
USCA1 Opinion

	




                            UNITED STATES COURT OF APPEALS                                FOR THE FIRST CIRCUIT                                 ____________________          No. 95-1451                    J. KENNETH ALEXANDER AND JOANNE M. ALEXANDER,                              Petitioners - Appellants,                                          v.                             INTERNAL REVENUE SERVICE OF                            THE UNITED STATES OF AMERICA,                                Respondent - Appellee.                                 ____________________                             ON APPEAL FROM A DECISION OF                             THE UNITED STATES TAX COURT                                 ____________________                                        Before                               Torruella, Chief Judge,                                          ___________                      Aldrich and Coffin, Senior Circuit Judges.                                          _____________________                                _____________________               Philip J.  Ryan, with  whom Ryan, Martin,  Costello, Leiter,               _______________             ________________________________          Steiger & Cass, P.C. was on brief for appellants.          ____________________               William  J. Patton,  Attorney,  Tax Division,  Department of               __________________          Justice, Loretta C. Argrett,  Assistant Attorney General, Gary R.                   __________________                               _______          Allen,  Attorney,  and Richard  Farber,  Attorney, Tax  Division,          _____                  _______________          Department of Justice, were on brief for appellee.                                 ____________________                                  December 22, 1995                                 ____________________                    TORRUELLA,  Chief  Judge.     Respondent-Appellee,  the                    TORRUELLA,  Chief  Judge                                ____________          Commissioner of Internal Revenue (the "Commissioner"), determined          a deficiency of $57,441 in  the 1989 Federal income tax filed  by          J.  Kenneth Alexander  (the "Taxpayer")  and Joanne  M. Alexander          (together, the "Appellants" or the "Petitioners").  The Tax Court          upheld the Commissioner's  determination and the  Petitioners now          seek review of that decision.   For the reasons stated  below, we          affirm.                                    I.  BACKGROUND                                    I.  BACKGROUND                    The pertinent facts, some of which have been stipulated          and incorporated  in the  district court's  findings, are  not in          dispute, and are recapitulated here.  Unless otherwise indicated,          all section references are to the Internal Revenue Code in effect          for  1989.  Internal Revenue Code, 26  U.S.C.   1 et seq. (1988 &                                                            ______          Supp. 1991).                    In 1983, Taxpayer entered  into an employment agreement          with  his employer,  W. F.  Young,  Inc. ("Young"),  according to          which Taxpayer would  remain in the capacities  of Executive Vice          President,  Treasurer,  and  Chief  Executive  Officer  until  he          reached  the age  of seventy  (70), on  December 13,  1993.    On          October 15,  1987, when Taxpayer  was sixty-four (64)  years old,          Young  terminated  Taxpayer's  employment.    Subsequent  to  his          termination, Taxpayer offered management consulting  services for          a fee, and in 1989 obtained a management consulting contract with          the Hanson Group of Ludlow, Massachusetts.                                         -2-                    On February  10, 1988,  Taxpayer filed a  civil lawsuit          against Young (the "lawsuit"),  in which Taxpayer was represented          by  the law firm of Ryan & White, P.C. ("Ryan & White").1  In his          complaint,  Taxpayer  alleged  a   breach  of  the  express  1983          employment  contract  (or  "Count  I"), a  breach  of  an implied          pension benefits contract (or "Count II"), and age discrimination          under Massachusetts  General Law, Chapter 151B,  Section 1 (1976)          (or "Count III").                    On May 1,  1989, Taxpayer and Young  executed a written          settlement agreement (the  "Settlement Agreement"), according  to          which Young was to  pay Taxpayer $350,000, of which  $100,000 was          allocated to  Count III, and  $250,000 to Counts  I and II.2   On          May 5, 1989, as  per the Settlement  Agreement, Young issued  two          checks  payable  to  "J.  Kenneth  Alexander  and Ryan  &  White,          Attorneys  for J.  Kenneth  Alexander,"  one  in  the  amount  of          $100,000  (for Count  III),  and  the  other  in  the  amount  of          $225,395.20 (for Counts I and II, less taxes withheld).                    On the  1989 Federal income tax  return, Taxpayer's tax          preparer   deducted   $245,100  from   the   settlement  proceeds          attributable to Counts I and II.  This deduction was explained in                                        ____________________          1   J. Kenneth Alexander v.  W. F. Young, Inc.,  Civil Action No.              ____________________     _________________          82-243 (Mass. Superior Court, Hampden County 1988).           2  The Settlement Agreement also provided that (i) Taxpayer would          be  deemed to have retired from Young effective October 15, 1987;          (ii) Taxpayer  would receive  monthly payments commencing  on May          15, 1989, and  continuing for  the duration  of Taxpayer's  life,          which total over $70,000  per year; and (iii) Taxpayer  and Young          executed releases,  according to which  Alexander surrendered all          claims arising out of his employment and its termination.                                         -3-          an  attached statement,  which stated that  Taxpayer paid  Ryan &          White $258,000 in legal  fees (the "Legal Fee").3  It also stated          that  according to  Ryan &  White's time  allocations, 5%  of the          Legal Fee was attributable to settlement of Count III, and 95% to          settlement of Counts I and II.  Accordingly, $245,100 (95% of the          $258,000  Legal Fee)  was deducted  from the  settlement proceeds          attributable to Counts I and II.                    The   Commissioner   sent   a   notice   of  deficiency          disallowing Taxpayer's direct deduction of the Legal Fee from the          settlement  proceeds.    The  Commissioner  determined  that  the          $250,000 received from Young in settlement of Counts I and II was          gross  income to Taxpayer, and that the Legal Fee associated with          Counts   I  and   II  were  miscellaneous   itemized  deductions.          Accordingly,  the  Commissioner  reduced  the  $245,100 deduction          reported on the 1989  return to $240,198, due to  the increase in          Taxpayer's adjusted gross income  and the two percent (2-percent)          adjusted  gross income  limitation for  miscellaneous deductions.          In  addition,  the Commissioner  determined  that,  due to  these          adjustments, Taxpayer was liable  for the Alternative Minimum Tax          ("AMT")  under  Section  55 of  the  Code,  which  resulted in  a          deficiency of $57,441.                    Petitioners filed  a petition in the  United States Tax          Court for  redetermination  of the  deficiency.   The  Tax  Court                                        ____________________          3  The additional information included  in the statement attached          to Petitioners' 1989 return, entitled "Disclosure Under Reg. Sec.          1.6661," is not included here because it is not essential for the          disposition of the issue on appeal.                                         -4-          rejected  Petitioners' arguments,  entering a  final judgment  on          January 31,  1995, upholding the Commissioner's  determination of          Petitioners'  tax deficiency.    This appeal  followed.   We have          jurisdiction pursuant to 26 U.S.C.   7482(a)(1).                                   II.  DISCUSSION                                   II.  DISCUSSION                    The only issue on appeal is the proper tax treatment of          the  Legal  Fee.    We  must determine  whether  the  Petitioners          properly  deducted the  Legal  Fee from  the settlement  proceeds          under Section 1001.   If we find that they did  not, then we must          determine whether to  treat the Legal Fee as an "above the line"4          trade or business deduction under Section 162  of the Code, or as          a miscellaneous itemized deduction "below the line."5                    On appeal, Petitioners essentially contend that the Tax          Court's decision  to uphold the Commissioner's deficiency finding          is caused by the erroneous determination that Taxpayer was in the          trade  or business of "the performance of services as an employee          during  1989."   Petitioners correctly  assert that  the defining          issue is whether Taxpayer was  Young's "employee" for purposes of          classifying  the  settlement  proceeds  and  for  determining the          deductibility of the Legal Fee  under Section 62(a)(1).  Although                                        ____________________          4  We make reference to the "line" on the federal income tax form          where adjusted gross income is calculated.          5   Petitioners do  not dispute  that by  treating the Legal  Fee          "below  the line" the amounts involved trigger the AMT and, thus,          their  tax deficiency.  We recognize that it is this ramification          which  drives   Petitioners'  challenge  to   the  Commissioner's          determination   that  the  Legal  Fee  is  to  be  treated  as  a          miscellaneous itemized deduction.                                         -5-          we agree with Petitioners' formulation of the defining issue,  we          reject their arguments and affirm the court below.                                A.  Standard of Review                                A.  Standard of Review                    We review the  Tax Court's decision "in the same manner          and to  the same extent  as decisions  of the district  courts in          civil actions tried  without a jury."  26 U.S.C.    7482(a).  The          treatment  of the  Legal Fee  is purely  a  question of  law and,          therefore, subject to  de novo  review.  Estate  of Robertson  v.                                 _______           ____________________          Commissioner,  15 F.3d 779, 781  (8th Cir. 1994);  see also First          ____________                                       ________ _____          National Bank in Albuquerque v. C.I.R., 921 F.2d 1081, 1086 (10th          ____________________________    ______          Cir. 1990) (stating that de novo review is applied to tax court's                                   _______          findings  of law and of ultimate fact derived from applying legal          principles to  subsidiary facts).   The  Tax Court's findings  of          fact  will only  be  disturbed  for  clear  error.    Manzoli  v.                                                                _______          Commissioner,  904  F.2d  101,  103  (1st  Cir.  1990);  U.S.  v.          ____________                                             ____          Thompson, 406 F.2d 1006, 1009 (9th Cir. 1969); see also Conner v.          ________                                       ________ ______          Commissioner,  847  F.2d  985     (1st  Cir.  1988)  (emphasizing          ____________          appropriateness   of  giving   weight  to   Commissioner's  well-          established views).                        B.  Characterization of the Legal Fee                        B.  Characterization of the Legal Fee                    Petitioners  argue that  the  Legal  Fee  was  properly          subtracted from  the amount  realized in  the settlement, as  per          Sections  1001 and 1016,6 in  order to determine  the "gain" from                                        ____________________          6  Section 1001(a) provides, in relevant part,                       The   gain  from   the   sale  or   other                      disposition  of  property  shall  be  the                      excess of the  amount realized  therefrom                                         -6-          the disposition  of Taxpayer's "valuable intangible  assets," the          express and implied contracts and  resulting lawsuit.  In support          of their position, Petitioners contend that the Legal Fee was the          "cost of  the disposition"  of Taxpayer's  assets because it  was          incurred after Taxpayer's employment was terminated for the "sole                   _____          purpose"  of  enhancing  their value  and  disposing  of  them by          obtaining either  a settlement or judgment.   Petitioners further          contend  that, because Sections 1001 and 1016 make no distinction          between  the basis and gain rules for capital or ordinary assets,          "there  is  a 'capital  account'  for all  assets,  whether those          assets are  considered capital  or ordinary."   Thus, Petitioners                                        ____________________                      over  the  adjusted  basis   provided  in                      [S]ection 1011 for determining gain . . .                      .          Section 1011(a) provides, in relevant part,                      The  adjusted  basis for  determining the                      gain  or  loss  from the  sale  or  other                      disposition    of   property,    whenever                      acquired, shall be the  basis (determined                      under [S]ection 1012 .  . .) adjusted  as                      provided in [S]ection 1016.          Section 1012 provides, in relevant part,                      The basis of  property shall be  the cost                      of such property . . . .          Section 1016 provides, in relevant part,                      (a)  General  rule. Proper  adjustment in                      respect  of  the  property  shall  in all                      cases be made                      (1)  for expenditures,  receipts, losses,                      or  other  items, properly  chargeable to                      capital account . . . .          26 U.S.C.    1001(a), 1011(a), 1012, 1016 (1988 & Supp. 1991).                                         -7-          conclude, the Legal Fee is an "expenditure . . . properly charged          to [the assets']  capital account" within the  meaning of Section          1016 to be  offset against  the settlement proceeds  in order  to          determine the "gain" under Section 1001.                    Upon de  novo review, we  reject Petitioners' arguments                         ________          invoking treatment under Section  1001, and their contention that          the Tax Court erred when it rejected them.                    In determining the  tax treatment of the Legal  Fee, we          take as our point of departure Section 61(a), which defines gross          income as  "all income from whatever source  derived," subject to          certain exclusions provided in the Code.  It includes, and is not          limited  to,   "[c]ompensation  for  services,   including  fees,          commissions, fringe benefits, and  similar items."  See Helvering                                                              ___ _________          v. Clifford,  309  U.S. 331,  334 (1940)  (finding that  Congress             ________          intended  to exert the "full measure of its taxing power" through          Section  61(a)).   Next,  we  take into  consideration  the well-          settled  rule  that the  classification  of  amounts received  in          settlement  of litigation is to  be determined by  the nature and          basis of  the action settled, and amounts  received in compromise          of a  claim must be considered  as having the same  nature as the          right compromised.  Parker v. United States, 573 F.2d 42, 49, 215                              ______    _____________          Ct.Cl.  773 (quoting  Carter's Estate  v. Commissioner,  298 F.2d                                _______________     ____________          192,  194 (8th Cir. 1962)),  cert. denied, 439  U.S. 1046 (1978);                                       ____________          see  Furrer v. Commissioner, 566 F.2d 1115, 1116 (9th Cir. 1977),          ___  ______    ____________          cert. denied, 437  U.S. 903  (1978);  Clark  v. Commissioner,  67          ____________                          _____     ____________          T.C.M. (CCH) 3105 (1994).                                         -8-                    These two considerations  lead us to  our test: it  "is          not whether the action was one in tort or contract but rather the          question to  be  asked is  'In  lieu  of what  were  the  damages          awarded?'"   Raytheon Production Corp. v.  Commissioner, 144 F.2d                       _________________________     ____________          110,  113 (1st Cir.)  (citation omitted), cert.  denied, 323 U.S.                                                    _____________          779 (1944); see Getty  v. Commissioner, 913 F.2d 1486,  1490 (9th                      ___ _____     ____________          Cir. 1990) (applying Raytheon  test in characterizing  settlement                               ________          payment  for  tax  purposes).   An  amount  received  in lieu  of          compensation  under  an  employment  contract  constitutes  gross          income to  the recipient  in the year  in which it  was received.          See  Furrer v. Commissioner, 566  F.2d at 1117  (holding lump sum          ___  ______    ____________          payment  for termination  of an  agency relationship  is ordinary          income);  Heyn v. Commissioner, 39  T.C. 719, 720 (1963) (holding                    ____    ____________          amount  received in  consideration of  an employment  contract is          ordinary income); Clark  v. Commissioner, 67 T.C.M. (CCH) at                                 _____     ____________                      ___          (finding  that  lump sum  payment  received  upon termination  of          employment contract is ordinary income); Rev. Rul. 58-301, 1958-1          C.B. 23,  24 (holding lump sum payment received by an employee as          consideration  for the  cancellation  of his  employment contract          constitutes  gross income to the recipient in the taxable year of          receipt); cf. Rev. Rul. 80-364, 1980-2 C.B. 294  (illustrating by                    ___          way of three  hypothetical examples the income and employment tax          consequences  of   interest  and   attorney's  fees   awarded  in          connection with claims for back wages).                    Under  this  rubric,   whether  Taxpayer's   employment          contracts are  "property" or "intangible assets"  in the abstract                                         -9-          is irrelevant  to the proper analysis of  the characterization of          the settlement  proceeds and, thus,  the proper tax  treatment of          the  Legal  Fee.    The  Supreme  Court's  decision  in  Hort  v.                                                                   ____          Commissioner, 313 U.S. 28 (1941), is particularly instructive:          ____________                      Where,  as  in  this  case,  the disputed                      amount was essentially  a substitute  for                      rental  payments which     22(a) [of  the                      1932  Act]   expressly  characterizes  as                      gross  income, it  must  be  regarded  as                      ordinary  income,  and  it is  immaterial                      that  for  some  purposes   the  contract                      creating  right to  such payments  may be                      treated as "property" or "capital."          Id. at  31.   The cancellation  of the  lease  in Hort  "involved          ___                                               ____          nothing  more than  the  relinquishment of  the  right to  future          rental payments  in return for  a present substitute  payment and          possession of the leased  premises."  Id. at  32.  Because  those                                                ___          future  rents would have been  taxed as ordinary  income had they          been  received  in  the   ordinary  course  of  the  lease,   the          "substitute"  payment  should be  treated  no  differently.   Id.                                                                        ___          Similarly, here, assuming the  settlement was a "cancellation" of          Taxpayer's contractual  rights,  what Taxpayer  fought  for,  and          received, is merely a substitute payment for the compensation and          retirement  benefits  due  him  under  his  express  and  implied          employment contracts.  Because his salary and benefits would have          been taxed  as ordinary  income without  any offsetting basis  if          received  in  the  ordinary course  under  Taxpayer's  employment          contract,   the   "substitute"  payments   can   be   treated  no          differently.   See Henry v. Commissioner, 62 T.C. 605, 606 (1974)                         ___ _____    ____________          (holding  that  amounts  received  in  settlement  of  breach  of                                         -10-          employment  contract  must  be   held  impressed  with  the  same          compensatory, taxable  character); cf. Hodge v.  Commissioner, 64                                             ___ _____     ____________          T.C.  616 (1975)  (addressing  suit for  back  wages); Sterns  v.                                                                 ______          Commissioner, 14 T.C. 420  (1950), affd. per curiam 189  F.2d 259          ____________                       ____  __________          (6th Cir. 1951) (same).7                    Similarly,  Petitioners'  argument  that,  because  the          settlement was a "cancellation" of his contractual rights, it was          a  "disposition"  within  the  meaning  of  Section  1001(a),  is                                        ____________________          7   In support of their claim that Taxpayer's express and implied          contracts were  "intangible assets," Petitioners rely  on a Fifth          Circuit case  and two  revenue rulings holding  that professional          football or  baseball player contracts were  assets with distinct          values that  could be depreciated  by the team owners.   Laird v.                                                                   _____          U.S.,  556 F.2d  1224  (5th Cir.  1977) (discussing  professional          ____          football player  contracts), cert. denied, 434  U.S. 1014 (1978);                                       ____________          Rev. Rul.  77-137, 1971-C.B.  104 (same);  and Rev. Rul.  67-379,          1967-2  C.B.  127 (same,  baseball).    Petitioners' reliance  is          clearly inapposite and unpersuasive.  As the Tax Court noted, and          as Petitioners concede, Taxpayer's employment contract with Young          was neither a depreciable nor a capital asset in his hands.             Moreover, while Petitioners correctly maintain that Taxpayer's          contract  claims were  ordinary, not  capital, assets,  Furrer v.                                                                  ______          Commissioner, 566 F.2d  at 1117 (noting that "[i]f  all contracts          ____________          granting  rights could  be  considered  capital  assets,  without          inquiry  into  the  nature  of the  rights  granted,  almost  all          ordinary  income from  salaries, wages,  or commissions  could be          transformed  into capital  gain"),  they nonetheless  urge us  to          apply  here the rationale adopted  in a line  of cases addressing          the  deductibility of legal fees incurred in the disposition of a          capital asset.   See United  States v. Hilton  Hotels Corp.,  397                           ___ ______________    ____________________          U.S.  580 (1970); Woodward v. Commissioner,  397 U.S. 572 (1970);                            ________    ____________          Helgerson  v. United States, 426 F.2d 1293 (8th Cir. 1970); Baier          _________     _____________                                 _____          v. Commissioner, 63 T.C. 513 (1975), aff'd, 553 F.2d 117 (3d Cir.             ____________                      _____          1976); see also A.E. Staley Manufacturing Co. and Subsidiaries v.                 ________ ______________________________________________          Commissioner,  1995 WL 535269 at *46-48, 105 T.C. (CCH) 14 (1995)          ____________          (providing  a  recent discussion  of  the "origin  of  the claim"          analysis in the context  of capital assets).  These  cases simply          do not persuade  us that  Taxpayer's Legal Fee  should be  offset          against  the  settlement proceeds  because,  as  we have  already          explained, Taxpayer's Legal Fee was incurred to obtain damages in          the  nature of compensation due him under the express and implied          employment contracts.                                          -11-          unpersuasive.   As  the Tax Court  correctly noted,  assuming the          settlement was a "cancellation" of Taxpayer's rights, it does not          necessarily   follow   that    the   settlement   constituted   a          "disposition"  of "property" warranting  an offsetting  of basis.          See Herbert's Estate v. Commissioner, 139 F.2d 756 (3d Cir. 1943)          ___ ________________    ____________          (discussing meaning  of "disposition" and  holding extinguishment          of decedent's debt, represented by readily transferable notes and          open accounts,  was a  disposition), cert. denied,  322 U.S.  752                                               ____________          (1944).8   More  importantly, to  permit Taxpayer  to offset  his          "cost of  disposition" or  basis --  the Legal  Fee  -- would  be          fundamentally inapposite  in light  of the controlling  fact that          the settlement proceeds are clearly in the nature of compensation          as Young's employee.9                      To recapitulate, what is relevant  is that, as the  Tax          Court found, Taxpayer in substance was suing for damages suffered          by  the  loss  of  his  employment with  Young  --  his  loss  of          compensation in terms of salary and retirement benefits.  This is                                        ____________________          8  As  the Tax  Court correctly noted,  Petitioners' reliance  on          Herbert's Estate  is inapposite.   Petitioners fail  to recognize          ________________          that  the nature of the claim involved proved an important factor          in  the court's finding of a "disposition."  Unlike the executors          in  Herbert's Estate, Taxpayer did not hold a claim against Young              ________________          in  the sense  of  a "debt,"  that  was readily  transferable  or          liquidated  prior to settlement; nor,  was he in  any way Young's          "creditor."           9  One might intuitively  argue that some sort of  "basis" should          be  recognized  when one  has to  litigate  to receive  one's due          compensation.   The fact remains,  however, that the  Code simply          does  not  provide   for  the   offsetting  of   basis  in   such          circumstances except  in limited cases involving  capital assets.          Instead,  the Code permits  litigation expenses to  be taken into          account by way of a deduction.  See Section C, infra.                                            ___            _____                                         -12-          a factual determination and, indeed, is one with respect to which          we  find no clear error.   In fact, the claim  giving rise to the          Legal  Fee is  inexorably  rooted in  Taxpayer's employment  with          Young  --   indeed,  in  his  status   as  Young's  "employee."10          Because  the   damages  Taxpayer  received   are  essentially   a          substitute  for the  salary and  benefits he would  have received          under  the  employment  contract,  they  are  fully  included  as          ordinary  income in  Taxpayer's  gross income  under Section  61,          without  regard   to  whether  Taxpayer's   employment  contracts          constituted "property" or "intangible assets."  Hort, 313 U.S. at                                                          ____          31-32.11                    Thus, upon de  novo review, we find no  error of law in                               ________          the  Tax Court's rejection of  Petitioners' arguments in favor of          Section  1001  treatment,  because the  settlement  proceeds were                                        ____________________          10  We note also that under this  rubric it is irrelevant that at          the  time of  the  lawsuit, Taxpayer  was  no longer  on  Young's          payroll.   See  footnote 14,  supra, and  related text.   Equally                     ___                _____          irrelevant is  Taxpayer's stated purpose for  incurring the Legal          Fee, namely "to add value to [Taxpayer's] contract claims, and to          dispose  of those assets  by means  of either  a settlement  or a          courtroom  victory."   See  Woodward, 397 U.S.  at 578 (rejecting                                 ___  ________          purpose  test  and noting  that it  would  encourage a  resort to          formalisms  and artificial  distinctions); U.S.  v.  Gilmore, 372                                                     ____      _______          U.S. 39, 49 (1963) (rejecting purpose  test in favor of origin of          claim test).  Taxpayer's desire to obtain the salary and benefits          due under  the employment contracts  was clearly the  "origin" of          the  lawsuit - not his alleged desire to "dispose" of "intangible          assets."            11  We note that  we need not address the merits  of Petitioners'          claim regarding Sections 1001 and 1016, namely that because those          two sections make no distinction between the basis and gain rules          for capital or ordinary assets, "there is a 'capital account' for          all assets."                                          -13-          received in lieu of compensation and, as such, are fully included          as gross income under Section 61.                          C.  Deductibility of the Legal Fee                          C.  Deductibility of the Legal Fee                    Having  determined that  the Legal  Fee is  included in          gross income  under Section 61,  we turn  to the question  of its          deductibility.   It is well-settled that any accessions to wealth          received by a taxpayer  are included in his gross  income, unless          the  taxpayer  can demonstrate  that  the  amount received  falls          within a specific statutory  exclusion.  Commissioner v. Glenshaw                                                   ____________    ________          Glass,  348 U.S.  426, 431,  reh'g denied,  349 U.S.  925 (1955).          _____                        ____________          Section  162(a)  provides  that  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."   Section 62(a)(1)  adds that expenses  falling within          Section  162(a)  are  deducted from  gross  income  to  arrive at          "adjusted gross income,"  explicitly excluding expenses  incurred                                               _________          by a taxpayer engaged in the trade or business of the performance          of services as an employee.12                    Petitioners   argue  that,  if  the  entire  settlement          proceeds  allocable to Counts I and II constitute gross income to                                        ____________________          12  Section 62(a)(1) provides in pertinent part,                       The  deductions  allowed by  this chapter                      (other  than   by   part  VII   of   this                      subchapter) which are  attributable to  a                      trade  or  business  carried  on  by  the                      taxpayer, if such trade or  business does                                _______________________________                      not   consist   of  the   performance  of                      _________________________________________                      services by the taxpayer as an employee.                       _______________________________________          26 U.S.C. Section 62(a)(1) (1988 & Supp. 1991) (emphasis added).                                         -14-          him under  Section 61(a)  of the Code,  the Legal  Fee should  be          treated  as an "above the  line" trade or  business expense under          Section 162(a) of the Code, rather than a "miscellaneous itemized          deduction" under Section  63, as the  Commissioner found and  the          Tax Court  held.  The crux  of Petitioners' argument is  that the          "employee" limitations of Section  62(a)(1) do not apply, because          Taxpayer was not Young's  employee during 1989.  Pointing  to the          fact that  Taxpayer  was  employed  in  1989  as  an  independent          management  consultant,  they  maintain   that  the  Tax  Court's          application of Section 62(a)(1) is based on its erroneous finding          that Taxpayer was "in  the business of performing services  of an          employee" during 1989.                    We disagree with Petitioners.  First, we reiterate that          we find no clear  error in the Tax Court's  determination finding          that Taxpayer was "in  the business of performing services  of an          employee" during 1989.13   Second, we look to the  plain language          of  Section 62(a)(1).    As the  Tax  Court correctly  noted,  no          distinction  is  made in  Section  62(a)(1)  between present  and          former  employees  if the  expenses  originated in  the  trade or          business  of being an employee.14   Thus, the  fact that Taxpayer                                        ____________________          13  It is well-settled that an individual may engage in the trade          or  business  of rendering  services as  an  employee.   McKay v.                                                                   _____          Commissioner, 102 T.C. 465, 489  (1994), appeal docketed, No. 94-          ____________                             _______________          41189 (5th Cir. 1995) (collecting cases).           14  See  McKay, 102  T.C. at 489  (holding corporate  executive's              ___  _____          post-employment  litigation  expenses  incurred  in  suit against          former  employer  were incurred  in trade  or business,  and were          deductible, if  at all, under  Section 162);  McKeague v.  United                                                        ________     ______          States,  12 Cl. Ct. 671, 674-77 (1987) (finding, inter alia, that          ______                                           __________          former employee's  litigation expenses which originated  in trade                                         -15-          was not in actuality Young's employee in 1989 does not alter  the          controlling  fact that  the  lawsuit and  the ensuing  settlement          directly resulted  from his  employment with Young.   Petitioners          argue  in vain that Taxpayer should not be "saddled with employee          status" because  his  new trade  or  business as  an  independent          management   consultant  indicates  a  "break"  from  his  former          employment with Young  (Appellants' Brief,  p. 40).   Equally  in          vain, they argue  that the "[l]awsuit should be looked  at as the          ordinary  and  necessary  expense   incurred  by  an  independent          businessman  to  bring   suit  when   contracts  are   breached."          (Appellants'  Brief, p. 40).   As the Tax  Court correctly found,          there is absolutely no  connection between Taxpayer's lawsuit and          his  independent  management   consulting  business.     Instead,          Taxpayer's  lawsuit  was  "directly  connected  with,  or .  .  .          proximately   resulted   from"   his   employment   at   Young.15          Kornhauser,  276 U.S.  at  153.   It is  under  this rubric  that          __________                                        ____________________          or business  were deductible  as ordinary expenses  under Section          162), aff'd without published opinion,  852 F.2d 1294 (Fed.  Cir.                _______________________________          1988);  cf. Kornhauser v. United States, 276 U.S. 145, 153 (1928)                  ___ __________    _____________          (stating that where suit against a taxpayer is directly connected          with,   or  proximately  resulted  from,  his  business,  expense          incurred is a business expense).          15  We note also that on the "Disclosure Under Reg. Sec. 1.6661,"          Petitioners' tax preparer describes  the lawsuit against Young as          being  for   "age  discrimination,  back   wages  and  retirement          benefits." (Appellants' Appendix, p. 68).  We also note that  the          releases executed  pursuant to  the  Settlement Agreement  regard          "[a]ll claims  arising out of [Taxpayer's]  employment by [Young]          and the  cessation of [Taxpayer's] employment"  and "[a]ll claims          which  were  or could  have been  asserted  by [Taxpayer]  in the          Lawsuit  entitled  J.  Kenneth  Alexander v.  W.F.  Young,  Inc.,                             ______________________     __________________          Hampden  Superior Court  Civil  Action No.  88-243." (Appellants'          Appendix, p. 98).                                         -16-          Taxpayer is considered  to be  in the business  of being  Young's          "employee" for  purposes of  falling within the  Section 62(a)(1)          limitation.16                    In another  attempt  to circumvent  the application  of          Section  62(a)(1),  Petitioners  argue  that,  if  we   attribute          employee status to Taxpayer,  we should find that Young's  direct          payment of the settlement proceeds to R&W (by way of joint checks          payable  to  Taxpayer and  R&W as  joint  payees) qualifies  as a          reimbursement   arrangement  within   the   meaning  of   Section          62(a)(2)(A).    That section  provides  that  reimbursed employee          expenses  are permitted  to be  deducted from  gross income  when          arriving at  adjusted gross  income.17  Petitioners  contend that                                        ____________________          16  Similarly irrelevant is Petitioners' argument  that the Legal          Fee was not expended for the benefit of Young's business  and was          in  fact detrimental to Young.  See McKay, 102  T.C. at 488, n.23                                          ___ _____          (noting that  "[i]t  makes no difference whether the  employee is          defending himself in actions  that challenge his activities  as a          corporate  officer or the employee is bringing a suit against his          former  employer."); see also McKeague, 12 Cl. Ct. 671 (involving                               ________ ________          litigation  expenses  which  were  not incurred  for  benefit  of          taxpayer's employer).           17   Section 62(a)(2)(A)  provides,  in pertinent  part, that  in          determining adjusted gross income there will be allowed,                      [t]he  deductions  allowed  by   part  VI                      (section 161 and following) which consist                      of  expenses  paid  or  incurred  by  the                      taxpayer,   in    connection   with   the                      performance  by  him  of services  as  an                      employee, under a reimbursement  or other                                _______________________________                      expense  allowance  arrangement with  his                      _________________________________________                      employer.        The   fact    that   the                      ________                      reimbursement may be provided by  a third                      party  shall  not  be   determinative  of                      whether  or  not  the preceding  sentence                      applies.                                         -17-          Young's direct payment arrangement  was effectively providing for          the payment of the  Legal Fee pursuant to Section  62(a)(2)(A) in          light  of  the  fact   that  R&W  had  a  statutory   lien  under          Massachusetts  law for the payment  of the Legal  Fee.  See Mass.                                                                  ___          Gen. L.  ch. 221, sec. 50 (1986).  This argument fails because it          is  utterly without  support  in the  record.   As the  Tax Court          correctly found,  Petitioners have  not proven that  Taxpayer was          under a  "reimbursement or  other expense  allowance arrangement"          with  Young for  Taxpayer's Legal  Fee. Contrary  to Petitioners'          insistence,  the fact  that the record  shows Young's  direct and          joint payment is  "standard operating procedure" in  all types of          litigation  does   not  support   the  requisite  finding   of  a          reimbursement or other  "arrangement" or alter the fact that both          Young and  Taxpayer were  responsible for their  respective legal          costs.   Finally,  we  also note  that  the settlement  agreement          itself makes no  mention of  attorney's fees  and the  Taxpayer's          lawsuit  was  dismissed "without  prejudice  and  without costs."          Thus,  we reject Petitioners'  argument that  Section 62(a)(2)(A)          applies,  and reaffirm  our conclusion that  the Legal  Fee falls          squarely within Section 62(a)(1).                    Having determined that Section 62's employee limitation          applies, we turn to its effect on Taxpayer's Legal Fee.  Expenses                                        ____________________          26 U.S.C.    62 (1988  & Supp. 1991)  (emphasis added); see  H.R.                                                                  ___          Conf.  Rep.  No. 998,  100th Cong.,  2d  Sess. at  204. (allowing          reimbursed expenses only if  incurred pursuant to a reimbursement          or  other  expense   allowance  arrangement  requiring  employees          substantiate expenses covered thereunder to the person  providing          the reimbursement).                                         -18-          excluded  under the  Section 62(a)(1)  limitation are  treated as          "itemized  deductions"  under  Section  63, such  that  they  are          subtracted from adjusted gross income in computing the taxpayer's          "taxable income."   See  I.R.C.    63(d) (stating that  "itemized                              ___          deductions" include all deductions  not "allowable in arriving at          adjusted gross income" and  the deduction for personal exemptions          provided  by  Section  151).    In   turn,  under  Section  67(b)          "miscellaneous itemized  deductions" -- which are  defined as all          itemized  deductions  other  than those  specifically  enumerated          therein -- are subject to a  2-percent floor, such that they  are          allowable  "only  to  the  extent  that  the  aggregate  of  such          deductions exceeds 2 percent of adjusted gross income."   Because          trade  or business expenses subject  to Section 62(a)(1), such as          Taxpayer's Legal  Fee,  are not  among the  deductions listed  in          Section  67(b), statutory  construction leads  to the  conclusion          that they are miscellaneous itemized deductions subject to the 2-          percent floor.   See McKay, 102  T.C. at 493;18 cf.  In Re Black,                           ___ _____                      ___  ___________          131 B.R. 106, 108 (E.D.  Ark. 1991) (discussing the deductibility          of non-reimbursed employee business expenses).                    Upon  de   novo  review,   and  finding  no   merit  to                          _________          Petitioners' other arguments, we therefore affirm the Tax Court's          determination that the  Legal Fee is properly deducted "below the          line."                                        ____________________          18   We note  that, without  advancing much  by way  of argument,          Petitioners  urge  us  not to  follow  McKay  (and its  statutory                                                 _____          analysis),  claiming that it is  wrongly decided.   We merely add          that,  upon  de novo  review,  we  agree  with McKay's  statutory                       _______                           _____          analysis, and find the case on point.                                          -19-                     D.  Applicability of Alternative Minimum Tax                     D.  Applicability of Alternative Minimum Tax                    Petitioners  do  not  dispute  that  the  treatment  of          Taxpayer's  Legal  Fee  as  a  miscellaneous  itemized  deduction          triggers  the application  of  the Alternative  Minimum Tax  (the          "AMT") under Sections  55 and 56;19 nor do they  deny that, under          Section  56(b)(1)(A)(i), they  are  not permitted  to deduct  the          Legal Fee as  a miscellaneous itemized  deduction (as defined  in          Section 67(b))  in  computing the  AMT.   Petitioners  do  argue,          however, that  the Commissioner's "stretching"  interpretation of          Section  62(a)(1), adopted by the Tax Court and, now, this Court,          results in "gross  injustice, inequity and lack  of uniformity in          the  treatment of  taxpayers  similarly situated."   (Appellants'          Brief, p. 24).                    We recognize that, because the amounts involved trigger          the AMT and, thus,  Taxpayer's deficiency, the outcome smacks  of          injustice because  Taxpayer is effectively robbed  of any benefit          of the Legal Fee's  below the line treatment.   While unfortunate          for Petitioners  here, we  disagree that  there is  inequality of          treatment as compared to  similarly situated taxpayers.  Although          it  may seem  otherwise,  in reality  Petitioners  have not  been          denied their below the line deduction of the Legal Fee.                    The AMT was  enacted to "ensure  that no taxpayer  with          substantial economic  income can avoid significant  tax liability          by  using exclusions, deductions, and credits."  S. Rep. No. 313,          99th Cong.,  2d Sess. at 518,  1986-3 C.B. (Vol. 3)  v., 518; see                                                                        ___                                        ____________________          19  26 U.S.C.    55 and 56 (1988 & Supp. 1991).                                         -20-          also S. Rep. No. 1263, 95th Cong., 2d Sess., 1978-1 C.B. (Vol. 1)          ____          315, 499. It is well  established that equitable arguments cannot          overcome  the  plain  meaning  of  the  statute.    See  Okin  v.                                                              ___  ____          Commissioner, 808 F.2d 1338,  1340-42 (discussing the purpose and          ____________          constitutionality of the AMT), cert. denied, 484 U.S. 802 (1987);                                         ____________          Warfield  v. Commissioner,  84  T.C. 179,  184 (1985)  (rejecting          ________     ____________          argument that imposition  of the AMT  was unfair because  income-          producing  transaction was only a "one-time deal;" "[t]here is no          justification  for  creating such  an  exception  to the  express          terms"  of Section 55); see also Rawlins v. Commissioner, 1995 WL                                  ________ _______    ____________          610605,  at *5-8, 70 T.C.M. (CCH) 1046, ____ (1995).  Petitioners          are  bound  by  the tax  consequences  of  the  settlement as  it          actually occurred.  Id. at 184.                              __                                   III.  CONCLUSION                                   III.  CONCLUSION                    For the  foregoing reasons,  we affirm the  Tax Court's          decision and  uphold the  Commissioner's finding  of Petitioners'          deficiency.   The judgment of the Tax Court is affirmed.                                                         affirmed.                                                         ________                                         -21-
