*115 Decision will be entered under Rule 50.
1. Petitioner John W. Willmott was the owner of farms, business properties, oil-producing properties, stocks and bonds. In 1931 he executed a deed transferring a one-half interest in all his property to his wife for the purpose of reducing his income tax liability and thereafter returned only one-half the income from the properties as taxable to him. The Commissioner denied the validity of the transfer and determined a deficiency in his income tax on the ground that all the income from the property was his income. A part of the deficiency also resulted from the Commissioner's disallowance of two deductions claimed on account of losses resulting from the sale of securities to petitioner's son, the Commissioner contending that the sales were not bona fide. In proceedings before the United States Board of Tax Appeals the determination of deficiency was reversed in 1938. In that year petitioners paid the fees and expenses incident to this litigation, which were calculated as a whole and not subject to allocation as to the various issues of such litigation. Held, such expenditures not deductible either under section 23 (a) (1), *116 Revenue Act of 1938, or section 121, Revenue Act of 1942.
2. Held, under facts, petitioner John W. Willmott was engaged in business of managing farms, oil-producing property and business property and therefore his earned income should be computed under section 25 (a) (4), Revenue Act of 1938, which is accordingly found in a certain amount for each of the taxable years.
*322 In these proceedings the petitioners appeal from respondent's determination of deficiencies with regard to their income tax for the years 1938 and 1939. Counsel for respondent, at the hearing herein, conceded error as to certain issues and petitioners, upon brief, waived certain other issues. After these concessions and waivers, which will be given effect in computations to be filed under Rule 50, there remain two questions: (1) Are petitioners entitled to deduct from their gross income for the year 1938 the amount of attorney's fees paid in that year for legal services incident to litigation before the United States Board of Tax Appeals involving the income tax liability of one of the petitioners*117 for prior years? and (2) Is petitioner John W. Willmott entitled to earned income credits for each of the years 1938 and 1939 in excess of $ 300?
FINDINGS OF FACT.
The petitioners herein, John W. Willmott and Irene E. Willmott, are husband and wife and reside in the State of Kentucky. Their separate return for the taxable years 1938 and 1939 were filed with the collector of internal revenue for the district of Kenutcky.
In 1938 each of the petitioners paid the sum of $ 2,123.91 for attorneys' fees and expenses of litigation in connection with proceedings before the United States Board of Tax Appeals in which John W. Willmott was petitioner and which were given Docket Nos. 87060 and 87356. Our memorandum findings of fact and opinion were entered therein under date of April 5, 1938. We adopt by reference our findings of fact therein, as part of our findings in this proceeding. In our findings of fact and opinion entered April 5, 1938, we stated the issues involved in those proceedings as follows:
The issues raised by the pleadings are, (1) whether respondent erred in including in petitioner's taxable income for each of the taxable years income from properties, an undivided one-half*118 of which allegedly was owned by petitioner's wife, who filed a separate income tax return for each of such years; (2) whether respondent erred in disallowing for the year 1932 the deduction of a loss resulting from an alleged sale of an interest in certain properties to petitioner's son; and (3) whether respondent erred in disallowing a deduction for the year 1933 of a loss resulting from the alleged sale of certain bonds to petitioner's son.
*323 With regard to the first issue it was contended by respondent that an instrument dated December 1931, which purported to transfer an undivided one-half interest in all property owned by John Willmott to his wife, was invalid and therefore the income from all of the property was taxable to John W. Willmott. With regard to the second and third issues, it was the contention of respondent that the sales of certain securities by John W. Willmott to his son were not bona fide, and therefore the capital losses resulting from these sales were not deductible by John W. Willmott. The motive for the transfer of the one-half interest in his property by John W. Willmott to his wife and for the sales of the securities to his son was to reduce*119 his income tax liability. We held in that proceeding that the transfer to his wife was valid and that the sales to his son were bona fide, and that respondent erred in his determination of deficiency.
The petitioners, John W. Willmott and Irene E. Willmott, his wife, during the entire taxable years 1938 and 1939 lived on a farm of approximately 341 acres in Fayette County, Kentucky. They owned as tenants in common this farm on which they lived, and two other farms in that vicinity, one of 555 acres, partly in Fayette and partly in Woodford County, and one of 256 acres in Woodford County, Kentucky, and also 26 improved farms, aggregating approximately two thousand acres, and a number of tracts of unimproved farming land in the State of Oklahoma. Petitioners also owned as tenants in common several pieces of business property in San Diego, California, and one piece of business property in Oklahoma, and a large number of tracts of oil and gas lands located in several states, some of which were producing properties and some undeveloped. In addition, they owned in like manner bonds aggregating $ 293,000 in par value and issued by 54 different organizations, stocks in 111 companies*120 aggregating some $ 300,000 in value, and also 7 notes aggregating $ 40,000 in value.
During the taxable years in question, the petitioner, John W. Willmott, devoted his entire time to the operation of these various properties, managing his one-half interest in same for himself and his wife's one-half interest for her as her agent. He personally conducted the farming operations on the farm on which they resided, determining the live stock and crops to be grown, the manner in which they were grown, harvested and marketed, with the petitioner, John W. Willmott, doing a large part of the physical labor connected with the handling of such live stock and crops. The other two Kentucky farms were operated by share-tenants, selected by petitioners. Petitioner, John W. Willmott, advised with these tenants and directed them in a general way, determined what crops and live stock were to be grown by them, and stocked the farms with live stock for them under an arrangement whereby the tenants were to have one-half of the increase and petitioners were to bear one-half of certain items of expense connected therewith. Some *324 of the Oklahoma farms were likewise operated by share-tenants*121 and some were rented for money rent. Petitioners consulted and advised with these tenants as to the operation of the lands and maintenance of the buildings thereon and paid the taxes and certain other items of expense connected therewith.
The business properties in California and Oklahoma, above referred to, consisted of a laundry building, together with laundry equipment located in McAlester, Oklahoma, and an apartment house, a garage building, a residence, and a large property containing stores on the first floor with doctors' offices above, all located in San Diego, California. These properties were leased to various parties and managed by petitioner, John W. Willmott, with the assistance of a local manager who collected rents and attended to minor matters and referred all questions of substantial nature to the petitioners for decision. Petitioners advised with the manager as to repairs, improvements, leases, and collections and paid direct all bills and taxes except those of a petty nature.
The oil and gas properties above mentioned consisted of some fifty different tracts of land which were producing oil or gas, and a greater number of undeveloped properties located mainly*122 in Oklahoma and Texas, but a few also in other states. Petitioners acquired these properties from time to time as a favorable opportunity arose and formerly drilled them on their own account for oil. During recent years they found it more profitable to secure other parties to lease the lands and drill the wells for a portion of the oil or gas discovered. Petitioner, John W. Willmott, during the taxable years in question, devoted a substantial portion of his time to securing parties to lease and develop these lands, and also to the study of the oil and gas business in general, and of newly developed areas, with the object in view of purchasing additional properties, and did purchase additional properties whenever a favorable opportunity arose.
Petitioner, John W. Willmott, maintains an office in Lexington, Kentucky, where he employs a bookkeeper and stenographer and spends as much of his time as is consistent with his farming operations, working long hours each day. No stocks or bonds were sold by petitioners during the year 1938. During the year 1939, in five separate transactions, they sold stocks and bonds for an aggregate sales price of $ 26,675.99. On all important matters*123 involving the sale of their jointly owned properties or the making of new investments the petitioner, John W. Willmott, consults with his wife, whose judgment in such matters he respects.
Petitioners, in their income tax returns for the taxable years, each claimed an earned net income of 20 percent of their total respective net incomes as shown thereon and claimed an earned income credit of 10 percent of the earned net income thus calculated.
*325 Petitioner John W. Willmott was engaged during the taxable years in the business of managing and operating, on his own behalf and as agent for his wife, the farm properties, oil-producing properties, and business properties described above and located in Kentucky, Oklahoma, Texas, and California. A portion of the net income shown on the returns of this petitioner for the taxable year was derived from this business. The balance of this net income was from investments.
A reasonable allowance for the personal services actually rendered by petitioner John W. Willmott in the conduct of his business, in which both personal services and capital were material income-producing factors, for the year 1938 was the sum of $ 4,250, and for the *124 year 1939 was the sum of $ 3,750. Neither of these sums was in excess of 20 per cent of the net profits of this petitioner from the business in which he was engaged.
OPINION.
The first question for our decision is whether the attorneys fees paid by petitioners in 1938 incident to the litigation before the United States Board of Tax Appeals which we have described in our findings are properly deductible from petitioners' gross income in the year in which paid. Respondent has determined and now contends that this expenditure constituted personal expenses within the meaning of section 24 (a) (1), Revenue Act of 1938, and not ordinary and necessary expenses paid in carrying on a trade or business within the meaning of section 23 (a) (1). Petitioners, on the other hand, contend that these expenditures come within the classification of the latter section and are, therefore, deductible; and, further, that they are deductible under section 121 of the Revenue Act of 1942, which amends section 23 (a) of the Internal Revenue Code by the addition of the following:
(2) Non-trade or non-business expenses. -- In the case of an individual, all the ordinary and necessary expenses paid or incurred*125 during the taxable year for the production or collection of income, or for the management, conservation, or maintenance of property held for the production for income.
This provision, petitioners point out, is made retroactive to include the taxable year here involved.
Three issues were litigated before the Board of Tax Appeals. The principal issue had to do with the validity of a transfer by John W. Willmott of a half interest in income-producing properties to his wife. Irene E. Willmott. Respondent had determined that the transfer was invalid for tax purposes and, therefore, all of the income from these properties was taxable to the husband. We held to the contrary, even though it was conceded that the impelling motive of the transfer was *326 to minimize the income tax liability of the transferor. The other two issues had to do with the question of whether sales of securities made by John W. Willmott to a son for the purpose of establishing deductible capital losses were bona fide. We held that they were, although again it was obvious that the purpose of the sales was to permit John W. Willmott to make deductions from his gross income.
We are of the opinion that*126 none of these transactions which gave rise to the prior litigation constituted carrying on a trade or business within the meaning of the statute, or were connected with or resulted from any business carried on by petitioners or either of them. Therefore, the attorneys' fees paid in the course of such litigation are not ordinary and necessary expenses paid in carrying on a trade or business. See Malcolm G. Gibbs, 34 B. T. A. 1028, and cases therein cited. As the Supreme Court pointed out in Kornhauser v. United States, 276 U.S. 145">276 U.S. 145, an expense incident to litigation is deductible as a business expense "where the suit or action * * * is directly connected with, or * * * proximately resulted from, his [the taxpayer's] business * * *." Later, in Higgins v. Commissioner, 312 U.S. 212">312 U.S. 212, the Supreme Court said "* * * all expenses of every business transaction are not deductible. Only those are deductible which relate to carrying on a business." See, also, Thomas Martin O'Brien, 47 B. T. A. 561, 565.
We can see no substance in petitioners' argument that the*127 attorneys' fees in question should be deductible under section 121 of the Revenue Act of 1942, quoted above, as expenses paid for the conservation of property held for the production of income, the petitioner arguing that without the litigation that half of the property held by Irene E. Willmott would have been subjected to lien for an additional tax, and that half belonging to John W. Willmott would have been subjected to a lien for an increased surtax. To logically follow the reasoning of petitioners, we would be forced to conclude that the expenses of defending any type of litigation would be deductible by the owner of property because of the possibility that a judgment lien might attach to it. We do not think that section 121 goes, or was intended to go, so far.
Attorneys' fees and expenses of litigation are deductible under section 121 of the Revenue Act of 1942 only when the subject matter of the litigation bears a reasonable and proximate relation to the production or collection of income or to the management, conservation, or maintenance of property held for that purpose. In R. C. Coffey, 1 T. C. 579, the attorney's fees which we held to be*128 deductible were expended in obtaining a reduction of local tax assessments on the taxpayer's business properties; and of the accountant's fees involved *327 that part was allowed as a deduction which was paid for the accountant's services in the adjustment of local taxes on intangibles assessed on taxpayer's income-producing securities. It was clear that the subject matter of the professional services in question had a reasonable and proximate relation to "the management, conservation or maintenance of property held for the production of income." However in that case we held that the fees paid to an accountant for services rendered in establishing trusts for the taxpayer's children constituted a personal expense and were not deductible under any statutory provision. In the instant case, the transfer of a one-half interest in the property of petitioner John Willmott to his wife for the purpose of reducing his tax liability seems analogous to the establishment of the trusts for the taxpayer's children in R. C. Coffey, supra.The "management, conservation or maintenance of property held for the production of income" does not include a disposition*129 by the taxpayer of that property for the purpose of diverting the income produced by it to another so that the property is no longer held by the taxpayer for the production of income to him. Any fee paid by petitioner John Willmott incident to the transfer itself would not have been deductible under section 121 any more than fees paid incident to the creation of the trusts in the Coffey case. Since the original transaction (in this case the transfer of the one-half interest in his property by John W Willmott to his wife) was not proximately related to the production or collection of income or to the management, conservation, or maintenance of property held for the production of income, any litigation arising out of this transaction involving its tax consequences would also not be related to the management, conservation, or maintenance of such property, and fees and expenses paid in connection with the litigation would not be deductible under section 121.
As we have indicated, the principal issue involved in the proceedings brought by John W. Willmott before the United States Board of Tax Appeals involved the tax consequences of his transfer of a one-half interest in his property*130 to his wife. The other two minor issues had to do with the bona fides of two sales of securities to his son. The fees and expenses incident to the litigation, which are sought to be deducted here, were not broken down to show that part allocable to each issue. Assuming without deciding that the transactions involved in the sale of securities made for the purpose of establishing tax losses were proximately related to the production or collection of income or to the management, conservation or maintenance of property held for that purpose, we are not able on the record made in this case to determine what part of the fees and expenses paid were incident to these transactions. Therefore we must approve respondent's determination *328 denying the deduction of such fees and expenses, which were claimed as a whole and can not be allocated to the various issues involved.
There can be little doubt but that petitioner John W. Willmott was engaged in business, and that his business was the management, promotion, and exploitation, on his own behalf and as agent for his wife, of farm properties, oil-producing properties, and business properties owned by them. See Eugene Higgins, 39 B. T. A. 1005;*131 Higgins v. Commissioner, supra. In this business "both personal services and capital are material income-producing factors" within the meaning of section 25 (a) (4) of the Revenue Act of 1938, and, therefore, "a reasonable allowance as compensation for the personal services actually rendered by the taxpayer, not in excess of 20 per centum of his share of net profits of such trade or business, shall be considered as earned income" for the purpose of determining the earned income credit of John W. Willmott.
The record is not clear as to the exact amount during the taxable years of the net profits of the business carried on by petitioner John W. Willmott as distinguished from his other net income. Since he has the burden of proof on this issue, we are unable to make assumptions of fact in his favor.
However, construing the evidence on this question in a light most unfavorable to this petitioner, we nevertheless conclude that he is entitled to an earned income credit greater in amount than the minimum of $ 300 allowed by respondent. It is our opinion that a reasonable allowance for the personal services actually rendered by this petitioner to be considered*132 as earned income was the sum of $ 3,750 for the year 1939, and the sum of $ 4,250 for the year 1938, neither of said sums being in excess of 20 per centum of his net profits from the business in which he was engaged. His earned income credit for the respective years will, accordingly, be $ 375 and $ 425.
Decision will be entered under Rule 50.