Source: https://law.justia.com/cases/federal/appellate-courts/F3/94/523/602079/
Timestamp: 2019-08-22 14:16:10
Document Index: 248815277

Matched Legal Cases: ['§ 61', '§ 1', '§ 212', '§ 263', '§ 6653', '§ 6661']

John B. Leonard; Betty B. Leonard, Petitioners-appellants, v. Commissioner Internal Revenue Service, Respondent-appellee.james v. Crews; Dorothea G. Crews, Petitioners-appellants, v. Commissioner Internal Revenue Service, Respondent-appellee, 94 F.3d 523 (9th Cir. 1996) :: Justia
Justia › US Law › Case Law › Federal Courts › Courts of Appeals › Ninth Circuit › 1996 › John B. Leonard; Betty B. Leonard, Petitioners-appellants, v. Commissioner Internal Revenue Service,...
John B. Leonard; Betty B. Leonard, Petitioners-appellants, v. Commissioner Internal Revenue Service, Respondent-appellee.james v. Crews; Dorothea G. Crews, Petitioners-appellants, v. Commissioner Internal Revenue Service, Respondent-appellee, 94 F.3d 523 (9th Cir. 1996)
US Court of Appeals for the Ninth Circuit - 94 F.3d 523 (9th Cir. 1996)
Submitted May 7, 1996. *Decided July 31, 1996. As Amended Sept. 5, 1996
* We review de novo the tax court's determination that the prejudgment interest portion of the taxpayers' award is ordinary income. Kelley v. Commissioner, 45 F.3d 348, 350 (9th Cir. 1995).
Section 61(a) (4) of the Internal Revenue Code provides that gross income means all income from whatever source derived, including interest. 26 U.S.C. § 61(a) (4). Department of the Treasury regulations provide that interest income includes "the interest portion of a condemnation award." 26 C.F.R. § 1.61-7(a).
The taxpayers argue that the prejudgment interest portion of an inverse condemnation award is not income because it is paid to meet the constitutional mandate of just compensation under the Fifth Amendment. This argument was considered and rejected by the Supreme Court in Kieselbach v. Commissioner, 317 U.S. 399, 63 S. Ct. 303, 87 L. Ed. 358 (1943), where the Court held that the prejudgment interest portion of an eminent domain award is ordinary income.
It is undisputed that the taxpayers are not entitled to deduct the entirety of their attorney fees incurred and paid to obtain the award. Although taxpayers generally can deduct expenses to produce income, 26 U.S.C. § 212, they cannot deduct "capital expenditures." 26 U.S.C. § 263.
The court determines when to treat attorney fees as deductible by looking at the origin of the claim. United States v. Gilmore, 372 U.S. 39, 47-48, 83 S. Ct. 623, 628-29, 9 L. Ed. 2d 570 (1963). Attorney fees paid to establish the sales price of property are capital expenditures and therefore not deductible. United States v. Hilton Hotels Corp., 397 U.S. 580, 584, 90 S. Ct. 1307, 1309, 25 L. Ed. 2d 585 (1970). Attorney fees paid to obtain interest, which is ordinary income, are deductible. Kovacs v. Commissioner, 100 T.C. 124, 133, 1993 WL 46512 (1993), aff'd by unpublished disposition, 25 F.3d 1048 (6th Cir.), cert. denied, --- U.S. ----, 115 S. Ct. 424, 130 L. Ed. 2d 338 (1994).
We conclude the taxpayers are entitled to deduct what they actually paid their lawyers, according to the contingent fee contract, to obtain their share of the prejudgment interest portion of the award. Thus, they are entitled to deduct twenty-five percent of their proportionate share of the prejudgment interest portion of the award, plus their proportionate share of $17,750 (142 X $125).
The Commissioner imposed, and the tax court upheld the imposition of, penalties against the Crewses for negligent underpayment of tax pursuant to 26 U.S.C. § 6653(a) (1) (as in effect for fiscal year 1987), and substantial understatement of tax pursuant to 26 U.S.C. § 6661(a) (as in effect for fiscal year 1987).
We conclude that a reasonable taxpayer deciding how to treat an award of prejudgment interest such as the award in this case would not rely simply on the word of neighbors. See Sammons v. Commissioner, 838 F.2d 330, 337 (9th Cir. 1988) (taxpayer is negligent in underpaying taxes when he fails to do what a reasonable and ordinary prudent taxpayer would do under the circumstances). The Crewses used a tax preparer to assist them in the preparation of their tax return. Their failure to inform him of the interest award is difficult to understand. They committed to him the responsibility of preparing their tax return, but instead of seeking his advice on the tax implications of the interest award, they relied on the tax advice of neighbors, none of whom according to the record had any tax expertise. We agree with the tax court that this is not what an ordinary prudent taxpayer would have done under the circumstances.