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,

Justice, Loretta C. Argrett,

__________________
Allen,
_____

Attorney,

Tax Division,

Department of

Assistant Attorney General, Gary R.

_______

and Richard Farber,

_______________

Attorney, Tax

Department of Justice, were on brief for appellee.

Division,

____________________

December 22, 1995

____________________

TORRUELLA,
TORRUELLA,

Chief Judge.
Chief Judge
____________

Respondent-Appellee,

the

Commissioner of Internal Revenue (the "Commissioner"), determined

a deficiency of $57,441 in

J.

Kenneth Alexander

the 1989 Federal income tax filed

(the "Taxpayer")

and Joanne

(together, the "Appellants" or the "Petitioners").

upheld the Commissioner's

determination and the

seek review of that decision.

by

M. Alexander

The Tax Court

Petitioners now

For the reasons stated

below, we

affirm.

I.
I.

BACKGROUND
BACKGROUND

The pertinent facts, some of which have been stipulated

and incorporated

in the

district court's

dispute, and are recapitulated here.

findings, are

not in

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

with

his employer,

W. F.

which Taxpayer would

President,

reached

the age

October 15,

Young

Treasurer,

Young,

Inc. ("Young"),

remain in the capacities

and

of seventy

Chief

Taxpayer's

Executive

(70), on

1987, when Taxpayer

terminated

into an employment agreement

of Executive Vice

Officer

December 13,

was sixty-four (64)

employment.

according to

until

1993.

On

years old,

Subsequent

termination, Taxpayer offered management consulting

he

to

his

services for

a fee, and in 1989 obtained a management consulting contract with

the Hanson Group of Ludlow, Massachusetts.

-2-

On February

10, 1988,

against Young (the "lawsuit"),

by

Taxpayer filed a

civil lawsuit

in which Taxpayer was represented

the law firm of Ryan & White, P.C. ("Ryan & White").1

complaint,

Taxpayer

alleged

employment

contract

(or

"Count

breach

of

the

I"), a

breach

express

of

In his

1983

an implied

pension benefits contract (or "Count II"), and age discrimination

under Massachusetts

(or "Count III").

General Law, Chapter 151B,

Section 1 (1976)

On May 1,

1989, Taxpayer and Young

settlement agreement (the

which Young was to

allocated to

"Settlement Agreement"), according

pay Taxpayer $350,000, of which

Count III, and

$250,000 to Counts

May 5, 1989, as

per the Settlement

checks

to

payable

Attorneys

$100,000

executed a written

for J.

"J.

Kenneth

Kenneth

(for Count

III),

On

Agreement, Young issued

two

Alexander

the

$100,000 was

I and II.2

Alexander,"

and

to

and Ryan

&

White,

one

in

the

amount

of

other

in

the

amount

of

$225,395.20 (for Counts I and II, less taxes withheld).

On the

preparer

1989 Federal income tax

deducted

$245,100

attributable to Counts I and II.

____________________

from

the

return, Taxpayer's tax

settlement

proceeds

This deduction was explained in

J. Kenneth Alexander v.
____________________

W. F. Young, Inc.,
_________________

Civil Action No.

82-243 (Mass. Superior Court, Hampden County 1988).

The Settlement Agreement also provided that (i) Taxpayer would

be

deemed to have retired from Young effective October 15, 1987;

(ii) Taxpayer

would receive

15, 1989, and

continuing for

which total over $70,000

executed releases,

monthly payments commencing

the duration

of Taxpayer's

per year; and (iii) Taxpayer

according to which

on May

life,

and Young

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

that

according to

fees (the "Legal Fee").3

Ryan &

White's time

It also stated

allocations, 5%

of the

Legal Fee was attributable to settlement of Count III, and 95% to

settlement of Counts I and II.

$258,000

Legal Fee)

Accordingly, $245,100 (95% of the

was deducted

from the

settlement proceeds

attributable to Counts I and II.

The

Commissioner

sent

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

Counts

income to Taxpayer, and that the Legal Fee associated with

Accordingly,

and

the

II

were

miscellaneous

Commissioner

reduced

itemized

the

deductions.

$245,100 deduction

reported on the 1989

return to $240,198, due to

Taxpayer's adjusted gross income

adjusted

In

gross income

addition,

and the two percent (2-percent)

limitation for

the Commissioner

under

Section

55 of

miscellaneous deductions.

determined

adjustments, Taxpayer was liable

("AMT")

the increase in

that,

due to

these

for the Alternative Minimum Tax

the

Code,

which

resulted in

deficiency of $57,441.

Petitioners filed

Court for

redetermination

a petition in the

of the

deficiency.

United States Tax

The

Tax

Court

____________________

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,

January 31,

Petitioners'

entering a

final judgment

1995, upholding the Commissioner's

tax deficiency.

This appeal

jurisdiction pursuant to 26 U.S.C.

II.
II.

on

determination of

followed.

We have

7482(a)(1).

DISCUSSION
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

determine whether to

treat the Legal Fee as an "above the line"4

trade or business deduction under Section 162

not, then we must

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

during

or business of "the performance of services as an employee

1989."

Petitioners correctly

issue is whether Taxpayer was

classifying

the

settlement

deductibility of the Legal Fee

assert that

the defining

Young's "employee" for purposes of

proceeds

and

for

determining the

under Section 62(a)(1).

Although

____________________

We make reference to the "line" on the federal income tax form

where adjusted gross income is calculated.

Petitioners do

"below

not dispute

that by

treating the Legal

Fee

the line" the amounts involved trigger the AMT and, thus,

their

tax deficiency.

which

drives

determination

We recognize that it is this ramification

Petitioners'
that

the

challenge

Legal

miscellaneous itemized deduction.

-5-

Fee

to
is

the
to

be

Commissioner's
treated

as

we agree with Petitioners' formulation of the defining issue,

we

reject their arguments and affirm the court below.

A.
A.

We review the

and to

the same extent

civil actions tried

treatment

of the

Tax Court's decision "in the same manner

as decisions

without a jury."

Legal Fee

therefore, subject to

Commissioner,
____________

Standard of Review
Standard of Review

is purely

de novo
_______

review.

15 F.3d 779, 781

of the district

26 U.S.C.

courts in

7482(a).

question of

law and,

Estate of Robertson
____________________

(8th Cir. 1994);

The

v.

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

Commissioner,
____________

be

904

disturbed

F.2d

101,

for

clear

103

(1st

error.

Cir.

Manzoli
_______

1990);

U.S.
____

v.

v.

Thompson, 406 F.2d 1006, 1009 (9th Cir. 1969); see also Conner v.
________
________ ______

Commissioner,
____________

847

appropriateness

F.2d

of

985

giving

(1st

weight

Cir.

to

1988)

(emphasizing

Commissioner's

well-

established views).

B.
B.

Characterization of the Legal Fee

Characterization of the Legal Fee

Petitioners

subtracted from

Sections

argue that

the amount

1001 and 1016,6 in

the

realized in

Legal

was

properly

the settlement, as

order to determine

____________________

Fee

Section 1001(a) provides, in relevant part,

per

the "gain" from

The

gain

from

the

of

property

disposition
excess of the

sale

or

shall

amount realized

other
be

the

therefrom

-6-

the disposition

of Taxpayer's "valuable intangible

express and implied contracts and

resulting lawsuit.

assets," the

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

obtaining either

their value

and

disposing

a settlement or judgment.

of

them by

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

assets are

a 'capital

account'

considered capital

for all

assets,

or ordinary."

whether those

Thus, Petitioners

____________________

over

the

adjusted

basis

provided

in

[S]ection 1011 for determining gain . . .

.

Section 1011(a) provides, in relevant part,

The
gain

adjusted
or

loss

disposition

basis for
from the
of

determining the
sale

property,

or

other

whenever

acquired, shall be the

basis (determined

under [S]ection 1012 .

. .) adjusted

provided in [S]ection 1016.

as

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

respect

of

rule. Proper
the

property

adjustment in
shall

in all

cases be made

(1)
or

for expenditures,
other

receipts, losses,

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']

1016 to be

capital account" within the

offset against

meaning of Section

the settlement proceeds

in order

to

determine the "gain" under Section 1001.

Upon de novo review, we

________

invoking treatment under Section

reject Petitioners' arguments

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

certain exclusions provided in the Code.

derived," subject to

It includes, and is not

limited

to,

"[c]ompensation

for

commissions, fringe benefits, and

v. Clifford,
________

intended

309

61(a)).

settled

rule

settlement

of a

Next,

that the

192,

similar items."

334 (1940)

we

take into

fees,

See Helvering
___ _________

(finding that

consideration

classification

of litigation is to

of

Congress

claim must be considered

773 (quoting

the well-

amounts received

be determined by

the action settled, and amounts

right compromised.

Ct.Cl.

including

to exert the "full measure of its taxing power" through

Section

basis of

U.S. 331,

services,

in

the nature and

received in compromise

as having the same

nature as the

Parker v. United States, 573 F.2d 42, 49, 215

______
_____________

Carter's Estate
_______________

194 (8th Cir. 1962)),

v. Commissioner,
____________

cert. denied, 439

____________

298 F.2d

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?'"

110,

Raytheon Production Corp. v.

_________________________

113 (1st Cir.)

(citation omitted), cert. denied, 323 U.S.

_____________

779 (1944); see Getty

___ _____

v. Commissioner, 913 F.2d 1486,

____________

Cir. 1990) (applying Raytheon

________

payment

for

compensation

income to

See
___

tax

under

test in characterizing

purposes).

an

the recipient

An

income);

amount

for termination

of an

1490 (9th

settlement

in lieu

constitutes

in which it

F.2d at 1117

of

gross

was received.

(holding lump sum

agency relationship

is ordinary

T.C. 719, 720 (1963) (holding

consideration of

ordinary income); Clark

received

contract

in the year

Heyn v. Commissioner, 39
____
____________

received in

amount

employment

Furrer v. Commissioner, 566

______
____________

payment

Commissioner, 144 F.2d

____________

an employment

contract is

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

constitutes

for the

cancellation

of his

employment contract

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

contracts are

this

rubric,

whether

Taxpayer's

"property" or "intangible assets"

-9-

employment

in the abstract

is irrelevant

to the proper analysis of

the settlement

the

Legal

proceeds and, thus,

Fee.

The

Supreme

the characterization of

the proper tax

Court's

treatment of

decision

in

Hort
____

Commissioner, 313 U.S. 28 (1941), is particularly instructive:

____________

Where,

as

in

this

case,

amount was essentially

rental
1932
gross

a substitute

for

22(a) [of

the

payments which
Act]

expressly

income, it

ordinary

income,

the disputed

characterizes

must

be

and

it is

regarded

as
as

immaterial

v.

that

for

creating

some

purposes

right to

the

contract

such payments

may be

treated as "property" or "capital."

Id. at
___

31.

nothing

The cancellation

more than

rental payments

the

been

in return for

"substitute"

in

the

payment

Taxpayer's contractual

should be

rights,

the

Id. at
___

course

32.

treated

of

no

"involved

right to

taxed as ordinary

ordinary

Similarly, here, assuming the

in Hort
____

a present substitute

premises."

rents would have been

received

lease

relinquishment of

possession of the leased

future

of the

future

payment and

Because

those

income had they

the

lease,

the

differently.

Id.
___

settlement was a "cancellation" of

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.

been taxed

received

as ordinary

in

contract,

the

the

differently.

(holding

that

Because his salary and benefits would have

income without

ordinary course

"substitute"

any offsetting basis

under

payments

Taxpayer's

can

be

if

employment

treated

no

See Henry v. Commissioner, 62 T.C. 605, 606 (1974)

___ _____
____________

amounts

received

-10-

in

settlement

of

breach

of

employment

contract

compensatory, taxable

T.C.

616 (1975)

must

be

held

impressed

character); cf. Hodge v.

___ _____

(addressing

Commissioner, 14 T.C. 420

____________

suit for

back

with

the

same

Commissioner, 64
____________

wages); Sterns
______

(1950), affd. per curiam 189

____ __________

v.

F.2d 259

(6th Cir. 1951) (same).7

Similarly,

Petitioners'

argument

that,

because

the

settlement was a "cancellation" of his contractual rights, it was

"disposition"

within

the

meaning

of

Section

1001(a),

is

____________________

In support of their claim that Taxpayer's express and implied

contracts were
Circuit case

"intangible assets," Petitioners rely

and two

revenue rulings holding

football or

baseball player contracts were

values that

could be depreciated

U.S.,
____

556 F.2d

1224

(5th Cir.

on a Fifth

that professional

assets with distinct

by the team owners.

1977) (discussing

Laird v.
_____

professional

football player
Rev. Rul.
1967-2

contracts), cert. denied, 434

____________

77-137, 1971-C.B.

C.B.

127 (same,

104 (same);

baseball).

U.S. 1014 (1978);

and Rev. Rul.

67-379,

Petitioners' reliance

clearly inapposite and unpersuasive.

is

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,

Commissioner, 566 F.2d

____________

at 1117 (noting that "[i]f

granting

be

inquiry

rights could
into

ordinary

the

of the

gain"),

here the rationale adopted

capital

rights

salaries, wages,

into capital

all contracts

assets,

granted,

almost

or commissions

they nonetheless
in a line

without

all

could be

urge us

to

of cases addressing

deductibility of legal fees incurred in the disposition of a

capital asset.
U.S.

nature

income from

transformed
apply

the

considered

Furrer v.
______

See United States v. Hilton Hotels Corp.,

___ ______________
____________________

580 (1970); Woodward v. Commissioner,

________
____________

Helgerson
_________

397

397 U.S. 572 (1970);

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

recent discussion

analysis in the context

do not persuade
against

the

of

the "origin

of capital assets).

us that

These

Taxpayer's Legal Fee

settlement proceeds

because,

of

as

the claim"

cases simply

should be

offset

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

"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,

(1944).8

"cost of

was a

More

disposition), cert. denied,

____________

importantly, to

disposition" or

fundamentally inapposite

permit Taxpayer

basis --

in light

the Legal

Fee

322 U.S.

752

to offset

his

-- would

of the controlling

be

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

____________________

As

the Tax

Court correctly noted,

Herbert's Estate
________________
that

is inapposite.

Petitioners' reliance

Petitioners fail

on

to recognize

the nature of the claim involved proved an important factor

in

the court's finding of a "disposition."

in

Herbert's Estate, Taxpayer did not hold a claim against Young

________________

in

the sense

liquidated

of

a "debt,"

that

Unlike the executors

was readily

prior to settlement; nor,

transferable

was he in

or

any way Young's

"creditor."

One might intuitively

be

recognized

compensation.
does

not

when one

has to

litigate

The fact remains,

provide

circumstances except
Instead,

argue that some sort of

for

the

"basis" should

to receive

however, that the

offsetting

of

the Code permits

litigation expenses to

account by way of a deduction.

Code simply

basis

in limited cases involving

in

such

capital assets.

be taken into

See Section C, infra.

___
_____

-12-

one's due

a factual determination and, indeed, is one with respect to which

we

find no clear error.

Legal

Fee is

Young

--

Because

inexorably

indeed,

the

in

damages

substitute

for the

under

employment

the

ordinary

In fact, the claim

income in

rooted in

his

Taxpayer's employment

status

Taxpayer

salary and

contract,

Taxpayer's

giving rise to the

as

Young's

received

are

"employee."10

essentially

benefits he would

they

are

gross income

with

fully

have received

included

under Section

as

61,

without

regard

to

whether

Taxpayer's

employment

constituted "property" or "intangible assets."

contracts

Hort, 313 U.S. at

____

31-32.11

Thus, upon de novo review, we find no

________

the

Tax Court's rejection of

Section

1001

treatment,

error of law in

Petitioners' arguments in favor of

because the

settlement

proceeds were

____________________

10
the

We note also that under this

time of

payroll.

the

See
___

irrelevant is

rubric it is irrelevant that at

lawsuit, Taxpayer

footnote 14,

was

supra, and
_____

no longer

on

related text.

Taxpayer's stated purpose for

Young's

Equally

incurring the Legal

Fee, namely "to add value to [Taxpayer's] contract claims, and to

dispose

of those assets

courtroom
purpose

victory."
test

formalisms

See
___

and noting

and artificial

by means

of either

Woodward, 397 U.S.

________
that it

would

a settlement

at 578 (rejecting

encourage a

distinctions); U.S.

or a

v.

resort to

Gilmore, 372

____
U.S. 39, 49 (1963) (rejecting purpose
claim test).
due under
the

_______

test in favor of origin of

Taxpayer's desire to obtain the salary and benefits

the employment contracts

was clearly the

"origin" of

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.
C.

Having

gross income

Deductibility of the Legal Fee

Deductibility of the Legal Fee

determined that

under Section 61,

deductibility.

taxpayer

we turn

are included in his gross

can demonstrate

that

the

Glass,
_____

348 U.S.

reh'g denied,
____________

Section

162(a)

incurred

of its

426, 431,

provides

the

during the

that

ordinary

taxable year

falls

Commissioner v. Glenshaw
____________
________

349 U.S.

there "shall

and

income, unless

amount received

exclusion.

all

included in

to the question

within a specific statutory

deduction

Fee is

It is well-settled that any accessions to wealth

received by a taxpayer

the

the Legal

necessary

in carrying

be

925 (1955).

allowed

expenses

on any

as

paid

or

trade or

business."

Section

Section 62(a)(1)

162(a)

are

adds that expenses

deducted from

"adjusted gross income,"

gross

falling within

income

to

explicitly excluding expenses

_________

arrive at

incurred

by a taxpayer engaged in the trade or business of the performance

of services as an employee.12

Petitioners

proceeds

argue

that,

if

the

entire

allocable to Counts I and II constitute gross income to

____________________

12

settlement

Section 62(a)(1) provides in pertinent part,

The

deductions

(other

than

allowed by
by

part

subchapter) which are

trade

or

business

this chapter

VII

of

this

attributable to
carried

on

by

a
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

treated

Section 61(a)

as an "above the

of the Code,

the Legal

line" trade or

Fee should

be

business expense under

Section 162(a) of the Code, rather than a "miscellaneous itemized

deduction" under Section

Tax Court

held.

The crux

63, as the

Commissioner found and

of Petitioners' argument is

the

that the

"employee" limitations of Section

62(a)(1) do not apply, because

Taxpayer was not Young's

employee during 1989.

fact that

employed

Taxpayer

management

was

consultant,

they

in

1989

maintain

Pointing

as

that

an

to the

independent

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.

we find no clear

error in the Tax Court's

that Taxpayer was "in

Section 62(a)(1).

distinction

former

is

employees

determination finding

the business of performing services

employee" during 1989.13

of

First, we reiterate that

made in

if the

Second, we look to the

As the

Tax

Section

expenses

plain language

Court correctly

62(a)(1)

noted,

between present

originated in

of an

the

no

and

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

Commissioner, 102 T.C. 465, 489

____________

an

employee.

McKay v.
_____

(1994), appeal docketed, No. 94_______________

41189 (5th Cir. 1995) (collecting cases).

14

See
___

McKay, 102
_____

post-employment
former

States,
______

litigation

employer

deductible, if

T.C. at 489

expenses

were incurred
at all, under

(holding corporate
incurred

in trade

in

executive's

suit against

or business,

Section 162);

McKeague v.
________

and were

United
______

12 Cl. Ct. 671, 674-77 (1987) (finding, inter alia, that

__________

former employee's

litigation expenses which originated

-15-

in trade

was not in actuality Young's employee in 1989 does not alter

controlling

fact that

directly resulted

argue

the

from his

lawsuit and

the ensuing

employment with Young.

the

settlement

Petitioners

in vain that Taxpayer should not be "saddled with employee

status" because

management

his

consultant

employment with Young

vain, they argue

ordinary

new trade

and

businessman

(Appellants'

indicates

business as

"break"

(Appellants' Brief,

an

from

p. 40).

that the "[l]awsuit should be looked

necessary

to

or

bring

expense

suit

Brief, p. 40).

when

incurred

by

contracts

As the Tax

independent

his

former

Equally

in

at as the

an

independent

are

breached."

Court correctly found,

there is absolutely no

his

independent

Taxpayer's

proximately

Kornhauser,
__________

connection between Taxpayer's lawsuit and

management

lawsuit

was

resulted

276 U.S.

consulting

"directly

from"

at

connected

his

153.

business.

with,

employment

It is

Instead,

under

or .

at

Young.15

this rubric

that

____________________

or business

were deductible

as ordinary expenses

162), aff'd without published opinion,

_______________________________
1988);

under Section

852 F.2d 1294 (Fed.

Cir.

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

being

for

"age

discrimination,

the lawsuit against Young as

back

benefits." (Appellants' Appendix, p. 68).

releases executed

pursuant to

the

wages

and

retirement

We also note that

Settlement Agreement

the

regard

"[a]ll claims
and the
which

arising out of [Taxpayer's]

employment by [Young]

cessation of [Taxpayer's] employment"

were

or could

Lawsuit

entitled

Hampden

Superior Court

have been

asserted

by [Taxpayer]

J. Kenneth Alexander v.
______________________
Civil

Action No.

and "[a]ll claims

in the

W.F. Young, Inc.,

__________________

88-243." (Appellants'

Appendix, p. 98).

-16-

Taxpayer is considered

"employee" for

limitation.16

to be

purposes of

in the business

falling within the

of being

Young's

Section 62(a)(1)

In another

Section

62(a)(1),

attempt

to circumvent

Petitioners

employee status to Taxpayer,

argue

the application

that,

if

we

of

attribute

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

reimbursement

arrangement

62(a)(2)(A).

That section

expenses

are permitted

arriving at

within

provides

to be

adjusted gross

joint

payees) qualifies

the

meaning

that

deducted from

income.17

of

as a

Section

reimbursed employee

gross income

Petitioners

when

contend that

____________________

16

Similarly irrelevant is Petitioners' argument

that the Legal

Fee was not expended for the benefit of Young's business

in

fact detrimental to Young.

(noting that

"[i]t

T.C. at 488, n.23

makes no difference whether the

defending himself in actions

corporate

See McKay, 102

___ _____

and was

employee is

that challenge his activities

as a

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

part, that

in

taxpayer's employer).

17

Section 62(a)(2)(A)

provides,

in pertinent

determining adjusted gross income there will be allowed,

[t]he

deductions

allowed

by

part

VI

(section 161 and following) which consist

of

expenses

taxpayer,

paid
in

performance

or

incurred

connection

by

him

by

with

of services

the
the

as

an

employee, under a reimbursement or other

_______________________________
expense allowance arrangement with his
_________________________________________
employer.
________

The

fact

that

reimbursement may be provided by

party

shall

whether

or

not
not

be

applies.

-17-

a third

determinative

the preceding

the

of

sentence

Young's direct payment arrangement

the payment of the

light

of

the

Massachusetts

Gen. L.

is

Legal Fee pursuant to Section

fact

that

R&W

had

law for the payment

ch. 221, sec. 50 (1986).

utterly without

correctly found,

under a

was effectively providing for

support

"reimbursement or

statutory

of the Legal

lien

Fee.

under

See Mass.
___

This argument fails because it

in the

Petitioners have

62(a)(2)(A) in

record.

As the

not proven that

other expense

Tax Court

Taxpayer was

allowance arrangement"

with

Young for

insistence,

Taxpayer's Legal

the fact

joint payment is

litigation

does

that the record

costs.

not

support

itself makes no

lawsuit

Thus,

was

we

the

also note

mention of

that

direct and

all types of

finding

of

respective legal

the settlement

attorney's fees

dismissed "without

and reaffirm

requisite

responsible for their

we reject Petitioners'

applies,

shows Young's

"arrangement" or alter the fact that both

Taxpayer were

Finally,

to Petitioners'

"standard operating procedure" in

reimbursement or other

Young and

Fee. Contrary

prejudice

argument that

our conclusion that

and the

and

agreement

Taxpayer's

without costs."

Section 62(a)(2)(A)

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)

Conf.

No. 998,

100th Cong.,

Rep.

reimbursed expenses only if

or

other

expense

(emphasis added); see

___
2d

Sess. at

H.R.

204. (allowing

incurred pursuant to a reimbursement

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

deductions" include all deductions

adjusted gross income" and

provided

by

Section

itemized

deductions

"only

to

In

turn,

under

deductions" -- which are

other

therein -- are subject to a

allowable

not "allowable in arriving at

the deduction for personal exemptions

151).

"miscellaneous itemized

the

than those

Section

specifically

Section

Fee,

extent

are not

67(b), statutory

enumerated

2-percent floor, such that they

that

or business expenses subject

Taxpayer's Legal

67(b)

defined as all

the

aggregate

deductions exceeds 2 percent of adjusted gross income."

trade

"itemized

of

are

such

Because

to Section 62(a)(1), such as

among the

deductions listed

construction leads

to the

in

conclusion

that they are miscellaneous itemized deductions subject to the 2-

percent floor.

See McKay, 102

___ _____

131 B.R. 106, 108 (E.D.

T.C. at 493;18 cf.

___

In Re Black,
___________

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

Petitioners
analysis),
that,

upon

that, without
urge

us

advancing much

not to

follow

claiming that it is
de novo
_______

review,

McKay
_____

by way

(and its

wrongly decided.
we

agree

analysis, and find the case on point.

of argument,

statutory

We merely add

with McKay's
_____

statutory

-19-

D.
D.

Applicability of Alternative Minimum Tax

Applicability of Alternative Minimum Tax

Petitioners

Taxpayer's

triggers

Legal

Fee

as

the application

"AMT") under Sections

Section

do

not

of

that

miscellaneous

the

the Alternative

are

of

deduction

Minimum Tax

not permitted

a miscellaneous itemized

treatment

itemized

55 and 56;19 nor do they

56(b)(1)(A)(i), they

Legal Fee as

dispute

(the

deny that, under

to deduct

deduction (as defined

the

in

Section 67(b))

in

however, that

Section

computing the

AMT.

Petitioners

the Commissioner's "stretching"

do

argue,

interpretation of

62(a)(1), adopted by the Tax Court and, now, this Court,

results in "gross

injustice, inequity and lack

the

taxpayers

treatment of

of uniformity in

similarly situated."

(Appellants'

Brief, p. 24).

We recognize that, because the amounts involved trigger

the AMT and, thus,

injustice because

Taxpayer is effectively robbed

of the Legal Fee's

for Petitioners

Taxpayer's deficiency, the outcome smacks

below the line treatment.

here, we

disagree that

of any benefit

While unfortunate

there is

inequality of

treatment as compared to

similarly situated taxpayers.

it

in reality

may seem

otherwise,

of

Petitioners

Although

have not

been

denied their below the line deduction of the Legal Fee.

The AMT was

substantial economic

by

enacted to "ensure

that no taxpayer

income can avoid significant

using exclusions, deductions, and credits."

99th Cong.,

2d Sess. at 518,

19

26 U.S.C.

55 and 56 (1988 & Supp. 1991).

-20-

tax liability

S. Rep. No. 313,

1986-3 C.B. (Vol. 3)

____________________

with

v., 518; see

___

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

meaning

the

plain

Commissioner, 808 F.2d 1338,

____________

of

the

statute.

See
___

Okin
____

v.

1340-42 (discussing the purpose and

constitutionality of the AMT), cert. denied, 484 U.S. 802 (1987);

____________

Warfield
________

v. Commissioner,
____________

argument that imposition

producing

610605,

are

T.C. 179,

of the AMT

184 (1985)

(rejecting

was unfair because

income-

transaction was only a "one-time deal;" "[t]here is no

justification

terms"

84

for

creating such

an

exception

to the

express

of Section 55); see also Rawlins v. Commissioner, 1995 WL

________ _______
____________

at *5-8, 70 T.C.M. (CCH) 1046, ____ (1995).

bound

by

the tax

consequences

of

the

Petitioners

settlement as

it

actually occurred.

Id. at 184.
__

III.
III.

For the

CONCLUSION
CONCLUSION

foregoing reasons,

we affirm the

Commissioner's finding

Tax Court's

decision and

uphold the

of Petitioners'

deficiency.

The judgment of the Tax Court is affirmed.

affirmed.
________

-21-