
    364 F.2d 425
    NORTON CLAPP, INDIVIDUALLY AND AS EXECUTOR OF THE ESTATE OF EVELYN CLAPP, DECEASED v. THE UNITED STATES
    [No. 463-60.
    Decided July 15, 1966.
    Plaintiff’s motion to strike opinion and dismiss proceeding denied October 14, 1966]
    
      
      WüKam E. Evenson, attorney of record, for plaintiff.
    
      Mitchell Sanvuelson, witb whom was Assistant Attorney General Mitchell Rogovin, for defendant.
    Before Cowen, Ohief Judge, Laramore, Durfee, Davis, and Collins, Judges.
    
   Per Curiam:

This case was referred to Trial Commissioner Mastín G. White with directions to make findings of fact and recommendation for conclusions of law. The commissioner has done so in an opinion and report filed on March 8, 1966. Plaintiff has filed no exceptions to or brief on this report and the time for so filing pursuant to the Buies of the court has expired. On April 28, 1966, defendant filed a motion that the court adopt the findings, opinion and conclusion of law of the trial commissioner. Since the court agrees with the trial commissioner’s findings, opinion and recommended conclusion of law, as hereinafter set forth, it hereby adopts the same as the basis for its judgment in this case without oral argument. Plaintiff is, therefore, not entitled to recover and the petition is dismissed.

OPINION OF COMMISSIONER

White, Commissioner:

The plaintiff sues for refunds of income taxes paid for the years 1947, 1948, 1949, and 1950. The question to be decided by the court is whether legal expenses that aggregated more than $300,000 during the 4-year period and were reasonably incurred in connection with the defense of several related lawsuits, and a payment in. the amount of $125,000 that was made in 1949 to settle the litigation just mentioned, were deductible from gross income for tax purposes.

The plaintiff contends that the question stated in the preceding paragraph merits an affirmative answer. The defendant takes a contrary position.

It is my opinion that the question previously outlined should be answered in the negative, and, accordingly, that the plaintiff is not entitled to recover.

The several lawsuits referred to in the first paragraph of this opinion were instituted in 1947 and 1948 by or on behalf of David J oyce, as the sole legatee and executor of the estate of Mary Davis Clapp Joyce, deceased. The present plaintiff had been married to Mary Davis Clapp Joyce at one time, but, prior to the institution of the lawsuits by David Joyce, the plaintiff and Mary Davis Clapp Joyce had been divorced in 1940, the present plaintiff had married Evelyn Clapp, Mary Davis Clapp Joyce had married David Joyce, and Mary Davis Clapp Joyce had then died subsequent to that marriage.

The marriage of Mary Davis Clapp J oyce to David J oyce occurred early in 1945. Later in the same year, Mary Davis Clapp J oyce was killed in an automobile accident on July 19, 1945. Her will left all her estate to David Joyce and named him as executor.

After the death of Mary Davis Clapp Joyce, David Joyce filed or caused to be filed in 1947 and 1948 the several lawsuits that gave rise to the legal expenses and the compromise payment with which we are concerned in the present case. One of the Joyce lawsuits was filed in the Superior Court of tbe State of California for Ventura County, two of tbe actions were filed in tbe Superior Court of tbe State of Washington for King County, and another action was filed in tbe United States District Court for the Western District of Washington. Tbe present plaintiff was a defendant in each of tbe Joyce lawsuits.

Tbe gist of tbe allegations in tbe J oyce lawsuits was that the 1940 divorce proceedings between tbe present plaintiff and Mary Davis Clapp Joyce were the result of a conspiracy between tbe present plaintiff and others, that a fraud was perpetrated on tbe court by tbe present plaintiff and others in connection with such proceedings, and that the present plaintiff deceived and defrauded Mary Davis Clapp Joyce in connection with an ancillary property settlement agreement dated July 10, 1940, thereby retaining for himself most of the community property of the marriage, although Mary Davis Clapp Joyce lawfully owned an undivided one-half interest in all the community property under the law of the State of the marital domicile. The total amount claimed by or on behalf of David Joyce in the several lawsuits, as the sole legatee and executor of the estate of Mary Davis Clapp Joyce, deceased, was alleged to be not less than $14,705,839.71 and perhaps as much as $26,000,000.

An effort was made in the litigation to have a constructive trust for the benefit of David Joyce judicially impressed on an undivided one-half interest in all the property which was owned by Mary Davis Clapp J oyce and the present plaintiff as of July 10, 1940, and which was still in the possession of the present plaintiff or persons claiming under him, including Evelyn Clapp, or, in the alternative, to obtain a judicial declaration that such property was owned by the present plaintiff and the estate of Mary Davis Clapp Joyce as tenants in common. Also, a money judgment was sought for the value of any of the community property of Mary Davis Clapp Joyce and the present plaintiff that had been disposed of by the present plaintiff after July 10, 1940, to bona fide purchasers who had no notice of the alleged fraud against Mary Davis Clapp Joyce.

All the Joyce litigation against the present plaintiff was eventually withdrawn and released on June 3,1949, pursuant to a compromise agreement under which, the present plaintiff paid David Joyce $125,000 in settlement of Mr. Joyce’s claims.

The plaintiff reasonably expended more than $300,000 during the 4-year period, 1947-1950, in connection with the defense of the Joyce litigation.

For the calendar year 1947, the plaintiff and his wife, Evelyn Clapp, filed separate tax returns. For the calendar years 1948, 1949, and 1950, joint income tax returns were filed by the plaintiff and his wife.

The plaintiff in his income tax return for 1947, and the plaintiff and Evelyn Clapp in their joint income tax returns for 1948, 1949, and 1950, claimed as deductible expenses the amounts which the plaintiff had expended during the respective years for legal expenses in connection with the defense of the J oy ce litigation. In addition, the plaintiff and Evelyn Clapp claimed a deduction for 1949 with respect to the $125,000 that was paid to David Joyce in settlement of the litigation.

The claimed deductions were disallowed by the Internal Revenue Service, which made deficiency assessments of income taxes for the several years. The deficiency assessment for 1947 was made against the plaintiff, and the deficiency assessment for 1948 was made against the plaintiff and Evelyn Clapp. Evelyn Clapp died on April 9, 1951. The deficiency assessments for 1949 and 1950 were made subsequent to Evelyn Clapp’s death, and, consequently, such assessments were made against the plaintiff and the estate of Evelyn Clapp, deceased. The deficiencies for the several years, together with the accrued statutory interest, were duly paid.

On June 27, 1956, the plaintiff timely filed claims for refunds of income taxes with respect to the years 1947, 1948, 1949, and 1950, asserting that the legal expenses which had been incurred in defending against the Joyce litigation, and the compromise payment which had been made to settle that litigation, were properly deductible for income tax purposes. The claim for 1947 was filed by the plaintiff individually, and the claims for 1948, 1949, and 1950 were filed by the plaintiff individually and as executor of the estate of Evelyn Clapp, deceased.

All the claims mentioned in the preceding paragraph were disallowed by the Commissioner of Internal Eevenue on January 16,1959.

The present action was instituted thereafter on December 20,1960, by the plaintiff individually and as executor of the estate of Evelyn Clapp, deceased.

The plaintiff contends that the legal expenses and the compromise payment previously mentioned were deductible from gross income for tax purposes under Section 23 (a) (2) of the Internal Eevenue Code of 1939, as amended (26 U.S.C. § 23 (a) (2) (1946)). During the period involved in the present case, that statutory provision was phrased as follows:

§ 23. Deductions from gross Income.
In computing net income there shall be allowed as deductions:
(a) Expenses.
* * * * *
(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.

On the other hand, it is the defendant’s position that the legal expenses and the compromise payment involved in this case were non-deductible personal or family expenses within the meaning of Section 24(a) (1) of the 1939 Code, as amended (26 U.S.C. § 24(a)(1) (1946)), which provided that in computing net income, no deduction should be allowed for “Personal, living, or family expenses, except extraordinary medical expenses * *

The legal issue before the court in this case is similar to the one that was dealt with by the Supreme Court in United States v. Gilmore, 372 U.S. 39 (1963). In that case, the respondent had obtained a divorce from his wife in California; he had incurred legal expenses in successfully resisting his wife’s claims to certain assets, which she asserted were community property under California law; and a controversy bad subsequently arisen between tbe respondent and tbe United States as to whether such legal expenses were deductible for income tax purposes under Section 23(a) (2) of the Internal Revenue Code of 1939, as amended. The Supreme Court said (at page 46) that the only kind of expenses deductible under Section 23(a) (2) were those that related to a “profit-seeking” purpose; and (at page 48) that the test to be used in determining whether litigation costs incurred in resisting a claim were deductible under that statutory provision was whether or not the claim that was resisted arose “in connection with the taxpayer’s profit-seeking activities.” The Court went on to say (at page 48) that the answer to the question did not “depend on the consequences that might result to a taxpayer’s income-producing property from a failure to defeat the claim * * In applying these principles to the case before it, the Court noted (at page 51) that the wife’s claims stemmed entirely from the marital relationship, and not from any income-producing activity. Accordingly, the Court held (at page 52) that none of the respondent’s expenditures in resisting those claims was deductible under Section 23(a)(2) of the Internal Revenue Code of 1939, as amended.

It seems clear that, under the test stated by the Supreme Court in the Gil/more case, the legal expenses which were incurred by the present plaintiff in connection with the defense of the Joyce lawsuits, and the compromise payment which was made by the plaintiff in settling the Joyce claims, were not deductible under Section 23(a) (2) of the Internal Revenue Code of 1939, as amended. The Joyce claims all arose out of the marital relationship that existed at one time between the plaintiff and Mary Davis Clapp Joyce, and were grounded on the contention that, by virtue of such marital relationship, Mary Davis Clapp Joyce lawfully owned an undivided one-half interest in property, which the present plaintiff fraudulently withheld from her at the time of their divorce. The Joyce claims did not arise “in connection with the taxpayer’s profit-seeking activities,” to use the language of the Supreme Court.

It is true that David Joyce sought to wrest property from the plaintiff in the lawsuits that gave rise to the legal expenses and the compromise payment with which we are concerned in the present litigation. The meager record before the court does not provide clear evidence concerning the nature and extent of the property that David J oyce sought to take from the plaintiff. However, it can probably be inferred that such property was very valuable, that much of it was income-producing, and that if the plaintiff had not resisted and ultimately settled the Joyce claims, he would have lost considerable income-producing property. Even so, according to the Supreme Court’s decision in the Gibnwre case, the avoidance of such consequences was not sufficient to bring the plaintiff’s legal expenses and the compromise payment within the scope of Section 23(a) (2) of the Internal Revenue Code of 1939, as amended.

Since the J oyce claims did not arise in connection with any profit-seeking activities on the part of the plaintiff, the Supreme Court’s decision in the Gilmore case requires a holding in the present case that the plaintiff’s expenditures in resisting and settling those claims did not constitute deductible expenses under Section 23(a) (2) of the Internal Revenue Code of 1939, as amended, but, rather, were non-deductible personal or family expenses within the meaning of Section 24(a) (1) of the 1939 Code, as amended.

It necessarily follows that the plaintiff is not entitled to recover in the present action, and that the petition should be dismissed.

FINDINGS on Fact

1. Norton Clapp (who will usually be referred to hereafter in the findings as “the plaintiff”) is a citizen of the United States and a resident of the State of Washington.

2. Evelyn Clapp died on April 9, 1951. The plaintiff has since been, and now is, the duly appointed, qualified, and acting executor of the estate of said decedent.

3. The plaintiff and Evelyn Clapp were husband and wife during the taxable periods in issue herein. For the calendar year 1947, the plaintiff and his wife filed separate tax returns. For the calendar years 1948, 1949, and 1950, joint income tax returns were made and filed by the plaintiff and his wife.

4.The net taxable income of the plaintiff, or of the plaintiff and his wife, for each of the four calendar years involved in this litigation, as determined by the Commissioner of Internal Eevenue after audit of the pertinent tax returns (and after disallowing as deductions from gross income the sums involved in this litigation), was as follows:

1947-$394,396.30
1948 - 639,448.72
1949 - 499,921.06
1950 - 636,957.73

5.The plaintiff, or the plaintiff and his wife, paid Federal income taxes for each of the years in issue in the following amounts:

1947 -$301,178.50
1948 _ 472,468.14
1949 - 355,566.86
1950 - 476,393.05

6.(a) The plaintiff claims, and the defendant denies, that the taxable income mentioned in finding 4 should be reduced by allowing as deductions certain disbursements made by the plaintiff in the years in issue in connection with the defense of certain litigation and claims hereinafter referred to as the “ Joyce claims.”

(b) The amount of such disbursements made in each of the years was as follows:

1947 -$14,234.42
1948 - 39,085.01
1949 _ 88,384.20
1950 - 163, 068. 83

(c) Such disbursements were made in payment of fees and costs for attorneys, court costs, witness expense, investigation expense, depositions, trial preparation, and other direct litigation costs of the plaintiff actually and reasonably incurred in defending against the Joyce claims.

7.(a) The plaintiff at one time was married to Mary Davis Clapp. However, they were divorced in 1940.

(b) David Joyce, early in 1945, married Mary Davis Clapp, the divorced former wife of the plaintiff. He was an Australian citizen and a flying officer with the BAAF. Mary, by her will dated January 20, 1945, left all her estate to David Joyce. Mary was killed in an automobile accident on July 19,1945.

8. The Joyce claims were asserted in lawsuits against the plaintiff herein by, at the instance of, and for the account of David Joyce as the surviving spouse and sole legatee and devisee of Mary. Among such lawsuits were the following:

9. The California action was instituted in 1947 against the plaintiff. The complaint alleged that pursuant to fraudulent divorce proceedings in the State of Washington, which resulted from a conspiracy between the present plaintiff and others, and in which a fraud was perpetrated on the court, and in which Mary Davis Clapp Joyce was deceived and defrauded, the plaintiff had acquired from Mary a disproportionate share of the community property of the parties and that he held the same either as constructive trustee or as a tenant in common or otherwise was accountable therefor to David Joyce, together with the revenues, income, proceeds, and gains therefrom. The total claim was alleged to be not less than $14,705,839.71 and perhaps up to an estimated total of $26,000,000. The complaint was eventually amended. In such action, attachments were issued against property. There was a demurrer to the original complaint, and also to the amended complaint. There was a motion to strike substantial portions of the complaint as scandalous, irrelevant, libelous, and immaterial. Similar motions were addressed to the amended complaint. In due course, the present plaintiff (a defendant in the previous litigation) submitted a motion to dismiss such action under the doctrine of forum non conveniens, and this resulted in the entry of an order of January 16,1948, by the court directing the dismissal of the action conditioned upon the due institution of a corresponding proceeding in Federal or state courts in the State of Washington and the appearance therein of the present plaintiff as a defendant in that action. An appeal was taken by David Joyce from that order. Later, on January 31, 1949, a final order of dismissal of the California case was entered.

10. The King County, Washington, Superior Court case No. 374968 brought by DeVink against the bank and the present plaintiff sought, among other things, to require the payment to David Joyce of the capital gains of $117,403.38 occurring since July 10, 1940, in the course of administering two trusts set up at that time 'by the present plaintiff and Mary Clapp for the benefit of their children and over $4,000 per month from the trust against the interests and welfare of the children of the present plaintiff and Mary Joyce.

11. Some aspects of the claims of David Joyce are also reflected in the proceedings had in probate proceedings in the Superior Court of the State of Washington for King County, No. 95151, entitled “In the Matter of the Estate of Mary Joyce, Deceased.”

12. The King County, Washington, Superior Court case No. 387653 brought by DeVink as Administratix against Norton Clapp et al. alleged substantially the same claims as are recited in the pleadings in the Ventura County case and, in fact, is virtually a duplicate of that pleading and with the same prayer for relief. The plaintiff herein, as the defendant in said King County case, submitted a demurrer. He also directed to said pleading motions to strike substantially the same as had been submitted to the Ventura County Court in California.

13. (a) Following the entry of the Ventura County, California, court order dismissing the action there under the doctrine of forum non conveniens, an action was instituted by David Joyce in the United States District Court for the Western District of Washington, Northern Division, Cause No. 1948. In general, this alleged substantially the same charges of conspiracy, fraud, and deceit as were initially alleged in the Ventura County case, but this complaint brought in new contentions to the effect that Mary was imposed on as a consequence of her having authored an “indiscreet letter.” The prayer for relief was similar to that in the Ventura County case and in the case brought by DeVink in King Comity. Among other motions, the plaintiff here and defendant in such action moved to dismiss the action for failure to state grounds for relief. The order of the United States District Court entered July 30,1948, described the extensive work done by counsel for the plaintiff here in preparing the presentation of such motion to dismiss. The court ruled that, despite the questionable sufficiency of the complaint in some respects, the rule that every reasonable inference favorable to the pleader should be indulged in the hearing of such a motion necessitated the overruling of the motion and the holding of the allegations sufficient to require an answer and defense.

(b) An amended complaint was filed, as required by the court. This amended pleading enlarged some of the claims inserted in the earlier corresponding cases above referred to and asserted claims of constructive trust, of tenancy in common, and many other claims of a proprietary interest in the property and income of the plaintiff herein. Sales and transfers in excess of $200,000 were pleaded, and these amounts were admitted. All the relief sought in the Ventura County case and the King County case was also prayed for in the Federal court case, and other relief in addition. A motion to dismiss was directed to the amended complaint.

(c) In due course, an amended answer of the present plaintiff to the amended complaint of David Joyce was prepared and filed in the Federal court. It was admitted in such pleading that at the time of the marriage of plaintiff and Mary in July 1929, Mary owned no property whatsoever and the entire property and estate claimed by David Joyce had initially all been the property of the plaintiff herein, and that in 1931 the alleged agreements converting the separate property of the present plaintiff to community property of Norton Clapp and Mary Clapp were entered into in the form pleaded, and that such agreements were executed for business, personal, and tax reasons, in tbe interests of Mary Clapp, Norton Clapp, and their family and in contemplation of the continuance of their marital status.

(d) David Joyce in said action admitted many of the allegations of the amended answer of Norton Clapp to the amended complaint, but, nevertheless, in a reply pleading asserted the existence of constructive trust, tenancy in common, and of undistributed community property, etc., allegedly wrongfully withheld and allegedly wrongfully not accounted for and allegedly the property of said David Joyce, including the earnings and income thereof since 1940.

14. All the several lawsuits and claims against the present plaintiff were eventually withdrawn and released on June 3, 1949, conformable to a compromise and settlement.

15. The plaintiff further claims, and the defendant denies, that the taxable income for the year 1949, as stated in finding 4, should have been reduced by allowing as a deduction in that year the amount paid by the plaintiff as a settlement of the Joyce claims. On June 3, 1949, the plaintiff disbursed the sum of $125,000 in settlement of the Joyce claims, and to terminate further litigation concerning such claims.

16. The disallowance as deductions of the disbursements referred to in findings 6 and 15 resulted in deficiency assessments of income taxes being made against the plaintiff for 1947, against the plaintiff and Evelyn Clapp for 1948, and against the plaintiff and the estate of Evelyn Clapp, deceased, for 1949 and 1950. The deficiencies, together with the accrued statutory interest, were duly paid.

17. The limitation periods for assessing income tax deficiencies and for claiming refunds were duly extended by appropriate statutory agreements between the Commissioner of Internal Revenue and the plaintiff relative to 1947, and between the Commissioner and the plaintiff and the estate of Evelyn Clapp, deceased, relative to 1948 and 1949.

18. Within the limitation periods, the plaintiff timely filed a claim for refund on Form 843 with respect to the year 1947, and the plaintiff and the estate of Evelyn Clapp, deceased, timely filed claims for refunds relative to the years 1948, 1949, and 1950. All the claims were filed on June 27, 1956.

19. The claims for refund were for the full amount of any overpayment of tax due solely to the disallowance of the deductions of expenses arising out of the Joyce claims. The claims requested refunds of not less than the following sums :

1947 _ $6,747.06
1948 _ 34,394.81
1949 _ 166,973.14
1950 _ 150,968.33

20. On January 16, 1959, the Commissioner of Internal Eevenue notified the plaintiff and the estate of Evelyn Clapp, deceased, by registered mail that the claims for refund were disallowed in full and rejected.

21. The parties have stipulated and agreed that pursuant to Rule 47 (c) this proceeding shall be limited to the issues of law and fact relating to the right of the plaintiff to recover, reserving the determination of the amount of recovery, if any, for further proceedings.

CONCLUSION OP LAW

Upon the foregoing findings of fact and opinion, which are adopted by the court and made a part of the judgment herein, the court concludes as a matter of law that the plaintiff is not entitled to recover, and the petition is dismissed. 
      
      The opinion, findings of fact, and recommended conclusion of law are submitted under tlie order of reference and Rule 57(a).
     
      
       Agreements extending the respective limitation periods had been entered into between the plaintiff and the Commissioner of Internal Revenue.
     