Howard v. Commissioner , 32 T.C. 1284 ( 1959 )

Robert S. Howard and Antoinette Lees Howard, Petitioners, v. Commissioner of Internal Revenue, Respondent

Howard v. Commissioner

Docket No. 62090

United States Tax Court

32 T.C. 1284; 1959 U.S. Tax Ct. LEXIS 79;

September 28, 1959, Filed

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Decision will be entered under Rule 50.

1. Held: That a property settlement agreement between petitioner's father and mother in 1930, whereby the beneficial interest in certain stock was transferred in trust for the benefit of petitioner and his brothers, was a taxable exchange. The basis to petitioner of a portion of such stock distributed to him in 1950 upon liquidation of the trust is determined accordingly. Sec. 113(a)(3), 1939 Code.

2. Held, that legal fees and other expenses incurred by petitioner in 1948 in connection with an official investigation into the artificial stimulation of certain horses owned by him were deductible as ordinary and necessary business expenses. Sec. 23(a)(1)(A), 1939 Code.

3. Held, a claimed deduction for "stakes to jockeys" was properly disallowed for failure of proof. Sec. 23(a)(1)(A), 1939 Code.

Adam Y. Bennion, Esq., and Stafford R. Grady, Esq., for the petitioners.

Mark Townsend, Esq., and Thomas S. Greaves, Esq., for the respondent.

Raum, Judge. Drennen, J., concurring. Fisher, J., agrees with this concurring opinion. Turner, J., dissenting. Murdock and Pierce, JJ., agree with this dissent.

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RAUM

Respondent determined deficiencies in petitioners' income taxes for 1948, 1950, and 1951 in the respective amounts of $ 13,198.02, $ 36,413.85, and $ 109,033.16.

The three issues remaining for determination relate to the years 1948 and 1951:

1. What is petitioners' basis in 1,324 shares of stock for the purpose of computing gain upon a liquidating distribution received from a corporation in 1951?

2. Are petitioners entitled to deduct legal fees and other expenses amounting to $ 16,558.74 incurred in 1948 in connection with an investigation by the California Horse Racing Board into the artificial stimulation of certain horses owned and raced by petitioners?

3. Are petitioners entitled to an ordinary and necessary business expense deduction of $ 4,473 for amounts turned over to employees for payment to jockeys as inducements for good riding performances?

FINDINGS OF FACT.

Certain facts have been stipulated and are incorporated herein by reference.

Petitioners, husband and wife residing in Palm Springs, California, filed joint income tax returns for the calendar years 1948, 1950, and 1951 with the collector of internal revenue for the sixth district of California. Robert S. Howard will hereinafter be referred to as petitioner.

Petitioner's father, Charles S. Howard, was married to Fannie May Howard in 1901; they had four children -- Charles S. Howard, Jr., born December 22, 1902; Lindsay C. Howard, born March 31, 1904; Frank Robert Howard, born October 15, 1911; and Robert Stuart Howard (petitioner), born April 21, 1916.

In about 1906 Charles S. Howard, operating as a sole proprietor, became the sole and exclusive distributor of Buick automobiles in California, Oregon, Washington, Arizona, and Nevada; he also became the retail dealer for Buick in San Francisco, Oakland, Berkeley, and Los Angeles, California, and Portland, Oregon. The northern portion of the business (covering northern California, Oregon, and Washington) was designated Howard Automobile Company of San Francisco and the southern portion of the business (covering southern California, Arizona, and Nevada) was designated Howard Automobile Company of Los Angeles.

The distributorship and dealership agreements between Buick Motor Company and Howard Automobile Company contained similar clauses providing (1) that the agreements constituted personal contracts; (2) that they could not be transferred or assigned without the written consent of the Buick Motor Company; (3) that no alterations or variation of the terms would be valid unless made in writing; (4) that the agreements could be terminated by either party with or without cause upon 30 days' notice or without notice for specified cause; (5) that the word "Buick" and the goodwill attached thereto were specifically reserved to Buick Motor Company; (6) that termination of the agreements not only meant the loss of the right to receive new cars and parts but also the right to use the word "Buick."

As distributor for the western territory hereinbefore described, Charles S. Howard was entitled to purchase 10 per cent of the entire Buick factory output. It was Buick's practice at that time to allow its distributors a discount of 5 per cent of factory list price; dealers were allowed an additional 25 per cent. Thus, Charles S. Howard, as distributor and dealer, received a total discount of 30 per cent of factory list price on each Buick car which he sold at retail. His business was highly successful.

On October 2, 1916, Charles S. Howard and Fannie May Howard entered into a property settlement agreement whereby Charles conveyed bonds in the face amount of $ 110,000 to Fannie May "in her own absolute, separate right," and agreed to leave her one-fifth of the net estate he might own at death. The purpose of the agreement was to relieve Fannie May "from the possibility of future want, and adverse business conditions which may arise hereafter." In consideration, Fannie May, as party of the second part, agreed as follows:

The party of the second part shall, and hereby does waive and disclaim any community interest, either at law or in equity, in and to all other property now belonging, or which may hereafter belong to the party of the first part.

This agreement and conveyance above mentioned being intended as full and complete settlement between the parties hereto, so far as relates to the community interest, that is to say:

The property herein conveyed by the party of the first part to the party of the second part is hereby acknowledged to be the sole and separate property of said party of the second part, and all other property in which the parties hereto are interested in, is hereby acknowledged to be the sole and separate property of the party of the first part * * *

On August 1, 1917, Charles S. Howard transferred the business theretofore operated as Howard Automobile Company of Los Angeles to third persons in trust (hereinafter referred to as the 1917 trust) for the benefit of his wife and his four sons in order to provide for their "future welfare." The transfer included "all stock in trade, credit, accounts, furniture and fixtures and personal property of every kind and nature pertaining or relating to said business." This trust terminated on July 31, 1919, when the above-described property and business reverted to Charles S. Howard pursuant to a term of the trust indenture providing for such reversion after 2 years if he was still living. The earnings before taxes of the business during these 2 years were as follows:

Aug. 1 to Dec. 31, 1917	$ 182,204.88
Calendar year 1918	525,149.78
Jan. 1 to July 31, 1919	529,541.23
Total	1,236,895.89

From August 1, 1919, through June 30, 1920, Charles S. Howard operated Howard Automobile Company of Los Angeles as part of his sole proprietorship; the record does not reveal the separate income of the "Los Angeles branch" during this period.

On July 1, 1920, Charles S. Howard again transferred Howard Automobile Company of Los Angeles in trust (hereinafter referred to as the 1920 trust) for the benefit of his wife and four sons in order to provide for their "maintenance and support." The business, together with its "appurtenances and good will," was conveyed to Fannie May, as trustee, and she was directed to continue operating the business under the name of Howard Automobile Company of Los Angeles. Charles S. Howard, as trustor, agreed to assist the trustee in the management of the business, without salary; to assign to, or hold in trust for, the trustee any interest the trustor might have in any contract with the Buick Motor Company for the purchase of Buick automobiles for sale in the territory covered by the trust agreement, "but not in excess of a reasonable proportion of the automobiles that may be purchased under such contract"; to appoint the trustee as dealer in Buick automobiles for the territory covered by the agreement, subject to the approval of Buick Motor Company; and to sell Buick automobiles to the trustee at their cost to the trustor.

The book value of the business transferred to the 1920 trust was $ 262,511, computed as follows from a statement attached to the 1920 trust indenture:

Cash		$ 84,290.96
Notes receivable		230,713.28
Sales debtors		20,294.66
Cars		603,709.82
Buick parts		41,125.51
Sundry stock		51,323.03
Gas and oil stock		1,980.27
J & D tire stock		672.95
Furniture and fixtures		5,457.72
Shop equipment		2,962.69
Deposits			$ 99,491.07
Buick Motor Company claims		8,126.08
Trade creditors			23,132.61
U.S. Government (accts. payable)			88,052.80
Reserve accounts			27,450.93
Loss	$ 21,450.93
Employees liability ins.	6,000.00
Howard Automobile Company, San Francisco		242,185.08
		1,292,842.05	238,127.41
Excess of assets over liabilities			1,054,714.64
Less deductions as per agreement			819,654.57
New Buick cars		577,469.49
Accounts receivable -- Howard Automobile
Company, S.F		242,185.08
Excess of assets over liabilities			1 235,060.07

It was provided in the trust agreement that "new Buick cars" and "accounts receivable -- Howard Automobile Company, S.F." (San Francisco) were not to be transferred to the trust; the trustor, however, agreed to sell such "new Buick cars" to the trustee at cost. No item of goodwill was included in the computation of book value.

Fannie May, as trustee, was directed to apply the net income (after taxes) of the business for the benefit of herself and the four Howard sons, as follows: One-fifth of the net income was to be accumulated for the benefit of each of the sons until he reached the age of 21, or until his prior death, to be paid to him upon reaching such age, or to his heirs if he died prior thereto; the remaining one-fifth of the net income, and all such income not to be accumulated for the sons, was to be applied by the trustee to her own use and benefit. Within 1 year after reaching the age of 21, each son could elect to reconvey to the trust his interest in accumulated net income in which case the trustee was directed to pay to such son from time to time one-fifth of the net income accruing from the business from the time he reached the age of 21 until the termination of the trust. The trust was to terminate when the youngest son reached the age of 25, or upon the death of the last survivor of the sons if none reached that age. Upon termination, the corpus and accumulated net income of the trust was to be distributed -- one-fifth to each son who elected to reconvey his interest in net income accumulated prior to his reaching the age of 21, and the remainder to Fannie May or her heirs as her or their separate property.

For the period July 1, 1920, through December 20, 1923, the earnings before taxes of the business transferred in trust were as follows:

July 1, 1920 -- June 30, 1921	$ 947,742.34
July 1, 1921 -- June 30, 1922	622,048.31
July 1, 1922 -- June 30, 1923	1,080,735.91
July 1, 1923 -- Dec. 20, 1923	611,685.58
Total	3,262,212.14

Charles S. Howard's dealership and distributorship franchises were never assigned to Howard Automobile Company of Los Angeles, nor was Fannie May, as trustee, ever appointed as dealer for Buick Motor Company. Instead, Charles S. Howard continued to hold the franchises and sold Buick cars to the Los Angeles Company at cost so that it obtained the full benefit of the 30 per cent discount previously mentioned. Pertinent franchises were assigned to Howard Automobile Company of San Francisco in 1923 when that business was incorporated. Charles S. Howard owned 100 per cent of the stock of the San Francisco corporation.

In 1923 Fannie May, as trustee, decided to incorporate the business of the trust. On December 20, 1923, pursuant to court order, the assets of the trust were transferred to Howard Automobile Company of Los Angeles, a corporation, in exchange for 15,000 shares of the corporation's stock, the total number of shares issued. The trustee allocated 3,000 shares to each of the five beneficial interests in the trust. The name of the corporation was changed to Howard Securities Co. on or about January 8, 1948.

The book value of Howard Automobile Company of Los Angeles on December 20, 1923 (based upon the book value of the business as of the time the trust was created, namely, $ 262,511, plus the accumulated net income of the trust in the amount of $ 1,897,298.72), was $ 2,159,809.72, or $ 143.9873 per share.

Charles S. Howard, Jr., became 21 on December 22, 1923; Lindsay C. Howard became 21 on March 31, 1925; Frank Robert Howard died on May 9, 1926. Neither Charles, Jr., nor Lindsay, nor the heirs of Frank elected to reconvey their interests in the accumulated net income and, therefore, forfeited so much of the stock theretofore allocated to them as represented their respective interests in the corpus of the trust. The remaining shares, representing their respective interests in the accumulated net income, were distributed as follows:

Beneficiary	Shares	Shares	Total
	forfeited	distributed
Charles S. Howard, Jr	365	2,635	3,000
Lindsay C. Howard	272	2,728	3,000
Heirs of Frank Robert Howard	204	2,796	3,000
Total	841	8,159	9,000

The 841 forfeited shares were thereafter held in trust for Fannie May as residuary beneficiary under the 1920 trust indenture, thereby increasing her interest in the trust to 3,841 shares.

In addition, Charles S. Howard and Fannie May, as the heirs of Frank, each received 1,398 shares of stock as his separate property.

The earnings before taxes of the Howard Automobile Company of Los Angeles for the period December 20, 1923, through December 31, 1930, were as follows:

Period	Income
Dec. 20, 1923 -- Dec. 31,
1923	$ 13,604.04
1924	677,690.48
1925	1,019,932.63
1926	1,422,264.19
1927	1,524,188.99
1928	846,052.62
1929	656,414.47
1930	512,624.28

Charles S. Howard and Fannie May Howard separated on August 10, 1929. After prolonged negotiations they entered into a property settlement agreement dated March 7, 1930. The agreement recited, among other things,

a. That the parties desired to forever settle and determine their respective property rights and obligations, including all questions pertaining to any future earnings or income of either and any home stead, distributive share, community property, inheritance, or dower;

b. That each party had been represented by counsel in negotiating the settlement;

c. That Fannie May and her counsel had been afforded full opportunity to investigate the nature, extent, and value of the properties of Charles S. Howard, and had examined and considered the agreement of October 2, 1916, and the trust agreement of July 1, 1920, and "her rights in and to the properties held" thereunder;

d. That a balance sheet of Howard Automobile Company of Los Angeles, as of December 31, 1929, and a statement showing the financial condition of Charles S. Howard as of February 11, 1930, had been prepared, examined by Fannie May and her counsel, and annexed to the agreement; and

e. That "each party hereto is making and entering into this agreement solely on the understanding that this agreement will be a final settlement and determination of all property rights claims, obligations and demands as between the parties, regardless of whether their marital status remains the same in the future or is altered by divorce or otherwise."

Under the agreement Charles S. Howard paid to Fannie May Howard cash in the sum of $ 812,000. He also entered into a trust agreement with Crocker First Federal Trust Company as trustee and Fannie May as third party, of which the corpus was cash and bonds in the sum of $ 2,500,000. The income from the trust was payable currently to Fannie May during her life; in addition she was granted the power to withdraw from corpus the amount of $ 50,000 per year during her lifetime, which right of withdrawal was cumulative. The trust was to terminate upon the death of Fannie May, the remaining principal to be distributed among the issue of Charles S. Howard and Fannie May.

On her part, Fannie May conveyed to Charles S. Howard, as his sole and separate property, the 1,398 shares of stock in Howard Automobile Company of Los Angeles received by her as an heir of Frank Robert Howard. She also executed a trust agreement (hereinafter referred to as the 1930 trust) with Charles S. Howard, Charles S. Howard, Jr., and Lindsay C. Howard as trustees, and Charles S. Howard as third party, whereby she conveyed to the trustees her entire beneficial interest in the 3,841 shares of stock in Howard Automobile Company of Los Angeles then held for her benefit pursuant to the terms of the 1920 trust, and she also conveyed "any remainder or reversionary interests" in the 3,000 shares of stock which had been allocated in trust for petitioner. The stipulated fair market values on December 31, 1929, of the blocks of 1,398 shares and 3,841 shares were $ 612,735.47 and $ 1,683,488.53, respectively, or $ 438.29 per share.

The income of the 1930 trust was to be paid to Charles S. Howard during his life or until the death of the last survivor of his children if that should occur during his lifetime. Upon termination, the corpus was to be distributed to Charles S. Howard, if living, or, if the termination was caused by his death, among the issue then surviving of Charles S. Howard and Fannie May. Fannie May agreed to resign as trustee under the 1920 trust indenture and to cooperate in securing the appointment of Charles S. Howard, Charles S. Howard, Jr., and Lindsay C. Howard as successor trustees.

As part of the property settlement agreement Charles S. Howard quitclaimed any interest he might have had in a residence which Fannie May had purchased subsequent to the separation and in a small residence which she owned for the benefit of her maid; Fannie May quitclaimed any interest she might have had in any of her husband's properties. The agreement of October 2, 1916, was "cancelled and annulled"; more specifically, Charles S. Howard was released from his obligation to leave one-fifth of his net estate to Fannie May; however, the bonds in the face amount of $ 110,000 which had been conveyed to Fannie May pursuant to that agreement, and all income therefrom and properties into which any of the bonds might have been converted, were to "remain the separate property" of Fannie May.

The financial statement of Charles S. Howard attached to the property settlement agreement showed his assets and liabilities as of February 11, 1930, to be as follows:

Assets
		Estimated
	Book value	actual value
Cash	$ 86,981.23	$ 86,981.23
Accounts receivable	185,652.18	126,773.02
Notes receivable	19,835.85	8,000.00
Mortgages receivable	22,105.84	14,035.00
Stocks	2,805,832.32	7,320,623.93
Bonds	2,029,361.28	2,000,740.50
Real estate	286,769.86	286,769.86
Boats and equipment	73,941.61	73,941.61
Accrued interest	5,017.62	5,017.62
	5,515,497.79	9,922,882.77
Liabilities
Accounts payable	$ 72,188.91	$ 72,188.91
Income tax, 1929	27,227.34	27,227.34
Net worth	5,416,081.54	9,823,466.52
	5,515,497.79	9,922,882.77

On March 7, 1930, Charles S. Howard's life expectancy was 18.16 years; Fannie May's life expectancy was 20.18 years.

Neither Charles S. Howard nor Fannie May reported any income tax liability as resulting from the foregoing property settlement agreement.

Fannie May commenced an action for divorce against Charles S. Howard on March 17, 1931. Thereafter, on May 6, 1931, they executed a further agreement which recited in substance that subsequent to execution of the agreement of March 7, 1930, Fannie May had retained new counsel, had given notice of rescission of that agreement, had instituted divorce proceedings, and alleged the existence of community property. Charles S. Howard denied these allegations but in order to settle forever all matters between them he paid Fannie May the further cash sum of $ 500,000 pursuant to the agreement of May 6, 1931. An interlocutory decree of divorce was entered on May 8, 1931, and a final decree on May 17, 1932. Fannie May married Edmond E. Herrscher on May 21, 1932. She died on October 9, 1942.

Petitioner reached the age of 21 on April 21, 1937. Upon his election not to reconvey his interest in the accumulated net income of the 1920 trust, he forfeited 131 shares of stock in Howard Automobile Company of Los Angeles, representing his interest in the corpus of the 1920 trust. Since, by agreement of March 7, 1930, Fannie May had conveyed her entire beneficial interest in the 1920 trust to the 1930 trust, the beneficial interest in the 131 forfeited shares reverted to the 1930 trust, increasing its corpus to a beneficial interest in 3,972 shares. The remainder of the 3,000 shares allocated to the 1920 trust for petitioner was distributed to him as representing his interest in the accumulated net income of that trust.

The 1920 trust terminated on April 21, 1941, when petitioner reached the age of 25. The 1930 trust terminated upon the death of Charles S. Howard on June 6, 1950, and the 3,972 shares of stock of Howard Automobile Company of Los Angeles (then Howard Securities Co.) were distributed in three equal shares of 1,324 each to petitioner and his two living brothers. During the year 1951 the Los Angeles corporation was liquidated and dissolved. For purposes of computing gain on the corporate liquidation petitioner contends the 1,324 shares surrendered by him had a basis of at least $ 402.10 per share. The Commissioner determined in the notice of deficiency that these shares had a basis of $ 143.99 per share.

During 1948 and for several years prior thereto, petitioner was engaged in the business of owning and racing horses at various racetracks throughout the United States and particularly in California. Petitioner's family was well known and well regarded in the horseracing business; his father, Charles S. Howard, had been engaged in owning and racing horses since 1935 and 1936 and had owned "Seabiscuit," winner of the Santa Anita Handicap in 1938; his brother Lindsay had also owned and raced horses.

Petitioner owned approximately 12 horses during the Hollywood Park Racing Meet in Los Angeles in the summer of 1948. He employed John Thomas Engle as trainer of his horses; Engle had formerly been associated with Charles S. Howard's stables.

On July 1, 1948, the racing stewards at Hollywood Park suspended Engle's trainer's license for violating the rules of the California Horse Racing Board in that three horses which were under his care had been entered into races on May 18, June 29, and June 30, 1948, in stimulated and/or "nerved" condition. The applicable rules made the trainer "absolute insurer of and responsible for the condition of the horses entered in a race, regardless of the acts of third parties."

Petitioner was required by the racing stewards to obtain another trainer before he could again race horses at that meeting. The purses won by the stimulated horses were forfeited and redistributed to the second, third, and fourth place entrants.

Following Engle's suspension, the California Horse Racing Board undertook an investigation of the incident. Petitioner himself was subject to investigation as a person who might have had "the care, or attendance" of the horses in question, or who might otherwise have been implicated in the prohibited acts. However, petitioner was never formally charged with any violation; he was interrogated by the California Horse Racing Board in executive session and completely exonerated of any culpability in the matter.

Had the Racing Board found petitioner implicated in the stimulation charges, it could have suspended or revoked his license to race horses in California. Similar action taken by other States and foreign countries pursuant to a reciprocity agreement then in effect would have barred petitioner from racing in such other jurisdictions also.

At the conclusion of its investigation, the Racing Board filed formal charges against Engle. On September 20, 1948, after hearing, Engle's license was revoked for having violated sections 1930 and 1508, title 4, California Administrative Code; pursuant to section 1936, title 4, California Administrative Code, Engle was barred from the public enclosures and stable areas of all racetracks in California.

Petitioner expended $ 16,558.74 in legal fees and other expenses incident to the investigation of the facts surrounding the aforementioned charges and in presenting the facts to the Racing Board. His deduction of that amount as an ordinary and necessary business expense in his 1948 income tax return was disallowed by the respondent.

During 1948, payments in the total amount of $ 5,273 were made from petitioner's business to Engle, R. J. McRoberts, and J. Gironda, all employees of petitioner but none of whom was a jockey. Of this amount, $ 4,473 was charged on petitioner's books as a racing expense and deducted on his income tax return for 1948 as "stakes to jockeys."

"Stakes to jockeys" are payments made to jockeys, in addition to their regular fees, for riding in a particular race, intended to induce them to ride for a particular owner and give a good performance. These "stakes" take the form either of cash payments to the jockey or the purchase and delivery to him of a win ticket on his mount. Such inducements are not uncommon in the horseracing business.

Petitioner did not know whether the amounts in question were in fact paid over by his employees to jockeys as indicated by the books, nor has any evidence been introduced to indicate which jockeys, if any, received the alleged payments, or to show that any such amounts were received by the foregoing employees with instructions to pay them out as "stakes to jockeys." Respondent disallowed the deduction.

OPINION.

1. Basis of Stock. -- We are asked in this case to determine the basis to petitioner of 1,324 shares of stock distributed to him upon the liquidation of a trust and subsequently surrendered by him for redemption. Petitioner contends that, under the law as it existed in 1930, the property settlement of March 7, 1930, was a taxable sale or exchange giving rise to recognized gain. If so, the basis to the 1930 trust of the beneficial interest in stock transferred by Fannie May was its basis in the hands of Fannie May, increased by the amount of gain recognized by Fannie May on the transfer. Sec. 113(a)(3), I.R.C. 1939. Respondent, on the other hand, urges that the property settlement was a nontaxable event under the law as it existed in 1930, that no gain was recognized by Fannie May on the transfer of her beneficial interest to the 1930 trust, and, therefore, that the basis of that interest in the hands of the 1930 trust was simply its basis in the hands of Fannie May.

The record supports petitioner's view. The property settlement of March 7, 1930, was a bargained-for transaction resulting in the transfer of property rights for a consideration. Such transfers are generally treated as giving rise to taxable gain or loss, and respondent offers no sufficient reason for according different treatment to the transfer in question. C. C. Rouse, 6 T.C. 908">6 T.C. 908, affirmed 159 F. 2d 706 (C.A. 5). Cf. Jessie Lee Edwards, 22 T.C. 65">22 T.C. 65; Johnson v. United States, 135 F. 2d 125 (C.A. 9), reversing 45 F. Supp. 377">45 F. Supp. 377 (S.D.Cal.). The 1930 settlement agreement was not merely a partition or division of community property, as suggested by respondent. Cf. Frances R. Walz, Administratrix, 32 B.T.A. 718">32 B.T.A. 718. In view of the agreement of October 2, 1916, wherein Fannie May waived and disclaimed any community interest in property belonging to her husband, it is doubtful whether any of the property transferred pursuant to the 1930 agreement was in fact community property. Secondly, the evidence indicates that in 1930 Charles S. Howard was primarily interested in acquiring control of the Los Angeles corporation; and the cash and bonds transferred by him pursuant to the 1930 agreement represented merely the price that he paid for the stock. Moreover, even if there were community property, it does not appear that any such property was divided in kind, or that the parties attempted to inventory such property and make an equitable division thereof.

Respondent relies heavily upon the Memorandum Opinion of this Court in Fannie May Herrscher (dated May 10, 1939), holding that the $ 500,000 paid to Fannie May pursuant to the settlement of May 6, 1931, did not constitute ordinary income to her. However, that case was concerned not with the recognition of gain but with the realization of ordinary income upon receipt of the $ 500,000, since respondent did not allege a sale or exchange of property under the 1931 agreement and Charles S. Howard specifically denied the existence of any community property rights in Fannie May. The question in the present case relates to the recognition of gain to Fannie May upon the transfer of property by her for a consideration. In the earlier case, respondent did not raise the issue of sale or exchange v. division of community property -- the issue now before us -- and the Court did not appear to consider that issue. In the circumstances, we do not regard it as controlling here.

Respondent's further argument is based on the fact that neither Charles S. Howard nor Fannie May reported any tax liability resulting from the 1930 agreement. He contends that "as no gain was reported, no gain was 'recognized.'" The argument is unsound. Every revenue act since the Act of 1924 has specified that upon the sale or exchange of property the entire amount of gain or loss shall be "recognized," except as otherwise provided. Revenue Acts of 1924 and 1926, sec. 203(a); Revenue Acts of 1928, 1932, 1934, 1936, I.R.C. 1939, sec. 112(a); I.R.C. 1954, sec. 1002. Thus recognition of gain or loss depends upon statutory provision and not upon whether such gain or loss is reported.

The fair market value of the stock in question was $ 438.29 per share on December 31, 1929. Since respondent does not deny that Fannie May received full and adequate consideration in money or money's worth for her beneficial interest, we find that the basis to the 1930 trust of the beneficial interest thereby transferred was "at least $ 402.10 per share," as urged by petitioner. The basis to petitioner, as a distributee of the 1930 trust, is the same as it was to the trust. Cf. Richard Archbold, 40 B.T.A. 1238">40 B.T.A. 1238, affirmed 115 F. 2d 1005 (C.A. 2), certiorari denied 313 U.S. 584">313 U.S. 584.

In view of the foregoing conclusions, we need not consider other issues relating to the fair market value of the business on July 1, 1920.

2. Deductibility of Legal Fees. -- The amounts expended by petitioner in connection with the investigation conducted by the Racing Board were deductible under section 23(a), I.R.C. 1939, as ordinary and necessary business expenses. Petitioner was in the horseracing business and the investigation was directly concerned with the artificial stimulation of certain horses owned and raced by petitioner. We are not persuaded by respondent's argument that petitioner "voluntarily" assumed Engle's defense and, therefore, that the expenses incurred were not ordinary and necessary to his business. Petitioner himself was under suspicion, as was anyone having access to the stables where the horses in question were kept. Had petitioner's license been revoked he would have been out of the horseracing business altogether. It may be true that the expenses were incurred on Engle's behalf as well as petitioner's, but Engle was an important employee of petitioner's and his implication in the charges affected petitioner's business reputation. From petitioner's point of view, the expenses were in defense of his business generally. So characterized, there is no burden on petitioner to allocate any portion of his expenses to the defense of Engle in particular.

We see no merit in respondent's argument that petitioner's expenses resulted from acts of an employee performed outside the scope of his employment. The scope of Engle's employment clearly included the duty to care for and attend petitioner's horses; it was precisely a breach of that duty that resulted in the revocation of his license. Cf. San-Knit-Ary Textile Mills, Inc., 22 B.T.A. 754">22 B.T.A. 754.

Nor do we accept respondent's contention that allowance of the deduction would frustrate the public policy expressed in sections 1930, 1508, and 1936, title 4, California Administrative Code, pursuant to which Engle's license was revoked. As concluded above, the amount expended by petitioner was in defense of his business generally, and petitioner himself was completely exonerated. To be sure, Engle was not exonerated, and had he paid his own expenses they probably would not have been deductible by him. But petitioner was blameless, and the amounts expended by petitioner in defense of himself and of his business are deductible.

3. "Stakes to Jockeys." -- This issue must be decided against petitioner for want of satisfactory proof. The amount in controversy, $ 4,473, was merely a bookkeeping entry, representing a portion of payments made to certain persons who were employees (but not jockeys) of petitioner's. Deduction was claimed on the ground that the controverted payments consisted of stakes to jockeys. The evidence was fragmentary and unpersuasive. No showing was made as to any amounts paid over to jockeys, and we cannot say on this record that any portion of the amount involved was in fact paid out for a purpose that would justify the claimed deduction. Cf. Mitten Management, Inc., 29 B.T.A. 569">29 B.T.A. 569.

Decision will be entered under Rule 50.

DRENNEN

Drennen, J., concurring: Based on the findings of fact in the majority opinion, I agree with the result reached in this case. However, I would make it clear that the rule relied on is applicable only when the facts of a particular case warrant it. I would not agree that as a general rule when one spouse surrenders property owned outright by him or her to the other spouse for other property of a different kind in a negotiated property settlement incident to a divorce a taxable exchange occurs.

TURNER

Turner, J., dissenting: I am unable to agree with the conclusion that the settlement evidenced by the agreement dated March 7, 1930, was a taxable exchange. In my opinion, the settlement was an agreed division of the property of parties looking to a divorce, and was not a transaction which would give rise to taxable income or a deductible loss. I accordingly note my dissent.

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Footnotes

• 1. $ 235,060.07, plus reserve for loss of $ 21,450.93 and reserve for employees' liability insurance of $ 6,000, equals book value of $ 262,511.