                           T.C. Memo. 2001-1



                      UNITED STATES TAX COURT



 FRANCIS LAWRENCE AND KATHRYN TENOPIR REMKIEWICZ, Petitioners v.
           COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 2585-99.                 Filed January 3, 2001.



     Francis L. Remkiewicz, pro se.

     Andrew R. Moore, for respondent.



             MEMORANDUM FINDINGS OF FACT AND OPINION

     GERBER, Judge:   Respondent determined a $10,286 deficiency

in petitioners’ 1996 Federal income tax.       After concessions, the

issue that remains for our consideration is whether petitioners

are entitled to deduct any portion of attorney’s fees incurred in

connection with the termination of employment and the pursuit of

a civil rights action.
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                         FINDINGS OF FACT

     Petitioners resided in Oakdale, California, at the time

their petition was filed in this case.   Francis L. Remkiewicz

(petitioner), during August 1993, was employed by the Board of

the Lynwood School District as an assistant superintendent for

business services.   Petitioner, who is Caucasian, was supervised

by an African American; the senior management staff was composed

exclusively of African Americans; and the school district board

was composed of a majority of African Americans.   Petitioner

believed that he was being discriminated against, and he was

concerned that his employment could be terminated.   Although he

believed himself to be qualified, he was given substandard

ratings, bypassed in his line of authority or command, and his

responsibilities were relegated to African American employees who

were subordinate to petitioner.

     During April 1994, petitioner made a complaint about the

perceived discrimination to the U.S. Equal Employment Opportunity

Commission, which in turn referred the matter to the California

Department of Fair Employment and Housing, which in turn notified

petitioner’s school board.   The school board notified petitioner

that they did not intend to reemploy him at the end of his 1-year

term and offered him an opportunity to address the board during

April 1994.   Petitioner expected to be terminated from his

current position but hired an attorney for the purpose of
                                 - 3 -

protecting his employment reputation and to make sure that the

termination of his employment did not jeopardize his potential

for future employment.     The attorney attended the school board

meeting at which petitioner’s performance, evaluation, and the

intent not to reemploy him were the subject matter.     In

particular, petitioner sought to have the attorney attempt to

limit any damaging information that might be available in

connection with his past employment with the Lynwood School

District.

         After representing petitioner at the board meeting,

petitioner’s attorney explained that the most effective approach

for reaching their objectives would be to bring a discrimination

action under title VII of the Civil Rights Act of 1964, 42 U.S.C.

secs. 2000a to 2000b-2.1    Petitioner’s complaint was filed on

October 12, 1995, in the United States District Court, Central

District of California alleging racial discrimination against him

by the Lynwood School District and its trustees.     Petitioner

obtained a position at the Oakdale School District where the

superintendent knew of his termination from the prior school

district.   It was understood that the continuation of

petitioner’s position with the Oakdale District depended on his

success in the final resolution of petitioner’s litigation


     1
       As amended in 1991, see United States v. Burke, 504 U.S.
229, 241 n.12 (1992).
                               - 4 -

against the Lynwood School District.    The cause of action was

based solely on the Civil Rights Act of 1964, 42 U.S.C. secs.

2000a to 2000b-2.   Petitioner alleged discrimination in placing

him on administrative leave and not reviewing his employment

agreement, and he sought damages for emotional distress, backpay,

punitive damages, attorney’s fees, and the cost of his suit.

     During 1996, the parties to the above-referenced litigation

entered into a settlement agreement under which petitioner

received damages of $140,000 solely for emotional distress.    Also

during 1996, petitioner paid legal fees and costs, in the total

amount of $55,127.03, for the legal representation concerning the

termination of his employment with the Lynwood District and the

Civil Rights Act litigation and its settlement.    On their U.S.

Individual Income Tax Return (Form 1040) for 1996, petitioners

claimed, on Schedule A, Itemized Deductions, the $55,127.03 for

legal fees and costs, and respondent disallowed the claim.    Of

the $55,127.03 in legal fees, $10,000 is attributable to the

attorney’s efforts before the school board and to protect

petitioner’s potential for future compensation as an employee.

                              OPINION

     Respondent agrees that petitioner’s $140,000 settlement

recovery is exempt from tax under section 104(a)(2).2   The

     2
       All section references are to the Internal Revenue Code in
effect for the year in issue, and all Rule references are to the
                                                   (continued...)
                                   - 5 -

controversy here is whether petitioners are entitled to deduct3

any part of the legal fees and costs incurred in his legal

representation before the school board and the subsequent civil

rights legal action.       See, e.g., Rutt-Hahn v. Commissioner, T.C.

Memo. 1996-536.       Respondent, however, relies on section 265 to

support his determination that these otherwise allowable

deductions may not be deducted if allocable or attributable to

excludable income.

       Section 265, in pertinent part, provides:

       SEC. 265(a) General Rule.--No deduction shall be
       allowed for--

            (1) Expenses.-–Any amount otherwise allowable as a
       deduction which is allocable to one or more classes of
       income * * * wholly exempt from the taxes imposed by
       this subtitle, or any amount otherwise allowable under
       section 212 (relating to expenses for the production of
       income)* * * .

See also Bent v. Commissioner, 87 T.C. 236, 251 (1986) (and cases

cited therein), affd. 835 F.2d 67 (3d Cir. 1987).

       Petitioners argue that the legal fees and costs were not

attributable to the receipt of income that is exempted by section

104.       Petitioner contends that his purpose in hiring the attorney


       2
      (...continued)
Tax Court Rules of Practice and Procedure, unless otherwise
indicated.
       3
       Petitioners sought the deduction on Schedule A, Itemized
Deductions, and, accordingly, there is no dispute as to whether
their deduction is subject to the limitations connected with such
deductions.
                               - 6 -

was to protect his ability to earn income.    Accordingly, we must

consider whether the legal fees are attributable to petitioner’s

employment status and not to the tax-exempt income.

     Section 1.265-1(b), Income Tax Regs., deals with the

definition of the terms “exempt” and “nonexempt” income for

purposes of section 265.   Section 1.265-1(b)(1), Income Tax

Regs., in pertinent part, states that a “‘class of exempt income’

means any class of income (whether or not any amount of income of

such class is received or accrued) wholly exempt from the taxes

imposed by subtitle A of the Code.”    Section 1.265-1(b)(2),

Income Tax Regs., defines “nonexempt income” as “any income which

is required to be included in gross income.”    There is no

question that petitioner’s lawsuit recovery was exempt income.

Likewise, petitioner’s current and possibly his future

compensation from employment would meet the definition for

nonexempt income set forth in the regulation.    In that regard, in

addition to the $140,000 recovery, petitioner’s attorney’s

efforts permitted him to continue earning employee compensation,

both during the year under consideration and for future years.4

     Section 1.265-1(c), Income Tax Regs., provides for

allocation of expenses between exempt and nonexempt sources of

income, as follows:

     4
       For the taxable year under consideration (1996),
petitioner reported almost $69,000 in wages from employment in
the Oakdale School District.
                                 - 7 -

     Expenses and amounts otherwise allowable which are
     directly allocable to any class or classes of exempt
     income shall be allocated thereto; and expenses and
     amounts directly allocable to any class or classes of
     nonexempt income shall be allocated thereto. If an
     expense or amount otherwise allowable is indirectly
     allocable to both a class of nonexempt income and a
     class of exempt income, a reasonable proportion thereof
     determined in light of all the facts and circumstances
     in each case shall be allocated to each.

     Initially, petitioner hired the lawyer to protect his

current employment and ensure his future employment and his

ability to earn a living.   To the extent that the lawyer’s

services dealt with those aspects, the regulation permits

allocation to nonexempt income.    In that regard, to the extent

that any portion of the legal fee was attributable to the

protection of petitioner’s employment status, it may be

deductible under section 162.

     The $140,000 of exempt income was attributable to the

lawyer’s efforts.   We have also found that $10,000 of the

$55,127.03 in legal fees was attributable to the lawyer’s

representation of petitioner before the school board and his

efforts to protect petitioner’s current and potential for future

employment.   Accordingly, respondent’s determination is sustained

with respect to $45,127.03 of the claimed legal fees, and

petitioners are entitled to a deduction of $10,000.

     To reflect the foregoing,

                                         Decision will be entered

                                 under Rule 155.
