Summary
In Herman A. Moore Trust v. Commissioner, 49 T.C. 430 (1968), acq. 1968-2 Cum.Bull. 2, a trust sought a deduction under I.R.C. § 212(2) and Treas. Reg. § 1.212-1(i), allowing a deduction for "expenses of litigation, which are ordinary and necessary in connection with the performance of the duties of administration..."
Summary of this case from Southland Royalty Co. v. U.S.Opinion
Docket No. 6785-65.
1968-01-25
HERMAN A. MOORE TRUST, NORTH CAROLINA NATIONAL BANK, TRUSTEE, U/W, PETITIONER v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT
William K. Van Allen, for the petitioner. Charles B. Sklar, for the respondent.
William K. Van Allen, for the petitioner. Charles B. Sklar, for the respondent.
Trustee of petitioner was the defendant in a State court litigation brought by the beneficial remaindermen of petitioner to have their interests accelerated following the renunciation by the life income beneficiary of part of her interest. The complaint in the State court action prayed that the trustee be ordered to set up separate trusts of equal amount for the respective benefit of each remainderman. The court decided adversely to the remaindermen's claim, which decision was affirmed on appeal. However, the court, in accordance with State law, charged the legal expenses of all the parties to the suit against petitioner. Petitioner paid these expenses and then claimed them as a deduction in computing its income tax for the year in question. Held, the attorneys' fees incurred by petitioner in connection with the State court litigation were deductible expenses pursuant to sec. 212(2), I.R.C. 1954, and were not capital expenditures incurred in defending or perfecting title to property; and these expenses were the ordinary and necessary expenses of petitioner.
WITHEY, Judge:
The respondent has determined a deficiency in income tax of petitioner for the fiscal year ended April 30, 1962, in the amount of $21,426.30, the entire amount of which is in controversy. The deficiency results solely from the respondent's disallowance of a claimed deduction of petitioner in the amount of $44,000, which amount petitioner sought to deduct pursuant to section 212 of the Internal Revenue Code of 1954.
All references are to the Internal Revenue Code of 1954 unless otherwise stated.
The entire residuary estate was to be divided into equal shares for the benefit of decedent's children, or issue of each deceased child as a group, after the widow's death. For reasons not apparent, the will accomplished this in two bites— each trust was initially to be $100,000 under Item IV(B) and the remaining residue was then to be divided equally between the trusts under Item V.
The issues for decision in this case are:
(1) Whether attorneys' fees incurred by petitioner in connection with certain trust litigation are expenses deductible under section 212(2), or whether the amounts were capital expenditures incurred in defending or perfecting title to property; and
(2) If the Court should hold the attorneys' fees not to be capital expenditures, whether these expenses, other than the amounts paid to the trustee's own counsel, are the ordinary and necessary expenses of the trust.
FINDINGS OF FACT
Such facts as have been stipulated are so found.
The petitioner is the Herman A. Moore Trust, a trust created under the will of Herman A. Moore, deceased, with the North Carolina National Bank, having its principal office at 200 South Tryon Street, Charlotte, N.C., as trustee. The fiduciary income tax return for petitioner's taxable year ended April 30, 1962, was filed with the district director, Greensboro, N.C.
Herman A. Moore, a resident of North Carolina, died testate on January 12, 1948, survived by his wife and two minor children, Herman, Jr., and Jane (hereinafter sometimes referred to as the children). The pertinent portions of the will left by Herman A. Moore on the death are as follows:
ITEM IV. I give, devise and bequeath all the rest, residue and remainder of my property and estate, of every nature and wherever situate, unto the AMERICAN TRUST COMPANY, a corporation of North Carolina with principal office at Charlotte, North Carolina, IN TRUST, however, for the uses and purposes as follows:
A
If my wife, EMMIE McCONNELL MOORE, shall survive me, my Trustee is directed to pay to her in equal monthly installments the sum of Twelve Thousand Dollars ($12,000.00) per year for an during the period of her natural life. Such payments shall be made out of income therefor, and any deficiency shall be paid out of the principal of my trust estate.
The Trustee in its discretion may add to and augment the payments of One Thousand Dollars ($1,000.00) per month, provided for above, as in its discretion it shall deem such action necessary to provide for the comfortable support and maintenance of my wife. * * *
If, after paying or making provisions for the payment of said annuity of Twelve Thousand Dollars ($12,000.00) by (sic) my wife, and after paying to my said wife any sum or sums required under the next preceding paragraph, and after paying or making provision for the payment of all taxes and other expenses and charges against my trust estate, there shall remain any surplus net income from my trust estate, such surplus net income shall accumulate in the hands of my Trustee and shall be invested and reinvested and added to the principal of my trust estate and shall thenceforth be subject to the terms and provisions hereinafter contained controlling the distribution of the principal of this trust.
B
On the death of my wife, EMMIE McCONNELL MOORE, I direct my Trustee to set aside a special trust of One Hundred Thousand Dollars ($100,000.00) each for each child then living or if any child shall have died leaving issue, a trust in the same amount shall be set up for the issue of such child as a group.
(1) Any trust so set up for a son shall be distributed as follows: Said Trustee shall pay the entire net income of such trust to such son commencing at age 21 and until he has arrived at the age of 35 years. During the minority of such son the Trustee is vested with the power in its discretion to use income and to invade the principal of such trust to the extent necessary to provide for the support and education of such son. Said Trustee is not required to pay said money to a guardian, but is directed herein to make payments direct to him or for his benefit. In determining whether said principal shall be invaded for such purposes or the extent to which such principal shall be invaded, the Trustee shall take into consideration any and all other income and property (including any benefits being received from life insurance policies) which are available to such son for such purposes.
(2) If such son shall be 35 years of age at the time of the death of my wife, said Trustee shall make immediate distribution to such son of the amount which would otherwise have been set up in trust for him, or if such son shall arrive at the age of 35 years after the death of my wife, the corpus of said trust shall be paid over to him in full at age 35.
C
Any trust so set up for a daughter shall be distributed as follows:
Said Trustee shall administer the same similarly in all respects as provided in the trust for each son in the paragraph next preceding, except as follows:
From age 21 through 35 each such daughter shall receive all the net income and thereafter for life all net income or Three Hundred ($300.00) Dollars per month, whichever is the greater, and to accomplish this purpose, the principal may be invaded to the extent necessary.
ITEM V. The residuary of said corpus of the trust after the creation of the trusts, provided for above, shall be equally divided between the trust for the children thus set up, and added thereto, unless otherwise disposed of by codicil to this will.
The residuary estate of Herman A. Moore, which was delivered to the trustee under Item IV of the will, consisted primarily of Auto Finance Co. stock, which had a value in 1948 of approximately $650,000.
During the 12-year period from the date of the testator's death in 1948 to February 9, 1960, the market value of the assets held in trust under Item IV increased to in excess of $3,500,000. The net annual income of the trust and the distributions therefrom were as follows:
+----+ ¦¦¦¦¦¦ +----+
Total Amount net income distributed Federal Income of trust to life and North retained before income Carolina by taxes beneficiary taxes trustee Annual average to Apr. 30, 1959 $97,499.90 $32,538.72 $38,987.23 $25,973.95 Fiscal year ended Apr. 30, 1961 138,579.53 37,468.99 57,093.44 45,111.74
On February 9, 1960, the life income beneficiary, decedent's widow, executed a document by which she renounced and quitclaimed any interest she might have at any time in 16,660 out of the 90,160 shares of Auto Finance Co. stock which the trust held at that date. At the time of the renunciation the widow was 53 years old, Herman, Jr., was 30 and had four children, and Jane was 24 and had two children. The pertinent portions of the renunciation are as follows:
WHEREAS * * * no provision was made (in the will) for the distribution of income to our children or their issue during my life, and
WHEREAS * * * the net annual income in excess of possible distributions to me will be unavailable to me or to my children and grandchildren during the years when it is most needed by them.
WHEREAS, I desire to renounce and abandon my rights and interest in a portion of the surplus principal of said trust in excess of the portion thereof that, under reasonably anticipated circumstances would be required to provide for the payments distributable to me as aforesaid, for administration by the Trustee under said Will, * * *
NOW, THEREFORE, I hereby renounce, abandon, release, waive and quitclaim * * * all right, title and interest, whether in income, principal or otherwise, which I may now have or might have hereafter under said Will in 16,660 shares of common stock of Auto Finance Company held by said Trustee as part of the principal of the trust * * * upon the condition that such renunciation * * * and quitclaim shall operate, and shall be construed, solely as a renunciation * * * and quitclaim of my interest in the aforesaid 16,660 shares * * * including all future income therefrom * * *
Herman A. Moore, Jr., and Jane Moore Keesler requested that the trustee divide the 16,660 shares of Auto Finance Co. stock, which was the subject of the renunciation, into two equal shares and administer each for their respective benefits in accordance with the provisions of Item IV-B of the will of Herman A. Moore. That is, as to the particular shares of stock which were the subject of the renunciation, the trustee was requested to set up a separate trust for the testator's sone and daughter, each having as its principal an equal portion of the 16,660 shares in question. Without benefit of a court order, the trustee refused to do so. Thereupon, in October 1960, Jane and Herman, Jr., instituted an action in the Mecklenburg County Superior Court, North Carolina, naming as parties defendant the trustee of petitioner, the life income beneficiary, and the children of Jane and Herman, Jr., including any unborn issue, for whom Robert L. Hines was appointed guardian ad litem. The complaint prayed for the following relief:
1. That a guardian ad litem be appointed to represent all unknown persons, in being or not in being, who have or may have any interest, present or future, in the assets of the trust * * *
2. That the defendant * * * Bank be ordered and directed to divide the 16,660 shares of * * * stock renounced * * * equally between separate trusts for the respective benefit of each of the plaintiffs and hold said property and administer such trusts as if defendant * * * (life income beneficiary) were deceased, pursuant to the terms of Item IV, B, of the Last Will and Testament of Herman A. Moore.
3. That the plaintiffs recover their costs and expenses herein incurred, including reasonable counsel fees, from the trust now being administered by defendant Bank pursuant to Item IV of said will * * *
In its answer, the trustee generally admitted all factual matters alleged in the complaint, but in effect denied that the renunciation document served to accelerate the beneficial remainder interests of Herman, Jr., and Jane in the 16,660 shares of stock. The trustee prayed that the relief sought in the complaint be denied, and that the costs of the action be taxed against Herman, Jr., and Jane. The answer filed by the widow admitted the factual allegations of the complaint, alleged that the renunciation was effective and legally valid, and prayed that the relief sought by the plaintiffs be in all respects granted, and also that she recover her costs and an allowance for reasonable counsel fees from the defendant trustee. The guardian ad litem denied that the renunciation was valid or that in any way it accelerated the activation of plaintiffs' interests in either principal or income. The guardian ad litem further prayed that the costs of the action be taxed against the plaintiffs, but requested that reasonable counsel fees of the guardian be borne by the trust.
On June 28, 1961, following a hearing on the merits held during that month, the Superior Court of Mecklenburg County decreed, inter alia, that (1) the purported renunciation did not operate to accelerate the remainder interests of Herman, Jr., and Jane, or to terminate the contingent remainder interests of the grandchildren under Item IV of the will of Herman A. Moore in and to the 16,660 shares of stock in question; (2) the said stock was to be held by the trustee in a separate account and none of the income from such shares was to be paid to the life income beneficiary but, rather, such income was to be accumulated and at the death of the life income beneficiary was to be distributed as directed in the will; and (3) the costs of the action, including reasonable allowance for attorneys of the litigant parties should be paid by the trustee out of the income of the trust created under the provisions of Item IV of the will of Herman A. Moore.
The judgment of the Superior Court of Mecklenburg County was appealed to the North Carolina Supreme Court by plaintiffs Herman, Jr., and Jane. In an opinion filed December 13, 1961, Keesler v. North Carolina National Bank, 256 NC. 12, 122 S.E.2d 807 (1961), the North Carolina Supreme Court affirmed the decision of the county court. Thereafter, on March 1, 1962, the Superior Court of Mecklenburg County entered a judgment that provided, in pertinent part, as follows:
THIS CAUSE coming on to be heard * * * upon motion of the guardian ad litem and counsel for the other parties hereto for fixing and determination of the allowances for fees of the guardian ad litem and for attorneys fees to be taxed in the costs of this suit * * * after due hearing and consideration of said matter finds as facts that this suit required the construction of the Will of Herman A. Moore, deceased and the fixing and determination of the rights of the individual parties hereunder and the duties of the Trustee with respect thereto; that the questions involved have engaged the attention of the parties and their attorneys since October 1958; that in view of the importance of the litigation, the nature of the legal questions involved, the amount and character of the work performed by the guardian ad litem and the respective attorneys in connection therewith, including the preparation and presentation of the matter in the Superior Court and in the Supreme Court, the allowances * * * for their services rendered by said guardian ad litem and by said attorneys in connection with the subject matter of this litigation, and are ordinary and necessary expenses of the Trustee incurred in connection with the subject matter of this litigation, and are ordinary and necessary expenses of the Trustee incurred in connection with the performance of the duties of administration of the trust;
In its judgment on March 1, 1962, the Superior Court of Mecklenburg County ordered payment of the following amounts:
+---------------------------------------------------------------------------+ ¦Attorney ¦ ¦Amount ¦ +---------------------------+--------------------------------------+--------¦ ¦Robert L. Hines ¦Guardian ad litem for children and ¦$12,000 ¦ +---------------------------+--------------------------------------+--------¦ ¦ ¦unborn issue of Herman A. Moore, ¦ ¦ +---------------------------+--------------------------------------+--------¦ ¦ ¦Jr., and Jane M. Keesler. ¦ ¦ +---------------------------+--------------------------------------+--------¦ ¦Lassiter, Moore & Van Allen¦Attorneys for Herman A. Moore, ¦8,000 ¦ +---------------------------+--------------------------------------+--------¦ ¦ ¦Jr., and Jane M. Keesler. ¦ ¦ +---------------------------+--------------------------------------+--------¦ ¦Boyle, Cansler & Lockhart ¦Attorneys for life income beneficiary-¦12,000 ¦ +---------------------------+--------------------------------------+--------¦ ¦Pierce, Wardlow, Knox & ¦Attorneys for the trustee (North ¦12,000 ¦ +---------------------------+--------------------------------------+--------¦ ¦Caudle. ¦Carolina National Bank). ¦ ¦ +------------------------------------------------------------------+--------¦ ¦Total ¦44,000 ¦ +---------------------------------------------------------------------------+
Hines rendered services as guardian ad litem from July 14, 1960, to December 21, 1961, during which period he spent 173 hours in connection with the case.
Lassiter, Moore & Van Allen, attorneys for plaintiffs Herman A. Moore, Jr., and Jane Moore Keesler were employed to perform various legal services for the above children, including study and review of the will of Herman A. Moore, research in connection with the development of a plan for acceleration of the interests of the children based on the renunciation by the life income beneficiary, and the institution of the State court litigation which gave rise to this case. The attorneys in the firm expended an aggregate of 494 hours in connection with the above services rendered between May 29, 1958, and January 16, 1962.
Attorney Lloyd Caudle was first contacted by the American Commercial Bank (now North Carolina National Bank) in October 1958, with regard to interpretation of a plan which had been submitted to the trustee concerning the problem later litigated. Caudle's firm concluded that the plan was not consistent with the provisions of the Herman A. Moore will, and that the trustee should obtain a court decision on the proposed plan before proceeding to take any action thereunder. Caudle's firm represented the trustee for the entire period from October 1958 to April 1962.
During the taxable year ended April 30, 1962, petitioner-trustee paid to the clerk of the Superior Court of Mecklenburg County the above sum of $44,000 as set forth in the judgment of the county court filed March 1, 1962. Petitioner-trustee claimed a deduction for that amount on its fiduciary income tax return for its taxable year ended April 30, 1962. In the notice of deficiency mailed to petitioner on September 9, 1965, respondent determined that the $44,000 paid by the trust in connection with the above litigation was not a proper deduction of the trust, and disallowed it.
ULTIMATE FINDINGS
The primary purpose of petitioner in defending the State court litigation was to obtain the aid of the court in the conduct and management of the Herman A. Moore Trust.
The $44,000 paid by the petitioner as ordered by the State court was an ordinary and necessary expense of petitioner.
OPINION
The first issue for decision in this case is whether attorneys' fees incurred by petitioner in connection with certain litigation are deductible expenses for the management, conservation, or maintenance of property held for the production of income, or whether the amounts were capital expenditures incurred in defending or perfecting title to property.
The facts giving rise to this case, briefly stated, are as follows: Petitioner is the Herman A. Moore Trust created pursuant to the will of Herman A. Moore. Under this will the trustee of petitioner was directed to pay a portion of the trust income to the testator's widow during the lifetime and to accumulate the balance. Upon the death of the testator's widow, the trustee was to divide the principal of the trust into equal shares to be held in special trusts for the benefit of the children of the deceased when living or their issue. Twelve years after the establishment of the trust, the testator's widow renounced her interest in a portion of the trust assets. The action in which the court costs involved in the litigation were incurred was brought by the testator's two children, in which they unsuccessfully contended that the release and renunciation of the widow acted to accelerate their beneficial remainder interest in the renounced property, and that the trustee should hold that property and administer the trusts as if the widow had died.
On these facts, petitioner contends that the legal fees it paid in connection with its defense of the above suit are deductible expenses relying on section 212(2) which provides that
there shall be allowed as a deduction all the ordinary and necessary expenses paid or incurred during the taxable year
(2) for the management, conservation, or maintenance of property held for the production of income * * *
and on section 1.212-1(i), Income Tax Regs., which provides that
(i) Reasonable amounts paid or incurred by the fiduciary of an estate or trust on account of administration expenses, including fiduciaries' fees and expenses of litigation, which are ordinary and necessary in connection with the performance of the duties of administration are deductible under section 212 * * *
Respondent, on the other hand, argues that the legal fees are nondeductible, relying on section 1.212-1(n), Income Tax Regs., ‘Capital expenditures are not allowable as nontrade or nonbusiness expenses,‘ and on section 1.212-1(k), Income Tax Regs.
(k) Expenses paid or incurred in defending or perfecting title to property * * * constitute a part of the cost of the property (i.e., a capital expenditure) and are not deductible expenses. * * *
Before embarking on an analysis of the ‘defense of title’ contention, it is noted that as the Supreme Court stated in Trust of Bingham v. Commissioner, 325 U.S. 365 (1945):
Section 23(a)(2) (of the 1939 Code, now sec. 212 of the 1954 Code) is comparable and in pari materia with section 23(a)(1) (of the 1939 Code, now sec. 162 of the 1954 Code) authorizing the deduction of business or trade expenses. * * *
Thus, defense-of-title cases in the trade or business area are equally applicable to cases arising under the nontrade or nonbusiness section of the Code and will be so considered in the following discussion.
Respondent's position is that since in the State court proceedings the children sought to vest equitable title in themselves and legal title in newly created trusts for their benefit, the amounts expended by the trustee in defending against the suit were ‘expenses paid or incurred in defending or perfecting title to property.’ However, this does not necessarily follow. As was stated in Industrial Aggregate Co. v. United States, 284 F.2d 639 (C.A. 8, 1960):
The decided cases, including our own, have given recognition and impetus to this standard of the regulation (i.e., the standard of defense or perfection of title to property contained in sec. 39.24(a)-2, Regs. 118, the 1939 Code equivalent of sec. 1.263(a)-2(c), Income Tax Regs., under the 1954 Code which is the equivalent in the trade or business area of sec. 1.212-1(k), the regulation involved in this case) and hold generally that expenditures made in defense or perfection of title are capital items and are not deductible as expenses from gross income. * * *
At the same time, ever since Kornhauser v. United States, 276 U.S. 145, * * * cases recognize that the mere fact that title to property happens to be involved in litigation does not necessarily mean that expenditures of that litigation are automatically rendered non-deductible by the regulation. * * * Practicality and substance are to be recognized.9 The test which appears to have been established is that of primary purpose. Thus, if the primary or sole purpose of the suit is to perfect or defend title, the expenditures are not deductible. * * * On the other hand, even though title may be involved, if its defense or perfection is not the primary purpose of the litigation, the expenditures do not encounter the barrier of the regulation's standard and they may qualify instead as ordinary and necessary expenses. * * * (Footnote omitted.)
* * * And whose purpose is to govern? Is it that of the taxpayer's opposition in instituting the litigation against it or is it that of the taxpayer in defending it * * * We might be inclined to the view that what is controlling is the taxpayer's purpose, in the aggregate, in taking all such steps as it feels are necessary or advisable to effect its desired result. * * *
In applying the above test of purpose to the circumstances of this case, we are of the opinion that defense of its title was not the primary purpose of the trustee in defending against the children's State court suit.
At issue in the State court proceeding was the question of the application of the doctrine of acceleration of estates in remainder to the widow's renunciation of part of the assets of Herman A. Moore Trust. The children maintained that the activation of the trusts provided in the will of Herman A. Moore for their benefit was accelerated by reason of the document executed by their mother. The trustee denied this. It is important to note that if the children succeeded in their claim, the trust property involved would be going to the remaindermen of the trust, not to a party unintended to benefit under the trust. Thus, although title was involved, the real question as regards the trustee was one of timing— do the remaindermen's interests take effect now or at a later time— the answer to which question was vital to the trustee's administration of the trust. Granted if the trustee won, such interests would not take effect until the death of the widow, but the trustee's primary purpose in defending was not to defend its title but rather to obtain a decision upon the question as to when the remaindermen's rights to the property involved were to be activated in order to aid the trustee in its management of the trust property.
That the trustee's primary purpose in defending was to obtain clarification by the court in order to aid in its trust administration, rather than defense of its title is borne out by certain of the facts stipulated by the parties and by the children's complaint in the State court action. In the stipulated facts it is stated that ‘(Trustee's law) firm concluded that the plan was not consistent with the provisions of the Herman A. Moore Will, and that the trustee should obtain a court decision on the proposed plan before proceeding to take any action thereunder.’ Also, paragraph 13 of the children's complaint alleges that although the children have demanded that the trustee now hold the renounced property in trust for them, ‘defendant Bank has declined to do so without the protection of a court order.’
Another factor supporting our decision is the apparent conclusion by the State court judge who heard the case that it involved a question of administration rather than of defense of title. North Carolina has adopted the Uniform Principal and Income Act. Section 12 of that Act (N.C. Gen. Stat. Sec. 37-12(b)) provides that expenses of administration are normally paid out of trust income. It then provides that
All other expenses, including * * * costs incurred in maintaining or defending any action to protect the trust or the property or assure the title thereof * * * shall be paid out of principal * * *
The court directed that the allowances involved ‘be paid out of the income of the trust,‘ thereby indicating that in the court's opinion a question of administration rather than title was involved. Despite the fact that the court's conclusions as to the characterization of the nature of the suit are not determinative of a Federal income tax question, Burnet v. Harmel, 287 U.S. 103 (1932), we find it helpful in our search for the primary purpose of the State court litigation.
A useful analogy is provided by Industrial Aggregate Co. v. United States, supra. In that case the taxpayer was lessee under four leases, each of which contained a termination clause for default by the lessee of any of the covenants thereunder, and an extension provision allowing up to 10 years' extension, under certain conditions, if the lessee complied with its agreement with lessor. As the termination date of the leases approached, the lessor and the taxpayer attempted to invoke the respective termination and extension provisions of the lease. Finally, the lessor brought an action against the taxpayer-lessee in a State court, demanding forfeiture of taxpayer's estate and treble damages, under a certain Minnesota statute, in the amount of $490,000. The taxpayer in its answer denied the alleged defaults claimed and asserted two counterclaims upon which it requested equitable relief against forfeiture and a declaratory judgment that the lease had been duly extended. The court decided that the primary purpose of the litigation was ‘the resolution of the issue of the taxpayer-lessee's alleged violations of the operating covenants of the four leases.’ It then went on to state:
That the determination of this issue involved the taxpayer's consequent right, or lack of right, to the extension, and thus involved continuing title to the leaseholds as extended, does not make this purpose any less primary.
So in the present case, the fact that the trustee's interest in the property was extended does not make any less primary its purpose to have the court clarify the time of activation of the remaindermen's interests so as to allow the trustee to properly administer the trust.
Respondent relies heavily on the case of Manufacturers Hanover Trust Co. v. United States, 312 F.2d 785 (CT. Cl. 1963). In that case after the death of the life beneficiary of the trust a question arose as to the validity of the continuing trusts to the beneficiary's survivors. The taxpayer-trustee brought an action for an accounting and in that action the residuary legatee of the will under which the trust in question was established, challenged the taxpayer's title to the trust property. The court held that the primary purpose of the suit was the perfection and defense of taxpayer's title to the trust property and thus the expenses incurred were not deductible. However, in Manufacturers Hanover, the trustee was litigating the continuing validity of the entire trust, and if the trustee had lost, the property in question would have gone not to the remaindermen of the trust but to the residuary legatee of the will. Thus, it was not a question of timing, i.e., when a remainder interest under the trust should be activated, but rather a question of title, i.e., whether the trust and the trustee's title to the trust property were valid at all, which was at the center of the litigation in Manufacturers Hanover, and the court therein so held.
Nor do the other cases cited by respondent, which hold that defense of title was the primary purpose of the earlier litigation, affect in any way our decision in this case. Accordingly, we hold that the expenses incurred by petitioner in connection with the prior State court litigation were not capital expenditures incurred in defending or protecting title to property, but were deductible expenses under section 212(2).
Respondent, however, argues alternatively that if the Court should hold the attorneys' fees not to be capital expenditures, then these fees, other than the fees paid to the trustee's own counsel, are not ordinary and necessary expenses of the trust, but rather were incurred solely for the personal and family purposes of the widow and the children.
The question thus presented is whether the payment by the trust of the legal expenses of the other parties to the State court proceeding pursuant to the order of the State court are ordinary and necessary expenses of the trust. Although the judgment of the State trial court in so ordering payment by the trustee stated that the legal fees of all the parties ‘are ordinary and necessary expenses of the Trustee incurred in connection with the performance of the duties of administration of the trust,‘ the State court's conclusions as to the characterization of the nature of the expenditures are not determinative of a Federal income tax question. Burnet v. Harmel, supra. Moreover, in the recent Supreme Court case of Commissioner v. Estate of Bosch, 387 U.S. 456 (1957), the Court enunciated the rule that in the application of a Federal statute, the decision of a State trial court even as to an underlying issue of State law is not controlling.
However, our independent review of the law of the State of North Carolina has satisfied us that the order of the court requiring that the trustee pay the expenses of all the parties to the litigation is proper and in accordance with the laws of that State. See N.C. Gen. Stat. sec. 6-21 (Supp. 1965);
Little v. Wachovia Bank and Trust Co., 252 N.C. 229, 113 S.E.2d 689 (1960). And as this Court stated in Calvin Pardee Erdman, 37 T.C. 1119 (1962), affd. 315 F.2d 762 (C.A. 7, 1963):
Sec. 6-21. Costs allowed either party or apportioned in discretion of court.— Costs in the following matter shall be taxed against either party, or apportioned among the parties, in the discretion of the court:(2) Caveats to wills and any action or proceeding which may require the construction of any will or trust agreement, or fix the rights and duties of parties thereunder; * * *The word ‘costs' as the same appears and is used in this section shall be construed to include reasonable attorneys' fees in such amounts as the court shall in its discretion determine and allow. * * *
The will gave each child a testamentary power of appointment over his or her trust in favor of his or her spouse or issue or spouses of such issue.
When the legal fees of a beneficiary involved in trust litigation are ordered paid from a trust, it is because the beneficiary has benefited the trust by his involvement in the suit * * * Thus, although the beneficiary himself may have been benefited by the outcome of the suit, the advantage accruing to the trust is considered of sufficient magnitude that the beneficiary should be relieved of the burden of paying the legal fees.
This transaction is similar to that which occurs when a corporation pays the legal expenses of a stockholder who brings a derivative suit. In several instances this Court has held the payments of these expenses are properly expenditures of the corporation. Charles Kay Bishop, 25 T.C. 969 (1956); Shoe Corporation of America, 29 T.C. 297 (1957); B. T. Harris Corporation, 30 T.C. 635 (1958). In several situations payment by a fiduciary of the legal expenses of other parties to litigation has been treated as a proper expenditure of the fiduciary. Loyd v. United States, 153 F.Supp. 416 (1957); Kohnstamm v. Pedrick, 66 F.Supp. 410 (1946); and Leonard A. Farris, 22 T.C. 104 (1954), reversed on other grounds 222 F.2d 320 (C.A. 10, 1955).
Although the issue to be decided in the Erdman case was the deductibility of the legal fees by the beneficiary, and not their deductibility by the trust, we find the Court's discussion quoted above most helpful in the case before us.
We note that this case involved the deductibility by the beneficiary of expenses paid by the trustee and charged against principal. The question whether such expenses were deductible as ‘ordinary and necessary’ by the trustee was not involved, since, under the 1939 Code, which was applicable to that case, expenses charged against principal were not deductible in determining distributable net income. See 37 T.C. at 1123.
In Shoe Corporation of America, 29 T.C. 297 (1957), discussed in the Erdman opinion above, respondent argued that the fees and expenses involved therein were not taxpayer's but were somebody else's. We held this argument to be without merit, reasoning that the District Court in its final decree directed that such fees and expenses should be taxed as costs and paid by the defendant corporation and that by so doing it was following the general rule that where the result of a stockholder's suit inures to the benefit of the stockholders generally the fees of the attorney for the parties instituting the action are taxed against the corporation on the theory that the corporation has been benefited and should pay the reasonable value of the services rendered to it.
Analogously, in the present case, the final judgment of the trial court directed that the legal fees for all parties to the litigation be taxed against the trust. In so doing, the trial court was exercising the discretion vested in it by North Carolina law to tax reasonable attorneys' fees against either party in any action or proceeding requiring the interpretation of a trust, and was following the general principle of trust law that attorneys' fees of a party may be charged against the trust where benefit to the trust results from the involvement of that party in the litigation.
Respondent further argues in support of his contention that the expenses involved were personal expenses of the widow and children, that a substantial portion of the fees awarded to the children's attorneys were incurred in connection with personal tax planning and consultation services rendered during the 2 years prior to the execution of the purported renunciation and subsequent filing of the complaint in the North Carolina court, and that such amounts cannot be considered to have been expended for the benefit of the trust. Respondent's argument stems from the fact that in the ‘Memorandum for the Court Re Attorney's Fees' filed by the children's attorneys in the State court. However, the State court awarded only $8,000 for the 494 hours of work listed by the children's attorneys, an hourly rate of $16.18. On the other hand, the guardian ad litem expended 173 hours for which he received $12,000, an hourly rate of $69.36. Our conclusion drawn from this disparity is that the court, in accordance with the general trust principles described above, taxed legal fees against the trust for only so much of the services rendered by the children's attorneys as benefited the trust in that particular litigation. This conclusion is buttressed by the State court's language in its final judgment wherein it stated: ‘the allowances * * * for their services herein constitute reasonable compensation for the respective services rendered by said guardian ad litem and by said attorneys in connection with the subject matter of this litigation.’ (Emphasis added.)
Accordingly, we hold that the legal expenses taxed against the trust in the State court litigation are the ordinary and necessary expenses of the trust, and are deductible by the trust pursuant to section 212(2).
Reviewed by the Court.
Decision will be entered for the petitioner.
HOYT, J., dissents.
TANNENWALD, J., concurring:
I think the use of a ‘primary purpose’ test in cases of this type is inappropriate, because it implies that the subjective intent of the parties ought to be taken into account. I believe that, in the area of litigation expenses, it is ‘the origin and character of the claim with respect to which (the) expense was incurred’ which controls. See United States v. Gilmore, 372 U.S. 39, 49 (1963). The rationale which underpins this mandate of the Supreme Court is equally applicable in determining whether an expenditure is a nondeductible capital item or a deductible expense within the purview of section 212 and in determining whether the expenditure is a nondeductible personal item or a section 212 deduction.
It is significant that the widow herein did not seek to make a transfer outside the will.
1 She merely renounced her rights to a specific portion of the trust in favor of the holders of the next eventual estate under the will, with a resultant gap in the testator's dispositive direction to the trustee. The gap thus created was essentially with respect to the disposition of the income from the renounced specific portion. The fundamental question was whether that income should be paid currently to the son or the daughter or be accumulated by the trustee until the widow's death for their benefit, or for the benefit of their issue.
To be sure, if the renunciation had been held effective, the son would probably have received his share of the corpus earlier than the decedent had provided— in all likelihood, he would attain the age of 35 while the widow was still alive. No such possibility of acquisition of corpus inured in favor of the daughter, because at all times she was only entitled to the income from her share. Concededly, the trusts for the benefit of the grandchildren might have become effective at an earlier time than specified by the testator, i.e., upon the death of the son or daughter while the widow was still living. Perhaps, also, the son and the daughter would have acquired an expanded testamentary power of appointment
2 in the sense that the exercise of such power could have become effective while the widow lived, although it is far from clear that, under the will, such powers of appointment were not in fact exercisable while the widow was alive, with disposition in accordance with the terms of exercise merely postponed until her death. But these shiftings of interest in corpus were merely incidental to the basic question arising from the renunciation, i.e., who was entitled to the income currently— the trustee, on the one hand, or the son and daughter, on the other. Cf. Estate of Frederick Cecil Bartholomew, 4 T.C. 349 (1944), acq. 1955-1 C.B. 3.
In the foregoing context, ‘the origin and character of the claim with respect to which (the) expense was incurred’ (see United States v. Gilmore, supra) was rooted in a dispute over the right to income from a specific portion of the trust. Since there is no contention herein, apart from the dispute as to the nature of the North Carolina litigation, that the allowance to the attorney for the trustee was not ‘ordinary and necessary,‘ I agree with the majority that the payment of such allowance constituted a proper deduction by the trustee either as an expense ‘for the management * * * of property held for the production of income’ under section 212(2) or, conceivably, as an expense for ‘the production or collection of income’ under section 212(1). Cf. Estate of Frederick Cecil Bartholomew, supra at 361.
In predicating my analysis on the existence of a dispute over the right to income, I do not mean to imply that legal fees incurred by a fiduciary on its own behalf, in connection with other disputes involving rights to the assets subject to fiduciary administration, may not also be deductible under appropriate circumstances. I am not convinced that Manufacturers Hanover Trust Co. v. United States- 312 F.2d 785 (Ct. Cl. 1963), so heavily relied upon by respondent, is correct in applying to cases of the type involved herein the usual distinctions as to defense of title and in drawing the line disputes under and disputes dehors the governing instrument. Cf. Loyd v. United States, 153 F.Supp. 416 (Ct. Cl. 1957); see Trust of Harold B. Spero, 30 T.C. 845, 856 (1958). In any event, that case is clearly distinguishable. The issue therein turned upon who was entitled to the trust estate upon the death of the life beneficiary— the trustee or a third party not directly interested in the trust, i.e., the grantor's estate. In holding that the origin and character of the underlying claim involved a question of title (see 312 F.2d at 790), the Court of Claims carefully noted (also at page 790) that
This situation is to be distinguished from that which would arise if a fiduciary sought to deduct expenses incurred in determining which of several potential beneficiaries was entitled to receive trust property. (Emphasis added.)
The allowances to the guardian ad litem and to the attorneys for the widow, son, and daughter present a somewhat different issue. The ‘origin and character of the claim’ with respect to which these expenses were incurred is, of course, the same as that involved in the allowances to the attorneys for the trustee. In addition, these expenses were paid by the trustee pursuant to a court order which characterized them as ‘ordinary and necessary,‘ although, as the majority points out, this is not determinative for tax purposes. Clearly, the trustee was entitled in the North Carolina litigation to a determination binding on all interested parties and this required representation of the minor grandchildren and unborn grandchildren, who were legally incapable of representing themselves. On this basis, I think the payment of the allowance to the guardian ad litem constituted an ordinary and necessary expense of the trustee and is therefore deductible under section 212.
The allowances to the attorneys for the widow, son, and daughter present a more difficult question. While they were required to be parties to the litigation in order to give the trustee full protection, they were adults and consequently were in a different category with respect to the necessity of legal representation. Realistically, the allowances were incurred in an effort to acquire rights for the son and daughter by sustaining the widow's renunciation. The foundation for the litigation was self-created, i.e., by the parties themselves, unlike the situation in Calvin Pardee Erdman, 37 T.C. 1119 (1962), where the litigation involved the original instrument itself. Both the trustee and the North Carolina court had the benefit of legal counsel acting on behalf of the trustee and the guardian ad litem, so it is hard to see how the involvement of other attorneys in the litigation benefited the trust. Indeed, the position taken by those attorneys, if successful, would have denied the trustee's right to accumulate income. Under these circumstances, I do not think the theory that allowances to attorneys of trust beneficiaries are made to benefit the litigants, advanced in Calvin Pardee Erdman, supra,
3 is applicable. Shoe Corporation of America, 29 T.C. 297 (1957), relied upon by the majority, is beside the point. In that case, the taxpayer itself recovered money in the litigation with respect to which the expenses were paid.
In view of the foregoing, I am of the view that the amounts paid by the trustee as allowances to the attorneys for the widow, son, and daughter are not ‘ordinary and necessary expenses' of the trust. Rather, they constituted distributions for the benefit of those individuals. However, since these expenses were directed by the North Carolina court to be charged against income, they would appear to be deductible by the trust as an ‘amount of income * * * required to be distributed currently.'
Sec. 661(a). On this basis, the ultimate decision of the majority in respect of these items is correct. Under the foregoing approach, the distributable income, represented by the amount of such allowances, might well be includable in the gross income of these beneficiaries under section 662, but we need not decide whether the amounts would then be deductible by them as ‘ordinary and necessary expenses' under section 212. Compare Marion A. Burt Beck, 15 T.C. 642, 670 (1950), affirmed per curiam 194 F.2d 537 (C.A. 2, 1952), with Stella Elkins Tyler, 6 T.C. 135 (1946).
The will provided for discretionary distributions, under certain circumstances, for the benefit of the widow and children.