1. Attorney's fees and other legal expenses, reasonable in
amount, incurred by a taxpayer (a licensed dentist engaged in
selling artificial dentures by mail) in resisting issuance by the
Postmaster General of a "fraud order" which would destroy his
business, and in connection with subsequent proceedings on judicial
review, the final result of which was unsuccessful for the
taxpayer,
held, in computing income tax under the Revenue
Acts of 1936 and 1938, deductible under § 23(a) as "ordinary and
necessary" expenses of the business. P.
320 U. S.
472.
2. The policy of 39 U.S.C. §§ 259 and 732, which authorize the
Postmaster General to issue fraud orders, will not be frustrated by
allowance of the deduction. P.
320 U. S.
474.
Page 320 U. S. 468
3. The Board of Tax Appeals was not required to regard an
administrative finding of guilt under 39 U.S.C. §§ 259 and 732 as
barring the deduction. P.
320 U. S.
475.
4. Whether an expenditure is directly related to a business and
whether it is ordinary and necessary are, in most instances,
questions of fact, the decision of which by the Board of Tax
Appeals is binding on the courts; but here, the Board denied the
claimed deduction not by an independent exercise of judgment, but
upon the erroneous view that denial was required as a matter of
law. P.
320 U. S.
475.
133 F.2d 567 affirmed.
Certiorari,
319 U. S. 70, to
review the reversal of a decision of the Board of Tax Appeals, 47
B.T.A. 95, which affirmed the Commissioner's determination of a
deficiency in income tax.
MR. JUSTICE BLACK delivered the opinion of the Court.
The question here is whether lawyer's fees and related legal
expenses paid by respondent are deductible from his gross income
under Section 23(a) of the Revenue Acts of 1936 and 1938 as
ordinary and necessary expenses incurred in carrying on his
business. [
Footnote 1]
Page 320 U. S. 469
The fees and expenses were incurred under the following
circumstances. From 1926 through 1938, respondent, a licensed
dentist of Chicago, Illinois, made and sold false teeth. During the
tax years 1937 and 1938, this was his principal business activity.
His was a mail order business. His products were ordered,
delivered, and paid for by mail. Circulars and advertisements sent
through the mail proclaimed the virtues of his goods in lavish
terms. At hearings held before the Solicitor of the Post Office
Department pursuant to U.S.C. Title 39, §§ 259 and 732, respondent
strongly defended the quality of his workmanship and the
truthfulness of every statement made in his advertisements, but the
Postmaster General found that some of the statements were
misleading and some claimed virtues for his goods which did not
exist. Thereupon, on February 19, 1938, a fraud order was issued
forbidding the Postmaster of Chicago to pay any money orders drawn
to respondent and directing that all letters addressed to him be
stamped "Fraudulent" and returned to the senders. Such a sweeping
deprivation of access to the mails meant destruction of
respondent's business. He therefore promptly sought an injunction
in a United States District Court, contending that there was no
proper evidential basis for the fraud order. On review of the
record, that Court agreed with him, and enjoined its enforcement.
The Court of Appeals drew different inferences from the record,
held that the evidence did support the order, and remanded with
instructions to dissolve the injunction and dismiss the bill.
Farley v. Heininger, 105 F.2d 79. Respondent's petition
for certiorari was denied by this Court on October 9, 1939.
Heininger v. Farley, 308 U.S. 587.
During the course of the litigation in the Post Office
Department and the courts, respondent incurred lawyer's fees and
other legal expenses in the amount of $36,600, admitted to be
reasonable. In filing his tax returns for the years
Page 320 U. S. 470
1937 and 1938, he claimed these litigation expenses as proper
deductions from his gross receipts of $287,000 and $150,000. The
Commissioner denied them on the ground that they did not constitute
ordinary and necessary expenses of respondent's business. The Board
of Tax Appeals [
Footnote 2]
affirmed the Commissioner, 47 B.T.A. 95, and the Circuit Court of
Appeals reversed and remanded. 133 F.2d 567. We granted certiorari
because of an alleged conflict with the decisions of other
circuits. [
Footnote 3]
There can be no doubt that the legal expenses of respondent were
directly connected with "carrying on" his business.
Kornhauser
v. United States, 276 U. S. 145,
276 U. S. 153;
cf. Appeal of Backer, 1 B.T.A. 214;
Pantages Theater
Co. v. Welch, 71 F.2d 68. Our enquiry therefore is limited to
the narrow issue of whether these expenses were "ordinary and
necessary" within the meaning of Section 23(a). In determining this
issue, we do not have the benefit of an interpretative departmental
regulation defining the application of the words "ordinary and
necessary" to the particular expenses here involved.
Cf.
Textile Mills Securities Corp. v. Commissioner, 314 U.
S. 326,
314 U. S. 338.
Nor do we have the benefit of the independent judgment of the Board
of Tax Appeals. It did not deny the deductions claimed by
respondent upon its own interpretation of the words "ordinary and
necessary" as applied to its findings of fact.
Cf. Hormel v.
Helvering, 312 U. S. 552,
312 U. S.
555-556. The interpretation it adopted was declared to
be required by the Second Circuit Court's reversal of the Board's
view in
National
Page 320 U. S. 471
Outdoor Advertising Bureau, Inc. v. Commissioner, 32
B.T.A. 1025. [
Footnote 4]
It is plain that respondent's legal expenses were both "ordinary
and necessary" if those words be given their commonly accepted
meaning. For respondent to employ a lawyer to defend his business
from threatened destruction was "normal;" it was the response
ordinarily to be expected.
Cf. Deputy v. Du Pont,
308 U. S. 488,
308 U. S. 495;
Welch v. Helvering, 290 U. S. 111,
290 U. S. 114;
Kornhauser v. United States, supra. Since the record
contains no suggestion that the defense was in bad faith or that
the attorney's fees were unreasonable, the expenses incurred in
defending the business can also be assumed appropriate and helpful,
and therefore "necessary."
Cf. Welch v. Helvering, supra,
290 U. S. 113;
Kornhauser v. United States, supra, 276 U. S. 152.
The government does not deny that the litigation expenses would
have been ordinary and necessary had the proceeding failed to
convince the Postmaster General that respondent's representations
were fraudulent. [
Footnote 5]
Its argument is that dentists in the mail order business do not
ordinarily and necessarily attempt to sell false teeth by
Page 320 U. S. 472
fraudulent representations as to their quality; that respondent
was found by the Postmaster General to have attempted to sell his
products in this manner, and that therefore the litigation
expenses, which he would not have incurred but for this attempt,
cannot themselves be deemed ordinary and necessary. We think that
this reasoning, though plausible, is unsound in that it fails to
take into account the circumstances under which respondent incurred
the litigation expenses.
Cf. Welch v. Helvering, supra,
290 U. S.
113-114. Upon being served with notice of the proposed
fraud order, respondent was confronted with a new business problem
which involved far more than the right to continue using his old
advertisements. He was placed in a position in which not only his
selling methods but also the continued existence of his lawful
business were threatened with complete destruction. So far as
appears from the record, respondent did not believe, nor under our
system of jurisprudence was he bound to believe, that a fraud order
destroying his business was justified by the facts or the law.
Therefore, he did not voluntarily abandon the business, but
defended it by all available legal means. To say that this course
of conduct and the expenses which it involved were extraordinary or
unnecessary would be to ignore the ways of conduct and the forms of
speech prevailing in the business world.
Cf. Welch v.
Helvering, supra, 290 U. S. 115.
Surely the expenses were no less ordinary or necessary than
expenses resulting from the defense of a damage suit based on
malpractice, or fraud, or breach of fiduciary duty. Yet, in these
latter cases, legal expenses have been held deductible without
regard to the success of the defense. [
Footnote 6]
Page 320 U. S. 473
The Bureau of Internal Revenue, the Board of Tax Appeals, and
the federal courts have from time to time, however, narrowed the
generally accepted meaning of the language used in Section 23(a) in
order that tax deduction consequences might not frustrate sharply
defined national or state policies proscribing particular types of
conduct. A review of the situations which have been held to belong
in this category would serve no useful purpose, for each case
should depend upon its peculiar circumstances. [
Footnote 7] A few examples will suffice to
illustrate the principle involved. Where a taxpayer has violated a
federal or a state statute and incurred a fine or penalty, he has
not been permitted a tax deduction for its payment. [
Footnote 8] Similarly, one who has incurred
expenses for certain types of lobbying and political pressure
activities with a view to influencing federal legislation has been
denied a deduction. [
Footnote
9] And a taxpayer who has made payments to an influential party
precinct captain in order to obtain a state printing contract has
not been allowed to deduct
Page 320 U. S. 474
their amount from gross income. [
Footnote 10] It has never been thought, however, that the
mere fact that an expenditure bears a remote relation to an illegal
act makes it nondeductible. The language of Section 23(a) contains
no express reference to the lawful or unlawful character of the
business expenses which are declared to be deductible. And the
brief of the government in the instant case expressly disclaims any
contention that the purpose of tax laws is to penalize illegal
business by taxing gross instead of net income.
Cf. United
States v. Sullivan, 274 U. S. 259.
If the respondent's litigation expenses are to be denied
deduction, it must be because allowance of the deduction would
frustrate the sharply defined policies of 39 U.S.C. §§ 259 and 732,
which authorize the Postmaster General to issue fraud orders. The
single policy of these sections is to protect the public from
fraudulent practices committed through the use of the mails. It is
not their policy to impose personal punishment on violators; such
punishment is provided by separate statute, [
Footnote 11] and can be imposed only in a
judicial proceeding in which the accused has the benefit of
constitutional and statutory safeguards appropriate to trial for a
crime. Nor is it their policy to deter persons accused of violating
their terms from employing counsel to assist in presenting a
bona fide defense to a proposed fraud order. It follows
that to allow the deduction of respondent's litigation expenses
would not frustrate the policy of these statutes, and to deny the
deduction would attach a serious punitive consequence to the
Postmaster General's finding which Congress has not expressly or
impliedly indicated should result from such a
Page 320 U. S. 475
finding. We hold, therefore, that the Board of Tax Appeals was
not required to regard the administrative finding of guilt under 39
U.S.C. §§ 259 and 732 as a rigid criterion of the deductibility of
respondent's litigation expenses.
Whether an expenditure is directly related to a business and
whether it is ordinary and necessary are doubtless pure questions
of fact in most instances. Except where a question of law is
unmistakably involved, a decision of the Board of Tax Appeals on
these issues, having taken into account the presumption supporting
the Commissioner's ruling, [
Footnote 12] should not be reversed by the federal
appellate courts. [
Footnote
13] Careful adherence to this principle will result in a more
orderly and uniform system of tax deductions in a field necessarily
beset by innumerable complexities.
Cf. Hormel v. Helvering,
supra. However, as we have pointed out above, the Board of Tax
Appeals here denied the claimed deduction not by an independent
exercise of judgment, but upon a mistaken conviction that denial
was required as a matter of law. We therefore affirm the judgment
of the Circuit Court of Appeals reversing and remanding the cause
to the Board of Tax Appeals.
Affirmed.
[
Footnote 1]
Revenue Act of 1936, c. 690, 49 Stat. 1658.
"§ 23. Deductions from gross income."
"In computing net income there shall be allowed as
deductions:"
"(a) Expenses. -- All the ordinary and necessary expenses paid
or incurred during the taxable year in carrying on any trade or
business. . . ."
Section 23(a) of the Revenue Act of 1938, c. 289, 52 Stat. 460,
is identical with Section 23(a) of the Revenue Act of 1936.
[
Footnote 2]
Section 504(a) of the Revenue Act of 1942, c. 619, 56 Stat. 798,
957, U.S.C. Title 26, § 1100, changes the name of the Board of Tax
Appeals to "The Tax Court of the United States."
[
Footnote 3]
Helvering v. National Outdoor Advertising Bureau, Inc.,
89 F.2d 878;
Helvering v. Superior Wines & Liquors,
Inc., 134 F.2d 373.
[
Footnote 4]
Helvering v. National Outdoor Advertisement Bureau, Inc.,
supra, Note 3 In that
case, the taxpayer had incurred legal expenses, defending a suit
begun by the United States to enjoin violations of the Sherman Ac.
It had successfully defended part of the charges against it, but
had agreed to the entry of a consent decree of injunction as to the
balance. The Board held that all of the legal expenses were
ordinary, and were proximately connected with the taxpayer's
business, and that to allow them as deductions would not be against
public policy. The Circuit Court reversed as to that portion of the
expenses attributable to the consent decree.
See also Helvering
v. Superior Wines & Liquors, Inc., supra, Note 3 where the Board was reversed for
allowing a taxpayer in the liquor business to deduct lawyer's fees
incurred in connection with a compromise of liability for civil
penalties assessed for improper bookkeeping under U.S.C. Title 26,
§ 2857
et seq.
[
Footnote 5]
See Note 8
infra.
[
Footnote 6]
Malpractice: C.B. V.-1, 226; Fraud:
Helvering v.
Hampton, 79 F.2d 358; Breach of fiduciary duty:
Isaac P.
Keeler v. Commissioner, 23 B.T.A. 467.
See also the
examples of deductible expenses set forth in
Kornhauser v.
United States, 276 U. S. 145.
[
Footnote 7]
For a collection and analysis of many of the cases,
see
Note (1941) 54 Harv.L.Rev. 852; 4 Mertens, Law of Federal Income
Taxation (1942) §§ 25.35-25.37, 25.102-25.105.
[
Footnote 8]
Great Northern R. Co. v. Commissioner, 40 F.2d 372;
Bonnie Bros., Inc. v. Commissioner, 15 B.T.A. 1231;
Burroughs Bldg. Material Co. v. Commissioner, 47 F.2d 178;
Appeal of Columbus Bread Company, 4 B.T.A. 1126. A
taxpayer who has been prosecuted under a federal or state statute
and convicted of a crime has not been permitted a tax deduction for
his attorney's fee.
Estate of Thompson v. Commissioner, 21
B.T.A. 568;
Burroughs Bldg. Material Co. v. Commissioner,
supra. But, if he has been acquitted, a deduction has been
allowed.
Commissioner v. People's Pittsburgh Trust Co., 60
F.2d 187;
cf. Citron-Byer Co. v. Commissioner, 21 B.T.A.
308;
Hal Price Headley v. Commissioner, 37 B.T.A. 738.
Cf. Helvering v. Superior Wines & Liquors, Inc.,
supra, Note 3
[
Footnote 9]
Textile Mills Securities Corp. v. Commissioner,
314 U. S. 326,
314 U. S. 338.
Cf. Sunset Scavenger Co., Inc. v. Commissioner, 84 F.2d
453.
[
Footnote 10]
Rugel v. Commissioner, 127 F.2d 393.
Cf.
Kelley-Dempsey & Company v. Commissioner, 31 B.T.A. 351,
where deduction was denied for the expense of commercial
extortion.
[
Footnote 11]
Criminal Code, Section 215, 25 Stat. 873, 35 Stat. 1130, U.S.C.
Title 18.
[
Footnote 12]
See Welch v. Helvering, 290 U.
S. 111,
290 U. S.
115.
[
Footnote 13]
Cf. Helvering v. F. & R. Lazarus & Co.,
308 U. S. 252,
308 U. S. 255;
Dobson et al v. Commissioner, post, p.
320 U. S. 489.