                              T.C. Memo. 2018-80



                        UNITED STATES TAX COURT



                    SKY M. LUCAS, Petitioner v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent



      Docket No. 24111-16.                        Filed June 11, 2018.



      Kevin Noel Kemp, for petitioner.

      Rose E. Gole and Gennady Zilberman, for respondent.



                          MEMORANDUM OPINION


      VASQUEZ, Judge: In this case, respondent determined a deficiency in

petitioner’s Federal income tax of $1,760,709 for 2010.
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[*2] After concessions,1 the remaining issue for decision is whether petitioner is

entitled to a deduction for legal and professional fees for the 2010 and 2011 tax

years.2

                                    Background

      The parties submitted this case fully stipulated under Rule 122.3 Our

findings of fact consist of the stipulated facts and facts drawn from the stipulated

exhibits. The stipulation of facts, the supplemental stipulation of facts, and the

attached exhibits are incorporated herein by this reference. Petitioner resided in

New Hampshire at the time the petition was filed.


      1
         The parties filed two stipulations of settled issues, in which they made
several concessions for 2010 and for several years not in issue. See infra note 2.
Because it is unclear how these concessions will affect the calculation of the 2010
deficiency, we will require a Rule 155 computation.
      2
          The notice of deficiency makes adjustments to petitioner’s returns for tax
years 2009, 2010, 2011, and 2012 but determines a deficiency only for 2010.
Because respondent’s adjustments have not resulted in any deficiencies for 2009,
2011, or 2012, we do not have jurisdiction over those years. See Martz v.
Commissioner, 77 T.C. 749 (1981). However, part of petitioner’s 2010 deficiency
is attributable to adjustments to petitioner’s 2011 net operating loss. We may
compute the correct tax liability for a year not in issue when such a computation is
necessary to determine the correct tax liability for a year that has been placed in
issue. Lone Manor Farms, Inc. v. Commissioner, 61 T.C. 436, 440 (1974), aff’d,
510 F.2d 970 (3d Cir. 1975).
      3
       Unless otherwise indicated, all section references are to the Internal
Revenue Code in effect for the year in issue, and all Rule references are to the Tax
Court Rules of Practice and Procedure.
                                           -3-

[*3] I.         Vicis Capital, LLC

          Petitioner formed Vicis Capital, LLC (Vicis), with two other partners in

2004; each partner owned a one-third interest. Vicis was an investment adviser for

several funds (Vicis Funds) including Vicis Capital International Fund

(International Fund). The Vicis Funds paid Vicis a management fee of 1.5% of

assets under management per annum. Vicis also received performance fees equal

to 20% of profits earned by the Vicis Funds during the year. Between February

2005 and December 2008, Vicis’ assets under management grew from

approximately $290 million to approximately $5.6 billion.

          Under its advisory agreement with the International Fund, Vicis could elect

to defer all or a portion of the management and performance fees payable by the

International Fund for payment in subsequent years. If Vicis elected to defer

management or performance fees, the deferred fees were invested in the

International Fund portfolio, and the amount of the deferred fees ultimately

distributed would depend on the performance of the portfolio from deferral until

distribution. Vicis elected to defer a portion of its International Fund performance

fees for each of 2006, 2007, and 2008.

          Vicis’ fortunes changed after the onset of the 2008 financial crisis. From

December 2008 through September 2009, investors in the Vicis Funds requested
                                          -4-

[*4] approximately $3 billion in redemptions. Vicis began liquidating its portfolio

in September 2009, and Vicis’ principals decided to wind down operations in

January 2010. Vicis’ deferred payment plan with the International Fund

terminated in February 2010, and the deferred performance fees were distributed

to Vicis. As of September 27, 2010, the Vicis convertible portfolio was

completely liquidated.

II.      Petitioner’s Divorce

         Petitioner and his former wife, Margaret Lucas, were married on July 2,

1994. Ms. Lucas filed for divorce on January 28, 2008. Between the date of the

divorce filing and the date the divorce was granted, petitioner received

$48,723,169 in distributions from Vicis.4 While the divorce action was pending,

petitioner was not involved with any business or employment activity other than

Vicis.

         The largest issue in the divorce was the valuation and equitable distribution

of petitioner’s interest in Vicis including the nearly $47 million in distributions




         4
         The parties to the divorce stipulated that $2 million of this amount
constituted a loan from Vicis; net distributions totaled $46,723,169.
                                         -5-

[*5] made to petitioner.5 Ms. Lucas argued that the distributions were part of the

marital estate even though petitioner received them after she had filed for divorce.

      A final divorce hearing was held from April 18 through 21, 2011. The

Family Division of the Circuit Court of Pinellas County, Florida (circuit court),

determined that Vicis was without a fair market value at the time of the trial and

valued petitioner’s interest in Vicis at $5,095,000 as of the divorce filing date.

The circuit court found that, of the nearly $47 million in distributions,

approximately $4.7 million represented deferred compensation attributable to

petitioner’s predivorce earnings and was a marital asset subject to equitable

distribution. The circuit court held that the remaining amount of the distributions

was a nonmarital asset and therefore not subject to equitable distribution. After

determining that the total marital estate was worth $15,522,158, the circuit court

awarded Ms. Lucas their Belleair, Florida, property and an equalizing cash

payment of $6,676,412.

      As a result of these proceedings, petitioner paid several million dollars of

legal and professional fees.6 On his 2010 Schedule A, Itemized Deductions,


      5
          Neither Vicis nor the International Fund were parties to the divorce suit.
      6
        Petitioner hired a law firm to represent him in the divorce. He also hired a
consulting group and an expert witness to help resolve the valuation issues
                                                                      (continued...)
                                        -6-

[*6] petitioner deducted legal and professional fees of $1,337,158. For 2011

petitioner deducted legal and professional fees of $1,644,261 on his Schedule E,

Supplemental Income and Loss. The parties have stipulated that these amounts

were incurred by petitioner with respect to issues related to Vicis in the divorce.

      On August 12, 2016, respondent timely issued a statutory notice of

deficiency for 2010. Respondent determined a deficiency of $1,760,709,

disallowing, in part, deductions for petitioner’s nonbusiness bad debts and

miscellaneous itemized deductions. Respondent also disallowed, in part,

petitioner’s claimed deduction for Schedule E expenses for 2011. Petitioner

timely petitioned this Court.

                                     Discussion

I.    Burden of Proof

      As a general rule, the Commissioner’s determination of a taxpayer’s liability

in a notice of deficiency is presumed correct, and the taxpayer bears the burden of

proving that the determination is incorrect.7 Rule 142(a); Welch v. Helvering, 290



      6
      (...continued)
concerning his interest in Vicis.
      7
        Petitioner does not contend that the burden of proof should be shifted to
respondent pursuant to sec. 7491(a), and there is no justification on this record for
doing so. See Higbee v. Commissioner, 116 T.C. 438, 442-443 (2001).
                                         -7-

[*7] U.S. 111, 115 (1933). Deductions are a matter of legislative grace, and the

taxpayer ordinarily bears the burden of proving entitlement to any deduction

claimed. Rule 142(a); INDOPCO, Inc. v. Commissioner, 503 U.S. 79, 84 (1992);

New Colonial Ice Co. v. Helvering, 292 U.S. 435, 440 (1934).

II.   Deductions for Legal and Professional Fees

      Petitioner claimed deductions for legal and professional fees for both 2010

and 2011. Petitioner argues that he is entitled to deductions for these fees under

section 162(a) because they were paid to defend a claim for profits earned in his

trade or business. Petitioner implicitly argues that he is entitled to these

deductions under section 212 if section 162 does not apply.

      Respondent contends that petitioner cannot claim deductions for the legal

and professional fees under either section 162(a) or section 212 because they are

nondeductible personal expenses under section 262. For the following reasons,

we sustain respondent’s determination.

      Section 162(a) governs the deductibility of litigation costs as a business

expense. Section 162(a) allows an individual to deduct all of the ordinary and

necessary expenses of carrying on his or her trade or business. Section 212

governs the deductibility of litigation costs as an itemized deduction, when the

costs are incurred as a nonbusiness profit-seeking expense. Section 212 allows an
                                        -8-

[*8] individual to deduct all of the ordinary and necessary expenses paid or

incurred in: (1) producing income, (2) managing, conserving, or maintaining

property held for the production of income, or (3) determining, collecting, or

refunding any tax. Sections 162(a) and 212 are considered in pari materia, except

for the fact that the income-producing activity of the former section is a trade or

business whereas the income-producing activity of the latter section is a pursuit of

investing or other profit-making that lacks the regularity and continuity of a

business.8 See Woodward v. Commissioner, 397 U.S. 572, 575 n.3 (1970); United

States v. Gilmore, 372 U.S. 39, 44-45 (1963); Bingham’s Tr. v. Commissioner,

325 U.S. 365, 374-375 (1945). No deduction is allowed with respect to personal,

living, or family expenses. Sec. 262.

      In Gilmore, 372 U.S. at 48, the Supreme Court held that whether legal fees

are deductible expenses or nondeductible personal expenses depends upon

      8
         A deduction of litigation costs under sec. 162(a) may be more desirable to
an individual than a deduction under sec. 212. The primary advantage to a
deduction under sec. 162(a), vis-a-vis a deduction under sec. 212, rests on each
deduction’s effect on gross income and adjusted gross income. A deduction under
sec. 162(a) is subtracted in full from gross income to arrive at adjusted gross
income. A deduction under sec. 212 is subtracted from adjusted gross income to
arrive at taxable income and is subject to certain floor limitations in sec. 67(a).
The benefit from a deduction of litigation costs under sec. 212 may also be limited
by application of the alternative minimum tax. Guill v. Commissioner, 112 T.C.
325, 328-329 (1999); see also sec. 56(b); Benci-Woodward v. Commissioner, T.C.
Memo. 1998-395.
                                         -9-

[*9] whether the claim arises in connection with the taxpayer’s profit-seeking

activities or his personal activities. Under this “origin of the claim” test, the Court

held that legal expenses paid to defeat claims arising from a marital relationship

were personal and nondeductible. Id. at 51-52. The Court noted that it is

irrelevant whether the taxpayer’s income-producing property would be affected by

the outcome of the divorce proceeding. See id. at 48. For ascertaining the source

of claims giving rise to legal expenses, we apply a “but for” test. See Fleischman

v. Commissioner, 45 T.C. 439, 446 (1966). If the claim could not have existed but

for the marriage relationship, the expense of defending it is a personal expense and

not deductible. See id.

      To be sure, a deduction for legal expenses is not necessarily precluded

because the taxpayer’s underlying claim arose in a divorce action. Barry v.

Commissioner, T.C. Memo. 2017-237. The regulations provide a limited

exception under section 212 for divorce-related legal fees incurred for the

production or collection of taxable alimony income. See Wild v. Commissioner,

42 T.C. 706, 710-711 (1964); sec. 1.262-1(b)(7), Income Tax Regs. The legal

costs of securing rights to other forms of income are also deductible. See Hahn v.

Commissioner, T.C. Memo. 1976-113 (allowing a section 212 deduction for legal

fees relating to obtaining possession of, and income rights to, a corporation
                                        - 10 -

[*10] already owned by the taxpayer). A taxpayer may also deduct legal fees

incurred to resist actions by the taxpayer’s ex-spouse that interfere with the

business activities of the taxpayer’s corporation. See Liberty Vending, Inc. v.

Commissioner, T.C. Memo. 1998-177.

      On the record before us, it is clear that but for her marriage to petitioner,

Ms. Lucas would have no claim to petitioner’s interest in Vicis. Ms. Lucas’ claim

to the Vicis distributions stemmed entirely from her marriage to petitioner. Thus,

under Gilmore, the legal and professional fees paid by petitioner are personal and

not deductible.

      Petitioner argues that facts in this case are similar to those in Hahn, in which

we held that the taxpayer’s legal fees were deductible. We disagree. In Hahn, the

taxpayer’s deductible legal fees were incurred securing income from jointly owned

property over which her ex-husband had taken possession. As we explained in

Barry v. Commissioner, T.C. Memo. 2017-237, the Hahn taxpayer’s deductible

legal fees were business connected. In contrast petitioner’s legal fees had no

connection to Vicis’ investment advisory business. They were incurred defending

petitioner’s Vicis ownership and distributions from equitable distribution in a

divorce action.
                                        - 11 -

[*11] Petitioner has not demonstrated that the expenses are otherwise deductible

under section 162(a) or section 212. In the divorce action at issue, petitioner was

neither pursuing alimony from Ms. Lucas nor resisting an attempt to interfere with

his ongoing business activities. Cf. Liberty Vending, Inc. v. Commissioner, T.C.

Memo. 1998-177; sec. 1.262-1(b)(7), Income Tax Regs. Furthermore, petitioner

engaged in little trade or business activity during 2010 and 2011. Vicis began

liquidating its portfolio in September 2009 and thereafter petitioner was not

engaged in any business activity other than a limited management role with Vicis.

Petitioner has not established that Ms. Lucas’ claim related to the winding down

of Vicis. Nor has petitioner established that the fees he incurred to defeat her

claim were “ordinary and necessary” to his trade or business. We therefore sustain

respondent’s disallowance of petitioner’s deductions for legal and professional

fees for 2010 and 2011.

      In reaching all of our holdings herein, we have considered all arguments

made by the parties, and to the extent not mentioned above, we find them to be

irrelevant or without merit.
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[*12] To reflect the foregoing,


                                           Decision will be entered

                                  under Rule 155.
