The opinion of the court was delivered by: HERLANDS
Plaintiff moves for summary judgment, Rule 56 of the Federal Rules of Civil Procedure, 28 U.S.C.A.; defendants cross-move for summary judgment. The facts are stipulated. The only issue is purely one of law.
The action is by plaintiff-taxpayer for a refund of portions of the income taxes paid for the calendar years 1940 and 1941. The subject-matter of the action consists of certain legal expenses, totalling $ 18,125, incurred and paid by plaintiff in 1940 and 1941. The Bureau of Internal Revenue disallowed these expenditures as deductible on the ground that they were capital expenses and, therefore, not deductible under the controlling statute Internal Revenue Code of 1939, § 23(a)(2), 26 U.S.C.A. § 23(a)(2).
A consideration of the history and nature of the litigation, in connection with which plaintiff paid the legal expenses, is necessary in order to determine the true character of those expenses and hence their deductibility.
On January 24, 1928, Berthold Hochschild died. Part of his estate included 6,698 shares of the common capital stock of Climax Molybdenum Company (hereinafter called 'Climax'). In that same year, his daughter, Gertrude, plaintiff herein, received 2,232 2/3 Climax shares under her father's will. This represented one-third of her father's Climax stockholdings. Gertrude and her two brothers, Harold and Walter, each received one-third of their father's Climax stock.
About ten years later, on December 31, 1938, one Alfred Turner instituted a stockholders' derivative action on behalf of The American Metal Company (hereinafter called 'American'). Plaintiff's father had been an officer and director of American. He and other persons connected with American had entered into certain stock arrangements with Climax whereby they eventually obtained Climax stock. Turner claimed, inter alia, that such Climax stock had been obtained personally by plaintiff's father and other American personnel in breach of their fiduciary duty to American whereby American was unlawfully deprived of the corporate opportunity to acquire such Climax stock.
Shortly after the Turner action was begun, another stockholder (Gutwillig) commenced a similar action. The two stockholders' actions were consolidated in 1939; and the consolidated actions are referred to in this opinion as the 'Turner action.'
At the time that the Turner action was instituted, the Estate of Berthold Hochschild had been entirely distributed.
In the Turner action, forty-two persons were named as defendants. Among the defendants was Gertrude, plaintiff herein. She was named as a defendant solely in her capacity as a co-executor of the last will and testament of her father. She had never held office in or been employed by either Climax or American. Gertrude's two brothers were also named as defendants. Harold was named as a defendant both individually and as a co-executor. Walter was named solely in his capacity as a co-executor. The three executors of the Hochschild Estate appeared in the action on January 14, 1939.
The relief sought in the Turner action was (1) to impose a constructive trust on the Climax stock hold by defendants; (2) to obtain an accounting by defendants for damages and for benefits received by defendants, or, in the case of defendants joined in a representative capacity, by their decedent; and (3) to obtain an accounting of the value of any Climax shares which defendants had held but were unable to transfer to American because of sale or other disposition of such shares.
In defending the litigation, the legal expenses were shared among certain of the defendants, including Berthold Hochschild's estate. Such expenses were shared in proportion to the amount of Climax stock that had been issued to such defendants (including Berthold Hochschild) on April 1, 1918. The total expenses allocated to Berthold Hochschild's estate were thus determined. Since the Hochschild Estate had been fully distributed prior to the commencement of the Turner case, and since each of the three Hochschild children had received one-third of their father's Climax stock, Gertrude's share of the legal expenses was one-third of the total legal expenses allocated to the Hochschild Estate. This amounted to $ 5,625 in 1940 and $ 12,500 in 1941, paid out of Gertrude's personal funds.
After a trial in the Supreme Court of the State of New York, County of New York, Turner v. American Metal Co., 36 N.Y.S.2d 356, and an appeal to the Appellate Division of that court, 268 App.Div. 239, 50 N.Y.S.2d 800, the complaint in the Turner case was dismissed on the merits. All defendants were exonerated from liability. The Turner litigation terminated in 1945.
The parties agree that one fundamental question is presented for the Court's determination:
May the legal expenses incurred by plaintiff be deducted as 'ordinary and necessary expenses paid or incurred during the taxable year for the production or collection of income, or for the management, conservation, or maintenance of property held for the production of income', under § 23(a)(2) of the Internal Revenue Code of 1939?
Plaintiff claims that the legal expenses incurred and paid by her were ordinary and necessary expenses incurred in connection with the management, conservation, or maintenance of income-producing property and were, therefore, deductible. Defendants claim that the expenses were a capital cost, because they were incurred in 'defending or perfecting title to ...