USCA1 Opinion
UNITED STATES COURT OF APPEALS
FOR THE FIRST CIRCUIT
____________________
No. 95-1451
J. KENNETH ALEXANDER AND JOANNE M. ALEXANDER,
Petitioners - Appellants,
v.
INTERNAL REVENUE SERVICE OF
THE UNITED STATES OF AMERICA,
Respondent - Appellee.
____________________
ON APPEAL FROM A DECISION OF
THE UNITED STATES TAX COURT
____________________
Before
Torruella, Chief Judge,
___________
Aldrich and Coffin, Senior Circuit Judges.
_____________________
_____________________
Philip J. Ryan, with whom Ryan, Martin, Costello, Leiter,
_______________ ________________________________
Steiger & Cass, P.C. was on brief for appellants.
____________________
William J. Patton, Attorney, Tax Division, Department of
__________________
Justice, Loretta C. Argrett, Assistant Attorney General, Gary R.
__________________ _______
Allen, Attorney, and Richard Farber, Attorney, Tax Division,
_____ _______________
Department of Justice, were on brief for appellee.
____________________
December 22, 1995
____________________
TORRUELLA, Chief Judge. Respondent-Appellee, the
TORRUELLA, Chief Judge
____________
Commissioner of Internal Revenue (the "Commissioner"), determined
a deficiency of $57,441 in the 1989 Federal income tax filed by
J. Kenneth Alexander (the "Taxpayer") and Joanne M. Alexander
(together, the "Appellants" or the "Petitioners"). The Tax Court
upheld the Commissioner's determination and the Petitioners now
seek review of that decision. For the reasons stated below, we
affirm.
I. BACKGROUND
I. BACKGROUND
The pertinent facts, some of which have been stipulated
and incorporated in the district court's findings, are not in
dispute, and are recapitulated here. Unless otherwise indicated,
all section references are to the Internal Revenue Code in effect
for 1989. Internal Revenue Code, 26 U.S.C. 1 et seq. (1988 &
______
Supp. 1991).
In 1983, Taxpayer entered into an employment agreement
with his employer, W. F. Young, Inc. ("Young"), according to
which Taxpayer would remain in the capacities of Executive Vice
President, Treasurer, and Chief Executive Officer until he
reached the age of seventy (70), on December 13, 1993. On
October 15, 1987, when Taxpayer was sixty-four (64) years old,
Young terminated Taxpayer's employment. Subsequent to his
termination, Taxpayer offered management consulting services for
a fee, and in 1989 obtained a management consulting contract with
the Hanson Group of Ludlow, Massachusetts.
-2-
On February 10, 1988, Taxpayer filed a civil lawsuit
against Young (the "lawsuit"), in which Taxpayer was represented
by the law firm of Ryan & White, P.C. ("Ryan & White").1 In his
complaint, Taxpayer alleged a breach of the express 1983
employment contract (or "Count I"), a breach of an implied
pension benefits contract (or "Count II"), and age discrimination
under Massachusetts General Law, Chapter 151B, Section 1 (1976)
(or "Count III").
On May 1, 1989, Taxpayer and Young executed a written
settlement agreement (the "Settlement Agreement"), according to
which Young was to pay Taxpayer $350,000, of which $100,000 was
allocated to Count III, and $250,000 to Counts I and II.2 On
May 5, 1989, as per the Settlement Agreement, Young issued two
checks payable to "J. Kenneth Alexander and Ryan & White,
Attorneys for J. Kenneth Alexander," one in the amount of
$100,000 (for Count III), and the other in the amount of
$225,395.20 (for Counts I and II, less taxes withheld).
On the 1989 Federal income tax return, Taxpayer's tax
preparer deducted $245,100 from the settlement proceeds
attributable to Counts I and II. This deduction was explained in
____________________
1 J. Kenneth Alexander v. W. F. Young, Inc., Civil Action No.
____________________ _________________
82-243 (Mass. Superior Court, Hampden County 1988).
2 The Settlement Agreement also provided that (i) Taxpayer would
be deemed to have retired from Young effective October 15, 1987;
(ii) Taxpayer would receive monthly payments commencing on May
15, 1989, and continuing for the duration of Taxpayer's life,
which total over $70,000 per year; and (iii) Taxpayer and Young
executed releases, according to which Alexander surrendered all
claims arising out of his employment and its termination.
-3-
an attached statement, which stated that Taxpayer paid Ryan &
White $258,000 in legal fees (the "Legal Fee").3 It also stated
that according to Ryan & White's time allocations, 5% of the
Legal Fee was attributable to settlement of Count III, and 95% to
settlement of Counts I and II. Accordingly, $245,100 (95% of the
$258,000 Legal Fee) was deducted from the settlement proceeds
attributable to Counts I and II.
The Commissioner sent a notice of deficiency
disallowing Taxpayer's direct deduction of the Legal Fee from the
settlement proceeds. The Commissioner determined that the
$250,000 received from Young in settlement of Counts I and II was
gross income to Taxpayer, and that the Legal Fee associated with
Counts I and II were miscellaneous itemized deductions.
Accordingly, the Commissioner reduced the $245,100 deduction
reported on the 1989 return to $240,198, due to the increase in
Taxpayer's adjusted gross income and the two percent (2-percent)
adjusted gross income limitation for miscellaneous deductions.
In addition, the Commissioner determined that, due to these
adjustments, Taxpayer was liable for the Alternative Minimum Tax
("AMT") under Section 55 of the Code, which resulted in a
deficiency of $57,441.
Petitioners filed a petition in the United States Tax
Court for redetermination of the deficiency. The Tax Court
____________________
3 The additional information included in the statement attached
to Petitioners' 1989 return, entitled "Disclosure Under Reg. Sec.
1.6661," is not included here because it is not essential for the
disposition of the issue on appeal.
-4-
rejected Petitioners' arguments, entering a final judgment on
January 31, 1995, upholding the Commissioner's determination of
Petitioners' tax deficiency. This appeal followed. We have
jurisdiction pursuant to 26 U.S.C. 7482(a)(1).
II. DISCUSSION
II. DISCUSSION
The only issue on appeal is the proper tax treatment of
the Legal Fee. We must determine whether the Petitioners
properly deducted the Legal Fee from the settlement proceeds
under Section 1001. If we find that they did not, then we must
determine whether to treat the Legal Fee as an "above the line"4
trade or business deduction under Section 162 of the Code, or as
a miscellaneous itemized deduction "below the line."5
On appeal, Petitioners essentially contend that the Tax
Court's decision to uphold the Commissioner's deficiency finding
is caused by the erroneous determination that Taxpayer was in the
trade or business of "the performance of services as an employee
during 1989." Petitioners correctly assert that the defining
issue is whether Taxpayer was Young's "employee" for purposes of
classifying the settlement proceeds and for determining the
deductibility of the Legal Fee under Section 62(a)(1). Although
____________________
4 We make reference to the "line" on the federal income tax form
where adjusted gross income is calculated.
5 Petitioners do not dispute that by treating the Legal Fee
"below the line" the amounts involved trigger the AMT and, thus,
their tax deficiency. We recognize that it is this ramification
which drives Petitioners' challenge to the Commissioner's
determination that the Legal Fee is to be treated as a
miscellaneous itemized deduction.
-5-
we agree with Petitioners' formulation of the defining issue, we
reject their arguments and affirm the court below.
A. Standard of Review
A. Standard of Review
We review the Tax Court's decision "in the same manner
and to the same extent as decisions of the district courts in
civil actions tried without a jury." 26 U.S.C. 7482(a). The
treatment of the Legal Fee is purely a question of law and,
therefore, subject to de novo review. Estate of Robertson v.
_______ ____________________
Commissioner, 15 F.3d 779, 781 (8th Cir. 1994); see also First
____________ ________ _____
National Bank in Albuquerque v. C.I.R., 921 F.2d 1081, 1086 (10th
____________________________ ______
Cir. 1990) (stating that de novo review is applied to tax court's
_______
findings of law and of ultimate fact derived from applying legal
principles to subsidiary facts). The Tax Court's findings of
fact will only be disturbed for clear error. Manzoli v.
_______
Commissioner, 904 F.2d 101, 103 (1st Cir. 1990); U.S. v.
____________ ____
Thompson, 406 F.2d 1006, 1009 (9th Cir. 1969); see also Conner v.
________ ________ ______
Commissioner, 847 F.2d 985 (1st Cir. 1988) (emphasizing
____________
appropriateness of giving weight to Commissioner's well-
established views).
B. Characterization of the Legal Fee
B. Characterization of the Legal Fee
Petitioners argue that the Legal Fee was properly
subtracted from the amount realized in the settlement, as per
Sections 1001 and 1016,6 in order to determine the "gain" from
____________________
6 Section 1001(a) provides, in relevant part,
The gain from the sale or other
disposition of property shall be the
excess of the amount realized therefrom
-6-
the disposition of Taxpayer's "valuable intangible assets," the
express and implied contracts and resulting lawsuit. In support
of their position, Petitioners contend that the Legal Fee was the
"cost of the disposition" of Taxpayer's assets because it was
incurred after Taxpayer's employment was terminated for the "sole
_____
purpose" of enhancing their value and disposing of them by
obtaining either a settlement or judgment. Petitioners further
contend that, because Sections 1001 and 1016 make no distinction
between the basis and gain rules for capital or ordinary assets,
"there is a 'capital account' for all assets, whether those
assets are considered capital or ordinary." Thus, Petitioners
____________________
over the adjusted basis provided in
[S]ection 1011 for determining gain . . .
.
Section 1011(a) provides, in relevant part,
The adjusted basis for determining the
gain or loss from the sale or other
disposition of property, whenever
acquired, shall be the basis (determined
under [S]ection 1012 . . .) adjusted as
provided in [S]ection 1016.
Section 1012 provides, in relevant part,
The basis of property shall be the cost
of such property . . . .
Section 1016 provides, in relevant part,
(a) General rule. Proper adjustment in
respect of the property shall in all
cases be made
(1) for expenditures, receipts, losses,
or other items, properly chargeable to
capital account . . . .
26 U.S.C. 1001(a), 1011(a), 1012, 1016 (1988 & Supp. 1991).
-7-
conclude, the Legal Fee is an "expenditure . . . properly charged
to [the assets'] capital account" within the meaning of Section
1016 to be offset against the settlement proceeds in order to
determine the "gain" under Section 1001.
Upon de novo review, we reject Petitioners' arguments
________
invoking treatment under Section 1001, and their contention that
the Tax Court erred when it rejected them.
In determining the tax treatment of the Legal Fee, we
take as our point of departure Section 61(a), which defines gross
income as "all income from whatever source derived," subject to
certain exclusions provided in the Code. It includes, and is not
limited to, "[c]ompensation for services, including fees,
commissions, fringe benefits, and similar items." See Helvering
___ _________
v. Clifford, 309 U.S. 331, 334 (1940) (finding that Congress
________
intended to exert the "full measure of its taxing power" through
Section 61(a)). Next, we take into consideration the well-
settled rule that the classification of amounts received in
settlement of litigation is to be determined by the nature and
basis of the action settled, and amounts received in compromise
of a claim must be considered as having the same nature as the
right compromised. Parker v. United States, 573 F.2d 42, 49, 215
______ _____________
Ct.Cl. 773 (quoting Carter's Estate v. Commissioner, 298 F.2d
_______________ ____________
192, 194 (8th Cir. 1962)), cert. denied, 439 U.S. 1046 (1978);
____________
see Furrer v. Commissioner, 566 F.2d 1115, 1116 (9th Cir. 1977),
___ ______ ____________
cert. denied, 437 U.S. 903 (1978); Clark v. Commissioner, 67
____________ _____ ____________
T.C.M. (CCH) 3105 (1994).
-8-
These two considerations lead us to our test: it "is
not whether the action was one in tort or contract but rather the
question to be asked is 'In lieu of what were the damages
awarded?'" Raytheon Production Corp. v. Commissioner, 144 F.2d
_________________________ ____________
110, 113 (1st Cir.) (citation omitted), cert. denied, 323 U.S.
_____________
779 (1944); see Getty v. Commissioner, 913 F.2d 1486, 1490 (9th
___ _____ ____________
Cir. 1990) (applying Raytheon test in characterizing settlement
________
payment for tax purposes). An amount received in lieu of
compensation under an employment contract constitutes gross
income to the recipient in the year in which it was received.
See Furrer v. Commissioner, 566 F.2d at 1117 (holding lump sum
___ ______ ____________
payment for termination of an agency relationship is ordinary
income); Heyn v. Commissioner, 39 T.C. 719, 720 (1963) (holding
____ ____________
amount received in consideration of an employment contract is
ordinary income); Clark v. Commissioner, 67 T.C.M. (CCH) at
_____ ____________ ___
(finding that lump sum payment received upon termination of
employment contract is ordinary income); Rev. Rul. 58-301, 1958-1
C.B. 23, 24 (holding lump sum payment received by an employee as
consideration for the cancellation of his employment contract
constitutes gross income to the recipient in the taxable year of
receipt); cf. Rev. Rul. 80-364, 1980-2 C.B. 294 (illustrating by
___
way of three hypothetical examples the income and employment tax
consequences of interest and attorney's fees awarded in
connection with claims for back wages).
Under this rubric, whether Taxpayer's employment
contracts are "property" or "intangible assets" in the abstract
-9-
is irrelevant to the proper analysis of the characterization of
the settlement proceeds and, thus, the proper tax treatment of
the Legal Fee. The Supreme Court's decision in Hort v.
____
Commissioner, 313 U.S. 28 (1941), is particularly instructive:
____________
Where, as in this case, the disputed
amount was essentially a substitute for
rental payments which 22(a) [of the
1932 Act] expressly characterizes as
gross income, it must be regarded as
ordinary income, and it is immaterial
that for some purposes the contract
creating right to such payments may be
treated as "property" or "capital."
Id. at 31. The cancellation of the lease in Hort "involved
___ ____
nothing more than the relinquishment of the right to future
rental payments in return for a present substitute payment and
possession of the leased premises." Id. at 32. Because those
___
future rents would have been taxed as ordinary income had they
been received in the ordinary course of the lease, the
"substitute" payment should be treated no differently. Id.
___
Similarly, here, assuming the settlement was a "cancellation" of
Taxpayer's contractual rights, what Taxpayer fought for, and
received, is merely a substitute payment for the compensation and
retirement benefits due him under his express and implied
employment contracts. Because his salary and benefits would have
been taxed as ordinary income without any offsetting basis if
received in the ordinary course under Taxpayer's employment
contract, the "substitute" payments can be treated no
differently. See Henry v. Commissioner, 62 T.C. 605, 606 (1974)
___ _____ ____________
(holding that amounts received in settlement of breach of
-10-
employment contract must be held impressed with the same
compensatory, taxable character); cf. Hodge v. Commissioner, 64
___ _____ ____________
T.C. 616 (1975) (addressing suit for back wages); Sterns v.
______
Commissioner, 14 T.C. 420 (1950), affd. per curiam 189 F.2d 259
____________ ____ __________
(6th Cir. 1951) (same).7
Similarly, Petitioners' argument that, because the
settlement was a "cancellation" of his contractual rights, it was
a "disposition" within the meaning of Section 1001(a), is
____________________
7 In support of their claim that Taxpayer's express and implied
contracts were "intangible assets," Petitioners rely on a Fifth
Circuit case and two revenue rulings holding that professional
football or baseball player contracts were assets with distinct
values that could be depreciated by the team owners. Laird v.
_____
U.S., 556 F.2d 1224 (5th Cir. 1977) (discussing professional
____
football player contracts), cert. denied, 434 U.S. 1014 (1978);
____________
Rev. Rul. 77-137, 1971-C.B. 104 (same); and Rev. Rul. 67-379,
1967-2 C.B. 127 (same, baseball). Petitioners' reliance is
clearly inapposite and unpersuasive. As the Tax Court noted, and
as Petitioners concede, Taxpayer's employment contract with Young
was neither a depreciable nor a capital asset in his hands.
Moreover, while Petitioners correctly maintain that Taxpayer's
contract claims were ordinary, not capital, assets, Furrer v.
______
Commissioner, 566 F.2d at 1117 (noting that "[i]f all contracts
____________
granting rights could be considered capital assets, without
inquiry into the nature of the rights granted, almost all
ordinary income from salaries, wages, or commissions could be
transformed into capital gain"), they nonetheless urge us to
apply here the rationale adopted in a line of cases addressing
the deductibility of legal fees incurred in the disposition of a
capital asset. See United States v. Hilton Hotels Corp., 397
___ ______________ ____________________
U.S. 580 (1970); Woodward v. Commissioner, 397 U.S. 572 (1970);
________ ____________
Helgerson v. United States, 426 F.2d 1293 (8th Cir. 1970); Baier
_________ _____________ _____
v. Commissioner, 63 T.C. 513 (1975), aff'd, 553 F.2d 117 (3d Cir.
____________ _____
1976); see also A.E. Staley Manufacturing Co. and Subsidiaries v.
________ ______________________________________________
Commissioner, 1995 WL 535269 at *46-48, 105 T.C. (CCH) 14 (1995)
____________
(providing a recent discussion of the "origin of the claim"
analysis in the context of capital assets). These cases simply
do not persuade us that Taxpayer's Legal Fee should be offset
against the settlement proceeds because, as we have already
explained, Taxpayer's Legal Fee was incurred to obtain damages in
the nature of compensation due him under the express and implied
employment contracts.
-11-
unpersuasive. As the Tax Court correctly noted, assuming the
settlement was a "cancellation" of Taxpayer's rights, it does not
necessarily follow that the settlement constituted a
"disposition" of "property" warranting an offsetting of basis.
See Herbert's Estate v. Commissioner, 139 F.2d 756 (3d Cir. 1943)
___ ________________ ____________
(discussing meaning of "disposition" and holding extinguishment
of decedent's debt, represented by readily transferable notes and
open accounts, was a disposition), cert. denied, 322 U.S. 752
____________
(1944).8 More importantly, to permit Taxpayer to offset his
"cost of disposition" or basis -- the Legal Fee -- would be
fundamentally inapposite in light of the controlling fact that
the settlement proceeds are clearly in the nature of compensation
as Young's employee.9
To recapitulate, what is relevant is that, as the Tax
Court found, Taxpayer in substance was suing for damages suffered
by the loss of his employment with Young -- his loss of
compensation in terms of salary and retirement benefits. This is
____________________
8 As the Tax Court correctly noted, Petitioners' reliance on
Herbert's Estate is inapposite. Petitioners fail to recognize
________________
that the nature of the claim involved proved an important factor
in the court's finding of a "disposition." Unlike the executors
in Herbert's Estate, Taxpayer did not hold a claim against Young
________________
in the sense of a "debt," that was readily transferable or
liquidated prior to settlement; nor, was he in any way Young's
"creditor."
9 One might intuitively argue that some sort of "basis" should
be recognized when one has to litigate to receive one's due
compensation. The fact remains, however, that the Code simply
does not provide for the offsetting of basis in such
circumstances except in limited cases involving capital assets.
Instead, the Code permits litigation expenses to be taken into
account by way of a deduction. See Section C, infra.
___ _____
-12-
a factual determination and, indeed, is one with respect to which
we find no clear error. In fact, the claim giving rise to the
Legal Fee is inexorably rooted in Taxpayer's employment with
Young -- indeed, in his status as Young's "employee."10
Because the damages Taxpayer received are essentially a
substitute for the salary and benefits he would have received
under the employment contract, they are fully included as
ordinary income in Taxpayer's gross income under Section 61,
without regard to whether Taxpayer's employment contracts
constituted "property" or "intangible assets." Hort, 313 U.S. at
____
31-32.11
Thus, upon de novo review, we find no error of law in
________
the Tax Court's rejection of Petitioners' arguments in favor of
Section 1001 treatment, because the settlement proceeds were
____________________
10 We note also that under this rubric it is irrelevant that at
the time of the lawsuit, Taxpayer was no longer on Young's
payroll. See footnote 14, supra, and related text. Equally
___ _____
irrelevant is Taxpayer's stated purpose for incurring the Legal
Fee, namely "to add value to [Taxpayer's] contract claims, and to
dispose of those assets by means of either a settlement or a
courtroom victory." See Woodward, 397 U.S. at 578 (rejecting
___ ________
purpose test and noting that it would encourage a resort to
formalisms and artificial distinctions); U.S. v. Gilmore, 372
____ _______
U.S. 39, 49 (1963) (rejecting purpose test in favor of origin of
claim test). Taxpayer's desire to obtain the salary and benefits
due under the employment contracts was clearly the "origin" of
the lawsuit - not his alleged desire to "dispose" of "intangible
assets."
11 We note that we need not address the merits of Petitioners'
claim regarding Sections 1001 and 1016, namely that because those
two sections make no distinction between the basis and gain rules
for capital or ordinary assets, "there is a 'capital account' for
all assets."
-13-
received in lieu of compensation and, as such, are fully included
as gross income under Section 61.
C. Deductibility of the Legal Fee
C. Deductibility of the Legal Fee
Having determined that the Legal Fee is included in
gross income under Section 61, we turn to the question of its
deductibility. It is well-settled that any accessions to wealth
received by a taxpayer are included in his gross income, unless
the taxpayer can demonstrate that the amount received falls
within a specific statutory exclusion. Commissioner v. Glenshaw
____________ ________
Glass, 348 U.S. 426, 431, reh'g denied, 349 U.S. 925 (1955).
_____ ____________
Section 162(a) provides that there "shall be allowed as a
deduction all the ordinary and necessary expenses paid or
incurred during the taxable year in carrying on any trade or
business." Section 62(a)(1) adds that expenses falling within
Section 162(a) are deducted from gross income to arrive at
"adjusted gross income," explicitly excluding expenses incurred
_________
by a taxpayer engaged in the trade or business of the performance
of services as an employee.12
Petitioners argue that, if the entire settlement
proceeds allocable to Counts I and II constitute gross income to
____________________
12 Section 62(a)(1) provides in pertinent part,
The deductions allowed by this chapter
(other than by part VII of this
subchapter) which are attributable to a
trade or business carried on by the
taxpayer, if such trade or business does
_______________________________
not consist of the performance of
_________________________________________
services by the taxpayer as an employee.
_______________________________________
26 U.S.C. Section 62(a)(1) (1988 & Supp. 1991) (emphasis added).
-14-
him under Section 61(a) of the Code, the Legal Fee should be
treated as an "above the line" trade or business expense under
Section 162(a) of the Code, rather than a "miscellaneous itemized
deduction" under Section 63, as the Commissioner found and the
Tax Court held. The crux of Petitioners' argument is that the
"employee" limitations of Section 62(a)(1) do not apply, because
Taxpayer was not Young's employee during 1989. Pointing to the
fact that Taxpayer was employed in 1989 as an independent
management consultant, they maintain that the Tax Court's
application of Section 62(a)(1) is based on its erroneous finding
that Taxpayer was "in the business of performing services of an
employee" during 1989.
We disagree with Petitioners. First, we reiterate that
we find no clear error in the Tax Court's determination finding
that Taxpayer was "in the business of performing services of an
employee" during 1989.13 Second, we look to the plain language
of Section 62(a)(1). As the Tax Court correctly noted, no
distinction is made in Section 62(a)(1) between present and
former employees if the expenses originated in the trade or
business of being an employee.14 Thus, the fact that Taxpayer
____________________
13 It is well-settled that an individual may engage in the trade
or business of rendering services as an employee. McKay v.
_____
Commissioner, 102 T.C. 465, 489 (1994), appeal docketed, No. 94-
____________ _______________
41189 (5th Cir. 1995) (collecting cases).
14 See McKay, 102 T.C. 489 (holding corporate executive's
___ _____
post-employment litigation expenses incurred in suit against
former employer were incurred in trade or business, and were
deductible, if at all, under Section 162); McKeague v. United
________ ______
States, 12 Cl. Ct. 671, 674-77 (1987) (finding, inter alia, that
______ __________
former employee's litigation expenses which originated in trade
-15-
was not in actuality Young's employee in 1989 does not alter the
controlling fact that the lawsuit and the ensuing settlement
directly resulted from his employment with Young. Petitioners
argue in vain that Taxpayer should not be "saddled with employee
status" because his new trade or business as an independent
management consultant indicates a "break" from his former
employment with Young (Appellants' Brief, p. 40). Equally in
vain, they argue that the "[l]awsuit should be looked at as the
ordinary and necessary expense incurred by an independent
businessman to bring suit when contracts are breached."
(Appellants' Brief, p. 40). As the Tax Court correctly found,
there is absolutely no connection between Taxpayer's lawsuit and
his independent management consulting business. Instead,
Taxpayer's lawsuit was "directly connected with, or . . .
proximately resulted from" his employment at Young.15
Kornhauser, 276 U.S. at 153. It is under this rubric that
__________
____________________
or business were deductible as ordinary expenses under Section
162), aff'd without published opinion, 852 F.2d 1294 (Fed. Cir.
_______________________________
1988); cf. Kornhauser v. United States, 276 U.S. 145, 153 (1928)
___ __________ _____________
(stating that where suit against a taxpayer is directly connected
with, or proximately resulted from, his business, expense
incurred is a business expense).
15 We note also that on the "Disclosure Under Reg. Sec. 1.6661,"
Petitioners' tax preparer describes the lawsuit against Young as
being for "age discrimination, back wages and retirement
benefits." (Appellants' Appendix, p. 68). We also note that the
releases executed pursuant to the Settlement Agreement regard
"[a]ll claims arising out of [Taxpayer's] employment by [Young]
and the cessation of [Taxpayer's] employment" and "[a]ll claims
which were or could have been asserted by [Taxpayer] in the
Lawsuit entitled J. Kenneth Alexander v. W.F. Young, Inc.,
______________________ __________________
Hampden Superior Court Civil Action No. 88-243." (Appellants'
Appendix, p. 98).
-16-
Taxpayer is considered to be in the business of being Young's
"employee" for purposes of falling within the Section 62(a)(1)
limitation.16
In another attempt to circumvent the application of
Section 62(a)(1), Petitioners argue that, if we attribute
employee status to Taxpayer, we should find that Young's direct
payment of the settlement proceeds to R&W (by way of joint checks
payable to Taxpayer and R&W as joint payees) qualifies as a
reimbursement arrangement within the meaning of Section
62(a)(2)(A). That section provides that reimbursed employee
expenses are permitted to be deducted from gross income when
arriving at adjusted gross income.17 Petitioners contend that
____________________
16 Similarly irrelevant is Petitioners' argument that the Legal
Fee was not expended for the benefit of Young's business and was
in fact detrimental to Young. See McKay, 102 T.C. 488, n.23
___ _____
(noting that "[i]t makes no difference whether the employee is
defending himself in actions that challenge his activities as a
corporate officer or the employee is bringing a suit against his
former employer."); see also McKeague, 12 Cl. Ct. 671 (involving
________ ________
litigation expenses which were not incurred for benefit of
taxpayer's employer).
17 Section 62(a)(2)(A) provides, in pertinent part, that in
determining adjusted gross income there will be allowed,
[t]he deductions allowed by part VI
(section 161 and following) which consist
of expenses paid or incurred by the
taxpayer, in connection with the
performance by him of services as an
employee, under a reimbursement or other
_______________________________
expense allowance arrangement with his
_________________________________________
employer. The fact that the
________
reimbursement may be provided by a third
party shall not be determinative of
whether or not the preceding sentence
applies.
-17-
Young's direct payment arrangement was effectively providing for
the payment of the Legal Fee pursuant to Section 62(a)(2)(A) in
light of the fact that R&W had a statutory lien under
Massachusetts law for the payment of the Legal Fee. See Mass.
___
Gen. L. ch. 221, sec. 50 (1986). This argument fails because it
is utterly without support in the record. As the Tax Court
correctly found, Petitioners have not proven that Taxpayer was
under a "reimbursement or other expense allowance arrangement"
with Young for Taxpayer's Legal Fee. Contrary to Petitioners'
insistence, the fact that the record shows Young's direct and
joint payment is "standard operating procedure" in all types of
litigation does not support the requisite finding of a
reimbursement or other "arrangement" or alter the fact that both
Young and Taxpayer were responsible for their respective legal
costs. Finally, we also note that the settlement agreement
itself makes no mention of attorney's fees and the Taxpayer's
lawsuit was dismissed "without prejudice and without costs."
Thus, we reject Petitioners' argument that Section 62(a)(2)(A)
applies, and reaffirm our conclusion that the Legal Fee falls
squarely within Section 62(a)(1).
Having determined that Section 62's employee limitation
applies, we turn to its effect on Taxpayer's Legal Fee. Expenses
____________________
26 U.S.C. 62 (1988 & Supp. 1991) (emphasis added); see H.R.
___
Conf. Rep. No. 998, 100th Cong., 2d Sess. at 204. (allowing
reimbursed expenses only if incurred pursuant to a reimbursement
or other expense allowance arrangement requiring employees
substantiate expenses covered thereunder to the person providing
the reimbursement).
-18-
excluded under the Section 62(a)(1) limitation are treated as
"itemized deductions" under Section 63, such that they are
subtracted from adjusted gross income in computing the taxpayer's
"taxable income." See I.R.C. 63(d) (stating that "itemized
___
deductions" include all deductions not "allowable in arriving at
adjusted gross income" and the deduction for personal exemptions
provided by Section 151). In turn, under Section 67(b)
"miscellaneous itemized deductions" -- which are defined as all
itemized deductions other than those specifically enumerated
therein -- are subject to a 2-percent floor, such that they are
allowable "only to the extent that the aggregate of such
deductions exceeds 2 percent of adjusted gross income." Because
trade or business expenses subject to Section 62(a)(1), such as
Taxpayer's Legal Fee, are not among the deductions listed in
Section 67(b), statutory construction leads to the conclusion
that they are miscellaneous itemized deductions subject to the 2-
percent floor. See McKay, 102 T.C. at 493;18 cf. In Re Black,
___ _____ ___ ___________
131 B.R. 106, 108 (E.D. Ark. 1991) (discussing the deductibility
of non-reimbursed employee business expenses).
Upon de novo review, and finding no merit to
_________
Petitioners' other arguments, we therefore affirm the Tax Court's
determination that the Legal Fee is properly deducted "below the
line."
____________________
18 We note that, without advancing much by way of argument,
Petitioners urge us not to follow McKay (and its statutory
_____
analysis), claiming that it is wrongly decided. We merely add
that, upon de novo review, we agree with McKay's statutory
_______ _____
analysis, and find the case on point.
-19-
D. Applicability of Alternative Minimum Tax
D. Applicability of Alternative Minimum Tax
Petitioners do not dispute that the treatment of
Taxpayer's Legal Fee as a miscellaneous itemized deduction
triggers the application of the Alternative Minimum Tax (the
"AMT") under Sections 55 and 56;19 nor do they deny that, under
Section 56(b)(1)(A)(i), they are not permitted to deduct the
Legal Fee as a miscellaneous itemized deduction (as defined in
Section 67(b)) in computing the AMT. Petitioners do argue,
however, that the Commissioner's "stretching" interpretation of
Section 62(a)(1), adopted by the Tax Court and, now, this Court,
results in "gross injustice, inequity and lack of uniformity in
the treatment of taxpayers similarly situated." (Appellants'
Brief, p. 24).
We recognize that, because the amounts involved trigger
the AMT and, thus, Taxpayer's deficiency, the outcome smacks of
injustice because Taxpayer is effectively robbed of any benefit
of the Legal Fee's below the line treatment. While unfortunate
for Petitioners here, we disagree that there is inequality of
treatment as compared to similarly situated taxpayers. Although
it may seem otherwise, in reality Petitioners have not been
denied their below the line deduction of the Legal Fee.
The AMT was enacted to "ensure that no taxpayer with
substantial economic income can avoid significant tax liability
by using exclusions, deductions, and credits." S. Rep. No. 313,
99th Cong., 2d Sess. at 518, 1986-3 C.B. (Vol. 3) v., 518; see
___
____________________
19 26 U.S.C. 55 and 56 (1988 & Supp. 1991).
-20-
also S. Rep. No. 1263, 95th Cong., 2d Sess., 1978-1 C.B. (Vol. 1)
____
315, 499. It is well established that equitable arguments cannot
overcome the plain meaning of the statute. See Okin v.
___ ____
Commissioner, 808 F.2d 1338, 1340-42 (discussing the purpose and
____________
constitutionality of the AMT), cert. denied, 484 U.S. 802 (1987);
____________
Warfield v. Commissioner, 84 T.C. 179, 184 (1985) (rejecting
________ ____________
argument that imposition of the AMT was unfair because income-
producing transaction was only a "one-time deal;" "[t]here is no
justification for creating such an exception to the express
terms" of Section 55); see also Rawlins v. Commissioner, 1995 WL
________ _______ ____________
610605, at *5-8, 70 T.C.M. 1046, ____ (1995). Petitioners
are bound by the tax consequences of the settlement as it
actually occurred. Id. at 184.
__
III. CONCLUSION
III. CONCLUSION
For the foregoing reasons, we affirm the Tax Court's
decision and uphold the Commissioner's finding of Petitioners'
deficiency. The judgment of the Tax Court is affirmed.
affirmed.
________
-21-
