ 73,154.72. The disallowance of a deduction for a particular contribution is not contested. The issues for decision are whether the Commissioner correctly determined:
1. That A. P. Steckel realized additional long-term capital gain in 1949 in the approximate amount of $ 225,000 when said sum, to which Steckel was entitled in payment for common stock, was paid to the clerk of the District Court as security pending the appeal of a judgment against A. P. Steckel; and
2. That deductions to which A. P. Steckel was entitled upon the payment of the judgment in1956 U.S. Tax Ct. LEXIS 148">*150 1951 cannot be related back to 1949.
FINDINGS OF FACT.
The stipulated facts are so found.
Petitioner is the executor of the Estate of A. P. Steckel (hereinafter referred to as Steckel) and has been substituted herein for Steckel, the original petitioner, who died on August 19, 1954. Steckel resided in Youngstown, Ohio, and filed his income tax return for the taxable year 1949 with the collector of internal revenue for the eighteenth district of Ohio.
In 1926 the Cold Metal Process Company (hereinafter referred to as Cold Metal) was formed and Steckel acquired 600 of the 2,000 shares of capital stock issued. Cold Metal was organized to exploit certain inventions of Steckel relating to the hot and cold rolling of metals.
Until 1934 Steckel was the president of Cold Metal. In that year Steckel became involved in sharp and bitter disagreements with a 26 T.C. 600">*602 majority of the board of directors of Cold Metal and was involuntarily removed as an officer of that corporation.
In 1935 Steckel employed the law firm of Lurie & Alper to represent him in a case pending in United States District Court for the Northern District of Ohio, Eastern Division, entitled F. du Pont Thompson, et al. v.1956 U.S. Tax Ct. LEXIS 148">*151 The Cold Metal Process Company, et al., in which Steckel and the other directors of Cold Metal were defendants. At a conference in February 1935, Lurie & Alper first discussed in detail with Steckel the terms of their employment. At that time Steckel explained that his only assets consisted of his stock in Cold Metal. He represented that if he could retain his stock interest by avoiding or deterring money judgments against him and if the assets of Cold Metal were not wasted or diverted by the dominant stockholders of Cold Metal, his stock would be worth in time as much as several million dollars. He employed Lurie & Alper to represent him in any litigation involving Cold Metal and his interest therein, and to render further services directed at preserving and enhancing his stock interest in the company. Steckel informed them that under existing conditions he would be unable to pay for their services, and that their compensation would be contingent upon his ability to retain the stock and the stock becoming valuable.
Lurie & Alper, and another attorney whom they engaged to act as trial counsel, performed various legal services for Steckel from the time of their employment until1956 U.S. Tax Ct. LEXIS 148">*152 1941. They represented him in the above case of Thompson, et al. v. Cold Metal Process Company, et al., which was a suit by minority stockholders of Cold Metal requesting that the directors be required to account for breaches of their duty and that a receiver be appointed for Cold Metal. In that case the court held that the directors, other than Steckel, had been guilty of breaches of duty and ordered those directors to repay Cold Metal the moneys of which it had been wrongfully deprived. While Steckel was technically a defendant in this action, the suit had been brought by nominal plaintiffs, inspired by Steckel, and Steckel's counsel carried the principal trial burden in establishing the plaintiff's case.
The above counsel also represented Steckel in another action brought by the Standard Slag Company to force Steckel to sell 160 shares of his Cold Metal stock in return for the sum of $ 56,000. In 1938 while the appeal of a decree against Steckel was pending in this action, Steckel decided to accept the Standard Slag Company's offer, and he delivered the 160 shares in return for $ 56,000.
At the time of the employment of Lurie & Alper, Cold Metal had obtained a money judgment1956 U.S. Tax Ct. LEXIS 148">*153 against Steckel in the amount of $ 18,364.15 in the Common Pleas Court. Lurie & Alper appealed this case for Steckel as it was desirable in the protection of Steckel's interest that, if possible, this judgment be reversed and in any event 26 T.C. 600">*603 that no levy of execution should be made to enforce it against Steckel's stock interest in Cold Metal. The judgment was finally affirmed by the Supreme Court of Ohio in 1938.
The above attorneys also performed additional services for Steckel by attending directors' meetings and studying financial statements of Cold Metal, by attempting to obtain financing for Steckel and for Cold Metal, and by attempting to settle the controversy between Steckel and the other directors.
On October 23, 1936, Steckel had transferred 420 shares of Cold Metal stock to the Peoples-Pittsburgh Trust Company, which later became the Peoples First National Bank of Pittsburgh (hereinafter referred to as the Pittsburgh Bank), under an escrow depository agreement. The agreement provided that the stock would stand in Steckel's name on the books of the corporation and Steckel would retain the right to all dividends. However, under the agreement he could transfer the1956 U.S. Tax Ct. LEXIS 148">*154 beneficial interest in any of the shares, and if all of the stock was sold by Steckel the proceeds would be distributed among the beneficial owners. At that time Steckel had transferred to others the beneficial interest in 21 shares.
In 1940 Cold Metal paid a dividend of $ 1,325 per share. Additional dividends in the aggregate amount of $ 1,126 per share were paid in the years 1941 to 1944.
On December 28, 1945, the Pittsburgh Bank held 300 shares of stock of Cold Metal under the above escrow agreement. Steckel was the beneficial owner of 185 of the shares and was entitled to one-half of the profit on 18 additional shares. On said date one of the stockholders of Cold Metal, the Union National Bank of Youngstown, Ohio, trustee of the Leon A. Beeghly Fund (hereinafter referred to as the trustee), entered into a separate contract with each of the other stockholders of Cold Metal, including Steckel. Under the contracts the trustee acquired the shares of all of the other stockholders. It acquired the 300 shares standing in Steckel's name and held in escrow by the Pittsburgh Bank for $ 5,000 per share. The contract provided that the trustee would pay $ 200 per share upon delivery1956 U.S. Tax Ct. LEXIS 148">*155 of the stock certificates. It further provided that Cold Metal would be dissolved and that the balance of $ 4,800 per share would be paid if and when certain funds were received by the trustee upon the rescission or modification of certain court and administrative orders. The contract stated that when the funds became available they would be applied first to the payment of an additional $ 1,800 per share to the stockholders receiving less than $ 6,000 per share (such as Steckel), and said stockholders would be paid the balance of the stipulated purchase price ($ 3,000 per share in the case of Steckel) after an additional $ 800 per share had been paid to those stockholders who were selling their stock for more than $ 6,000 per share.
26 T.C. 600">*604 During 1948 Steckel gave away his right to the proceeds from the disposition of 24 of the 185 shares of Cold Metal stock of which he had been the sole beneficial owner at the time he had entered into the contract of December 28, 1945.
In 1946 Lurie & Alper had not been paid for the legal services they had rendered Steckel. On November 14, 1946, they filed suit against Steckel in the District Court alleging that the reasonable value of their1956 U.S. Tax Ct. LEXIS 148">*156 services was $ 300,000 and that they had incurred expenses on Steckel's behalf in the amount of $ 7,225.80. They prayed that they receive judgment against Steckel in the amount of $ 307,225.80, together with interest thereon at the rate of 6 per cent per annum from the 15th day of January 1941, and for the costs of the action. In his answer to the complaint Steckel denied that he was indebted to Lurie & Alper and alleged that their services were of no benefit to him. The District Court in its opinion, dated May 28, 1948, found that the complainants had spent a total of 1,539 1/4 days on Steckel's behalf, that "a fair per diem allowance for an average of all the days would be $ 100," and that the complainants were entitled to $ 153,925 for services and $ 8,738.07 for expenses. On June 7, 1948, the court entered a judgment for Lurie & Alper in the amount of $ 162,663.07 and costs, later determined to be $ 37.24. Steckel filed a motion for a new trial on June 11, 1948. On June 17, 1948, the District Court ordered that the motion be held until it determined whether funds, which were being held by the clerk of the District Court in another action, would be paid to Cold Metal.
On 1956 U.S. Tax Ct. LEXIS 148">*157 June 21, 1948, a writ of execution on the above judgment was returned by the United States marshal wholly unsatisfied. On January 6, 1949, the District Court entered an order in aid of execution, ordering the trustee to hold, subject to further order of the court, any funds up to $ 300,000 to which Steckel or the Pittsburgh Bank might be entitled under the contract of December 28, 1945.
In early 1949 certain funds which had been impounded were turned over to the trustee. On March 4, 1949, the trustee paid $ 1,000 per share to each of the old stockholders of record of Cold Metal, except Steckel, who had disposed of their stock for less than $ 6,000 per share. On March 9, 1949, $ 300,000, which was due the Pittsburgh Bank on the 300 shares transferred to the trustee by Steckel, was set aside by the trustee and was held by it in safekeeping pursuant to the order of the District Court. On August 29, 1949, each of the former stockholders of Cold Metal, including the Pittsburgh Bank as the escrow agent of Steckel, received an additional $ 800 per share from the trustee. The amount received by the Pittsburgh Bank was $ 240,000.
On September 3, 1949, Steckel filed a motion requesting 1956 U.S. Tax Ct. LEXIS 148">*158 the District Court to modify its order in aid of execution so as to permit the release of that part of the funds held pursuant to the order which was 26 T.C. 600">*605 in excess of an amount reasonably sufficient to pay the judgment and costs. On October 12, 1949, the District Court entered orders overruling the motion of June 11, 1948, for a new trial, and granting the motion to modify the order in aid of execution.
On October 20, 1949, Steckel filed his notice of appeal from the judgment of the District Court. On November 9, 1949, the District Court entered an order with respect to the security to be provided by Steckel to obtain a stay of execution pending the appeal. The order stated that the parties had agreed as to the security to be provided, other than a supersedeas bond, and that the trustee was holding in cash a sum, of which at least $ 225,000 was the property of Steckel. The District Court therefore found that Steckel should furnish the sum of $ 225,000 as security, and ordered the trustee to pay that amount to the clerk of the court. The trustee was released from the order in aid of execution on any sums in excess of $ 225,000. The order further stated that upon the payment1956 U.S. Tax Ct. LEXIS 148">*159 of the $ 225,000 to the clerk of the court the execution of the judgment would be stayed pending the appeal, and that until the appeal was docketed in the Court of Appeals, the District Court would retain jurisdiction to consider any application which Steckel might make to substitute an adequate supersedeas bond for the security provided in the order.
The sum of $ 225,000 was paid to the clerk of the District Court pursuant to the above order, and the balance of $ 75,000 was paid to the Pittsburgh Bank. On November 23, 1949, the Pittsburgh Bank distributed $ 1,800 per share, using the above $ 75,000, plus the $ 240,000 it had received on August 29, 1949, to each of the persons, other than Steckel, entitled thereto under the escrow agreement. It paid the balance of $ 77,900 to Steckel, who reported that amount in his income tax return for 1949 as long-term capital gain. Respondent determined that he should also have reported as capital gain in 1949 the $ 225,000 paid to the clerk of the District Court.
On November 17, 1950, the Court of Appeals for the Sixth Circuit affirmed the judgment of the District Court in favor of Lurie & Alper (185 F.2d 921), 1956 U.S. Tax Ct. LEXIS 148">*160 and the Supreme Court denied certiorari on March 26, 1951 (340 U.S. 953">340 U.S. 953). Thereafter, on April 9, 1951, the District Court ordered that Lurie & Alper be paid out of the $ 225,000 fund the amount due them, including interest and costs, such sum totaling $ 190,355.82. The balance of $ 34,644.18 was ordered paid to Steckel. The payments were made pursuant to this order.
The cost of the stockholders' derivative action and the attempts to obtain financing for Cold Metal were capital expenditures. Of the sums received by Lurie & Alper, $ 33,000 represents that portion of this capital expenditures allocable to the 161 shares and the half interest in the profits on 18 additional shares for which the $ 225,000 was paid.
26 T.C. 600">*606 OPINION.
The question is the amount of long-term capital gain realized by Steckel in 1949. In 1945 Steckel transferred his stock in the Cold Metal Process Company to another stockholder, the Union National Bank of Youngstown, Ohio, trustee of the Leon A. Beeghly Fund. The trustee was to pay for the stock when and if it received certain funds. In 1949 the trustee received a portion of the funds mentioned and was ready to make a partial1956 U.S. Tax Ct. LEXIS 148">*161 payment for the stock. However, it was prevented from making a payment to Steckel by an order of the District Court in aid of execution of a judgment against Steckel. The judgment represented an award of just compensation to attorneys, Lurie & Alper, for legal services rendered Steckel and necessary expenses incurred during a 6-year period ending in 1941 in connection with Steckel's Cold Metal stock and his interest in that corporation. Later in 1949, pursuant to an agreement of the parties (Steckel and Lurie & Alper), the District Court ordered the trustee to pay $ 225,000 of the amount it was holding for Steckel to the clerk of the District Court to serve as security, in lieu of a supersedeas bond, for a stay of execution pending Steckel's appeal from the judgment.
Respondent determined that Steckel realized taxable gain in 1949 to the extent of the full $ 225,000 paid to the clerk of the court. Petitioner contends that no gain was realized because the money was not received by Steckel in that year. Alternatively, petitioner contends that the judgment should be taken into account in determining Steckel's gain, and as a further alternative petitioner argues that the amount ultimately1956 U.S. Tax Ct. LEXIS 148">*162 paid in satisfaction of the judgment represented a part of the cost of Steckel's Cold Metal stock and should be taken into account in determining the amount of gain realized in 1949.
We agree with respondent that Steckel received taxable gain in 1949 upon payment of the $ 225,000 to the clerk of the District Court. The entire payment was for Steckel's benefit, ultimately to be turned over to him or used to discharge his lawful debt. Under similar circumstances it has been held that the taxpayer realizes gain or receives income at the time of the payment even though the payment is made to a third party to hold pending the outcome of a dispute between the taxpayer and his alleged creditor. Dwight A. Ward, 20 T.C. 332, affd. 224 F.2d 547; Francis R. Hart, 21 B. T. A. 1001, reversed on other grounds 54 F.2d 848. We agree with petitioner, however, that the judgment is to be taken into account for the purpose of determining the amount of taxable gain realized in 1949. Accordingly we must determine what, if any, portion of the judgment in favor of Lurie & Alper represented1956 U.S. Tax Ct. LEXIS 148">*163 an addition to the cost basis of Steckel's stock for which the $ 225,000 payment was made. Both parties agree that this is governed by the nature of the services rendered by Lurie & Alper. Petitioner contends that the services were rendered Steckel either in defense 26 T.C. 600">*607 of his title to the stock or in order to protect his investment in the corporation; and therefore the cost of those services should be capitalized. Respondent contends that, with the possible exception of the cost of defending the action by the Standard Slag Company to compel Steckel to sell 160 shares of his Cold Metal stock, no part of the cost of the services was a capital expenditure, but that the full amount was an ordinary and necessary expense for the management, conservation, or maintenance of property held for the production of income within the purview of section 23 (a) (2) of the Internal Revenue Code of 1939.
If an expenditure is a proper addition to cost it should be capitalized even though it would otherwise be deductible as an expense. Daniel S. W. Kelly, 23 T.C. 682, affd. 228 F.2d 512; Shipp v. Commissioner, 217 F.2d 401,1956 U.S. Tax Ct. LEXIS 148">*164 affirming a Memorandum Opinion of this Court dated June 15, 1953; E. W. Brown, 19 T.C. 87, affirmed on this point 215 F.2d 697. In addition to expenses for defending or perfecting title to property, which concededly must be capitalized, this Court has held that "Payments made by a stockholder of a corporation for the purpose of protecting his interest therein must be regarded as an additional cost of his stock * * *." Eskimo Pie Corporation, 4 T.C. 669, 676, affd. 153 F.2d 301. See also South American Gold & Platinum Co., 8 T.C. 1297, affd. 168 F.2d 71. However, in both of the cases last cited, the stockholder paid expenses or obligations of the corporation in order to protect its interest therein, and the payment was in a real sense an addition to the capital of the corporation.
In the instant case the expenses of defending the suit to compel Steckel to sell 160 shares of his Cold Metal stock were clearly a capital expenditure; but, for the reasons hereinafter stated, that is of no aid to petitioner. 1956 U.S. Tax Ct. LEXIS 148">*165 In addition, that part of the fees allocable to the stockholders' derivative action against the directors of Cold Metal should be capitalized. In that action Steckel's attorneys carried a substantial portion of the burden of proving breaches of duty on the part of the other directors which resulted in the court ordering those directors to repay Cold Metal the moneys of which it had been wrongfully deprived. This action was beneficial to Cold Metal and to the stockholders in general. In such cases the expense of the action is normally borne by the corporation which receives the direct benefit. Charles Kay Bishop, 25 T.C. 969. Where the expense is borne by a stockholder, the expenditure represents an additional contribution to the capital of the corporation. The expense of attempting to obtain financial aid for Cold Metal falls in the same category. As in Eskimo Pie Corporation and South American Gold & Platinum Co., both supra, the payment of expenses of the corporation by a stockholder in order to protect his interest therein is a proper addition to the cost of his stock.
26 T.C. 600">*608 The remaining fees, however, were not shown to be1956 U.S. Tax Ct. LEXIS 148">*166 a capital expenditure. The amount attributable to the other services was not a proper expense of the corporation. To a large extent the remaining services consisted of watching the day-by-day affairs of Cold Metal in order to safeguard Steckel's investment and of trying to obtain financing for Steckel in order to conserve his stock interest in that corporation, and were not rendered in directly defending or perfecting Steckel's title to the stock.
The remaining item is the cost of appealing the money judgment obtained by Cold Metal against Steckel. Normally, the cost of defending such an action is not deductible as an expense even where an adverse judgment would force the taxpayer to sell part of his income-producing property. Lykes v. United States, 343 U.S. 118">343 U.S. 118; Frank M. Cobb, 10 T.C. 380, affd. (C. A. 6) 173 F.2d 711, certiorari denied 338 U.S. 832">338 U.S. 832, rehearing denied 338 U.S. 882">338 U.S. 882. The rationale of the Lykes and Cobb cases is not that the expenditure should be capitalized, but that the conservation of income-producing property1956 U.S. Tax Ct. LEXIS 148">*167 is too remote to allow the deduction of the expense. Here there might be a closer relationship than in the Lykes and Cobb cases between the legal expenses incurred and the property being conserved, and for that reason the cost of the action might or might not be deductible as a nonbusiness expense. However, Steckel's title to the stock was not even remotely involved in the litigation, and in no event could the cost of the action be capitalized as an expenditure for defending his title. Ordinarily, expenses which merely protect a taxpayer's financial position, so as to allow him to retain property, are not proper additions to the cost of that property. See dissenting opinion of Judge Frank in Hochchild v. Commissioner, (C. A. 2) 161 F.2d 817, 819.
Although a substantial portion of the judgment in favor of Lurie & Alper represented a capital expenditure, not all of that amount is allocable to the shares for which the $ 225,000 payment was made to the clerk of the court. First, no part of the cost of defending the suit by the Standard Slag Company is allocable to those shares for which the payment was made. That was a suit to compel Steckel1956 U.S. Tax Ct. LEXIS 148">*168 to sell 160 shares of his Cold Metal stock. While an appeal was pending in that action, Steckel decided to accept the Standard Slag Company's offer; and in 1938 he delivered the 160 shares in return for $ 56,000. The full cost of defending that action is allocable to those 160 shares. Second, while that portion of the cost of the services and expenses of Lurie & Alper attributable to the stockholders' derivative action and to obtaining financing for Cold Metal was a capital expenditure, it should be allocated equally among all of the shares held at the time those services were rendered. Cf. Commissioner v. Laguna Land & Water Co., (C. A. 9) 118 F.2d 112; John B. 26 T.C. 600">*609 , 44 B. T. A. 851. Most of those services were performed in 1935 and 1936 when Steckel owned 580 shares of Cold Metal stock. The $ 225,000 in question represented a partial payment for only 161 of those shares plus a half interest in the proceeds of 18 additional shares.
While an allocation is required, it is impossible either to determine with exactitude what portion of the total fees is attributable to the derivative action and to 1956 U.S. Tax Ct. LEXIS 148">*169 the efforts to obtain financing for Cold Metal or to ascertain with any certainty what portion of this capital expenditure is allocable to the stock interest for which the $ 225,000 payment was received. However, bearing heavily on petitioner, because the inexactitude is due, at least in part, to it and to Steckel ( Cohan v. Commissioner, 39 F.2d 540; James Petroleum Corporation, 24 T.C. 509 (on appeal C. A. 2)), we have found that services and expenses rendered and incurred by Lurie & Alper in the amount of $ 33,000 is a proper addition to the cost of the stock for which the $ 225,000 payment was made.
For the above reasons it is our opinion that Steckel did not realize taxable gain in excess of $ 192,000 because of the payment of the $ 225,000 to the clerk of the court in 1949. However, to the extent of $ 192,000, we cannot upset the respondent's determination despite the fact that the disbursement of any portion of that amount to Lurie & Alper might have entitled Steckel to deduct the amount disbursed as expenses and capital losses on other stock. The computation of the gain realized on the disposition of stock1956 U.S. Tax Ct. LEXIS 148">*170 is not affected by capital losses on other stock and by nonbusiness expense deductions. Therefore, when in 1949 the trustee paid $ 225,000 to the clerk of the court, Steckel was certain to realize gain in the amount of $ 192,000 on the stock for which the payment was made; and the gain was realized at that time even though the money was not received by him. As stated above, the realization of gain on the disposition of stock is not to be deferred solely because the proceeds are deposited with a third party who will ultimately either pay the money to the taxpayer or use the money to discharge the taxpayer's lawful debt. The fact that the payment of the debt will give rise to capital losses on other stock and nonbusiness expense deductions, neither of which are to be taken into account in computing the gain in question, is not in our opinion a logical reason for creating an exception to the general rule and postponing the realization of gain. Furthermore, any capital losses or nonbusiness expense deductions to which Steckel was entitled upon the payment of the judgment in 1951 cannot be related back to 1949. Arrowsmith v. Commissioner, 344 U.S. 6">344 U.S. 6;1956 U.S. Tax Ct. LEXIS 148">*171 Estate of Hetty B. Levy, 17 T.C. 728.
Decision will be entered under Rule 50.