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Burch v. United States

decided: January 18, 1983.

ORLO G. BURCH AND MARJORIE C. BURCH, PLAINTIFFS-APPELLANTS,
v.
UNITED STATES OF AMERICA, DEFENDANT-APPELLEE



Appeal by plaintiffs Orlo G. Burch and Marjorie C. Burch from a judgment of the Northern District of New York, Howard G. Munson, Chief Judge, entered in favor of the United States on plaintiffs' claim that certain attorney's fees were deductible under § 212 of the Internal Revenue Code as expenses that were personal and for the management, conservation or maintenance of income-producing property rather than for defense of title to the property. Reversed in part and remanded.

Lumbard, Mansfield and Kearse, Circuit Judges.

Author: Mansfield

MANSFIELD, Circuit Judge:

Orlo G. Burch and Marjorie C. Burch*fn1 appeal from a judgment of the Northern District of New York, Howard G. Munson, Chief Judge, denying plaintiffs' claim that certain attorney's fees paid by plaintiffs were deductible under § 212 of the Internal Revenue Code.*fn2 Because we believe that a substantial portion of the attorney's fees were deductible under § 212, we reverse in part and remand for further proceedings.

A. Monroe Burch, father of plaintiff Orlo Burch, died in 1954. His will placed certain stocks in trust, the income to be paid to his wife (Orlo's mother) for life and upon her death the corpus to be distributed to Orlo. Within a few years of his father's death, plaintiff fell deeply into debt. He consulted an attorney, Chester J. Winslow, about ways to protect his remainder interest in the stocks from his creditors. In January 1957 Burch signed a trust instrument drafted by Winslow, under which Burch conveyed "all [his] right, title, and interest" in the stocks to Winslow as trustee. The stated purposes of the trust were to pay off Burch's debts and to provide support for Burch and his family. Shortly after signing this trust instrument, Burch objected to the absence of an express provision permitting him to revoke it. Winslow responded by drafting a second trust agreement, signed by Burch in February 1957, which was identical to the earlier agreement except that the trust was expressly made revocable upon payment of Burch's creditors and the establishment of trusts for his children. In May 1957 Burch signed an agreement which provided that Winslow was to be paid 25% of the value of the trust assets as compensation for his services as trustee under the foregoing trusts. With these agreements in place, Winslow apparently forestalled Burch's creditors by assuring them that they would be paid once Burch received his inheritance.

In 1969 Burch's mother died. By that time the stocks bequeathed to plaintiff by his father and now in the Winslow trust were worth nearly $3 million, and under the terms of the May 1957 agreement Winslow's prospective fee would be approximately $750,000. Shortly after the death of Burch's mother, Winslow submitted both the January 1957 and the February 1957 trust agreements to the New York State Surrogate's Court, seeking to have the trust assets delivered to himself and to collect his fee. Burch then retained other counsel and brought suit in the Supreme Court of New York to invalidate both trust agreements, to remove Winslow as trustee (should either agreement be found to be valid), and to have the court determine Winslow's fees. The case was settled a few months later. Under the settlement agreement, Winslow resigned as trustee and accepted $185,000 in legal fees for his services as trustee. The other creditors were paid, trusts were established for the education of Burch's children, and the remaining trust assets were paid to Burch.

In Burch's lawsuit against Winslow, he incurred legal fees of $79,983.10. Burch deducted these legal fees in three approximately equal parts from gross income as reported in his income tax returns for 1971, 1972, and 1973, claiming that they were deductible under § 212(2) of the Internal Revenue Code as expenses for the management or conservation of property held for the production of income. When the IRS objected to these deductions, Burch paid the deficiencies alleged by the IRS and filed suit for a refund in the United States District Court for the Northern District of New York. Before that court the IRS made two arguments for non-deductibility: first, that the attorney's fees were personal expenses, and second, that they were capital expenses. The district court held the attorney's fees non-deductible on the former theory, and did not reach the government's contention that they were capital expenditures.

Discussion

Section 212(2) of the Internal Revenue Code, note 2, supra, permits the deduction of ordinary and necessary expenses incurred for the "management, conservation, or maintenance of property held for the production of income." The corresponding Treasury Regulation makes clear that § 212 does not permit the deduction of expenses "paid or incurred in defending or perfecting title to property." 26 C.F.R. § 1.212-1(k).*fn3 We have upheld this regulation, see Galewitz v. Commissioner, 411 F.2d 1374, 1377 (2d Cir.), cert. denied, 396 U.S. 906, 24 L. Ed. 2d 182, 90 S. Ct. 221 (1969); Levitt & Sons v. Nunan, 142 F.2d 795, 797 (2d Cir. 1944) (approving predecessor of § 1.212-1(k)), and the principle it embodies has been affirmed repeatedly by the Supreme Court, see Woodward v. Commissioner, 397 U.S. 572, 575, 25 L. Ed. 2d 577, 90 S. Ct. 1302 (1970); Spreckels v. Commissioner, 315 U.S. 626, 86 L. Ed. 1073, 62 S. Ct. 777 (1942).

The policy behind 26 C.F.R. § 1.212-1(k) is that expenses incurred in acquiring income-producing property -- such as brokerage fees incurred in the process of acquiring stocks -- are "part of the cost of the property," id., and are therefore treated as non-deductible capital expenditures. These expenditures are added to the basis of the capital asset in connection with which they are incurred, and are taken into account for tax purposes either through depreciation of the asset or through reduction of the capital gain (or augmentation of the loss) when the asset is sold. Woodward, supra, 397 U.S. at 575. The test for deductibility of legal fees under § 212 is ordinarily an objective one, looking to the "origin" or "character" of the claim litigated rather than to the subjective "purpose" of the taxpayer in pursuing it.*fn4 Woodward, supra, 397 U.S. at 577-78; United States v. Gilmore, 372 U.S. 39, 49, 9 L. Ed. 2d 570, 83 S. Ct. 623 (1963).

The government here argues that Burch's legal expenses are properly characterized as expenditures incurred in perfecting Burch's title to his remainder interest in certain stocks, an interest that Burch had earlier assigned over to Winslow. Burch, by contrast, contends that his expenditures were not aimed at securing title to the trust fund assets but at "managing" and "conserving" them. The district court found that the state court litigation arose out of Burch's attempt to counter "(1) Winslow's claim of control over the trust property, and (2) Winslow's claims to twenty-five per cent of the trust corpus."

With respect to the first of these issues, the government appears to be correct in characterizing the lawsuit as involving a dispute over title -- in this case, a dispute over whether Burch had the power to revoke the trust and regain legal ownership of the stocks held in trust. Under the terms of the will, by the time he commenced the lawsuit against Winslow, Burch's interest in the stock was no longer limited to that of a remainderman, but, with his mother's death, included all rights to the stock. In the meantime, however, he had executed two agreements expressly ceding "all right, title, and interest" in the stocks to Winslow, "together with all and every other right, title, property and interest, therein which first party has, or has a right to dispose of, it being the intention of this conveyance that the first party shall hereby grant to the second party, as trustee, any and all rights as remainderman therein."

Although the second (February 1957) agreement stated that the trust was revocable, there was serious doubt at the outset of Burch's suit against Winslow whether Burch had any right to revest in himself title to the corpus of the trust. First, the February 1957 trust agreement was arguably void since Burch had already transferred all his remainder interest to Winslow by the January agreement, and thus had nothing left to transfer in February. Indeed, Burch so argued in his complaint in the state Supreme Court. Accepting this argument, the January 1957 agreement would presumably be controlling. According to the testimony of one of Burch's lawyers at trial below, under the January agreement Burch "was finished for the rest of his life," because he had "given [the remainder interest] away," and "had no control over his own property." Second, even if the February 1957 agreement were controlling, that agreement itself might turn out to be irrevocable as a practical matter despite the provisions ostensibly making it revocable. This argument, too, was made by Burch himself in his complaint before the state Supreme Court, which stated that even under the trust of February 18, 1957, "revocability was still, in actuality, in the trustee's sole and absolute discretion and not in the hands of [Burch]."

These assertions by the plaintiff undercut his present claim that he "never did lose control of his income producing property"; they suggest at the very least that title to the corpus of the trust fund was seriously in dispute and that litigation was required in order to settle the question. Thus at least part of Burch's legal fees were incurred in a dispute over title to and ownership of the trust assets. The lawsuit was not over title merely in a formal sense, but in a very practical sense, since if Burch lost he would not be able to exercise any dominion or control over the stocks during his lifetime, or other incidents of ownership, including the right to sell or use the stocks for his own benefit. Burch's legal fees in regaining title to the trust corpus were therefore non-deductible capital expenditures. Woodward, supra, 397 U.S. at 575; Lucas v. Commissioner, 388 F.2d 472 (1st Cir. 1967); ...


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