Opinion
Docket No. 45571.
1954-06-30
HYMIE SCHWARTZ, AND HIS WIFE, JEANNETTE L. SCHWARTZ, PETITIONERS, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
Emil Corenbleth, Esq. , for the petitioners. Paul M. Newton, Esq. , and James F. Hoge, Jr., Esq. , for the respondent.
DEDUCTION—ATTORNEY FEES.—In 1950 petitioner employed attorneys in connection with an examination of his income tax returns for previous years where failure to report all business income and possible fraud was involved. The services of the attorneys were terminated and their fees paid in 1950, which was prior to final determination of additions to tax for fraud and return of an indictment for criminal fraud which resulted in conviction on a plea of nolo contendere. Held, fees deductible in 1950. Emil Corenbleth, Esq., for the petitioners. Paul M. Newton, Esq., and James F. Hoge, Jr., Esq., for the respondent.
The Commissioner determined a deficiency in income tax for the year 1950 in the amount of $6,492.02.
The only question for decision is whether or not certain attorney fees paid by petitioner Hymie Schwartz in 1950 in connection with his income tax liabilities for prior years were deductible under section 23(a)(1) or section 23(a)(2), Internal Revenue Code.
FINDINGS OF FACT.
Petitioners are husband and wife residing in Dallas, Texas. They filed a joint return for 1950 with the collector of internal revenue for the second district of Texas.
From 1943 to 1949, Hymie Schwartz, hereafter referred to as petitioner, was engaged in the loan, investment, and manufacturing business, and latter being carried on under the name of Lion Brand Manufacturing Company. In 1950 he was engaged in the loan, investment, and oil operation business.
In 1949 an examination of petitioner's books and records for the years 1942 through 1948 was begun by the Bureau of Internal Revenue. The investigation was conducted jointly by an agent and a special agent. Shortly after the investigation began petitioner employed Emil Corenbleth, an attorney of Dallas, Texas, to counsel and advise him with respect to the examination. Corenbleth took no actual part in negotiations with the agents. Petitioner's accountant who had been his auditor since 1933 and who had prepared the returns in question worked with the agents on the mechanics of the investigation.
Petitioner recognized shortly after the investigation began that additional income taxes would be due for the years under investigation, but he did not believe the facts would call for the imposition of any fraud penalties. From the outset petitioner wanted his correct tax liabilities cleared up. The main question involved was the failure to include in income proceeds from the sale of piece goods from the stock of Lion Brand Manufacturing Company. The investigation was completed in June 1950, but petitioner was not advised at that time of the amount of the deficiencies in income tax and civil penalties which the report proposed should be determined or that civil penalties would be determined.
In July 1950 after conferences at the office of the Intelligence Division of the Bureau of Internal Revenue at Dallas and in the Dallas office of the Penal Division of the Chief Counsel's office, petitioner was aware that the Bureau was considering whether or not to recommend criminal prosecution against him.
Petitioner was thereafter notified by the Treasury Department that the case had been transferred to Washington. His attorney, Corenbleth, arranged for a conference there and employed Francis G. Southworth, an accountant, to check certain records and assemble certain information from which schedules could be prepared for the hearing.
On October 16, 1950, petitioner and Corenbleth appeared at a conference in Washington before a special attorney in the Penal Division of the Chief Counsel's office. They knew at this time that the Intelligence Division of the Bureau had recommended that criminal fraud charges be brought against petitioner and that the office before which the hearing was had was the office which reviewed such recommendations and made decisions thereon. At the hearing petitioner and his attorney took the position that petitioner was willing to pay any taxes and interest that might be due but was unwilling to pay any fraud penalties because they believed no fraud had been committed. Petitioner did not deny there was unreported income and he and his attorney stated that an audit would be necessary to determine the amount and the discrepancy would have to be settled. A statement filed by Corenbleth at the hearing contained the following opening paragraph:
The following statement is submitted, supplementing the oral bearing given in this matter on the 16th day of October, 1950, at Washington, D. C., to show conclusively that Hymie Schwartz did not fraudulently evade the payment of income taxes for the years 1943, 1944, 1945, and 1946.
The statement concluded as follows:
It is respectfully submitted that there was no intent on the part of Mr. Hymie Schwartz to evade the payment of income taxes, and that this Department should permit him to pay his taxes, plus interest, and that this matter be closed. In this connection, it will be necessary to reconcile by audit the difference between the amount claimed by the Government and the amount that may be due by Mr. Schwartz and his wife, as it is the fixed policy of the Government, as we understand, to collect no more tax than is actually due.
After the October conference petitioner was advised that his case had been referred to the Attorney General of the United States for further action. He thereupon employed a firm of attorneys in Washington to handle his affairs before the Department of Justice. These attorneys made the necessary preliminary study of the facts involved and appeared with petitioner at least twice at conferences before a lawyer in the criminal section of the Tax Division of the Attorney General's office. Their primary purposes were to establish that no fraud had been committed, to forestall a possible criminal indictment for fraud, and to have the case settled by allowing petitioner to pay all civil liabilities plus interest.
During 1950 petitioner paid fees to Corenbleth in the amount of $2,750 and to the Washington attorneys in the amount of $7,500. Of the amount paid to Corenbleth $250 was paid for the services of the accountant Southworth. At the time the attorneys to whom these fees were paid were employed and at the time of payment no indictment of any kind had been returned against petitioner and neither he nor his attorneys knew whether or not an indictment would eventuate.
On May 3, 1951, the Federal grand jury in Dallas returned an indictment against petitioner on four counts charging evasion of his and his wife's income taxes for the years 1944 and 1945 under section 145(b) of the Internal Revenue Code. Petitioner then employed another Dallas attorney to represent him at the trial and paid him $6,500 for which no deduction has been claimed. Petitioner entered a plea of nolo contendere to the indictment. He was convicted on the plea, found guilty as charged, and was sentenced to serve 2 years in the Federal penitentiary and to pay a fine of $25,000. Later the sentence was modified by probating the 2-year sentence to 5 years and increasing the fine to $35,000.
On August 13, 1951, petitioners were furnished for the first time with a statement proposing deficiencies in income tax and additions to tax for fraud. They filed separate protests which were first reviewed by Corenbleth. By November 30, 1951, after conferences between the revenue agent and petitioner and his accountant a settlement was effected in which the proposed deficiencies were decreased, but a 50 per cent fraud penalty was paid.
On their joint return for 1950, petitioners claimed a deduction for legal fees in the total amount of $11,490 which included the $2,750 paid to Corenbleth and the $7,500 paid to the Washington lawyers.
This claimed deduction was disallowed with the explanation that the fees did not constitute proper deductions under the Internal Revenue Code.
OPINION.
TIETJENS, Judge:
The only question is whether petitioner may properly claim a deduction for fees paid in 1950 for legal services in connection with attempts to determine and settle his income tax liabilities for previous years.
In the ordinary case where litigation over income tax liabilities is carried on and attorney fees are contracted for and paid in connection therewith such a deduction would be a proper one. James A. Connelly, 6 T. C. 744. See also David L. Loew, 7 T. C. 363. Indeed, Regulations 111, section 29.23(a)–15 expressly provides that ‘Expenses paid or incurred by an individual in the determination of liability for taxes upon his income are deductible.’ Nevertheless, the Commissioner contends that section 24, Internal Revenue Code, which provides that personal expenses are not deductible cuts across the cited regulation in this case in such a way as to deny deductibility, apparently because additions to tax for fraud and a possible charge of criminal fraud are involved, and that was the phase of the problem on which the attorneys' services were concentrated. It is also urged that public policy should preclude the deduction.
It is apparent that the tax question in connection with which the attorneys were retained related to business income of petitioner. That the question pertained to previous years would not preclude deductibility and would seem to be of no consequence. James A. Connelly, supra.
Nor do we see how the fraud issue or public policy should preclude deduction of the fees by petitioner. Certainly, had the case been compromised before referral to the Attorney General, the fees would have been allowed as a deduction, regardless of the fact that the criminal fraud penalty was also compromised. Greene Motor Co., 5 T. C. 314, acquiescence noted 1945 C. B. 3. In the case at hand it is true that petitioner was finally indicted for criminal fraud in 1951 and convicted on a plea of nolo contendere and that his civil liability as finally determined and paid included additions to tax for fraud. But those facts eventuated after the services for which the fees here involved were charged had been concluded and the fees paid. The attorneys' services were not performed in connection with the criminal trial and there is no evidence in the record to connect them with that proceeding. No deduction is claimed for the fees of the attorney who handled the criminal trial. When the services here involved were terminated there was no certainty that an indictment would follow or even that additions to tax for fraud would be determined. There was some indication to the contrary, for the attorney in the Bureau of Internal Revenue before whom the hearing of October 16, 1950, was held stated at the conclusion of the hearing as follows:
The whole thing bogs down to whether or not these sales were intentionally left off—and I double it. It is possible, as I was going to say, that we may want to send the case back for further investigation. * * *
As we view it the legal fees here in question were for services in connection with determining the proper taxes due on petitioner's business income and in attempting to settle petitioner's proper liability for taxes. The services were abortive as far as the addition to taxes for fraud and the criminal liability are concerned, but the employment of the attorneys had terminated before any additions to tax for fraud had been determined and before an indictment had been returned. The deductibility of the fees in 1950, the year in which employment came to an end, should not be made to depend on events which came about in 1951.
Reviewed by the Court.
Decision will be entered for the petitioners.