Before SCHNACKENBERG, CASTLE and SWYGERT, Circuit Judges.
Petitioners, Calvin Pardee Erdman, personally, Calvin Pardee Erdman, and Calvin Pardee Erdman, Jr., executors of the estate of Eleanor D. Erdman, deceased, seek a review of a decision of the Tax Court of the United States determining a deficiency in federal income tax of petitioners for the calendar year 1953 in the amount of $6,377.65.
We think there is no need to restate in detail the facts (about which there is no dispute) because they are fully set forth in the Tax Court's decision at 37 T.C. No. 113. Only to place the problem in its proper setting shall we attempt an abbreviated summary of those facts essential to our decision.
Reuben H. Donnelley, the taxpayer's father, died in 1929. Article Six of his will created a trust totaling $500,000; the entire income was to go to his sister, Naomi, for life, if she survived her mother (which she did); and on Naomi's death the corpus was to go to whomever she should appoint by will, and in default of appointment to the taxpayer, Eleanor Erdman, nee Donnelley,*fn1 and Thorne Donnelley, children of Reuben, equally. Naomi released her power of appointment in 1942, and died in 1951.
The terms of the Article Six trust did not specifically provide for distribution of the corpus if the power of appointment was released, and the trustees thereunder instigated a suit to determine who was entitled to the property - the trustees of two residuary trusts*fn2 under Article Fifteen of Reuben's will, or Thorne and Eleanor.
The Circuit Court of Cook County held that the taxpayer and Thorne Donnelley, her brother, were entitled to the corpus; but when the trustees of the residuary trusts indicated they intended to appeal, the case was settled; the taxpayer and her brother divided sixtyfive percent of the corpus and accumulated trust income, and the remainder went to the residuary trusts. The Illinois court directed that all expenses of the litigation, including attorney fees (amounting to a total of $60,020), be paid from the corpus of the trust before distribution.
Of the $60,020, allowed for expenses, $25,005 was allowed to Thorne and the taxpayer to pay the attorneys who represented them. All of the attorneys were paid by the trustee from the trust fund.
The trustee did not take a deduction for any of the expenses of the litigation over the disposition of the Article Six trust. On the joint federal tax return filed by the taxpayer and her husband for the year 1953, however, a deduction of $20,000 was taken for attorney fees in the trust litigation.
The Tax Court upheld the Commissioner's determination that Eleanor and her husband, Calvin Pardee Erdman, were not entitled to the claimed deduction, nor any deduction for attorney fees in the Circuit Court action, and alternately the Tax Court refused to recognize petitioners' contention that the trust was entitled to deduct the expenses and that therefore, taxpayer need not treat certain payments from the trust as taxable income.
We agree with the Tax Court.
The suit brought by the trustee of the Article Six trust in which Thorne Donnelley and the taxpayer were made parties defendant was a suit in which petitioners sought to (and to a degree did) defend and perfect their title to property as beneficiaries under a testamentary trust.As such, their expenses toward this end are not deductible. Kelly v. Commissioner, 228 F.2d 512 (7th Cir., 1956). We are not impressed with petitioners' argument that, for all practical purposes, taxpayer and her brother were owners of the funds in dispute even if the Circuit Court of Cook County had determined - which it did not - that the trustees under the residuary trusts were entitled to those funds. They base this argument on the fact that the actuarial possibility of taxpayer's dying leaving at least one lawful descendant (which would have given her the right to appoint by will or to have the property pass intestate to her husband and descendants) was 9,991 out of 10,000. In spite of this statistical argument, we believe that, at the time of the Circuit Court suit, any possibility that Eleanor was not the absolute owner of the funds should the Circuit Court have awarded them to the trustees, made her title insecure, and expenditures to perfect that title were capital in nature, and hence not deductible. It is undisputed that there was an ambiguity in the will and that resort to the Circuit Court was proper.
In the alternative, it is elementary that a taxpayer may not take a deduction for expenses of management, conservation, or maintenance of property held for the production of income unless such expenses are the expenses of the taxpayer and paid or incurred by him. Anderson v. Wilson, 289 U.S. 20, 27, 53 S. Ct. 417, 77 L. Ed. 1004 (1933). Here, the Circuit Court ordered the attorneys' fees and costs to be paid out of the principal of the trust. Nowhere does the order specify that the lawyers themselves were to be paid by the trustee, but we note that the trustee did make the payments.
Under Illinois law legal fees incurred in litigation over trust property may be paid out of the principal of the trust. Illinois Revised Statutes, c. 30, Sec. 172(2). The Circuit Court of Cook County so ordered and the expenses thereby became chargeable to the trust - a separate legal, taxable entity - and payable by it. Anderson v. Wilson, supra at 27, 53 S. Ct. at 420. Hence, the expenditures were ...