Source: https://openjurist.org/372/us/39
Timestamp: 2019-04-19 02:23:05+00:00

Document:
Reargued Dec. 5, 6, 1962.
Wayne G. Barnett, Washington, D.C., for petitioner.
Eli Freed, San Francisco, Cal., for respondents.
Because of a conflict of views among the Court of Claims, the Courts of Appeals, and the Tax Court regarding the proper application of this provision,4 and the continuing importance of the question in the administration of the federal income tax laws, we granted certiorari on the Government's petition. 368 U.S. 816, 82 S.Ct. 57, 7 L.Ed.2d 22. The case was first argued at the last Term and set for reargument at this one. 369 U.S. 835, 82 S.Ct. 864, 7 L.Ed.2d 841.
'Of course it is true that in every divorce case a certain amount of the legal expenses are incurred for the purpose of obtaining the divorce and a certain amount are incurred in an effort to conserve the estate and are not necessarily deductible under section 23(a)(2), but when the facts of a particular case clearly indicate (as here) that the property, around which the controversy evolves, is held for the production of income and without this property the litigant might be denied not only the property itself but the means of earning a livelihood, then it must come under the provisions of section 23(a)(2) * * *. The only question then is the allocation of the expenses to this phase of the proceedings.'10 290 F.2d, at 947.
The Government does not question the amount or formula for the expense allocation made by the Court of Claims. Its sole contention here is that the court below misconceived the test governing § 23(a)(2) deductions, in that the deductibility of these expenses turns, so it is argued, not upon the consequences to respondent of a failure to defeat his wife's community property claims but upon the origin and nature of the claims themselves. So viewing Dixie Gilmore's claims, whether relating to the existence or division of community property, it is contended that the expense of resisting them must be deemed nondeductible 'personal' or 'family' expense under § 24(a)(1), not deductible expense under § 23(a)(2). For reasons given hereafter we think the Government's position is sound and that it must be sustained.
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.
Initially, it may be observed that the wording of § 23(a)(2) more readily fits the Government's view of the provision than that of the Court of Claims. For in context 'conservation of property' seems to refer to operations performed with respect to the property itself, such as safeguarding or unkeep, rather than to a taxpayer's retention of ownership in it.12 But more illuminating than the mere language of § 23(a)(2) is the history of the provision.
As noted in McDonald v. Commissioner, 323 U.S. 57, 62, 65 S.Ct. 96, 98, 89 L.Ed. 68, the purpose of the 1942 amendment was merely to enlarge 'the category of incomes with reference to which expenses were deductible.' And committee reports make clear that deductions under the new section were subject to the same limitations and restrictions that are applicable to those allowable under § 23(a)(1).14 Further, this Court has said that § 23(a)(2) 'is comparable and in pari materia with § 23(a)(1),' providing for a class of deductions 'coextensive with the business deductions allowed by § 23(a)(1), except for' the requirement that the income-producing activity qualify as a trade or business. Trust of Bingham v. Commissioner, 325 U.S. 365, 373, 374, 65 S.Ct. 1232, 1237, 89 L.Ed. 1670.
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 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?
'While the threatened deficiency assessment * * * added urgency to petitioner's resistance of it, neither its size nor its urgency determined its character. It related to the tax payable on petitioner's gifts * * *. The expense of contesting the amount of the deficiency was thus at all times attributable to the gifts, as such, and accordingly was not deductible.
'If, as suggested, the relative size of each claim, in proportion to the income-producing resources of a defendant, were to be a touchstone of the deductibility of the expense of resisting the claim, substantial uncertainty and inequity would inhere in the rule. * * * It is not a ground for (deduction) that the claim, if justified, will consume income-producing property of the defendant.' 343 U.S., at 125 126, 72 S.Ct., at 589, 590, 96 L.Ed. 791.
In Kornhauser v. United States, 276 U.S. 145, 48 S.Ct. 219, 72 L.Ed. 505, this Court considered the deductibility of legal expenses incurred by a taxpayer in defending against a claim by a former business partner that fees paid to the taxpayer were for services rendered during the existence of the partnership. In holding that these expenses were deductible even though the taxpayer was no longer a partner at the time of suit, the Court formulated the rule that 'where a suit or action against a taxpayer is directly connected with, or * * * proximately resulted from, his business, the expense incurred is a business expense * * *.' 276 U.S., at 153, 48 S.Ct., at 220, 72 L.Ed. 505. Similarly, in a case involving an expense incurred in satisfying an obligation (though not a litigation expense), it was said that 'it is the origin of the liability out of which the expense accrues' or 'the kind of transaction out of which the obligation arose * * * which (is) crucial and controlling.' Deputy v. du Pont, 308 U.S. 488, 494, 496, 60 S.Ct. 363, 366, 367, 368, 84 L.Ed. 416.
The principle we derive from these cases is that the characterization, as 'business' or 'personal,' of the litigation costs of resisting a claim depends on whether or not the claim arises in connection with the taxpayer's profit-seeking activities. It does not depend on the consequences that might result to a taxpayer's income-producing property from a failure to defeat the claim, for, as Lykes teaches, that 'would carry us too far'15 and would not be compatible with the basic lines of expense deductibility drawn by Congress.16 Moreover, such a rule would lead to capricious results. If two taxpayers are each sued for an automobile accident while driving for pleasure, deductibility of their litigation costs would turn on the mere circumstance of the character of the assets each happened to possess, that is, whether the judgments against them stood to be satisfied out of income- or nonincome-producing property. We should be slow to attribute to Congress a purpose producing such unequal treatment among taxpayers, resting on no rational foundation.
Confirmation of these conclusions is found in the incongruities that would follow from acceptance of the Court of Claims' reasoning in this case. Had this respondent taxpayer conducted his automobile-dealer business as a sole proprietorship, rather than in corporate form, and claimed a deduction under § 23(a)(1),17 the potential impact of his wife's claims would have been no different than in the present situation. Yet it cannot well be supposed that § 23(a)(1) would have afforded him a deduction, since his expenditures, made in connection with a marital litigation, could hardly be deemed 'expenses * * ncurred * * * in carrying on any trade or business.' Thus, under the Court of Claims' view expenses may be even less deductible if the taxpayer is carrying on a trade or business instead of some other income-producing activity. But it was manifestly Congress' purpose with respect to deductibility to place all income-producing activities on an equal footing. And it would surely be a surprising result were it now to turn out that a change designed to achieve equality of treatment in fact had served only to reverse the inequality of treatment.
For these reasons, we resolve the conflict among the lower courts on the question before us (note 4, supra) 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). We find the reasoning underlying the cases taking the 'consequences' view unpersuasive.
Baer v. Commissioner, 8 Cir., 196 F.2d 646, upon which the Court of Claims relied in the present case, is the leading authority on that side of the question.18 There the Court of Appeals for the Eighth Circuit allowed a § 23(a)(2) expense deduction to a taxpayer husband with respect to attorney's fees paid in a divorce proceeding in connection with an alimony settlement which had the effect of preserving intact for the husband his controlling stock interest in a corporation, his principal source of livelihood. The court reasoned that since the evidence showed that the taxpayer was relatively unconcerned about the divorce itself '(t)he controversy did not go to the question of * * * (his) liability (for alimony)19 but to the manner in which (that liability) might be met * * * without greatly disturbing his financial structure'; therefore the legal services were 'for the purpose of conserving and maintaining' his income-producing property. 196 F.2d, at 649—650, 651.
In classifying respondent's legal expenses the court below did not distinguish between those relating to the claims of the wife with respect to the existence of community property and those involving the division of any such property. Supra, p. 41-42. Nor is such a break-down necessary for a disposition of the present case. It is enough to say that in both aspects the wife's claims stemmed entirely from the marital relationship, and not, under any tenable view of things, from income-producing activity. This is obviously so as regards the claim to more than an equal division of any community property found to exist. For any such right depended entirely on the wife's making good her charges of marital infidelity on the part of the husband. The same conclusion is no less true respecting the claim relating to the existence of community property. For no such property could have existed but for the marriage relationship.22 Thus none of respondent's expenditures in resisting these claims can be deemed 'business' expenses, and they are therefore not deductible under § 23(a)(2).
The judgment of the Court of Claims is reversed and the case is remanded to that court for further proceedings consistent with this opinion. It is so ordered.
Judgment of Court of Claims reversed and case remanded.
The taxable years in question are 1953 and 1954. The year 1954 is governed by the 1954 Code. Since the relevant provisions, §§ 212 and 262, are substantially identical with those of the 1939 Code, for the sake of clarity we shall refer only to the 1939 Code.
Compare Lewis v. Commissioner, 253 F.2d 821 (C.A.2d Cir.), and Douglas v. Commissioner, 33 T.C. 349, with Gilmore v. United States, 290 F.2d 942 (Ct.Cl.)—the present case—and Baer v. Commissioner, 196 F.2d 646 (C.A.8th Cir.).
See Pereira v. Pereira, 156 Cal. 1, 103 P. 488, 23 L.R.A.,N.S., 880; Lenninger v. Lenninger, 167 Cal. 297, 139 P. 679; Huber v. Huber, 27 Cal.2d 784, 167 P.2d 708.
Under California law a party granted a divorce on grounds of extreme cruelty or adultery may, in the court's discretion, be awarded up to all of the community property of the marriage. Cal.Civ.Code, § 146. See Barham v. Barham, 33 Cal.2d 416, 202 P.2d 289; Wilson v. Wilson, 159 Cal.App.2d 330, 323 P.2d 1017. Such grounds for divorce were alleged by each of these spouses against the other.
See 4 Mertens, Law of Federal Income Taxation (rev. ed. 1960), § 25A.09, at 19—20.
H.R.Rep. No. 2333, 77th Cong., 2d Sess. 75: 'A deduction under this section is subject, except for the requirement of being incurred in connection with a trade or business, to all the restrictions and limitations that apply in the case of the deduction under section 23(a)(1)(A) of an expense paid or incurred in carrying on any trade or business.' See also S.Rep. No. 1631, 77th Cong., 2d Sess. 88.
The Treasury Regulations have long provided: 'An expense (not otherwise deductible) paid or incurred by an individual in determining or contesting a liability asserted against him does not become deductible by reason of the fact that property held by him for the production of income may be required to be used or sold for the purpose of satisfying such liability.' Treas.Reg. (1954 Code) § 1.212—1(m); see Treas.Reg. 118 (1939 Code) § 39.23(a)—15(k).
Expenses of contesting tax liabilities are now deductible under § 212(3) of the 1954 Code. This provision merely represents a policy judgment as to a particular class of expenditures otherwise non-deductible, like extraordinary medical expenses, and does not cast any doubt on the basic tax structure set up by Congress.
Besides the present case see to the same effect, e.g., Patrick v. United States, 288 F.2d 292 (C.A.4th Cir.), No. 22, reversed today, 372 U.S. 53, 83 S.Ct. 618; Owens v. Commissioner, 273 F.2d 251 (C.A.5th Cir.); Bowers v. Commissioner, 243 F.2d 904 (C.A.6th Cir.); McMurtry v. United States, 132 F.Supp. 114, 132 Ct.Cl. 418.
See, e.g., the present case, 290 F.2d, at 947; Tressler v. Commissioner, 228 F.2d 356, 361 (C.A.9th Cir.); Howard v. Commissioner, 202 F.2d 28, 30 (C.A.9th Cir.).
Compare, with the present case, Davis v. United States, 287 F.2d 168, 152 Ct.Cl. 805, reversed in part on other grounds, 370 U.S. 65, 82 S.Ct. 1190, 8 L.Ed.2d 335, in which the Court of Claims held to be nondeductible the legal expenses of resisting the wife's threat to stock not essential to protect the husband's employment.
The respondent's attempted analogy of a marital 'partnership' to the business partnership involved in the Kornhauser case, supra, is of course unavailing. The marriage relationship can hardly be deemed an income-producing activity.

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