                        T.C. Memo. 1998-177



                      UNITED STATES TAX COURT



          LIBERTY VENDING, INCORPORATED, Petitioner v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent

                   JOHN POULOS, Petitioner v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket Nos. 23958-96, 23959-96.     Filed May 13, 1998.



     Karl J. Smith and Joel S. Gilbert, for petitioners.

     Donna C. Hansberry and Victoria S. Crosley, for respondent.



             MEMORANDUM FINDINGS OF FACT AND OPINION


     FOLEY, Judge:   Respondent determined the following

deficiencies in petitioners' Federal income taxes:

           Liberty Vending, Inc., docket No. 23958-96

                     Year           Deficiency
                                  - 2 -


                      1991                  $2,272
                      1993                   3,750


                 John Poulos, docket No. 23959-96

                      Year                Deficiency

                      1991                 $18,842
                      1992                     803

All section references are to the Internal Revenue Code in effect

for the years in issue, and all Rule references are to the Tax

Court Rules of Practice and Procedure.        The issue for decision is

whether petitioners are entitled to deduct amounts paid for legal

fees.   We hold that Liberty Vending, Inc., may not and that John

Poulos may to the extent provided below.

                             FINDINGS OF FACT

     Some of the facts have been stipulated and are so found.          At

the time petitioners filed their petitions, Liberty Vending's

principal place of business and John Poulos' residence were in

Palatine, Illinois.

     John Poulos was the sole shareholder and operator of Galaxy,

Inc. (Galaxy), a subchapter S corporation, and Liberty Vending,

Inc. (Liberty), a subchapter C corporation.          Galaxy and Liberty

operated video game arcades and, on a weekly basis, collected

receipts from the video games, remitted a portion of such

receipts to the games' manufacturers, and notified the

manufacturers how often each game was used.          Galaxy had four

employees, and Liberty had two employees.
                                - 3 -


     In June of 1991, Mr. Poulos experienced heart problems and

was hospitalized for 2 or 3 days.    While Mr. Poulos was in the

hospital, Mrs. Poulos filed for divorce; obtained a temporary

restraining order against him; and obtained an ex parte order of

protection that gave her emergency possession of Liberty and

Galaxy and placed petitioners' bank accounts in escrow at

American National Bank (ANB) under the supervision of the Circuit

Court of Cook County, Illinois, Domestic Relations Division.

Mrs. Poulos and her boyfriend then went to Galaxy's and Liberty's

place of business, fired all of the employees, took large

quantities of cash and equipment, and removed the corporations'

books and records.

     Mr. Poulos learned of his wife's actions while in the

hospital.    After the hospital released him, he attempted to

enter the businesses, but discovered that the locks had been

changed.    To regain possession of his businesses, Mr. Poulos

retained the services of two law firms:    Greenburg & Hermann

(Greenburg) and Schiller, DuCanto and Fleck (Schiller).      Mr.

Poulos' corporate attorney, George Ritsos, also assisted in the

matter.    On June 20, 1991, Mr. Poulos' attorneys filed a motion

to dissolve the order of protection and the temporary restraining

order.

     While this motion was pending, Mr. Poulos received notices

of nonpayment from Galaxy's and Liberty's creditors.    In
                                - 4 -


addition, video game manufacturers notified Mr. Poulos that his

corporations were not fulfilling their service obligations, and

therefore, contracts with his companies would be canceled if he

could not rectify this problem.    Payments from the ANB escrow

account to Liberty's and Galaxy's creditors could not be made

without a court order, and Mr. Poulos had no other funds with

which to make these payments.   As a result, Mr. Poulos filed a

motion with the court to order such payments.

     In November of 1991, the court issued an order giving Mr.

Poulos possession of Liberty and Galaxy.    Mr. Poulos and his

attorneys continued their attempts to regain possession of the

corporate assets that had been taken by Mrs. Poulos and her

boyfriend.   In addition, they also represented Mr. Poulos in his

divorce action with Mrs. Poulos.

     The following table delineates legal expenses paid by Galaxy

in 1991 and Mr. Poulos in 1992:

                                   1991           1992

     Greenburg                  $35,000         $3,000
     Schiller                    25,000         22,000
     Mr. Ritsos                   5,000          2,000
                                 65,000         27,000

Approximately 60 percent of Schiller's and 70 percent of

Greenburg's fees related to the services performed on behalf of

Galaxy.

     On their respective income tax returns, Liberty deducted

legal fees of $15,150 for 1991 and $25,000 for 1993, and Galaxy
                                 - 5 -


deducted legal fees of $121,200 for 1991 and $25,000 for 1992.

Because Galaxy was a S corporation, the latter deductions passed

through to Mr. Poulos' tax returns for the years in issue.

Respondent disallowed the deductions.




                                OPINION

     Petitioners contend that Liberty and Galaxy are entitled to

deduct as ordinary and necessary business expenses the portion of

the legal fees attributable to regaining possession of the

corporations.   See sec. 162(a).   Petitioners further contend that

Mr. Poulos may deduct such fees because they were incurred for

the management, conservation, or maintenance of property held for

the production of income.   See sec. 212(2).   Respondent contends

that the legal expenses relate to Mr. Poulos' divorce proceeding

and, therefore, are personal expenses that should be disallowed.

See sec. 262(a).

     Petitioners' legal expenses are deductible if the origin of

the claim arose from their profit seeking, rather than Mr.

Poulos' personal, activities.    See United States v. Gilmore, 372

U.S. 39, 48 (1963).   Mr. Poulos' legal fees were incurred for the

purpose of establishing his right to possession of, or

participation in the income from, the corporations, and

therefore, such expenses arose from Mr. Poulos' profit-seeking
                                 - 6 -


activities.   See, e.g., Hahn v, Commissioner, T.C. Memo. 1976-113

(allowing a deduction for legal fees relating to obtaining

possession of, and participation of income from, a business

already owned by the taxpayer).    While the protective order was

in place, employees were fired, the corporations' creditors were

not paid, and services were not performed.       In addition, the

corporations could not pay creditors without the divorce court's

permission.   Thus, the corporations' profit-seeking activities

were curtailed.   See, e.g., Dolese v. United States, 605 F.2d

1146, 1152 (10th Cir. 1979) (holding that legal expenses of a

corporation arising out of a divorce proceeding between the

shareholder-owner and his wife were deductible, to the extent

that the costs were incurred to resist actions that interfered

with the business activities of the corporation).          Accordingly,

Mr. Poulos is entitled to deductions, including pass-through

deductions, for the portion of the legal fees relating to the

protective order (i.e., $44,500 for 1991 and $17,300 for 1992).

Liberty, however, is not entitled to deduct any of its alleged

legal expenses because it has not established that it paid such

expenses.

     To reflect the foregoing,


                                              Decisions will be entered

                                         under Rule 155.
