Before KALODNER, STALEY and HASTIE, Circuit Judges.
Are attorney fees incurred in contesting the Attorney General's seizure of the taxpayer's*fn1 income-producing property under the Trading with the Enemy Act, as amended,*fn2 deductible from gross income under the provisions of Section 23 of the Internal Revenue Code of 1939, as amended?*fn3
The question, of first impression, is presented by this petition for review of the Decision of the Tax Court of the United States which answered it in the negative, five judges dissenting.*fn4
The facts were stipulated and so found by the Tax Court as follows:
Madeleine duPont Ruoff, ("taxpayer"), and Hermann F. Ruoff, her husband, are citizens of the United States residing in Mahwah, New Jersey. They filed their joint federal income tax return for 1953 with the Collector of Internal Revenue for the district of Delaware. They kept their books and made their 1953 tax return on the cash basis.
On September 23, 1948, the Attorney General of the United States issued a vesting order under the Trading with the Enemy Act, relating to taxpayer's property. By that order he (a) found taxpayer to be a citizen of an enemy country, Germany; (b) determined that the national interest of the United States required that she be treated as a German national; and (c) vested in himself all of taxpayer's property in the United States, as identified on a schedule annexed to the order. He amended the vesting order nunc pro tunc on October 1, 1948. The Attorney General maintained powers of supervision and control with respect to all of taxpayer's property in the United States, but an order dated December 8, 1948, terminated supervision and control of certain property not here in controversy.
On September 23, 1948, taxpayer owned various corporate stocks and corporate and municipal bonds of an aggregate value of approximately $2,000,000. Before, at, and after September 23, 1948, those stocks and bonds produced annual dividend and interest income aggregating about $75,000. The property vested in the Attorney General included these stocks and bonds.
On September 23, 1948, taxpayer was the life beneficiary of the income of a trust established by herself in 1927 for her own benefit and that of her sons as remaindermen. The value of the corpus of the trust approximated $250,000 with an annual income of approximately $10,000. The property vested in the Attorney General included taxpayer's interest in this trust. It also included an interest in a mortgage requiring periodic principal and interest payments amounting to about $240 per year.
On October 7, 1948 taxpayer retained attorneys to pursue whatever administrative and judicial remedies were available to secure the return of the vested property. On November 10, 1948, the attorneys filed with the Attorney General taxpayer's notice of claim under the Trading with the Enemy Act for the return to her of the vested property. On November 15, 1948 they filed a civil action under the Trading with the Enemy Act in the United States District Court for the District of Columbia on taxpayer's behalf against the Attorney General for the return to her of the vested property, alleging that taxpayer was at all material times the lawful owner of the vested property. The defendant, the Attorney General, denied the allegation.
On August 12, 1953, taxpayer's attorneys and the Attorney General entered into a stipulation settling these matters. The stipulation provided that the vested property should be returned to taxpayer but that the Attorney General should retain the income increment thereon from the date of vesting to the date of the stipulation. On November 23, 1953, the Attorney General returned the vested property to taxpayer in accordance with the stipulation. The property returned to taxpayer included state and municipal bonds in the face amount of $88,000. The settlement stipulation also provided for the sale of taxpayer's life interest in the trust to the Attorney General.
Representation of taxpayer in these matters required that her attorneys do extensive preparatory work, make numerous appearances and arguments in court, and attend many conferences with departmental officials. Taxpayer paid $67,800.72 to her attorneys in 1953, which was reasonable compensation for the services rendered.
Taxpayer and her husband deducted $67,800.72 from gross income on their 1953 income tax return as legal expense. The Commissioner of Internal Revenue disallowed this deduction but in recomputing taxpayer's gain realized from the sale to the Attorney General of the life interest in the trust, the Commissioner allocated to the basis of the life interest $8,594.81 of the total legal fees of $67,800.72. The Tax Court sustained the Commissioner and this petition for review followed.
The Tax Court premised its decision on its conclusion that "In essence, the litigation * * * had as its subject only the petitioner's [taxpayer's] title to and possession of the seized property", and, accordingly, "* * * the present situation is no different from those in which it has been repeatedly held that expenses incurred in defense of title must be capitalized and are not deductible as current items."
On this petition for review taxpayer and the Commissioner cross swords in a duel of semantics - taxpayer contending its attorney fees were incurred in "recovering" the seized income-producing property while the Commissioner urges the fees were incurred in "reacquiring title" to the property. That that is so is apparent from taxpayer's "Statement of the Question Involved" and the Commissioner's "Counter-Statement of the Question Presented."*fn5
The Tax Court, it may be noted, made no finding with respect to the "recovering" or "reacquiring title" contentions which were there advanced as they are here, but said with respect to them (at page 207):
"Giving petitioner's [taxpayer's] claim its broadest scope, and assuming without deciding that the contest * * * was one to 'recover' petitioner's property and to safeguard and defend it rather than to acquire property whose ownership she had lost, it is clear that petitioner's right to the property was to some degree involved, and that her situation thus still falls within the rule ["defense-of-title" rule]."
The substance of taxpayer's contention is that the question of "title" to the seized property was "merely incidental" in her efforts to "recover" the property; that she had held "perfect title" to it for many years prior to its seizure and that had she not had such title the Attorney General could not have seized it; that the Attorney General's Vesting Order categorizing her as "a national of a designated enemy country (Germany)" and seizing the property only operated, under the Trading with the Enemy Act as a "provisional sequestration", subject to subsequent determination whether the property or its proceeds should be restored to her or be dealt with as enemy property; that the "defense-of-title" rule was not applicable in this situation, and, accordingly, she was entitled to deduction of her attorney's fees under Section 23 of the 1939 Code as expenditures made for the "conservation * * * of property held for the production of income."
The crux of the Commissioner's position is that "the legal effect of the vesting order * * * was to immediately divest the taxpayer of all right and interest in and to the property and to vest the title in the Custodian [Attorney General]", that, as earlier stated, the attorney fees were incurred "to re-acquire title to the property" and were therefore "a capital expenditure"; and, "in order to reacquire the title, it was necessary for the taxpayer to allege and prove, inter alia, that she acquired the 'original' or prevesting title prior to the June 14, 1941, amendment of Executive Order [8389, 12 U.S.C.A. § 95a note] which 'froze' or prohibited all transfers of foreign-owned property located in this country and that she had held it at all times thereafter until seizure."
Since the controversy here involves the application of Section 23(a) (2) of the Internal Revenue Code of 1939 it seems appropriate to state its provisions before proceeding to a discussion of the proper categorization of the attorney fees here.
"§ 23. Deductions from gross income. In computing net income there shall be allowed as deductions:
"(2) Non-trade or non-business expenses. In the case of an individual, all the ordinary and necessary expenses paid or incurred during the taxable year for the production or collection of income, or for the management, conservation, or maintenance of property held for the production of income."
It must immediately be noted that taxpayer does not dispute that expenditures in "defense-of-title" are capital outlays to be added to the cost of the property. She disputes, however, the Tax Court's application of the "defense-of-title" rule to the facts in the case at bar.
Coming now to the issue presented, which, as earlier stated, is one of first impression: Its resolution requires consideration of the setting of this case and preliminary determination of the effect of a "vesting order" upon title to the property seized, before deciding the ...