The opinion of the court was delivered by: LANE
This is an action for the recovery of income tax which plaintiffs claim was erroneously and illegally collected by the United States. Jurisdiction is founded upon 28 U.S.C. § 1346.
The facts from which the controversy arises are stipulated by the parties as follows:
1. On January 24, 1958, plaintiff, Carmen J. Caruso, took the examination for Assistant Building Inspector held by the New Jersey Civil (Service) Commission. Plaintiff passed first on the examination and was certified No. 1 on the List of Eligibles on August 15, 1958. There was a then existing vacancy for the position in question. Carmen J. Caruso is a veteran. 2. New Jersey Statutes 11:27-4, N.J.S.A. provide in part as follows: '* * * the appointing authority shall appoint the veterans whose standing is the highest on the register for the position to be filled.' 3. At the request of the municipality involved, namely, Hamilton Township, Mercer County, New Jersey, plaintiff's name was removed from the List of Eligibles by the Chief Examiner of the Civil Service Commission. Plaintiff then hired counsel and instituted legal proceedings toward reinstatement. A hearing was held at the Civil Service Commission which resulted in a successful conclusion for plaintiff and plaintiff's name was restored to the top of the List of Eligibles. 4. Hamilton Township then sought judicial review by taking an appeal to the Appellate Division of the Superior Court of the State of New Jersey. This Court affirmed the action of the Civil Service Commission and continued plaintiff's certification as No. 1, and as a result thereof, plaintiff was appointed to the position of Assistant Building Inspector for the municipality. 5. The legal costs involved in prosecuting plaintiff's case amounted to $ 3,600.00. 6. Plaintiff assumed the position in December, 1959, and was employed for the full year 1960 in this capacity. The legal fees of $ 3,600.00 which were incurred were billed to the plaintiff in 1960 and paid by him in 1960. 7. The plaintiff reported a full year's income from the capacity of Assistant Building Inspector for the year 1960 and on Page 2 of Form 1040, under the category of 'Itemized Deductions,' listed as a deduction the $ 3,600.00 fee paid to his attorneys. The defendant disallowed this deduction and this deduction is the sole basis for the refund claim involved in the instant suit.
While the circumstances presented here do not fall within any clear tax deduction, that is, one specifically exempting the particular expenditure by Mr. Caruso, neither is it readily apparent that Caruso's outlay is not deductible under the general but nonetheless express provisions of sections 162 and 212 of the Internal Revenue Code.
As observed in a recent Fifth Circuit opinion, 'the exact line of demarcation' between deductible and non-deductible expenses incurred in litigation is not always a perceptible one. Morgan's Estate v. C.I.R., 332 F.2d 144, 150 (5th Cir. 1964). In an attempt to ascertain these often elusive boundaries, the following guidelines are laid down by the Fifth Circuit:
This court feels the above standards are especially appropriate to the litigation at bar. Extensive research has revealed no case exactly in line with or dispositive of the facts herein presented.
In determining the deductibility of Mr. Caruso's expense, it is of particular importance to note that he had properly qualified for the first place on the Civil Service List of Eligibles, and that New Jersey law made his subsequent appointment mandatory. Thus, although Caruso had no 'job' in the usual sense, there was a position or status to be protected. Also, by way of plaintiff's eventual attainment, under law, of the job in question, the status of being in line for a compulsory appointment did have some relation to the production of future income.
Section 162 of 26 U.S.C. reads in pertinent part:
'(a) In general. -- There shall be allowed as a deduction all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business -- '
Denying the applicability of this section, the government has argued that plaintiff was not engaged in any trade or business at the time of the controverted expenditure.
It has long been recognized, however, that the performance of services as an employee does constitute such a trade or business within the meaning of the income tax statutes. The employee is deemed to be in the 'business' of earning his pay. Noland v. C.I.R., 269 F.2d 108, 111 (4th Cir. 1959). See also 2 C.C.H. 1964 Stand.Fed. Tax Rep. P1342. The clearest and most familiar examples of this deduction occur in the realm of travel and entertainment expenses. 26 C.F.R. §§ 1.162-1, 1.162-2, 1.162-17 (1961), as amended, 26 C.F.R. §§ 1.162-1, 1.162-17 (Supp.1964). But the spirit and effect of section 162 have carried even further. Thus, by a recently re-enacted Revenue Ruling, agency fees paid to secure employment are permissible deductions by an employee.Rev.Rul. 223, 1960-1 Cum.Bull. 57.
While there appears to be some question as to the bounds of this allowance, it seems well settled that such expenditures directly resulting in employment will so qualify. Thomas W. Ryan, 28 P-H Tax Ct.Rep. & Mem.Dec. P59,131 (1959).
A further ramification of section 162 affords taxpayer a credit for outlays incurred to preserve existing business. Once again, taking 'business' under the statute to include the performance of services for a salary, this aspect of the section can be seen in the regulations and cases dealing with educational expenses. See, e.g., Brooks v. C.I.R., 274 F.2d 96 (9th Cir. 1959). The former specifically allow deduction where the additional education is 'imposed as a condition to the retention by the taxpayer of his salary, status, or employment.' 26 C.F.R. § 1.162-5(a)(2) (1961). Legal expenses particularly qualify under this preservation theory of business deductions. For example, attorney's fees have been held deductible by a corporation officer when defending against an effort to remove him from control and management. Ingalls v. Patterson, 158 F.Supp. 627 (N.D.Ala.1958); Stanley v. Waldheim, 25 T.C. 839 (1956); E.L. Potter, 20 B.T.A. 252 (1930). Similarly in the Tax Court case of Annie Laurie Crawford, 5 T.C. 91 (1945), petitioner was allowed to deduct legal expenses incurred in re-establishing her right to act as co-executor of an estate following state court disqualification. The opinion in Annie Laurie Crawford indicates that the litigation costs were deductible both as section 162 business expenses and as section 212 non-business expenses. Id. at 94.
The court must, therefore, initially determine whether plaintiff as the number-one eligible for a civil service position falls within the legal framework defined above.
The general test for a section 162 deductible expense has been stated many times by the Tax Court. 'The crucial and controlling factor lies in determining whether the acts done and expenditures made were motivated by a purpose to protect or to promote the taxpayer's business or were made as an investment in a new enterprise.' Cubbedge Snow, 31 T.C. 585, 591 (1958). The theory of this test seems apparent. The federal government is willing to encourage an expense necessary to maintain an existing income-producing activity. It does not, however, intend to allow deductions for every potential income-producing activity. In the first case, the government is in effect looking after its own income interest; in the latter, it would be absorbing the costs of mere speculation.
Clearly, on the facts before this court, Caruso was protecting his eligibility status. He was endeavoring to preserve an already present employment advantage; and in so doing he acted in a manner not unlike one incurring an educational expense to maintain his job, or an executor of an estate ...