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Estate of Richard Baier v. Commissioner of Internal Revenue

April 6, 1976



Van Dusen, Adams and Weis, Circuit Judges.

Author: Van Dusen


VAN DUSEN, Circuit Judge.

The sole question presented on this appeal from the Tax Court is whether certain legal expenses incurred by the taxpayer during calendar years 1969-1971 qualify as an ordinary expense under § 212 of the Internal Revenue Code of 1954,*fn1 or whether those expenses must be treated as capital expenditures. The Tax Court held that the expenses have their origin in the disposition of a capital asset and, therefore, must be used to offset the realized capital gains. Baier v. Commissioner of Internal Revenue, 63 T.C. 513 (1975). We affirm.

Richard Baier was first employed by American Smelting and Refining Company (American) in 1933. In 1953, he became the chief engineer in a division of American's central research department. In conjunction with his promotion to this position, Baier signed an employment contract which contained the following provisions:

"7. [Employee] agrees that he will forthwith disclose and assign to the Company all discoveries, processes and inventions made or conceived in whole or in part by him . . . during his employment, relative to or useful in any business carried on by the Company . . . . and the said discoveries, processes and inventions shall become and remain the property of the Company . . . . Upon request of the Company . . . the [employee] agrees to make application . . . for letters patent of the United States and of any other countries where obtainable, on said discoveries, processes and inventions, and forthwith to assign all such applications and the letters patent thereon to the Company . . . .

"8. Under the provisions of the Executive Committee Circular No. 605 . . . employees of the Company making inventions in the course of their employment useful in the business of the Company, may derive certain benefits therefrom in accordance with the terms and conditions in said circular set forth; but the granting of such benefits is discretionary with the Company and the provisions of such circular are subject to withdrawal or change without notice."

App. at 54a-55a. Circular No. 605, incorporated by reference into the contract, provided that, if American should grant to any person or corporation other than itself the right to make, use or vend the discovery, process, or invention, then the company would give to the employee or employees responsible a 15% share in the net proceeds realized.

In August 1961, Baier and a co-inventor reduced to practice a method and apparatus for melting copper which had a tremendous commercial potential. In May 1962, American amended Circular No. 605 by issuing Executive Committee Circular Letter No. 995. Circular No. 995 was identical to Circular No. 605 in all material respects except that the payments made to employees under its terms would be limited to $20,000 per year and would be paid only while the employee was actively employed by American. Baier was asked to sign a new employment contract incorporating Circular No. 995, but he refused.

In accordance with the terms of the 1953 employment contract, Baier applied for a patent to cover the method and apparatus for melting copper, and assigned this application to American. Beginning in November 1962, American licensed the invention to various unrelated corporations.

A dispute arose between American and Baier over whether the payments to Baier for the invention were to be determined under the terms of Circular No. 605 or under the terms of Circular No. 995. The licensing fees realized by American were of such magnitude that the difference to Baier was extremely large. To protect his interests, Baier retained legal counsel and then commenced suit. In February 1964, a settlement was reached, the terms of which were substantially more favorable to Baier than the terms of Circular No. 995.

The payments received from American have been properly reported by Baier as long-term capital gains. See Treas. Reg. § 1.1235-1(c)(2). His legal counsel was retained on a contingent fee basis, entitling such counsel to a percentage of the payments made by American to Baier. Payments were made by Baier to his attorney in the years 1969, 1970 and 1971 and were claimed as an ordinary deduction for each year under 26 U.S.C. § 212. The Commissioner disallowed these payments as ordinary deductions and recharacterized them as capital expenditures, and ruled on the basis of 26 U.S.C. § 263*fn2 that they were not deductible. Accordingly, the Commissioner assessed a deficiency for the years 1969-1971. Baier petitioned the Tax Court for a redetermination of the deficiencies. After the Tax Court upheld the Commissioner, Baier filed a timely notice of appeal.

Baier contends that he incurred legal fees to enforce a fully executed contract, complete as to its terms, and not incident to the disposition of a capital asset (the invention underlying the patent). "Litigation was required not to fill in any missing terms [such as price] but to enforce the contract as written" (taxpayer's brief at p. 31). The Tax Court found that the terms of the contract were not final with respect to the invention disposition price, and therefore the legal expenses were incurred as the cost of setting that price. See United States v. Hilton Hotels Corp., 397 U.S. 580, 25 ...

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