113 T.C. No. 9



                UNITED STATES TAX COURT



    SKLAR, GREENSTEIN & SCHEER, P.C., Petitioner v.
      COMMISSIONER OF INTERNAL REVENUE, Respondent



Docket No. 11386-97.              Filed August 13, 1999.



     P is a corporation which provides medical services
and is a sponsor of a qualified deferred compensation
plan (the plan). S, G, and E were petitioner's owners
and employees. The plan, S, G, and E opened securities
investment accounts with X. After sustaining
substantial losses in their accounts, the plan, S, G,
and E filed a complaint against X alleging breach of
fiduciary duty and other claims. P was not a claimant
in the litigation. The litigation spanned 4 years, and
P paid nearly 50 percent of the litigation costs
incurred because the four claimants lacked the funds.
R determined that sec. 1.404(a)-3(d), Income Tax Regs.,
controls the deduction in this case and that only
expenses incurred by an employer that are of a
recurring nature are deductible thereunder.
     Held: P may deduct the portion of litigation
costs incurred in connection with the plan under sec.
162. Section 404 limits deductions for contributions
to a plan but does not preclude P from deducting its
                                  - 2 -


     payment of these plan expenses. See sec. 1.404(a)-
     3(d), Income Tax Regs. Held, further, accuracy-related
     penalty under sec. 6662(a) sustained.



     Leonard Bailin, for petitioner.

     Rose E. Gole, for respondent.



                                 OPINION

     LARO, Judge:   The parties submitted this case to the Court

without trial.   See Rule 122.    Petitioner petitioned the Court to

redetermine respondent's determination of a deficiency in tax for

1993 of $118,964, and an accuracy-related penalty for negligence

under section 6662(a) of $23,793.

     After concessions of the parties, we decide the following

issues:

     1.   Whether petitioner may deduct legal fees of $97,274 paid

on behalf of its qualified pension plan and certain individuals.

We hold it may to the extent discussed herein.

     2.   Whether petitioner is liable for the accuracy-related

penalty for negligence under section 6662(a).    We hold it is.

     Unless otherwise noted, section references are to the

Internal Revenue Code in effect for the year in issue.    Rule

references are to the Tax Court Rules of Practice and Procedure.
                                 - 3 -


                           Background

     All facts are stipulated.    The stipulated facts and exhibits

submitted therewith are incorporated herein by this reference.

Petitioner's principal place of business was in Woodmere, New

York, when it petitioned the Court.

     Petitioner is a professional corporation which provides

medical services in the area of internal medicine.    During 1993,

Dr. Steven Greenstein (Greenstein) and Dr. Max Scheer (Scheer)

were petitioner's sole shareholders, each owning 50 percent, and

were employees and officers of petitioner.    Dr. Leo Sklar (Sklar)

practiced medicine as an employee and shareholder of petitioner

until 1986, at which time he sold his interest and retired.

     During 1993, petitioner had in effect and was the sponsor of

a money purchase plan entitled the Sklar, Greenstein & Scheer

Employee Retirement Plan and Trust (the plan), which plan had

been in existence for several years.     Greenstein and Scheer were

the plan trustees during all relevant periods.    During 1985, Gary

Zahn (Zahn), a representative of Prudential-Bache Securities,

Inc. (Prudential), approached Sklar, Greenstein, and Scheer about

opening securities accounts with Prudential.    Impressed with

Zahn's perceived abilities, Sklar, Greenstein, and Scheer each

opened several personal accounts with Prudential,1 and they


     1
      For example, Sklar, Greenstein, and Scheer, each opened
individual retirement accounts and other higher risk funds, and
                                                   (continued...)
                               - 4 -


opened an account for the plan.   From 1985 through 1990, the plan

invested $192,614 in its account with Prudential, and Sklar,

Greenstein, and Scheer invested collectively $1,323,154.2

     By 1991, Sklar, Greenstein, Sheer, their respective spouses,

and the plan (collectively referred to as the claimants) were

dissatisfied with Zahn's account management and filed a complaint

with the American Arbitration Association (the Prudential

litigation).   The complaint alleged that Prudential was liable to

them for an array of actionable conduct, including that

Prudential and Zahn recommended inappropriate investments,

engaged in racketeering violations, committed breach of contract

and breach of fiduciary duty, made unauthorized trades, and

committed common-law fraud.   Petitioner was not a claimant in the

Prudential litigation.

     The Prudential litigation spanned 4 years, 1991 through

1994, and the claimants incurred collectively $578,359 in

attorney’s fees and other costs (the litigation costs).     During

the pendency of the case, petitioner paid and deducted $269,078

of the $578,359 in litigation costs, $97,272 of which was paid




     1
      (...continued)
each titled his account either in his individual name, the name
of his spouse, or in his name jointly with his spouse.
     2
      This amount represents the sum of the individual amounts
invested by Sklar, Greenstein, and Sheer, and deposited into
their respective accounts.
                               - 5 -


and deducted during 1993.3   The remaining amounts were paid by

the other claimants.

     As relevant, the plan provided the following regarding

payment of plan expenses:

     All reasonable costs, charges and expenses incurred by
     the Trustee in connection with the administration of
     the Fund and all reasonable costs, charges and expenses
     incurred by the Plan Administrator in connection with
     the administration of the Plan (including fees for
     legal services rendered to the Trustee or Plan
     Administrator) may be paid by the Employer, but if not
     paid by the Employer when due, shall be paid from the
     fund.

The plan provided that the trustees did not guarantee the trust

fund against investment loss, and that the trustees would be

indemnified by petitioner, as employer, for any liability to

which they might be subjected while acting as trustees.

     On August 31, 1993, Prudential and the claimants entered

into a settlement agreement calling for a cash payment by

Prudential of $2,302,324.58.   This amount was allocated among the

claimants in accordance with a collection factor applicable to

each claimant.4   The plan's collection factor was approximately

15 percent, and it received $347,588 of the settlement proceeds.

The collection factors of Sklar, Greenstein, and Scheer totaled



     3
      The total litigation costs incurred during 1993 were
$239,714.
     4
      The claimants' attorneys allocated the settlement proceeds
in accordance with an assigned collection factor which
purportedly reflected the strength of each claimant's case.
                               - 6 -


the remaining 85 percent, and Sklar, Greenstein, and Scheer

received the balance of the settlement proceeds in accordance

therewith.5

     On its return for 1993, petitioner deducted the $97,274 in

litigation costs paid.   Leonard Bailin (Bailin), a certified

public accountant who prepared the return, was the accountant for

all claimants in the Prudential litigation for many years

including 1993.   Bailin was aware that some of the litigation

costs were being paid by the petitioner because the other

claimants lacked funds and was aware that petitioner paid $97,274

in 1993.   Bailin neither discussed with petitioner nor advised it

regarding the propriety of petitioner's deducting litigation

costs, and he merely assumed they were deductible to petitioner.

Respondent determined that the litigation costs of $97,274 were

not deductible to petitioner, or, in the alternative, that

petitioner could only deduct the share allocable to the plan.




     5
      The claimants' attorneys also allocated the balance of
incurred but unpaid legal expenses to the claimants based upon
their collection percentage and deducted this amount from their
respective proceeds.
                                - 7 -


                              Discussion

     We decide for the first time whether section 1.404(a)-3(d),

Income Tax Regs., restricts an employer/plan sponsor's right to

deduct an expense related to a qualified pension plan when the

expense is ordinary and necessary to the employer but not

"recurring in nature".    Petitioner argues the regulation does not

restrict its right to deduct such a nonrecurring expense because

the text provides explicitly for deduction of "any" expense that

satisfies the "ordinary and necessary" test of section 162.

Respondent argues the regulation is read more narrowly to permit

deduction of only "administrative" expenses which are ordinary

and necessary and recurring in nature.     Respondent relies on Rev.

Rul. 86-142, 1986-2 C.B. 60, to support this position.    This

ruling, as discussed in detail below, concludes nonrecurring

expenses paid by an employer are not deductible under this

regulation.    We disagree.

     Our analysis starts at section 162(a), which provides

generally:    "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".6    However, if

contributions otherwise deductible under section 162 are made by



     6
      Respondent does not make an issue of whether petitioner
"incurred" the expenses but rather argues only that the "ordinary
and necessary" element is not met due to the nonrecurring
character of the expenses.
                               - 8 -


an employer to a deferred compensation plan, section 404 applies

and preempts the deductibility of such contributions under any

other section.7   Section 404(a) provides:

     If contributions are paid by an employer to or under a
     stock bonus, pension, profit-sharing, or annuity plan,
     or if compensation is paid or accrued on account of any
     employee under a plan deferring the receipt of such
     compensation, such contributions or compensation shall
     not be deductible under this chapter; but, if they
     would otherwise be deductible, they shall be deductible
     under this section, subject, however, to the following
     limitations as to the amounts deductible in any year *
     * *

As applicable, section 404(a)(1)(A) places generally the

deductible limit on contributions at the amount necessary to

satisfy the full funding standard provided by section 412(a).

The pre-emptive nature of section 404 as to plan contributions is

further clarified by section 1.162-10(a), Income Tax Regs., which

provides that no deduction is allowed under section 162 if the

amounts are used to provide benefits under a deferred

compensation plan.



     7
      The predecessor to sec. 404 first appeared in the Code as
sec. 23(p) of the Revenue Act of 1928, ch. 852, 45 Stat. 791,
799-802. Before adoption of the Revenue Act of 1942, ch. 619, 56
Stat. 798, contributions made to employees' deferred compensation
funds could be deducted either as "ordinary and necessary"
business expenses under sec. 23(a) (the predecessor to sec. 162),
or under the specific provisions for such deductions under sec.
23(p). See sec. 23(p) (1939); Tavannes Watch Co. v.
Commissioner, 

 (2d Cir. 1949), revg. 

(1948). The Revenue Act of 1942 amended sec. 23(p), making it
the exclusive section under which deductions for contributions to
deferred compensation plans could be claimed. See ch. 619, 56
Stat. 798, 863.
                               - 9 -


     Section 404 supplanted other code sections with respect to

deductions for contributions to a deferred compensation plan.     As

such, we initially address whether the payment of litigation

costs on behalf of the plan was a contribution under section 404.

Pertinent to this inquiry is section 1.404(a)-3(d), Income Tax

Regs., which provides:

     Any expenses incurred by the employer in connection
     with the plan, such as trustee's and actuary's fees,
     which are not provided for by contributions under the
     plan are deductible by the employer under section 162
     (relating to trade or business expenses), or 212
     (relating to expenses for production of income) to the
     extent that they are ordinary and necessary.[8]

     Neither the statute nor the regulations define the term

"contribution".   On brief, respondent proffers the following

definition:

     [contribution is] defined as an amount paid by an
     employer into a pension trust to provide for the
     payment of benefits under the plan and to provide for
     ordinary and necessary administrative expenses incurred
     by the plan to the extent that those expenses are paid
     from the trust fund. If the ordinary and necessary
     administrative expenses incurred by the plan are paid
     directly by the employer rather than from the trust
     fund, these amounts are not considered to be
     contributions and, hence are not subject to the limits
     of I.R.C. § 404.

We agree with respondent's definition.   The purpose of section

1.404(a)-3(d), Income Tax Regs., as we read it, is to clarify

that, if an employer pays ordinary and necessary plan-related


     8
      This regulation was adopted in 1956 after Congress'
overhaul of the Code in 1954 and has remained unchanged since
then. See T.D. 6203, 1956-2 C.B. 218, 219-278.
                             - 10 -


expenses directly to a third party from the employer's assets,

and if such expenses are not provided for by contributions under

the plan, those payments will not be deemed constructive

contributions to the plan subject to section 404 limitations but

rather are expenses deductible under section 162.   This

interpretation is in harmony with the statute, the purpose of

which is to limit deductions for contributions.   This

interpretation is supported by respondent's suggested definition

of "contribution" and by respondent's proffered rationale behind

the regulation:

     The intention of Treas. Reg. § 1.404(a)-3(d) was to
     provide employers with two alternative ways of meeting
     the ordinary and necessary expenses of administering
     pension plans for their employees. The employer can
     either pay these costs to the plan trustee in the form
     of additional plan contributions, and leave to the plan
     trustee the responsibility for paying the incurred
     expenses, or the employer may pay these expenses out of
     general assets of the employer and deduct them under
     I.R.C. § 162 to the extent they are ordinary and
     necessary.

     Payments by an employer to a third party for ordinary and

necessary plan expenses fall outside the definition of

"contribution" only if the expenses are "not provided for by

contributions under the plan".9   See sec. 1.404(a)-3(d), Income


     9
      This makes sense, for example, in the case of a defined
benefit plan where plan expenses provided for by the plan are
variables accounted for in the actuarial process. See sec.
1.404(a)-3(b), Income Tax Regs; Perdue, Qualified Pension and
Profit-Sharing Plan par. 13.06 (2d ed. 1998). In such cases
where the allowed contribution is increased to account for
                                                   (continued...)
                                  - 11 -


Tax Regs.     In this case, the plan provides the employer the

option of paying expenses, but does not mandate payment by the

employer.     Respondent concedes that this elective language means

the expenses were not provided for by contributions under the

plan.10     Thus, payment of the litigation costs is not treated as

an actual or constructive contribution to the plan subject to

section 404, and the allowance of the deduction is governed

instead by section 162, to the extent the costs are ordinary and

necessary expenses incurred by petitioner in connection with the

plan.

     Section 162 allows for a deduction if the expense was:       (1)

Ordinary and necessary; (2) paid or incurred during the taxable

year; (3) in carrying on the taxpayer's trade or business.       See

sec. 162(a); Welch v. Helvering, 

 (1933).     Ordinary

is determined by time, place, and circumstance.     The kind of

transaction out of which the obligation arose and its normalcy in



     9
      (...continued)
expenses, if the employer then pays the expenses directly a
deduction could be a "double dip".
     10
          Respondent maintains:

          Since the expenses at issue were paid directly by
     the employer, they are "not provided for by
     contributions under the plan" within the meaning of
     Treas. Reg. sec. 1.404(a)-3(d). As a result, the issue
     in this case is whether the expense for the Prudential
     litigation was an ordinary and necessary expense for
     the Retirement Plan and therefore deductible under
     I.R.C. § 162.
                               - 12 -


the particular business are controlling.   See Deputy v. DuPont,

, 496 (1940).   Necessary connotes a sense that the

expense is appropriate and helpful, rather than absolutely

essential.    See Welch v. Helvering, supra at 113.   Petitioner

maintained the plan as compensation for its employees, and the

plan lost money due to Prudential's alleged misconduct.    We are

convinced petitioner's funding of the litigation costs, to the

extent allocable to the plan, was both ordinary and necessary to

petitioner's trade or business.   Petitioner has satisfied the

section 162 requirements as to the portion of litigation costs

allocable to the plan set forth below.

     Respondent argues erroneously that section 1.404(a)-3(d),

Income Tax Regs., allows deduction only of expenses that are of a

"recurring nature" related to "administration" of the plan.

Citing Rev. Rul. 86-142, 1986-2 C.B. 60, respondent argues the

litigation costs are "non-recurring expenses" and therefore, not

deductible.   In that revenue ruling, the issue was whether the

employer could deduct amounts paid into a pension trust by an

employer to reimburse the trustee for broker’s fees paid by the

trust.   In holding the broker’s fees were not deductible, the

Commissioner reasoned:   "Brokers commissions are not recurring

administrative or overhead expenses, such as trustee or actuary

fees, incurred in connection with the maintenance of the trust or

plan."   See Rev. Rul. 86-142, 1986-2 C.B. 61.
                                - 13 -


       Respondent misconstrues the regulation.   To restate, section

1.404(a)-3(d), Income Tax Regs., is a clarification of whether

and in what circumstances payment by an employer of plan expenses

is a "contribution", the deduction of which is limited by section

404.    It further clarifies that section 162 governs the deduction

of any payments falling outside the reach of section 404.    In the

circumstances described in section 1.404(a)-3(d), Income Tax

Regs., section 404 does not limit or restrict expenses that are

otherwise deductible under section 162.    There is no requirement

under section 162 that the expense be "recurring in nature" or

related solely to administration, and, in fact, a payment may be

a one-time occurrence and still be ordinary and necessary.    See

Commissioner v. Heininger, 

 (1943); Welch v.

Helvering, supra at 114.

       To the extent respondent relies on Rev. Rul. 86-142, 1986-2

C.B. 60, we disagree with the reasoning therein and decline to

adopt that reasoning.11    See Stark v. Commissioner, 

(1986) (revenue ruling is not binding on this Court).    Respondent

does not argue the regulation is ambiguous or that any particular



       11
      Notwithstanding our holding herein, we do not believe the
result reached in Rev. Rul. 86-142, 1986-2 C.B. 60, would change
because broker's commissions incurred in connection with the
acquisition of securities must be capitalized. See Helvering v.
Winmill, 

 (1938); sec. 1.263(a)-2(e), Income Tax Regs.
Respondent has not raised the issue of whether the litigation
costs at issue here were capital expenses, and we express no
opinion in this regard.
                              - 14 -


canon of construction should be applied.12   See Estate of

Schwartz v. Commissioner, 

 (1984) (where

administrative regulations are ambiguous the rules of statutory

construction will apply); see also 1A Sands, Statutes and

Statutory Construction, sec. 31.06 (1872).   In any case, we need

only resort to one cardinal canon here as the regulation clearly

and unambiguously provides "any expenses" incurred by an employer

in connection with a plan are deductible under section 162 as

long as they are ordinary and necessary and are "not provided

for" by contributions under the plan.   We presume that the

Treasury, the drafter of the regulation, said what it means and

means what it said.   See Connecticut Natl. Bank v. Germain, 

 (1992) (for a discussion of the cardinal canon).     We do

not read the phrase "such as trustee's and actuary's fees" as

restricting the breadth of "any expenses" but rather as being

illustrative in nature.13

     Having decided petitioner may deduct the litigation costs

allocable to the plan, we decide which portion is so allocable.

Petitioner paid $97,274 in litigation costs in connection with a

case involving four separate claimants; to wit, Sklar,



     12
      For example, respondent does not argue the doctrine of
ejusdem generis to support his position that only expenses of the
same type as "trustee's and actuary's fees" may be deducted.
     13
      The term "such as" is defined as "for example". See
Webster's II New Riverside University Dictionary 1157 (1984).
                                - 15 -


Greenstein, Scheer, and the plan.     The claims of Sklar,

Greenstein, and Scheer accounted for 85 percent of the recovery

in this case, and a portion of the legal expenses incurred in

1993 was allocable to their claims.      To the extent petitioner

paid any portion of the litigation costs allocable to Sklar,

Greenstein, or Scheer, petitioner paid the expenses of other

taxpayers, and such expenses were not incurred in connection with

the plan.    Petitioner paid its own expenses only to the extent

that the litigation costs were allocable to the plan.      See George

R. Holswade, M.D., P.C.     v. Commissioner, 

, 699-701

(1984) (rejecting respondent's claim that an employer's payment

of a plan-related expense was the payment of another's expense).

     The claimants allocated the settlement proceeds and

remaining unpaid legal fees in accordance with a collection

factor.     Neither party has suggested that this allocation was

disproportionate or improper, and we find the allocation

percentages reasonable.     Of the $239,717 in litigation costs

incurred in 1993, 15 percent (the plan's collection factor) or

$35,957 is allocable to petitioner, and the remaining $203,760 is

allocable to Sklar, Greenstein, and Scheer.      We hold petitioner

may deduct the $35,957 allocable to the plan.

     The remaining $61,317 in litigation costs paid ($97,274-

$35,957) is allocable to Sklar, Greenstein, and Scheer.      This

stipulated record contains no evidence from which we can find
                              - 16 -


that petitioner's payment of litigation costs related to these

individuals was ordinary and necessary to petitioner's business

or was made by petitioner in connection with the plan.    To the

contrary, the only evidence regarding petitioner's motive for

paying the litigation costs is that all claimants lacked the

necessary funds.   This motive was not proximately related to the

plan or to petitioner's trade or business, and the expense was

neither ordinary nor necessary.   We sustain respondent's

determination to the extent of $61,317.

     Respondent determined petitioner is liable for the

accuracy-related penalty under section 6662(a) and (b)(1) for the

year in issue.   That section imposes a penalty equal to 20

percent of the portion of an underpayment that is attributable

to, among other things, negligence.    Petitioner will avoid this

penalty if the record shows that it was not negligent; i.e., it

made a reasonable attempt to comply with the provisions of the

Internal Revenue Code, and it was not careless, reckless, or in

intentional disregard of rules or regulations.   See sec. 6662(c);

Accardo v. Commissioner, 

, 452 (7th Cir. 1991), affg.

 (1990); Drum v. Commissioner, T.C. Memo. 1994-433,

affd. without published opinion 

 (9th Cir. 1995).

Negligence connotes a lack of due care or a failure to do what a

reasonable and prudent person would do under the circumstances.

See Allen v. Commissioner, 

 (1989), affd. 

                                - 17 -


(9th Cir. 1991); Neely v. Commissioner, 

, 947 (1985).

The accuracy-related penalty of section 6662 is not applicable to

any portion of an underpayment to the extent that an individual

has reasonable cause for that portion and acts in good faith with

respect thereto.    See sec. 6664(c)(1).   Such a determination is

made by taking into account all facts and circumstances,

including whether the taxpayer relied on a professional tax

adviser.    See sec. 1.6664-4(b)(1), Income Tax Regs.   Reliance on

the advice of a tax professional is a defense to the accuracy-

related penalty when the taxpayer establishes:    (1) The adviser

had sufficient expertise to justify reliance, (2) the taxpayer

provided necessary and accurate information to the adviser, and

(3) the taxpayer actually relied in good faith on the adviser’s

judgment.    See Ellwest Stereo Theatres of Memphis, Inc. v.

Commissioner, T.C. Memo. 1995-610.

     On this stipulated record, we conclude petitioner is liable

for the accuracy related penalty.    Petitioner conceded several

items in the notice of deficiency, and, as to the conceded items,

there is no evidence that reasonable cause existed or that

petitioner was not negligent.    As to the deduction for the

litigation costs attributable to the individual claimants, no

reasonable cause existed and there is no evidence petitioner was

not negligent.    While the parties stipulated "Mr. Bailin's

clients relied upon him to properly prepare their returns," the
                              - 18 -


parties also stipulated Bailin and petitioner never discussed the

issue and that they "assumed" the litigation costs were

deductible.   On this record, we conclude the elements for

reasonable reliance on a tax adviser are not satisfied.   We hold

petitioner is liable for the penalty for negligence on the entire

deficiency resulting from the Rule 155 computation.

     In reaching our holdings herein, we have considered each

argument made by the parties, and, to the extent not discussed

above, find those arguments to be irrelevant or without merit.

To reflect the foregoing,



                                    Decision will be entered

                               under Rule 155.