T.C. Memo. 2001-127

UNITED STATES TAX COURT

ANDREW S. AND LINDA HAYWORTH BRENNER, Petitioners v.

COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 13700-99. Filed June 4, 2001.

R determined that, for 1997, Ps were liable 

for the alternative minimum tax computed, in part, 

by adding back to Ps’ reported taxable income legal

fees incurred by P husband (H) and treated by Ps on

their original return as Schedule A miscellaneous

itemized deductions. See sec. 56(b)(1)(A)(i), I.R.C. 

Ps argue that the legal fees (1) were reimbursed to H

by N as part of N’s payment in settlement of an

arbitration proceeding instituted by H and arising out

of N’s firing of H in 1996 and (2) are reimbursed

employee business expenses deductible from gross

income. See sec. 62(a)(2)(A), I.R.C.

Held: Because H failed to substantiate his legal

fees to N as required by sec. 1.62-2(c) and (e), Income

Tax Regs., N’s reimbursement of such fees is treated as

made under a nonaccountable plan. Therefore, they are

deductible only as miscellaneous itemized deductions. 

See sec. 1.62-2(c)(3), (5), Income Tax Regs. R’s

deficiency determination is sustained.
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Howard W. Munchnick, for petitioners.

John J. Sweeney, for respondent.

MEMORANDUM FINDINGS OF FACT AND OPINION

HALPERN, Judge: By notice of deficiency dated May 21, 1999,

respondent determined a deficiency in petitioners’ Federal income

tax for 1997 in the amount of $68,716. The adjustment giving

rise to that deficiency is respondent’s determination that

petitioners are liable for the alternative minimum tax. After

concessions, the only issue remaining for decision is whether

petitioners may treat certain legal fees and related expenses

(the legal fees) as reimbursed employee business expenses

deductible from gross income pursuant to section 62(a)(2)(A)

rather than as miscellaneous itemized deductions, which are not

allowed as deductions in computing alternative minimum taxable

income subject to the alternative minimum tax. We hold that they

may not. Our reasons follow.

Unless otherwise indicated, all section references are to

the Internal Revenue Code in effect for the year at issue, and

all Rule references are to the Tax Court Rules of Practice and

Procedure.
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FINDINGS OF FACT

Some facts have been stipulated and are so found. The

stipulation of facts, with accompanying exhibits, is incorporated

herein by this reference.

At the time of the petition, petitioners resided in Amawalk,

New York.

Employment and Discharge of Petitioner Andrew S. Brenner by

Nomura Securities International, Inc.

Petitioner Andrew S. Brenner (petitioner) was an employee of

Nomura Securities International, Inc. (Nomura), from August 1987

until his termination from service by Nomura in May 1996. At

Nomura, petitioner traded Government and Government agency

securities and, by 1996, he had been promoted to managing

director and head governmental trader.

On April 15, 1996, Nomura advised petitioner that a review

of his positions in various securities revealed discrepancies in

his marking of the value of assets under his control. Nomura

advised petitioner to retain counsel, which he did. On May 22,

1996, Nomura terminated petitioner’s employment for alleged

mismarking or misvaluing of securities. As a result of that

termination and Nomura’s allegation that he had mismarked

securities, Nomura was required by Federal Law to file, and did

file, a Uniform Termination Notice (Form U-5) with both the New

York Stock Exchange (NYSE) and the National Association of

Securities Dealers (NASD).
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The Arbitration Proceeding

On May 23, 1996, petitioner commenced an arbitration

proceeding with the NASD (the arbitration proceeding) naming

Nomura as a party. He commenced the arbitration proceeding by

filing a Demand For Arbitration and Statement of Claim (the

original claim) alleging, inter alia, breach of his employment

contract with Nomura, breach of covenant of good faith and fair

dealing, and defamation. He sought damages in the sum of

$11,174,000 plus interest on his claims, punitive damages,

attorney’s fees, and costs. 

On July 19, 1996, Nomura filed a counterclaim alleged that

petitioner, while at Nomura, had been “parking” securities, and

sought “in excess of $500,000" for breach of a fiduciary duty. 

On May 13, 1997, petitioner filed a Second Amended Statement

of Claim (the amended claim) in which he asserted additional

claims, the most significant of which was a $3 million claim for

defamation in connection with the filing, by Nomura, of an

amended Form U-5, which disclosed that petitioner was involved in

an investigation by the NASD. 

Other Proceedings

Sometime after filing the original claim, petitioner

commenced an action in the New York State Supreme Court. In that

action, he moved to enjoin Nomura from filing the original Form

U-5 with the NYSE and NASD (the injunction action). The court
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permitted Nomura to file the Form U-5 but granted an injunction

requiring that it be filed under seal. That injunction was

vacated on appeal. In the same court, petitioner commenced a

second action against certain Nomura employees. With

petitioner’s concurrence, that action was ultimately dismissed

with prejudice.

Petitioner was also involved in separate investigations of

Nomura’s and petitioner’s trading activities while at Nomura,

instituted in 1996 by both the NYSE and the NASD (the NYSE and

NASD investigations). 

The Partial Summary Judgment Motions

In April 1997, petitioner moved for partial summary judgment

in the arbitration proceeding on the issue of whether Nomura

should be required to advance to him the legal fees to be

incurred by him in connection with the arbitration proceeding,

the injunction action, and the NYSE and NASD investigations. 

Nomura opposed petitioner’s motion and, itself, moved for partial

summary judgment dismissing petitioner’s claim for advancement or

reimbursement of the legal fees. Petitioner filed a reply in

further support of his own motion and in opposition to Nomura’s

motion. 

Petitioner’s position that Nomura was required to advance to

him the legal fees was based upon Article XIII of Nomura’s by-
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laws (Article XIII), as in effect at that time. In relevant

part, Article XIII provides as follows:

ARTICLE XIII

INDEMNIFICATION

SECTION 1. Except to the extent expressly

prohibited by the New York Business Corporation Law,

the corporation shall indemnify each person made or

threatened to be made a party to any action or

proceeding, whether civil or criminal, by reason of the

fact that such person * * * is or was a director or

officer of the corporation, against judgments, fines 

* * * penalties, amounts paid in settlement and

reasonable expenses, including attorneys’ fees,

actually and necessarily incurred in connection with

such action or proceeding, or any appeal therefrom 

* * *

Section 2. The corporation shall advance or

promptly reimburse upon request any person entitled

to indemnification hereunder for all expenses,

including attorneys’ fees, reasonably incurred in

defending any action or proceeding in advance of the

final disposition thereof upon receipt of an

undertaking by or on behalf of such person * * * to

repay such amount if such person is ultimately found

not to be entitled to indemnification or, where

indemnification is granted, to the extent the

expenses so advanced or reimbursed exceed the amount

to which such person is entitled * * *

Nomura’s memorandum in opposition to petitioner’s motion and in

support of its own motion for partial summary judgment argues

that, in Article XIII, Nomura “never intended to bear the legal

fees of an employee incurred in his action against Nomura”.

Before the arbitrator could decide the partial summary

judgment motions, the parties ended the arbitration proceeding by

agreeing to settle their dispute (the settlement).
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Settlement Negotiations

The settlement was achieved at two meetings (the settlement

meetings) involving petitioner and William Maitland, Nomura’s

chief legal officer. The settlement meetings occurred around the

close of 1997. At one of the settlement meetings, petitioner

offered to settle, telling Mr. Maitland that he would not take

anything less than $2 million. He justified that sum to 

Mr. Maitland based on a bonus he thought due him, interest, legal

fees, and a charitable contribution he wished Nomura to make. To

settle the arbitration proceeding, Mr. Maitland agreed that

Nomura would pay petitioner $1.9 million and, on his behalf,

contribute $100,000 to charity (together, the settlement

payment). Petitioner agreed to end the arbitration proceeding. 

Petitioner and Mr. Maitland did not discuss how the settlement

payment would be allocated among the claims made by petitioner. 

Mr. Maitland did not intend any part of the settlement payment to

be for any particular claim that petitioner had made. Petitioner

did not provide to Mr. Maitland any bills or invoices for legal

fees at either meeting.

The Settlement Agreement

On January 14, 1998, Nomura and petitioner executed a

Settlement Agreement and General Release (the settlement

agreement) by which the parties agreed to execute a stipulation

with respect to the arbitration proceeding that “all of the
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claims and the counterclaim that have been asserted in * * *

[the] arbitration are hereby dismissed with prejudice and without

costs to either party”; Nomura agreed to pay petitioner

$1,900,000, “less appropriate withholding for income, social

security and other taxes * * * in full satisfaction for the

resolution of the Settled Claims.” Nomura also agreed to donate,

in the name of petitioner’s son, $50,000 to the Children’s Cancer

Research Fund and $50,000 to the Children’s Cancer Research

Program. In consideration of the settlement payment, petitioner

released Nomura from liability for all existing claims (including

the legal fees) and from a litany of other claims, both known and

unknown, that petitioner might assert against Nomura in the

future, including but not limited to indemnification of legal

fees not yet incurred (the so-called “Settled Claims”). The

settlement agreement does not allocate any portion of the

settlement payment to petitioner’s legal fees or, in fact, to any

of the claims asserted by petitioner in the arbitration

proceeding.

Nomura’s Tax Reporting

 Nomura issued to petitioner a 1998 Form W-2, Wage and Tax

Statement, which reported as wages subject to tax withholding the

$1.9 million cash payment made to petitioner pursuant to the

settlement agreement. 
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1 Of the $215,354 petitioners claimed as a miscellaneous

itemized deduction on the original return, $178,993.37 was paid,

in part, in connection with the arbitration proceeding and, in

part, in connection with the injunction motion, and $36,314.90

was paid in connection with the NYSE and NASD investigations. 

Petitioners’ Tax Reporting

Petitioners timely filed a Form 1040, U.S. Individual

Income Tax Return, for 1997 (the original return). On the

original return, petitioners treated the legal fees (in the

amount of $215,3541) as a miscellaneous itemized deduction. On

May 20, 1999, petitioners submitted a Form 1040X, Amended U.S.

Individual Income Tax Return (the amended return), on which

petitioners treated the legal fees as a deduction in arriving at

adjusted gross income. 

Respondent’s Adjustment

As a result of his examination of the original return,

because petitioners had deducted the legal fees as a

miscellaneous itemized deduction, respondent added back the legal

fees to petitioners’ reported taxable income in respondent’s

computation of petitioners’ alternative minimum taxable income

subject to alternative minimum tax. 
- 10 -

OPINION

I. Introduction

A. Issue

We must determine whether petitioners have any alternative

minimum tax liability on account of their payment, and deduction,

of the legal fees.

B. Petitioners’ Argument

Petitioners argue as follows: They erroneously reported

the legal fees as a miscellaneous itemized deduction from

adjusted gross income on the original return. Of the settlement

payment, $600,000 was intended by Nomura as reimbursement of

petitioner’s legal expenses. That amount was paid to him

pursuant to Nomura’s bylaws, Article XIII. Article XIII

constitutes “a reimbursement or other expense allowance

arrangement”, as that term is used in section 62(a)(2)(A)

(without distinction, a reimbursement arrangement). The legal

fees (the $215,354 expended in 1997) were, therefore, deductible

from gross income in the determination of adjusted gross income

pursuant to that section. As a so-called “above the line”

deduction, such legal fees were not subject to “add back” in the

determination of alternative minimum taxable income. See sec.

56(b). 
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2 See, e.g., Stocks v. Commissioner, 98 T.C. 1, 10 (1992): 

“If the settlement agreement lacks express language stating what

the settlement amount was paid to settle, then the most important

factor * * * [in making that determination] is ‘the intent of the

payor’ as to the purpose in making the payment.” 

C. Respondent

Respondent argues as follows: The settlement payment was

intended by Nomura as a lump-sum payment in settlement of all

claims by petitioner against Nomura. No portion may be found to

discharge any particular claim in the arbitration proceeding such

as the claim for attorney’s fees. Even if it were assumed that

part of the settlement payment was intended as reimbursement of

the legal fees, such fees were not reimbursed pursuant to an

employee expense reimbursement plan covered by section

62(a)(2)(A). Petitioners were correct on the original return,

and payment of the legal fees is a miscellaneous itemized

deduction, which, on the facts of petitioners’ return, causes an

alternative minimum tax liability.

II. Discussion

A. Necessary Findings

In order for petitioners to prevail, we must find that

Nomura both intended at least $215,354 of the settlement payment

as reimbursement of the legal fees2 and made such reimbursement

pursuant to a reimbursement arrangement. To make the second

finding, we must find both that Article XIII is a reimbursement
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arrangement and that Nomura reimbursed the legal fees pursuant

to, and in accordance with Article XIII.

We shall deal first with the question of whether Nomura

reimbursed the legal fees pursuant to, and in accordance with,

Article XIII. Since, as we shall explain, we cannot make that

finding, we need not consider in any detail the remaining

required findings, since petitioners cannot prevail. For the

sake of argument, however, we shall assume that Nomura intended

$600,000 of the settlement payment as reimbursement of the legal

fees and Article XIII, on its face, qualifies as a reimbursement

arrangement for the reimbursement of such fees.

B. Section 62(a)(2)(A) and (c)

In pertinent part, section 62(a) provides:

[T]he term “adjusted gross income” means * * * gross

income minus the following deductions:

* * * * * * * 

(2) Certain trade and business deductions of

employees.--

 (A) Reimbursed expenses of employees.--The

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. * * *

In pertinent part, section 62(c) provides:

 (c) Certain arrangements not Treated as

Reimbursement Arrangements.--For purposes of subsection

(a)(2)(A), an arrangement shall in no event be treated
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as a reimbursement or other expense allowance

arrangement if--

 (1) such arrangement does not require the

employee to substantiate the expenses covered by

the arrangement to the person providing the

reimbursement, or

 (2) such arrangement provides the employee the

right to retain any amount in excess of the

substantiated expenses covered under the

arrangement.

C. Section 1.62-2, Income Tax Regs.

1. Overview

In pertinent part, section 1.62-2(c)(1), Income Tax Regs.,

provides: “[T]he phrase * * * [reimbursement arrangement] means

an arrangement that meets the requirements of paragraphs (d)

(business connection), (e) (substantiation), and (f) (returning

amounts in excess of expenses) of this section.” In pertinent

part, section 1.62-2(c)(2)(i), Income Tax Regs., provides that,

if an arrangement meets those requirements, “all amounts paid

under * * * [it] are treated as paid under an ‘accountable plan’”

(accountable plan). In pertinent part, subdivision (ii) of that

section provides that “only the amounts paid under the

arrangement that are not in excess of the substantiated expenses

are treated as paid under an accountable plan.” Payments under

an arrangement that does not satisfy one or more of the

requirements of paragraphs (d), (e), or (f) are treated as paid

under a “nonaccountable plan” (nonaccountable plan), and, even if

the arrangement satisfies those requirements, payments “in excess
- 14 -

of the substantiated expense are treated as paid under a

nonaccountable plan.” Sec. 1.62-2(c)(3)(ii), Income Tax Regs.

Payments under an accountable plan are excluded from the

employee’s gross income, are not reported as wages or other

compensation on the employee’s Form W-2, and are exempt from

withholding and payment of employment taxes. Sec. 1.62-2(c)(4),

Income Tax Regs. Payments under a nonaccountable plan are

included in employee gross income, are reported on the employee’s

Form W-2 as wages or other compensation, and are subject to

withholding and payment of employment taxes. Sec. 1.62-2(c)(5),

Income Tax Regs. Expenses attributable to nonaccountable plan

payments are deductible by the employee, but only as

miscellaneous itemized deductions. Id.

Section 1.62-2(i), Income Tax Regs., provides that the

requirements of paragraphs (d), (e), and (f) (business

connection, substantiation, and returning excess amounts,

respectively) are to be applied “on an employee-by-employee

basis.” Thus, violation of one of those requirements by one

employee “will not cause amounts to be paid to other employees to

be treated as paid under a nonaccountable plan.” In other words,

even if Nomura’s assumed reimbursement of the legal fees violates

one of the foregoing requirements of the regulations and is,

therefore, treated as made under a nonaccountable plan, Article
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3 For purposes of discussion, we accept as satisfied a

second requirement of sec. 1.62-2(d)(1), Income Tax Regs., that

the business expense reimbursement be “identified” where, as in

this case, “both wages and the reimbursement * * * are combined

in a single payment”.

XIII may still qualify as an accountable plan with respect to

Nomura employees other than petitioner.

2. Application to Petitioner’s Legal Fees

a. Business Connection

A reimbursement arrangement satisfies the business

connection requirement if it is limited to reimbursement for

deductible business expenses “that are paid or incurred by the

employee in connection with the performance of services as an

employee of the employer.” See sec. 1.62-2(d)(1), Income Tax

Regs. In this case, the reimbursed legal fees relate to actions

and proceedings that arose out of petitioner’s prior employment

with Nomura and, specifically, to Nomura’s termination of that

employment. As such, they satisfy the business connection

requirement. See Alexander v. Commissioner, 72 F.3d 938, 945

(1st Cir. 1995), affg. T.C. Memo. 1995-51; McKay v. Commissioner,

102 T.C. 465, 489 (1994), vacated and remanded on another issue

without published opinion 84 F.3d 433 (5th Cir. 1996).3

b. Substantiation

(1) Introduction

Under section 1.62-2(e)(1), Income Tax Regs., an arrangement

that reimburses business expenses meets the substantiation
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requirement “if it requires each business expense to be

substantiated to the payor in accordance with paragraph (e)(2)

[relating to expenses governed by section 274(d)] or (e)(3)

[relating to expenses not governed by section 274(d)]”. In

pertinent part, section 1.62-2(e)(3), Income Tax Regs.

(applicable to this case), provides:

An arrangement that reimburses business expenses * * *

meets the requirements of this paragraph (e)(3) if

information is submitted to the payor sufficient to

enable the payor to identify the specific nature of

each expense and to conclude that the expense is

attributable to the payor’s business activities. 

Therefore, each of the elements of an expenditure * * *

must be substantiated to the payor. It is not

sufficient if an employee merely aggregates expenses

into broad categories (such as “travel”) or reports

individual expenses through the use of vague,

nondescriptive terms (such as “miscellaneous business

expenses”). See § 1.162-17(b).

While section 1.62-2(e)(1), Income Tax Regs., appears to set

forth a precondition, i.e., that an arrangement specifically

require substantiation, section 1.62-2(e)(3), Income Tax Regs.,

seems to require action, i.e., that certain information actually

be submitted to the payor in accordance with the aforementioned

requirement. We assume that, to satisfy the substantiation

requirement, the arrangement must require that the information

called for by subparagraph (3) be submitted and that, for an

amount to be paid pursuant to a reimbursement arrangement, such

information must actually be submitted in accordance with such

requirement. See sec. 1.162-17(b), Income Tax Regs. (employee
- 17 -

need not report on his tax return certain expenses “for which he

is required to account and does account to his employer”). The

latter condition (reporting) is not met here.

(2) Discussion

Article XIII requires the return of any reimbursements or

advances to the extent such payments exceed the amount to which

the person paid is entitled. We assume that some accounting is

required to implement that provision (which we assume would

satisfy the specification requirement of section 1.62-2(e)(3),

Income Tax Regs.). Nevertheless, we believe that the facts

establish that no accounting was made here, so that the actual

substantiation requirement of section 1.62-2(e)(3), Income Tax

Regs., is not met. At best, the facts establish only that

petitioner told Mr. Maitland that he would settle for $2 million

based, in part, on his legal fees. That is not substantiation at

all.

During his testimony, petitioner stated several times that,

in negotiating with Nomura, he justified his claim for $2 million

on the basis, in part, of his legal fees, which he estimated to

be in excess of $600,000. He testified that, at the second

settlement meeting, he told Mr. Maitland: “I expended a little

over $600,000 at that point [in legal fees], and that’s how I was

getting my number.” He also testified that neither he nor his

attorneys ever documented, to Nomura, legal fees in that amount. 
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Although he testified that, at the first settlement meeting, his

attorneys possessed “a document * * * that had all the expenses,

the fees and what have you”, he admitted that the document was

not submitted to Nomura. Nor did petitioner provide to 

Mr. Maitland any confirmation of the legal fees during the second

settlement meeting. He did not dispute a statement by counsel

for respondent that “I think we’ve established you didn’t present

to him [Mr. Maitland] any bills or invoices at any time”. 

Petitioner did testify: “[W]e gave them a list of our

expenses at * * * [a] point in time * * * midway through * * *

[the arbitration proceeding] give or take.” However, Nomura’s

memorandum in opposition to petitioner’s motion for partial

summary judgment states that petitioner “has not given Nomura a

single time sheet or lawyer’s bill by which Nomura could evaluate

the nature and amount of the fees”; petitioner’s response to that

statement in his reply memorandum is, in effect, an admission of

such nondisclosure, which he justifies on the basis of “privilege

and confidentiality concerns”. Those memoranda, submitted during

the arbitration proceeding, cast doubt on the accuracy of

petitioner’s trial testimony. At the very least, they indicate

that the “list” referred to contained no more than “broad

categories” of expenses, not an itemization of specific bills or

invoices, which would qualify as substantiation under section

1.62-2(e)(3), Income Tax Regs. Moreover, the “list”, which was
- 19 -

prepared sometime in 1997, could not have contained more than a

fraction of the $600,000 estimated total legal fees as the final

amount was not known until all of the various legal proceedings

had been completed in late 1998. 

Mr. Maitland testified, and we have found, that (1) he and

petitioner did not discuss how the settlement payment would be

allocated among the claims made by petitioner, and (2) he did not

intend any part of the settlement payment to be for any

particular claim that petitioner had made.

Pursuant to the settlement agreement, Nomura made the

settlement payment and petitioner released Nomura from liability

for all existing claims, including any claim for present or

future legal expenses. To enter into the settlement agreement,

Mr. Maitland and, by him, Nomura did not require of petitioner

any accounting from him of his legal expenses. Nomura did not

attempt to enforce any substantiation requirement that may have

been implicit in Article XIII. More importantly, petitioner did

not substantiate his legal expenses to Nomura in any sense other

than, perhaps, telling Mr. Maitland that his claim was based in

part on legal expenses of $600,000. Even if that did occur, it

is not an accounting sufficient to satisfy section 1.62-2(e)(3),

Income Tax Regs.
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(3) Conclusion

With respect to the legal fees, petitioner did not meet the

substantiation requirement of section 1.62-(2)(e)(3), Income Tax

Regs.

c. Returning Amounts in Excess of Expenses

Because we find that petitioner failed to satisfy the

substantiation requirements of the regulations, it is unnecessary

to decide whether the conditions of section 1.162-2(f), Income

Tax Regs., were met. We note, however, that there is obviously a

technical violation of that paragraph arising from our finding

that petitioner failed to provide adequate substantiation of the

legal fees. Under such circumstances, he necessarily failed “to

return to the payor [Nomura] * * * [amounts] paid under the

arrangement in excess of the expenses substantiated” as required

by section 1.62-2(f)(1), Income Tax Regs.

d. Nonaccountable Plan

Amounts paid by Nomura to petitioner in excess of

substantiated expenses, which we find to be the entire $600,000

assumed reimbursement of the legal fees, are treated as paid

under a nonaccountable plan. Sec. 1.62-2(c)(2)(ii) and (3)(ii),

Income Tax Regs. Therefore, the entire $600,000 was properly

treated by Nomura as wages or other compensation on petitioner’s

1998 Form W-2, and by petitioners (to the extent of the $215,354
- 21 -

attributable to 1997) as a miscellaneous itemized deduction on

their 1997 return as filed. Sec. 1.62-2(c)(5), Income Tax Regs.

III. Conclusion

We hold that petitioners’ deduction of $215,354 for legal

fees for 1997 was properly reported as a miscellaneous itemized

deduction on Schedule A of the original return, as filed, and

that respondent properly added that amount to reported taxable

income in his computation of petitioners’ 1997 alternative

minimum tax. We, therefore, sustain respondent’s deficiency

determination.

Decision will be entered

under Rule 155.