Peoples-Pittsburgh Trust Co. v. Commissioner

*588 This proceeding is for the redetermination of an alleged deficiency in income tax of Herbert DuPuy for the calendar year 1921, amounting to $62,113.75. Only so much of the alleged deficiency as arises from the action of the respondent in disallowing as a deduction the amount of $162,048.12 attorney fees and other incidental expenses is in dispute, and the petitioners allege as error the respondent's*1835 action in refusing to allow such deduction.

The death of Herbert DuPuy, the original petitioner, subsequent to the filing of the petition herein, having been suggested to the Board, the Peoples-Pittsburgh Trust Co. and Amy H. DuPuy, executors under the will of Herbert DuPuy, were, on motion, substituted as parties petitioner. The facts were stipulated.

FINDINGS OF FACT.

Herbert DuPuy until the time of his death was a citizen of Pittsburgh, Pa. He graduated from Lehigh University in 1878, after having completed a course in metallurgical engineering. Thereafter, he entered the employment of Andrew Carnegie in the iron and steel business and continued in the iron and steel business continuously until 1919, making such business his life work.

During 1917 and 1918 he was chairman of the board of directors of the Crucible Steel Co. of America, and during those years he devoted his time and attention almost exclusively to the affairs of the Crucible Steel Co. of America, giving his personal attention to the consideration of war contracts for shells and other munitions. *589 His compensation as salary and bonus from that company was $548,877.25 for 1917 and $596,725.39*1836 for 1918. As the executive head of the Crucible Steel Co. of America he signed and made affidavit to the income and excess-profits-tax returns of that company and its subsidiaries for the fiscal years ending in 1917 and 1918.

Revenue agents examined and investigated the income and excess-profits-tax returns of the Crucible Steel Co. of America and its subsidiaries for the fiscal years ending in 1917 and 1918 and, being of the opinion that such returns were incorrect, fraudulent, and evasive, caused criminal charges to be preferred against Herbert DuPuy. The matter was so proceeded with that a Federal grand jury in the District Court of the United States for the Western District of Pennsylvania found an indictment or true bill (No. 159, November term, 1920) against Herbert DuPuy and George A. Turville, secretary and treasurer of the Crucible Steel Co. of America and its subsidiaries, who, together with Herbert DuPuy, had signed and made affidavit to the tax returns of that company and its subsidiaries for the fiscal years ending in 1917 and 1918. The indictment charged Herbert DuPuy and George A. Turville, among other things, with conspiracy to defraud the United States out of*1837 taxes legally and properly payable to the United States by the Crucible Steel Co. of America and its subsidiaries.

Herbert DuPuy employed counsel, special auditors, and other representatives to take charge of his case and to prepare a defense in his behalf. He was arraigned for trial in the District Court of the United States for the Western District of Pennsylvania and after a trial by a jury extending over a period of four weeks was found not guilty by the jury on April 8, 1921. He paid in fees to his attorneys and to his accountants and auditors, and for traveling and other incidental expenses, the amount of $162,048.12, as follows:

Herbert DuPuy instituted legal action against the Crucible Steel Co. of America in 1922 in the District Court of the United States for the Western District of Pennsylvania to recover the foregoing costs and expenses. The defendant company demurred to the plaintiff's declaration and the demurrer was sustained. *1838 .

OPINION.

SMITH: The issue in this case is whether the amount of $162,048.12 paid out by Herbert DuPuy as fees to attorneys and accountants *590 and incidental expenses in connection with defending himself from a criminal charge for conspiracy is deductible in computing his taxable net income for the calendar year 1921. Counsel for petitioners, on brief, after citing numerous decisions of the Board, including several decisions relating to the character of expenses incurred in defending criminal actions, contend that:

The United States of America prosecuted Herbert DuPuy on a charge of conspiring with George A. Turville to defraud the United States out of income and excess profits taxes legally and properly payable by the Crucible Steel Company of America and its subsidiaries to the United States for the years 1917 and 1918. Herbert DuPuy was the executive head of the Crucible Steel Company of America and of its subsidiaries. George A. Turville was Secretary and Treasurer of said corporations. The Two defendants, in their official capacities, executed and made affidavit to the tax returns of*1839 the Crucible Steel Company, for the years 1917 and 1918. It is obvious that the above action of Herbert DuPuy related to the trade or business. The law required corporations to prepare and file income tax returns for the years in question. The law also required these returns to be signed and sworn to by the executive officers. In preparing and signing the income tax returns of the Crucible Steel Company and of its subsidiaries, Herbert DuPuy was at one and the same time, complying with the requirements of the Revenue Act and also performing his duty towards the Crucible Steel Company and it subsidiaries, as chief executive officer. It can not be said that Herbert DuPuy was acting beyond the scope of his authority and, hence, individually. The Government challenged the tax returns, not because Mr. DuPuy was acting beyond the scope of his authority (and hence individually), but solely because Mr. DuPuy, while acting within the scope of his authority, as conceded by the Government, was party to a conspiracy to make a false return and thus defraud the United States out of taxes lawfully due and payable.

It is conceded in the stipulation of facts filed in this case, that during*1840 the years 1917, and 1918, Herbert DuPuy devoted his time and attention almost exclusively to the affairs of the Crucible Steel Company of America, giving his personal attention to the consideration of war contracts for shells and munitions. It is also stipulated that Herbert DuPuy was a Metallurgical Engineer by profession, and had made the iron and steel business his life work. That he was one of the leaders of the industry was conclusively established by the fact that his compensation from the Crucible Steel Company and its subsidiaries was $548,877.25 for the year 1917, and $596,725.39 for the year 1918. The performance of his duties and responsibilities as the executive head of the Crucible Steel Company and its subsidiaries was Herbert DuPuy's profession, vocation, trade or business. His ability in this profession and vocation produced a handsome income, of which the United States received the greater part in taxes.

The respondent maintains that the deductions claimed did not constitute ordinary and necessary expenses incurred by Herbert DuPuy in carrying on any trade or business, and in support of this contention counsel, on brief, cites numerous decisions of the Board*1841 and the decision in . With respect to contentions of counsel in this proceeding, we agree with the contention of counsel for petitioners that *591 Herbert DuPuy's business during 1917 and 1918 was that of being executive head of the Crucible Steel Co. of America and its subsidiaries, and we are further of the opinion that expenses incurred in defending an action growing out of acts done in the ordinary course of a trade or business where no crime was committed are ordinary and necessary expenses of such business. This leaves for our determination whether the acts committed by Herbert DuPuy out of which the criminal charges grew were connected with his trade or business. The relationship of the acts committed by DuPuy as between himself and the Crucible Steel Co. of America was considered by the District Court in , the court saying relative thereto that:

Applying the well-established legal test, to which I have referred several times in this opinion, to the case in hand, we find that the plaintiff's case must fail. The law required, *1842 and it became the duty of the corporation's officers to file proper tax returns. There was nothing in the execution of that agency which could subject the agent to a criminal prosecution for conspiracy, in the ordinary course of human affairs. It goes for the saying that it could not be contemplated by the parties, in the execution of the agency, that the United States would prosecute a party criminally for doing that which the law required him to do. It follows that the criminal prosecution which resulted, could not have been, and was not, a direct and natural consequence of the making of the tax returns. In no sense did it flow directly and immediately from the execution of the agency; that is, from the making of the tax returns. That was a proper and legal thing to do. On the other hand, the prosecution flowed from the Manner in which the return was made; the government charging, as set forth in the indictment, that the defendant was guilty, with another, of conspiracy to defraud the government, in making false and fraudulent tax returns. In doing a perfectly legal thing, the agent may do it in such careless or criminal manner as to subject himself to a charge of*1843 criminality, and for the expenses of defending himself against such charge there can be no recovery in law. Nowhere in the statement of claim does it appear that the returns so made were true and correct returns, or, if incorrect, that this was the result of honest mistake. This is a very significant omission. On the whole, I am persuaded, under the authorities and on principle, that the plaintiff has wholly failed to state a cause of action, and that the defendant is entitled to judgment on the pleadings.

However, in , the Supreme Court said:

On the case made by the petition the expenditure in question was either a personal expense or a business expense; it was not a living or family expense. And it was an "ordinary and necessary" expense, since a suit ordinarily and, as a general thing at least, necessarily requires the employment of counsel and payment of his charges. The petition is not as definite as it might have been, but from its allegations, interpreted as the Solicitor General concedes they may be, it appears that the accounting suit presented the question whether the compensation in respect of which*1844 the copartner sought an accounting was for professional services performed by petitioner during the existence of the partnership or after its termination, the defense to that suit being *592 based upon the latter alternative. In either view, the compensation constituted business earnings.

The Solicitor of Internal Revenue in a recent opinion has held that legal expenses incurred by a doctor of medicine in defending a suit for malpractice were business expenses within the meaning of the statute. In the course of the opinion it was said that such expenditures were as much ordinary and necessary business expenses as they would be if made by a merchant in defending an action for personal injuries caused by one of his delivery automobiles, and that in the latter case the deduction would be allowed without question. C.B. V-1, p. 226.

Another departmental ruling is to the effect that legal expenses incurred in defending an action for damages by a tenant injured while at work on the taxpayer's farm are deductible as a business expense. C.B. 5, p. 121.

In the *1845 , the Board of Tax Appeals held that a legal expenditure made in defending a suit for an accounting and damages resulting from an alleged patent infringement was deductible as a business expense.

The basis of these holdings seems to be that where a suit or action against a taxpayer is directly connected with, or, as otherwise stated (, proximately resulted from, his business, the expense incurred is a business expense within the meaning of section 214(a), subd. 1, of the act. These rulings seem to us to be sound and the principle upon which they rest covers the present case. * * *

In view of what has been said by the Supreme Court in the Kornhauser case, supra, we are of the opinion that although the character of the acts and the manner in which they were done prevented the recovery of the $162,048.12 from the Crucible Steel Co. of America, nevertheless the necessity of paying out that sum of money was occasioned by acts done by DuPuy in connection with his trade or business that were directly related thereto. No one will contend that it is not lawful for*1846 a doctor of medicine to practice his profession or that he would ordinarily be compelled to face criminal charges in connection with such practice, although it may be that the manner in which he conducts his practice may occasion the preferment of such charges. It must be conceded that every taxpayer has the right to carry on his business in such manner as seems to him best. If, in carrying on his business, he commits acts amounting to the commission of a crime, such acts can only be regarded as personal, and expenses incurred by him in a proceeding which establishes the criminal character of the acts are personal expenses. But where, as here, the acts are characterized as business acts, we are not further concerned as to whether they may have been careful or negligent. The $162,048.12 expended by Herbert DuPuy during 1921 constituted legal deductions in ascertaining his taxable net income for that year.

Reviewed by the Board.

Judgment will be entered under Rule 50.

LANSDON and ARUNDELL dissent.