                        T.C. Memo. 2004-45



                      UNITED STATES TAX COURT



     CHIEF INDUSTRIES, INC. AND SUBSIDIARIES, Petitioner v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 2007-00.             Filed March 2, 2004.



     Gerald P. Laughlin, Kent O. Littlejohn, and Frank J. Reida,

for petitioner.

     William R. Davis, Jr., for respondent.



             MEMORANDUM FINDINGS OF FACT AND OPINION


     LARO, Judge:   Petitioner seeks redetermination of

deficiencies in Federal income tax for the taxable years ended

June 30, 1996 and 1997, of $619,501 and $431,062, respectively.

The issues relate solely to respondent’s disallowance of a
                               - 2 -

claimed deduction for the taxable year ended June 30, 1996.       The

deficiencies arose in 2 taxable years because respondent’s

adjustment affected the amount of the general business credit

carried forward and applied to the taxable year ended June 30,

1997.

     After concessions by the parties, we are left to decide

whether petitioner may deduct a $3,082,710 payment that it made

to its former employee/shareholder Virgil R. Eihusen (V.

Eihusen).   Petitioner made the payment to V. Eihusen in

relinquishment of its obligations under an employment agreement

with him and in settlement of various legal claims which he had

filed against petitioner.   At the same time, petitioner also paid

V. Eihusen other amounts in reacquisition of all of his stock in

petitioner.

     We hold that petitioner may deduct the $3,082,710 payment

under section 162(a) as an ordinary and necessary business

expense and that section 162(k) does not preclude this deduction.

Unless otherwise indicated, section references are to the

Internal Revenue Code applicable to the subject years.     Rule

references are to the Tax Court Rules of Practice and Procedure.

                         FINDINGS OF FACT

     Many facts were stipulated, and we incorporate the parties’

stipulation of facts and the accompanying exhibits by this
                                - 3 -

reference.    When the petition was filed, petitioner’s principal

place of business was in Nebraska.

1.   Background

     Petitioner is a manufacturer that was established in 1954.

Its principal founder, V. Eihusen, was closely involved with

petitioner’s business operations for several decades.    Under his

leadership, petitioner grew from a small construction company

with two employees into a large conglomerate which, during each

of the subject years, had over $200 million in gross sales and

over 1,200 employees.    Petitioner’s growth was attributable, in

part, to its addition of key employees and its strategic

acquisitions.

     In 1987, V. Eihusen voluntarily relinquished his position as

petitioner’s president to his son, Robert G. Eihusen (R.

Eihusen).    V. Eihusen retained his positions as chairman of

petitioner’s board of directors (board) and its chief executive

officer (CEO).    In these capacities, V. Eihusen continued to play

a leading role on special projects, one of which was petitioner’s

1990 acquisition of an ethanol plant in Hastings, Nebraska.

     Because of its need for expansion of the ethanol facility,

petitioner required additional financing.    After extensive

negotiations with several financial institutions, petitioner

entered into a $35 million loan agreement (loan agreement) with

the Boatmen’s National Bank of St. Louis (bank) on November 4,
                                 - 4 -

1992.    The loan agreement contained various covenants restricting

petitioner’s ability to alter its business practices without

previous approval from the bank.

       Also in 1992, in furtherance of his continuing efforts to

explore investment opportunities for petitioner, V. Eihusen

considered having petitioner pursue a joint venture equity

investment in Russia (Russia project).    Members of the board

became concerned that pursuing the Russia project could cause

petitioner to breach one or more of the covenants spelled out in

the loan agreement.

2.     Removal of V. Eihusen and Its Immediate Aftermath

       On March 5, 1993, the board held a special meeting (meeting)

at which it removed V. Eihusen as petitioner’s chairman and CEO

and elected R. Eihusen to these positions.    At this time V.

Eihusen remained one of petitioner’s directors, shareholders, and

employees.    Also at the meeting, the board elected R. Eihusen,

Linda M. Berney, Barbara J. Saladen, and David Schocke as the

sole members of the administration committee (ESOP committee) of

the Employee Stock Ownership Plan (ESOP) of Chief Industries,

Inc.    Petitioner had established the ESOP and the related trust

in 1976 and had appointed First National Bank of Omaha (First

National) to serve as trustee.

       Commencing at the meeting and continuing afterward, V.

Eihusen and the board engaged in a prolonged struggle over
                                - 5 -

managerial control of petitioner.    V. Eihusen was then the

largest (but neither majority nor controlling) shareholder of

petitioner by virtue of his direct ownership of 364,047 shares of

common stock (4,219 of which were restricted shares) and his

indirect ownership of 8,757.706 shares of common stock held

through the ESOP.    The board did not want V. Eihusen to be able

to dictate the course of action with respect to petitioner’s

management and business affairs.    V. Eihusen desired to regain

managerial control of petitioner and to protect his lifetime

investment therein.

     On April 3, 1993, petitioner and V. Eihusen entered into an

employment agreement (employment agreement).    The employment

agreement provided that V. Eihusen could use the title “chairman

of the board emeritus” but could not hold himself out as able to

bind petitioner or to direct, hire, or fire any employee of

petitioner.   Petitioner’s obligations under the employment

agreement included continuing to pay V. Eihusen an annual salary

of $120,000, to provide him with health and dental benefits, and

to reimburse him for vehicle and office expenses in specified

monthly amounts.    The employment agreement did not have a

definite term but could be terminated by petitioner upon breach

of that agreement by V. Eihusen.

     Following the meeting, V. Eihusen met with lawyers and

discussed various courses of action relating to, among other
                               - 6 -

matters, his removal as petitioner’s chairman and CEO.    V.

Eihusen on several occasions also communicated with First

National representatives and objected to First National, in its

role as the ESOP’s trustee, voting the ESOP’s shares in

petitioner as directed by the ESOP committee because of what he

believed was the ESOP committee’s conflict of interest.    First

National continued receiving directives from the ESOP committee

with respect to voting the ESOP’s shares in petitioner.    The

voting maintained V. Eihusen’s lack of control of petitioner’s

board and management.

3.   ESOP Litigation

     Because it was receiving conflicting directives from the

ESOP committee and from V. Eihusen, First National on October 11,

1994, filed a lawsuit in the U.S. District Court for the District

of Nebraska (ESOP litigation), under the caption “First National

Bank of Omaha, as Trustee of the Chief Industries, Inc. Employee

Stock Ownership Plan and Trust, Plaintiff vs. Chief Industries,

Inc.; Robert G. Eihusen, Linda M. Berney, David Schocke, Barbara

Saladen, as members of the Administration Committee of the Chief

Industries, Inc. Employee Stock Ownership Plan; Virgil R.

Eihusen, Individually; and Robert G. Eihusen, Individually,

Defendants”.   First National essentially sought through this

lawsuit a declaratory judgment that it might vote the shares in

petitioner held by the ESOP in accordance with the specific
                                - 7 -

directives of the ESOP committee, and that such actions were a

reasonable exercise of its discretion in its capacity as the

ESOP’s trustee.    At that time, 32.27 percent of the outstanding

shares in petitioner were held by the ESOP.

     V. Eihusen counterclaimed in the ESOP litigation, alleging

conflict of interest and self-dealing on the part of the ESOP

committee.    He sought a ruling that the ESOP’s trustee was

required to allow passthrough voting of the ESOP’s shares in

petitioner in accordance with the direction of the participants.

In September 1995, the District Court ruled that petitioner could

direct the ESOP’s trustee on the voting of the ESOP’s shares in

petitioner.    V. Eihusen’s counterclaims were not included in this

ruling, and they remained pending.

     V. Eihusen had in his answer also cross-claimed against the

ESOP committee, alleging a breach of fiduciary duty, conversion,

and civil conspiracy.    He sought through these cross-claims both

equitable relief and compensatory damages.    The District Court

found these cross-claims to be preempted by Federal law and

dismissed them on October 10, 1995.

4.   Intermodal Litigation

     On or about May 15, 1995, petitioner and Mid-Am Intermodal

Sales Co. (Mid-Am) entered into a plan of reorganization (Mid-Am

purchase agreement).    The Mid-Am purchase agreement was

negotiated and executed without the knowledge of V. Eihusen, who
                               - 8 -

was still a member of the board at that time.    Pursuant to the

Mid-Am purchase agreement, petitioner acquired Mid-Am, and Mid-

Am’s sole shareholder, Thomas Hastings (Hastings), received,

among other things, 58,366 shares of stock in petitioner, a put,

and the entitlement to more shares as an earn-out.    The

consideration received by Hastings, a college friend of R.

Eihusen, was unusually generous as compared with the

consideration petitioner used in other acquisitions, and V.

Eihusen believed that this transaction was undertaken for the

purpose of diluting his ownership interest in petitioner.

     V. Eihusen filed a third-party complaint in the ESOP

litigation against members of the board, alleging that they

committed a breach of fiduciary duty owed to him and to other

shareholders of petitioner and that they engaged in civil

conspiracy.   Subsequently, he amended the third-party complaint

to name petitioner and Hastings as defendants.    V. Eihusen prayed

in the third-party complaint for an injunction, the rescission of

agreements among and between petitioner, Mid-Am, and Hastings, an

award of attorney’s fees and costs, and for the ordering of other

types of relief.   On October 30, 1995, the District Court

dismissed the third-party complaint, as amended, for lack of

subject matter jurisdiction.

     Following this dismissal, V. Eihusen on November 14, 1995,

filed a lawsuit in the District Court of Hall County, Nebraska
                               - 9 -

(Intermodal litigation), against petitioner, Thomas Hastings,

individually, and R. Eihusen, Linda M. Berney, Melvin Auch, and

Carolyn Loschen, as members of the board.   V. Eihusen alleged in

this lawsuit that the named board members had breached a

fiduciary duty, and he prayed for the cancellation and rescission

of the Mid-Am purchase agreement and any stock issuance

thereunder, or, alternatively, an order that petitioner issue

additional shares to V. Eihusen to restore his voting rights and

power to the same as it was before the acquisition of Mid-Am.

Other forms of relief V. Eihusen prayed for were various

injunctions, attorney’s fees, and costs.

5.   Negotiations for Settlement

     The board believed petitioner’s position to be strong in

both the ESOP litigation and the Intermodal litigation and

vigorously denied any wrongdoing on the part of it and

petitioner.   At the same time, the board appreciated the risks

involved in litigation and was mindful of the substantial time

and expense that petitioner needed to devote to this litigation.

     In accordance with these considerations, petitioner and V.

Eihusen considered a settlement proposal on November 1, 1995

(November 1995 proposal), under which V. Eihusen would withdraw

his claims in the ESOP litigation and Intermodal litigation and

surrender all of his stock in petitioner.   Petitioner, R.

Eihusen, and V. Eihusen amended that proposal on March 1, 1996.
                               - 10 -

Under the amended proposal (March 1996 proposal), V. Eihusen

would transfer all of his stock in petitioner, either owned

directly or indirectly through the ESOP, to petitioner, R.

Eihusen, or an entity controlled by R. Eihusen, and would

withdraw any claim against petitioner, its directors, and its

officers.    V. Eihusen would also immediately place 30,000 of

those shares in an escrow account and would agree to forfeit

those shares to R. Eihusen if V. Eihusen breached any of the

agreed-upon terms.

     Petitioner, in turn, would under the March 1996 proposal

agree to forgive a judgment (Hall County judgment) that it had

received against V. Eihusen;1 pay V. Eihusen $100 per share for

359,828 shares of stock in petitioner that he owned directly and

8,757.706 shares of stock in petitioner that he owned indirectly

through the ESOP; pay V. Eihusen $86.09 per share for 4,219

restricted shares of stock in petitioner; convey to V. Eihusen a

fee simple ownership, free of liens, of real property known as

the Indian Head Golf Club, certain real estate adjacent to it,

and all related personal property necessary to operate that

business;2 and indemnify V. Eihusen under certain circumstances,


     1
       This judgment arose from V. Eihusen’s obligation with
respect to a mid-1980s loan made by petitioner to a partnership,
in which V. Eihusen was a partner. The judgment amounted to
$1,386,951 including interest, as of June 28, 1996.
     2
         The parties stipulated that the value of the Indian Head
                                                     (continued...)
                               - 11 -

which were significantly more limited in scope than those

contained in the November 1995 proposal.

6.   The Final Settlement and Share Repurchase

     As contemplated by the March 1996 proposal, petitioner and

V. Eihusen entered into an “Agreement for the Purchase and Sale

of Stock and Settlement of Claims” on April 19, 1996 (definitive

agreement).    The definitive agreement replaced and superseded all

of the previous agreements and set forth the entire understanding

between the parties with respect to its subject matter.

     The terms of the definitive agreement were generally similar

to the terms of the March 1996 proposal.   One of the significant

differences between the documents was the form of conveyance of

the Indian Head Golf Club assets.   Instead of an outright

transfer of the assets, petitioner and V. Eihusen engaged in an

exchange of stock, with petitioner transferring to V. Eihusen all

of the shares of Indian Head Golf Club, Inc., in exchange for

16,740 unrestricted shares of stock in petitioner, so as to

purportedly qualify that exchange for tax-free treatment under

section 355.   The definitive agreement also contained the

obligation of petitioner and R. Eihusen to make a joint tender

offer (tender offer) for all issued and outstanding shares of

common stock in petitioner except for shares owned by V. Eihusen,



     2
      (...continued)
Golf Club and the related property was $1,673,735.
                             - 12 -

R. Eihusen, or members of the latter’s immediate family.    The

tender offer was required to be set at a minimum of $100 per

share.

     After the execution of the definitive agreement but before

its closing on June 28, 1996 (closing), V. Eihusen alleged that

petitioner had defaulted on the definitive agreement with respect

to a clause that obligated petitioner to continue operating the

Indian Head Golf Club in the ordinary course of business.     In

settlement of this allegation, petitioner agreed to assume the

lease obligations for certain golf carts, thereby incurring an

additional cost of $21,759 (golf cart adjustment).

     As contemplated by the definitive agreement, the parties

thereto exchanged certain items at closing.   Specifically,

petitioner transferred to V. Eihusen $32,308,800 in redemption of

323,088 unrestricted shares of stock in petitioner owned directly

by him; R. Eihusen transferred to V. Eihusen $2 million in

exchange for 20,000 unrestricted shares of stock in petitioner

owned directly by him; petitioner transferred to V. Eihusen

$875,770 in redemption of 8,757.706 unrestricted shares of stock

in petitioner owned indirectly by him through the ESOP;

petitioner transferred to V. Eihusen all of the shares of Indian

Head Golf Club, Inc., in redemption of 16,740 unrestricted shares

of stock in petitioner owned directly by him; and petitioner

transferred to V. Eihusen $363,214 in redemption of 4,219
                              - 13 -

restricted shares of stock in petitioner owned directly by him.

Petitioner also transferred to V. Eihusen $1,674,000, forgave the

Hall County judgment of $1,386,951, and factored in the golf cart

adjustment of $21,759 in release of litigation and employment

claims which V. Eihusen had, or may have had, primarily against

petitioner and its directors, officers, and employees.   V.

Eihusen, in turn, delivered to petitioner in addition to the

noted shares of stock:   (1) Certificates evidencing dismissal,

with prejudice, of all claims which he had outstanding against

petitioner in both the ESOP litigation and the Intermodal

litigation; (2) a global release of all claims he may have had

against petitioner, its subsidiaries, First National, the ESOP

committee, and petitioner’s officers, directors, employees, and

agents; (3) his resignation as a director, officer, and employee

of petitioner; and (4) his release of petitioner’s obligations

under the employment agreement.

     Petitioner deducted $3,082,710 ($1,674,000 + $1,386,951 +

$21,759) as an ordinary and necessary business expense, noting on

its tax return that this expense was a “lawsuit settlement cost”.

Respondent disallowed the deduction, determining that the payment

in question was a nondeductible expense either because it was

capital or because it was made in connection with petitioner’s

reacquisition of its stock.
                              - 14 -

                              OPINION

     The Commissioner’s determinations are presumed correct, and

taxpayers bear the burden of proving them wrong.   Rule 142(a)(1);

Welch v. Helvering, 290 U.S. 111, 115 (1933).   As one exception

to this rule, section 7491(a) places upon the Commissioner the

burden of proof with respect to any factual issue relating to

liability for tax if the examination of the taxpayer’s records

for the subject year began after July 22, 1998, and the taxpayer

maintained adequate records, satisfied the substantiation

requirements, cooperated with the Commissioner, and introduced

during the court proceeding credible evidence with respect to the

factual issue.   In that the record is sufficient for us to decide

this case on its merits, and neither party alleges the

applicability of section 7491(a) or of any other exception, we

need not and do not decide the burden of proof issue.3   D’Angelo

v. Commissioner, T.C. Memo. 2003-295.

     We decide first whether the disputed payment of $3,082,710

is otherwise deductible as an ordinary and necessary business



     3
       Respondent argues that petitioner has failed to establish
that the $3,082,710 was not paid as consideration for the
redeemed stock. We find to the contrary. Respondent does not
question the fairness of the price paid for the stock in
petitioner. Presuming without conceding that the price
approximated the value of the stock in petitioner, we note that
petitioner can pinpoint $3,082,710 as attributable to its
settlement of the litigation and employment claims by subtracting
from the total consideration paid under the definitive agreement
the total consideration paid for the stock.
                                - 15 -

expense under section 162(a).    Given our conclusion that it is,

we decide second whether its deduction is precluded by section

162(k), which applies to payments made “in connection with” the

reacquisition of stock.

1.   Section 162(a)

     Section 162(a) allows a deduction for all ordinary and

necessary expenses paid or incurred during the taxable year in

carrying on any trade or business.       To qualify for a deduction

under section 162(a), an item must (1) be paid or incurred during

the taxable year, (2) be for carrying on any trade or business,

(3) be an expense, (4) be a necessary expense, and (5) be an

ordinary expense.     Commissioner v. Lincoln Sav. & Loan

Association, 403 U.S. 345 (1971); Wells Fargo & Co. v.

Commissioner, 224 F.3d 874 (8th Cir. 2000), affg. in part and

revg. in part Norwest Corp. v. Commissioner, 112 T.C. 89 (1999);

Lychuk v. Commissioner, 116 T.C. 374 (2001).

     Respondent argues that petitioner may not deduct its payment

of $3,082,710 to V. Eihusen under section 162(a) for many of the

same reasons respondent advances in connection with section

162(k); namely, that the payment was made in connection with

petitioner’s reacquisition of its stock, or, in other words, in

connection with an acquisition of a capital asset.       Respondent

also argues for purposes of section 162(a) that the payment in

question is a capital expenditure because the claims settled by
                               - 16 -

this payment originated with V. Eihusen’s attempt to regain his

former positions with petitioner.   According to respondent,

ensuring that this attempt is unsuccessful “can” increase the

value of petitioner.   Petitioner argues that the payment is

deductible under section 162(a) in that the payment was made in

part to defend against attacks on petitioner’s business practices

and, as to the rest, made in cancellation of an employment

agreement.   We agree with petitioner.

     This Court has recently concluded that an expenditure must

be capitalized when it (1) creates or enhances a separate and

distinct asset, (2) produces a significant future benefit, or (3)

is incurred “in connection with” the acquisition of a capital

asset.   Lychuk v. Commissioner, supra at 385-386.    Respondent

focuses his argument on the first and third prongs.    Respondent

does not assert, and thus we have no occasion to find, that any

portion of petitioner’s payment to V. Eihusen produced a

significant long-term benefit to petitioner so as to require that

this payment be capitalized under INDOPCO, Inc. v. Commissioner,

503 U.S. 79 (1992).    As to the third prong, i.e., an expense

incurred in connection with the acquisition of a capital asset,

we reject that argument for the reasons discussed infra as to

section 162(k).   As to the first prong, i.e., creation or

enhancement of a separate and distinct asset, we conclude below

that the test of Lincoln Sav. & Loan is satisfied with respect to
                              - 17 -

both the litigation settlement and the release of the employment

agreement, and therefore reject that argument as well.

     Pursuant to the definitive agreement, petitioner and R.

Eihusen purchased all of V. Eihusen’s stock in petitioner for

$37,223,114.   Contemporaneously with that purchase, but

independent therefrom, petitioner also transferred to V. Eihusen

a value of $3,082,710 in settlement of existing and potential

disputes between the two of them and in relinquishment of V.

Eihusen’s rights under the employment agreement.   More

specifically, petitioner paid part of the $3,082,710 to V.

Eihusen to settle all of the claims which he advanced against

petitioner in the ESOP litigation and the Intermodal litigation,

and to settle all other claims which he may have had against

petitioner, First National, the ESOP committee, and petitioner’s

directors, officers, employees, and agents.   Petitioner paid the

rest of the $3,082,710 to V. Eihusen for his resignation as a

director, officer, and employee of petitioner and for his release

of petitioner from its obligations under the employment

agreement.

     As to the portion of the payment pertaining to the

settlement of litigation, payments made to settle litigation are

deductible as ordinary and necessary business expenses when they

have business origin and otherwise satisfy the mandates of

section 162(a).   Anchor Coupling Co. v. United States, 427 F.2d
                              - 18 -

429 (7th Cir. 1970); Eisler v. Commissioner, 59 T.C. 634 (1973);

Old Town Corp. v. Commissioner, 37 T.C. 845 (1962); Oliver v.

Commissioner, T.C. Memo. 1997-84.   A settlement payment has

business origin when the transaction or activity causing the

litigation originates in a trade or business; the potential

consequences of a failure to prosecute or defend the litigation

are secondary.   See Woodward v. Commissioner, 397 U.S. 572, 577

(1970); United States v. Gilmore, 372 U.S. 39, 44-51 (1963);

Wells Fargo & Co. v. Commissioner, supra at 887; Anchor Coupling

Co. v. United States, supra at 433.    The courts have created

three independent tests which are helpful to determine whether a

settlement payment with a business origin is deductible.    These

tests are (1) whether the taxpayer/payor lacked confidence that

it would have prevailed in the lawsuit if it was not settled, (2)

whether the taxpayer/payor made the payment to avoid damages or

liability which might have resulted in the absence of the

settlement, and (3) whether the belief held by the taxpayer/payor

concerning the validity of the claim against him or her was

justified to the extent that a reasonable person in his or her

place would have thought that settlement was necessary.     Old Town

Corp. v. Commissioner, supra at 858-859.    An answer in the

affirmative to any of these tests tends to establish that the

settlement payment is deductible under section 162(a).
                              - 19 -

     Here, the claims underlying the settlement payment and

alleging mismanagement by petitioner of its business, originated

in petitioner’s business decision to remove V. Eihusen as its

chairman and CEO.   In addition, in accordance with the three

tests enunciated by the Court in Old Town Corp., we conclude that

(1) members of the board lacked confidence that petitioner would

prevail in the subject litigation; (2) petitioner made the

settlement payment to avoid damages or liability it could have

incurred absent the settlement; and (3) members of the board were

justified in taking V. Eihusen’s claims seriously and acted

reasonably in attempting to settle the ESOP litigation and the

Intermodal litigation so as to reduce the expenditure of time and

the money.   Also, applying the test of Commissioner v. Lincoln

Sav. & Loan Association, 403 U.S. 345 (1971), to the portion of

petitioner’s payment made to settle the ESOP litigation and the

Intermodal litigation, we find that it (1) was paid or incurred

during the subject years; (2) was incurred in connection with

petitioner’s trade or business as it was directly related to

petitioner’s business practices; (3) was an expense; (4) was a

necessary expense in that petitioner was required to expend a

significant amount of resources in defending itself and its

directors, officers, and employees and hence settled the claims

so as to avoid larger expenditures in continuing to litigate

without any certainty of prevailing; and (5) was an ordinary
                              - 20 -

expense in that litigation, and the associated settlement costs,

commonly arise in the course of conducting business.   In view of

the foregoing, we conclude that the portion of the $3,082,710

relating to the settlement of litigation is deductible under

section 162(a) as an ordinary and necessary business expense.

     As to the portion of the payment made in discharge of

petitioner’s outstanding obligations under the employment

agreement, that portion also qualifies for deductibility under

section 162(a) to the extent it meets that section’s

requirements.   Peninsular Metal Prods. Corp. v. Commissioner, 37

T.C. 172 (1961); Driskill Hotel Co. v. Commissioner, a Memorandum

Opinion of this Court dated May 22, 1953.   Applying the test of

Commissioner v. Lincoln Sav. & Loan Association, supra, to the

portion of petitioner’s payment made to discharge its obligations

under the employment agreement, we find that this portion (1) was

paid or incurred during the subject years; (2) was incurred in

connection with petitioner’s trade or business as it was directly

related to conducting petitioner’s business; (3) was an expense;

(4) was a necessary expense in that petitioner had an obligation

to compensate V. Eihusen pursuant to the employment agreement;

and (5) was an ordinary expense in that costs associated with

maintaining or terminating an employment relationship commonly

arise in the course of conducting business.   Thus, we hold that
                              - 21 -

petitioner is entitled to deduct the portion of its payment to V.

Eihusen relating to the employment agreement.

     In sum, we find petitioner’s payment of $3,082,710 to V.

Eihusen to be deductible under section 162(a) as an ordinary and

necessary business expense.   Because we conclude that the entire

payment is deductible, we need not and do not apportion that

payment between the litigation settlement and the employment

agreement.

2.   Section 162(k)

     Respondent argues that petitioner may not deduct the payment

of $3,082,710 because it was made in connection with a

reacquisition of stock under section 162(k)(1).    We disagree with

respondent.

     Section 162(k)(1) disallows an “otherwise allowable”

deduction for any amounts “paid or incurred by a corporation in

connection with the reacquisition of its stock”.   By enacting

this provision in 1986, Congress wished to provide expressly that

all expenditures incurred in reacquisition by a corporation of

its own stock are nonamortizable capital expenditures.   In that

the record establishes that petitioner’s redemption of its shares

owned by V. Eihusen was a “reacquisition” under section 162(k),

our inquiry focuses on whether petitioner’s payment of $3,082,710

to V. Eihusen occurred “in connection with” that reacquisition.
                               - 22 -

     The phrase “in connection with” has been ascribed a broad

meaning both with respect to section 162(k) and with respect to

other statutory sections.    See, e.g., Snow v. Commissioner, 416

U.S. 500, 502-503 (1974); Huntsman v. Commissioner, 905 F.2d

1182, 1184 (8th Cir. 1990), revg. and remanding 91 T.C. 917

(1988); Ft. Howard Corp. v. Commissioner, 103 T.C. 345 (1994),

supplemented by 107 T.C. 187 (1996).    An expense, however, does

not fall within the broad meaning afforded it under section

162(k) simply because the expense is paid at a time that is

proximate to a redemption.   As the conferees made explicit in

their report underlying the enactment of section 162(k):

      while the phrase “in connection with [a]
      redemption” is intended to be construed broadly,
      the provision is not intended to deny a deduction
      for otherwise deductible amounts paid in a
      transaction that has no nexus with the redemption
      other than being proximate in time or arising out
      of the same general circumstances. For example, if
      a corporation redeems a departing employee’s stock
      and makes a payment to the employee in discharge of
      the corporation’s obligations under an employment
      contract, the payment in discharge of the
      contractual obligation is not subject to
      disallowance under this provision. * * * Payments
      in discharge of other types of contractual
      obligations, in settlement of litigation, or
      pursuant to other actual or potential legal
      obligations or rights, may also be outside the
      intended scope of the provision to the extent it is
      clearly established that the payment does not
      represent consideration for the stock or expenses
      related to its acquisition, and is not a payment
      that is a fundamental part of a “standstill” or
      similar agreement. [H. Conf. Rept. 99-841 (Vol.
      II), at II-168 to II-169 (1986), 1986-3 C.B. (Vol.
      4) 1, 168-169.]
                             - 23 -

The same conference report also explains that section 162(k) does

not apply to a discharge of a corporate obligation even when an

employment contract and a redemption agreement are contained in

the same document and are negotiated at the same time.     Id. at

II-169 n.4, 1986-3 C.B. (Vol. 4) at 169.

     The setting here is specifically referenced in the

conference report, which places outside of section 162(k) both a

payment in settlement of litigation and a payment in discharge of

a corporation’s obligation to a departing employee.   Respondent

attempts to downplay this portion of the report and in fact does

not even discuss it, focusing instead on our opinion in Ft.

Howard Corp. v. Commissioner, supra, and on the opinion of the

Court of Appeals for the Eighth Circuit in Huntsman v.

Commissioner, supra, for the proposition that the phrase “in

connection with” is construed broadly to reach all costs

connected in any way with a company’s reacquisition of its stock.

Respondent observes that V. Eihusen’s lawsuits centered on his

attempt to retain his lost positions and that these claims were

settled at the same time as his stock was redeemed.   Respondent

draws from this proximity and the broad construction given to the

phrase “in connection with” that the first event occurred “in

connection with” the second event.

     We agree with respondent that section 162(k) reaches broadly

to deny deductibility of all expenses which are paid “in
                                 - 24 -

connection with” a reacquisition of stock and does not simply

encompass those amounts which were paid for the reacquired stock

itself.    We disagree with respondent, however, that the payment

in question was made “in connection with” the reacquisition of

stock within the meaning of section 162(k).     In accordance with

the quoted legislative history underlying section 162(k),

payments, although arising out of the same general circumstances

as a reacquisition and made proximate thereto, are not denied

deductibility by section 162(k) when they lack any other nexus to

the reacquisition.    Such may be the case, the conference report

clarifies, where, as here, a reacquisition payment is accompanied

by a payment in settlement of claims as to litigation or

employment.

     In Ft. Howard, the taxpayer incurred expenses in obtaining

funds necessary to effect a leveraged buyout (LBO).     We concluded

that these financing expenses, except for certain interest

payments, were incurred “in connection with” the LBO because the

LBO would not have been possible without the financing.     We found

that the financing costs were both a cause and an effect of the

redemption.     We noted that financing was “necessary” to the

transaction as a whole and was an “integral part” of a detailed

plan.     Id. at 352-353.   Here, by contrast, there was no similar

relationship between petitioner’s settlement of the litigation

and employment claims, on the one hand, and its repurchase of
                              - 25 -

shares on the other hand.   In fact, the two transactions are not

linked in any way except that they were executed and negotiated

by the same parties and at the same time.

     In Huntsman, the Court of Appeals for the Eighth Circuit

construed the meaning of the phrase “in connection with” in the

context of section 461(g)(2), which allows for the deduction of

“points” paid on indebtedness incurred “in connection with” the

purchase or improvement of a principal residence.     The court read

the statute to require that the incurrence of indebtedness needs

only to have an “association” or “relation” with the purchase of

a residence to be connected with that purchase.   The court

allowed the taxpayers to deduct points which they paid nearly 3

years after the acquisition of their residence to obtain

financing used to satisfy their original 3-year balloon loan.

Id. at 1183-1186.   In our case we find no “association” or

“relation” between petitioner’s repurchase of V. Eihusen’s stock

and the settlement of the referenced claims.

     We have considered all arguments of the parties related to

our holdings set forth herein and, to the extent not discussed,

find those arguments to be irrelevant or without merit.



                                         Decision will be entered

                                    for petitioner.
