Source: https://supreme.justia.com/cases/federal/us/372/39/
Timestamp: 2019-04-24 00:03:49+00:00

Document:
Respondent sued for refund of part of the income taxes paid by him for the years 1953 and 1954, on the ground that legal expenses incurred by him in defending divorce litigation with his former wife were deductible under § 23(a)(2) of the Internal Revenue Code of 1939, as amended, which allots as deductions from gross income "ordinary and necessary expenses . . . incurred . . . for the conservation . . . of property held for the production of income." His gross income was derived almost entirely from his salary as president of three corporations which were franchised automobile dealers and from dividends from his controlling stock in such corporations. His wife had sued for divorce, alimony, and an alleged community property interest in such stock, and he alleged that, had he not succeeded in defeating these claims, he might have lost his stock, his corporate positions, and the dealer franchises, from which nearly all of his income was derived.
Held: none of respondent's expenditures in resisting these claims is deductible under § 23(a)(2). Pp. 372 U. S. 40-52.
(a) 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 or not it is deductible under § 23(a)(2). Pp. 372 U. S. 44-51.
(b) The wife's claims stemmed entirely from the marital relationship, and not, under any tenable view of things, from income-producing activity. Therefore, none of respondent's expenditures in resisting these claims can be deemed "business" expenses deductible under § 23(a)(2). Pp. 372 U. S. 51-52.
___ Ct. Cl. ___, 290 F. 2d 942, reversed and case remanded.
". . . ordinary and necessary expenses . . . incurred during the taxable year [Footnote 3] . . . for the . . . conservation . . . of property held for the production of income."
proper application of this provision, [Footnote 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. The case was first argued at the last Term and set for reargument at this one. 369 U.S. 835.
The end result of this bitterly fought divorce case was a complete victory for the husband. He, not the wife, was granted a divorce on his cross-claim; the wife's community property claims were denied in their entirety; and she was held entitled to no alimony. 45 Cal.2d 142, 287 P.2d 769.
"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. [Footnote 10]"
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.
"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. [Footnote 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 upkeep, rather than to a taxpayer's retention of ownership in it. [Footnote 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, 323 U. S. 62, 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). [Footnote 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, 325 U. S. 373-374 .
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?
property he might have. For example, it suggests that the expense of defending an action based upon personal injuries caused by a taxpayer's negligence while driving an automobile for pleasure should be deductible. Section 23(a)(2) never has been so interpreted by us. . . ."
"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 343 U. S. 125-126.
"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. . . ."
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, 308 U. S. 494, 308 U. S. 496.
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," [Footnote 15] and would not be compatible with the basic lines of expense deductibility drawn by Congress. [Footnote 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), [Footnote 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 . . . incurred . . . 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.
"[t]he controversy did not go to the question of . . . [his] liability [for alimony] [Footnote 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.
capacity to earn a living. [Footnote 20] Such may be the situation where loss of control of a particular corporation is threatened, in contrast to instances where the impact of a wife's support claims is only upon diversified holdings of income-producing securities. [Footnote 21] But that rationale too is unsatisfactory. For diversified security holdings are no less "property held for the production of income" than a large block of stock in a single company. And, as was pointed out in Lykes, supra, at 343 U. S. 126, if the relative impact of a claim on the income-producing resources of a taxpayer were to determine deductibility, substantial "uncertainty and inequity would inhere in the rule."
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. [Footnote 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).
In view of this conclusion, it is unnecessary to consider the further question suggested by the Government: whether that portion of respondent's payments attributable to litigating the issue of the existence of community property was a capital expenditure or a personal expense. In neither event would these payments be deductible from gross income.
The judgment of the Court of Claims is reversed, and the case is remanded to that court for further proceedings consistent with this opinion.
MR. JUSTICE BLACK and MR. JUSTICE DOUGLAS believe that the Court reverses this case because of an unjustifiably narrow interpretation of the 1942 amendment to § 23 of the Internal Revenue Code, and would accordingly affirm the judgment of the Court of Claims.
Despite the divorce, Dixie Gilmore is referred to throughout this opinion as the "wife."
Although the second Mrs. Gilmore, having been a party to one of the tax returns involved in this case, is also a respondent here, Mr. Gilmore will be referred to herein as the sole respondent.
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.).
He owned 100% of the outstanding stock of Don Gilmore-San Francisco, 73 1/3% of the outstanding stock of Don Gilmore-Hayward, and 60% of the outstanding stock of Don Gilmore-Riverside.
$1,024.90 in 1953, and $516.60 in 1954.
See Pereira v. Pereira, 156 Cal. 1, 103 P. 488; 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.
Section 24(a)(1) provides: "In computing net income no deduction shall in any case be allowed in respect of -- (1) Personal, living, or family expenses. . . ."
Several other issues involving deficiency assessments for the years 1953, 1954, and 1955 were decided by the Court of Claims, but they are not before this Court.
Surrey and Warren, Cases on Federal Income Taxation, 272 (1960).
See 4 Mertens, Law of Federal Income Taxation (rev. ed. 1960), § 25A.09 at 19-20.
See H.R.Rep. No. 2333, 77th Cong., 2d Sess. 46.
"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.
"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 nondeductible, like extraordinary medical expenses, and does not cast any doubt on the basic tax structure set up by Congress.
We find no indication that Congress intended § 23(a)(2) to include such expenses.
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, post, p. 372 U. S. 53; 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.
"Generally, attorney's fees and other costs paid in connection with a divorce, separation, or decree for support are not deductible by either the husband or the wife."
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, 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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