Docket No. 36045.
Eric Wm. Passmore, Esq., and Maurice Weinstein, Esq., for the petitioner. Paul Levin, Esq., for the respondent.
1. Petitioner, a close corporation, became a party litigant in two court proceedings brought by its former president, who was also a substantial stockholder, one suit having to do with the management and operation of petitioner and the other claiming the right to acquire a block of petitioner's stock carried by it as treasury stock. For representing it in these proceedings, petitioner paid fees to its attorneys. Held, that the fess so paid were, in part, ordinary and necessary expenses, deductible under section 23(a)(1)(A) of the Internal Revenue Code of 1939, and in part expenditures capital in character, and not deductible. The amount of deduction determined.
2. The proceedings were settled by agreement of the parties, and as a part of the settlement, petitioner's board of directors was expanded from three to five, and the two attorneys who had represented and antagonistic stockholders were made directors and for a period of 10 years given proxies to vote all of petitioner's stock. Petitioner paid each of the two new directors, in the taxable year, $1,000 for serving as a director. Held, that the directors' fees so paid were ordinary and necessary expenses deductible under section 23(a)(1) (A) of the Code. Eric Wm. Passmore, Esq., and Maurice Weinstein, Esq., for the petitioner. Paul Levin, Esq., for the respondent.
The respondent determined a deficiency in income tax against the petitioner for the taxable year 1946 in the amount of $1,958.49. The questions for decision are whether petitioner is entitled to deduct as ordinary and necessary business expenses, under section 23(a)(1)(A) of the Internal Revenue Code of 1939, (1) $6,184.60 paid as legal fees during the taxable year, and (2) $2,000 paid during the said year as directors' fees. Other assignments of error raised by the pleadings have been conceded by the parties, or dismissed pursuant to motion.
FINDINGS OF FACT.
Some of the facts have been stipulated and are found as stipulated.
The petitioner is a corporation organized and existing under the laws of the State of Wisconsin. It is, and for many years has been engaged in the retail furniture business in Milwaukee.
During 1946 petitioner's only stockholders were Stanley V. Waldheim, Helen W. Bienenstok, and Esther Waldheim. Stanley Waldheim and Helen Bienenstok are brother and sister, and Esther Waldheim is their niece. Robert L. Bienenstok is the husband of Helen Bienenstok.
For many years, Stanley Waldheim and Melvin Waldheim, his brother, had been active in the management of petitioner. After the death of Melvin, Robert Bienenstok became active in the management and operation of petitioner, along with Stanley. Friction developed between Stanley and Robert, and the result was that they were unable to agree on general business policies by which the petitioner was to be governed. Esther and Helen allied themselves with Robert, and the eventual result was the discharge of Stanley. At the time this action was taken, the board of directors consisted of Stanley, Esther, and Robert. A majority of petitioner's outstanding stock was then owned by Esther and Helen, who owned 333 1/3 and 1,000 shares, respectively. Stanley owned 666 2/3 shares, and 1,000 shares were carried by petitioner as treasury stock.
On April 6, 1945, immediately after his discharge from the employ of petitioner, Stanley filed three lawsuits in the Circuit Court of Milwaukee County.
The first lawsuit, Stanley V. Waldheim, plaintiff, versus Waldheim & Company, Inc., Robert L. Bienenstok, and Esther Waldheim, defendants, Case No. 195601, was an action praying that the defendants be ordered to deliver to Stanley 333 1/3 shares of petitioner's stock then carried by it as treasury stock, upon payment to petitioner by Stanley of $15,055.45. As a basis for his suit, Stanley alleged that he had procured a loan from the Marshall & Isley Bank, pledging a certificate for 333 1/3 shares of petitioner's stock as security therefor; that petitioner had agreed with him that it would pay his debt to the bank, take over the said debt and receive and hold the stock as security therefor, and upon repayment of the debt by him to petitioner, would surrender to him the certificate for the 333 1/3 shares; that petitioner did take over the debt from the Marshall & Isley Bank and the stock as collateral, but that though he had tendered to petitioner the amount of the debt, plus interest thereon, petitioner, through the actions of the other two defendants, had refused to accept the money and have the 333 1/3 shares of stock returned to him. In their answer, the defendants alleged that it had not been agreed that petitioner would take over the debt of Stanley to the bank and hold the 333 1/3 shares of stock as security, pending payment of the indebtedness, plus interest, by Stanley; that Stanley had defaulted on the debt to the bank, and that petitioner, rather than allow the stock to be sold at public auction, had purchased the stock; and that thereafter the stock had been held by petitioner as treasury stock. It was further alleged that there was no wrongful withholding of the stock from Stanley, upon his tender of the amount indicated.
The second lawsuit, Stanley v. Waldheim, plaintiff, versus Robert L. Bienenstok and Esther Waldheim, defendants, Case No. 195602, was an action praying that the defendants be restrained from putting into force and effect the notice of discharge of Stanley as an employee of petitioner, effective April 6, 1945. By intervention, petitioner was made a party plaintiff in that proceeding. As a basis for his suit, Stanley alleged his former connections with petitioner, both as an officer and employee; that Robert and Esther, acting ‘together in concert and by devices, schemes, artifices,‘ and the like, had entered upon a course of conduct designed to oust him from his connections with petitioner as an employee and officer, to his and petitioner's detriment. He further alleged that the business success of petitioner was largely due to his work and management; that the defendants were not experienced or capable to manage and operate petitioner and if permitted to proceed in the course they were following, the business of petitioner would suffer and financial losses would result. In their answer, the defendants admitted certain of the alleged acts, including the giving of notice to Stanley discharging him as an employee, but denied any collusion on their part or that their acts were wrongful. They also denied that the discharge of Stanley would result in damage to him or to petitioner, and alleged that the sooner Stanley left petitioner's ‘place of business, the better it will be for Company.’ In support of this allegation, it was further alleged that Stanley's conduct in remaining at petitioner's place of business and attempting to exercise authority over its employees and to perform the duties of the position from which he was discharged, was disrupting the orderly and proper management of petitioner, creating uncertainty and alarm among its employees, and seriously interfering with the daily operation of its business.
The third lawsuit, Stanley V. Waldheim, plaintiff, versus Helen W. Bienenstok, defendant, Case No. 196600, was an action for specific performance, alleging that 333 1/3 of the shares of petitioner's stock then held by Helen were rightfully his and praying that she be required to transfer the said shares to him and to pay over all dividends which had been received thereon by her.
Petitioner was represented in the lawsuits to which it was a party, and in negotiations which ultimately led to their settlement, by Eric Passmore, of the firm of Bloodgood & Passmore. Passmore also represented Helen Bienenstok in the third lawsuit. The services rendered by Bloodgood & Passmore to Helen in the third suit were not included in those for which petitioner was billed, and no part of the payments which petitioner made to Passmore or to the firm of Bloodgood & Passmore was for services rendered to her in connection with that suit or its settlement. Stanley was represented in the three lawsuits by Benjamin F. Saltzstein, while Esther and Robert were represented by I. A. Dinerstein. Both Saltzstein and Dinerstein were compensated independently by the parties whom they represented.
The premises occupied by petitioner were leased under an arrangement whereby the rental paid was determined by reference to the volume of petitioner's sales. The lessor advised petitioner that if the litigation between the stockholders and between it and the stockholders continued, the lease, which was to expire shortly, would not be renewed. In addition, petitioner had been informed by its bank that unless the lawsuits were settled, the bank would no longer be interested in carrying its line of credit. The petitioner in its operations required a substantial amount of bank credit.
Negotiations between the parties and counsel led to a settlement of the lawsuits. The settlement agreement was reduced to writing, and was, in part, as follows:
WHEREAS, the parties hereto believe that it is for the best interests of the Stockholders and of the Company to adjust any differences now existing and to agree upon future management of the Company in order that harmony and cooperation may prevail, and to that end desire to readjust the respective stock interests of the Stockholders, and to provide for a continuing management for a period of ten (10) years by electing officers and directors to serve for such period of time and to fix the compensation of such officers and directors, and their successors, for such period;
NOW, THEREFORE, in consideration of the premises and of the mutual covenants of the parties herein contained, it is hereby stipulated and agreed by all the parties as follows:
(1) The Articles of Incorporation of the Company shall be forthwith amended to increase the Board of Directors from three (3) to five (5) and to increase the term of office of the officers and directors from one (1) to ten (10) years. The Stockholders will cause the election as Directors for the period of ten (10) years of the following persons:
Robert L. Bienenstok
Stanley V. Waldheim
Benjamin F. Saltzstein
I. A. Dinerstein
Benjamin F. Saltzstein and I. A. Dinerstein shall be the only Directors to receive Directors' fees, which shall be fixed at One Thousand Dollars ($1,000.00) per annum. * * *
The Company will transfer to Stanley V. Waldheim three hundred thirty-three and one-third (333 1/3) shares of stock formerly outstanding in his name and acquired by the Company from Marshall & Ilsley Bank, for which he will pay the sum of Thirteen Thousand Dollars ($13,000.00) in cash, * * *
The settlement agreement also provided that Saltzstein and Dinerstein should resign at any time upon the ‘unanimous written request’ of Stanley, Robert, and Esther. While serving, they were to have the proxies of petitioner's stockholders as ‘voting trustees,‘ subject, however, to revocation thereof ‘by the written unanimous consent of the Stockholders.’
Pursuant to the settlement agreement, petitioner's board of directors was increased to five, and Dinerstein and Saltzstein became members in the manner agreed upon. In due course thereafter, Stanley, pursuant to the agreement, paid petitioner the sum of $13,000, and the petitioner in turn transferred or issued 333 1/3 shares of its treasury stock to him.
According to the minutes, petitioner's board of directors held meetings on the following dates in 1946: January 12, 1946, January 23, 1946, April 11, 1946, April 24, 1946, May 14, 1946, August 31, 1946, September 11, 1946, November 26, 1946. Saltzstein and Dinerstein did not attend the meetings on January 12, August 31, and September 11. In addition to the formal meetings listed, there were numerous informal meetings and telephone conversations between the directors in the course of the year with respect to the policies and operation of petitioner's business. Both Dinerstein and Saltzstein participated in these informal meetings and telephone conversations.
It was intended, under the agreement, that Saltzstein and Dinerstein should exercise and pass independent judgment in performing their duties as directors. It was not intended that either Saltzstein or Dinerstein in performing his duties as director should also be acting as counsel for his former client or clients. Both men had had wide professional and business experience, and it was anticipated that their service as directors would be in promotion of petitioner's business welfare. After they became directors, petitioner's operations resumed a more normal state, and by reason of their service the difficulties which petitioner had been experiencing due to friction between its officers and stockholders were substantially removed.
For the services rendered to it by Passmore in the first and second lawsuits, petitioner, in 1946, paid to Passmore, or to Bloodgood & Passmore, the sum of $6,184.64. Of the amount so paid, $4,500 covered the services which were directed to matters pertaining to petitioner's business operations, and the remainder was for services in connection with the lawsuit by Stanley, demanding issuance of the 333 1/3 shares of petitioner's stock to him.
During 1946 petitioner paid $1,000 each to Saltzstein and Dinerstein for their services as directors during the year.
The facts show that Case No. 195602 brought by Stanley had to do with, and directly affected petitioner's day-to-day operations. It is equally apparent from the facts that Case No. 195601 was directed to the right of Stanley to 333 1/3 shares of petitioner's capital stock, which petitioner claimed it had acquired by purchase and was carrying as treasury stock. The payments for the services performed by Passmore were not segregated as between the two suits. We have considered the evidence and have concluded thereon that $4,500 had to do with the services rendered in Case No. 195602, and that the remainder of the fees paid had to do with the services rendered in Case No. 195601. Cohan v. Commissioner, 39 F.2d 540.
We are also satisfied from the evidence, and hold that the fees paid to Passmore in connection with Case No. 195602 represented ordinary and necessary business expenses of petitioner, within the meaning of section 23(a)(1)(A) of the Internal Revenue Code of 1939. See Commissioner v. Heininger, 320 U.S. 467.
The fees paid for the services rendered in connection with the suit involving the 333 1/3 shares of petitioner's capital stock were capital in nature, and are not deductible under section 23(a)(1)(A) as ordinary and necessary business expenses. See Acer Realty Co. v. Commissioner, 132 F.2d 512, affirming 45 B.T.A. 333; Addison v. Commissioner, 177 F.2d 521, affirming a Memorandum Opinion of this Court, decided August 31, 1948.
The fees paid to Saltzstein and Dinerstein for their services as directors are, in our opinion, also clearly of a nature so as to constitute them as ordinary and necessary business expenses, within the meaning of section 23(a) (1)(A), and we so hold.
Decision will be entered under Rule 50.