                        T.C. Memo. 2009-219



                       UNITED STATES TAX COURT



    ERNEST A. GRALIA, JR., AND ROSE M. GRALIA, Petitioners v.
           COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 19075-06.               Filed September 21, 2009.



     Peter L. Banis, for petitioners.

     Nina P. Ching, for respondent.



                          MEMORANDUM OPINION


     HALPERN, Judge:    By notice of deficiency (the notice),

respondent determined deficiencies of $163,475 and $62,572 in

petitioners’ Federal income tax for taxable (calendar) years 1996

and 2001, respectively.

     Unless otherwise stated, section references are to the

Internal Revenue Code in effect for the years in issue and Rule

references are to the Tax Court Rules of Practice and Procedure.
                                   - 2 -

       The parties submitted this case fully stipulated under Rule

122.       The stipulated facts are so found, and the stipulation of

facts, with accompanying exhibits, is incorporated herein by this

reference.

       Respondent has conceded one issue; we must decide only

whether (1) petitioners’ deduction of a $600,000 settlement (the

settlement) is a miscellaneous itemized deduction and (2)

petitioners may deduct $15,217 in related legal fees (the legal

fees).1      Petitioners bear the burden of proof.   See Rule 142(a).2

                                Background

       Petitioners are husband and wife who made joint returns of

income for the years in issue.       At the time they filed the

petition, they resided in Florida.




       1
      Respondent made other adjustments in the notice that are
purely computational and that we need not discuss further.
       2
      Sec. 7491(a)(1) provides that, if a taxpayer offers
credible evidence with respect to an issue, the burden of proof
with respect to the issue is on the Commissioner. See also Rule
142(a)(2). Sec. 7491(a)(1) applies only if the taxpayer complies
with the relevant substantiation requirements in the Internal
Revenue Code, maintains all required records, and cooperates with
the Commissioner with respect to witnesses, information,
documents, meetings, and interviews. Sec. 7491(a)(2)(A) and (B).
The taxpayer bears the burden of proving compliance with the
conditions of sec. 7491(a)(2)(A) and (B). E.g., Ruckriegel v.
Commissioner, T.C. Memo. 2006-78. Petitioners neither propose
facts to support their compliance with the conditions of sec.
7491(a)(2)(A) and (B) nor argue that respondent bears the burden
of proof on any issue because of sec. 7491(a)(1). We therefore
conclude that sec. 7491(a)(1) does not apply to this case.
                                - 3 -

Petitioner’s Business

     Ernest A. Gralia, Jr. (petitioner), was a general contractor

involved in the construction of residential and commercial

buildings and was the owner and principal officer of an S

corporation, E.A. Gralia Construction Co. (Gralia Construction).

Charles F. Maurer, Jr. (Mr. Maurer), was the son of the owner of

a site development business, which petitioner sometimes hired as

a subcontractor on construction projects.   In 1972, when Mr.

Maurer graduated from high school, petitioner hired him as a

laborer.   In 1973, petitioner asked Mr. Maurer if he would like

to work in the company office instead of the field, and Mr.

Maurer accepted. Over the next few years, as Mr. Maurer began his

college education in business and finance, petitioner

increasingly depended on him to manage the office.

Eastmont and the Partnerships

     In 1975, petitioner became interested in undertaking

government-subsidized housing projects.   In late 1975, two men

asked petitioner to quote a price for the construction of a

proposed subsidized project, Pheasant Hill Village.   The two men

were the sole general partners of Pheasant Hill Village

Associates (Pheasant Hill).   In February 1978, petitioner

acquired a 55-percent general partnership interest in Pheasant

Hill (thereby replacing one of the general partners) and became

managing general partner of that partnership.   One month later,

petitioner’s lawyer formed Eastmont Development Corp. (Eastmont).

Petitioner was its president, Mr. Maurer its treasurer, and
                                 - 4 -

petitioner’s lawyer its clerk.    The same men were its three

directors.    Petitioner transferred a 45-percent general

partnership interest in Pheasant Hill to Eastmont, and Eastmont

replaced petitioner as managing general partner.      Eastmont issued

stock to petitioner and to no one else.      Mr. Maurer understood

himself to be entitled to one-third of Eastmont’s stock.

     Petitioner became involved in three other partnerships

(together with Pheasant Hill, the partnerships).      In the first

two partnerships, petitioner and Eastmont (or its wholly owned

subsidiary) were general partners.       In the third partnership, 120

Chestnut Street Limited Partnership (Chestnut House), petitioner

was both general partner and a limited partner.

     In September 1981, Mr. Maurer left his positions at Gralia

Construction and Eastmont.    At that time, he asked petitioner for

his share of Eastmont’s stock.    Petitioner demurred.

The State Court Case

     In April 1982, Mr. Maurer commenced a civil action against

petitioner and others in the Superior Court of Hampden County,

Massachusetts (the State court case and the superior court,

respectively).    Among other things, Mr. Maurer sought to recover

his share of Eastmont’s stock and any associated dividends or

other benefits.   The superior court bifurcated the action,

addressing liability first and damages second.      In February 1988,

the superior court issued a “Memorandum” (the first State court

ruling), holding that Mr. Maurer was a one-third owner of

Eastmont.    In December 1988, the superior court issued its
                               - 5 -

“Findings, Rulings and Order for Judgment” (the second State

court ruling; together with the first State court ruling, the

State court rulings).   The superior court prefaced its discussion

with its understanding of the nature of Mr. Maurer’s claims:

     This is not a stockholders’ derivative action in which
     the plaintiff seeks damages on behalf of the
     corporation for monies improperly expended by it. In
     this case[,] the plaintiff is seeking to recover his
     proportionate share of monies or other benefits which *
     * * [petitioner] may have taken from the corporation in
     the nature of dividends. He is seeking to enforce the
     fiduciary duty which * * * [petitioner], as majority
     shareholder, owed to him as minority shareholder (as
     defined in Donahue v. Rodd Electrotype Co. of New
     England, 367 Mass. 578, 328 N.E.2d 505 [(1975)]),
     rather than recompense for any loss alleged to have
     been caused to the corporation by * * * [petitioner’s]
     actions. See Bessette v. Bessette, 385 Mass. 806, 434
     N.E.2d 206 (1982). The effort, therefore, was to
     identify those payments or direct benefits which * * *
     [petitioner] had received from Eastmont Development
     Corporation since its formation.

The superior court found, among other facts, that petitioner had

been improperly claiming Eastmont’s share of the partnership

losses.

     [Petitioner] apparently has used his position of
     control to usurp a much larger proportion of the equity
     ownership than that to which he is entitled. On the
     record before me it is not possible to right the wrong
     that has been done to Eastmont except by ordering * * *
     [petitioner] to amend his tax returns for the years in
     question to reflect the true division of ownership.

The superior court also ordered petitioner to pay Mr. Maurer

approximately $12,000 for causing Eastmont to pay the premiums on

petitioner’s life insurance policy.    Petitioner appealed, and, in
                                 - 6 -

October 1994, the Massachusetts Appeals Court (the appeals court)

affirmed most of the State court rulings.3

The District Court Case
     In November 1996, Mr. Maurer commenced a civil action

against petitioner and others in the U.S. District Court for the

District of Massachusetts (the District Court case and the

District Court, respectively).    Mr. Maurer amended his complaint

three times,4 and, for purposes of this case, we consider only the

Third Amended Complaint and Jury Demand (the third amended

complaint).   In January 2001, Mr. Maurer agreed to the dismissal

of his action against the defendants in the District Court case

in return for $600,000.

     A single law firm represented the defendants in the District

Court case.   That law firm billed “The Gralia Group” for its

services, and, in 2001, Gralia Construction paid the law firm

$15,217 (i.e., the legal fees).

Petitioners’ Returns

     Petitioners filed a Form 1040, U.S. Individual Income Tax

Return, for 2001.   They attached thereto a Schedule C, Profit or

Loss From Business, which showed petitioner as the proprietor of

a business described as “CONSULTING-DIRECTOR”.   On that Schedule

C, petitioners claimed deductions for the settlement and the

     3
      The appeals court vacated that part of the second State
court ruling that required petitioner to amend his personal
income tax returns.
     4
      Although Mr. Maurer lodged a fourth amended complaint, the
case was settled before the District Court ruled on his motion
for leave to file a fourth amended complaint.
                                 - 7 -

legal fees, which caused them to have a net loss on Schedule C of

$615,217.    In October 2002, petitioners filed Form 1045,

Application for Tentative Refund, claiming a carryback net

operating loss for 1996 as a result of the Schedule C loss

claimed on their 2001 Form 1040.     In November 2003, petitioners

filed Forms 1040X, Amended U.S. Individual Income Tax Return, for

1996 and 2001.

The Notice

      In an attachment to the notice, respondent set forth his

adjustments giving rise to the deficiencies in issue.     He

explained that he was disallowing the deduction for the

settlement on the ground that the settlement was not “an ordinary

and necessary business expense as per Section 162 of the Internal

Revenue Code.”   He explained that he was disallowing the

deduction for the legal fees on the ground, among others, that

petitioner had not paid them.     The disallowance of the carryback

to 1996 followed from the disallowance of deductions for the

settlement and the legal fees.

                               Discussion
I.   Respondent’s Concession

      On brief, respondent concedes:     “[P]etitioners are entitled

to deduct the * * * [settlement] on Schedule A of their 2001

return as a miscellaneous expense subject to the limitations

under I.R.C. § 67.”   Specifically, respondent concedes that

petitioners may deduct the settlement as either an employee

business expense under section 162(a) or an expense related to
                                 - 8 -

petitioner’s investment in Eastmont under section 212(2).

Respondent’s concession, however, does not help petitioners much;

because of the alternative minimum tax, any miscellaneous

itemized deduction will have only a limited effect (if any) on

petitioners’ tax liabilities.5    See sec. 56(a)(4), (b)(1)(A)(i),

(d).

II.    Miscellaneous Itemized Deductions

       A.   Introduction

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

necessary expenses paid or incurred during the taxable year in

carrying on any trade or business”.      Section 212(2) allows a

deduction for certain expenses related to investments; i.e.,

expenses “for the management, conservation, or maintenance of

property held for the production of income”.      Most section 162(a)

expenses related to the performance of services as an employee

and section 212(2) expenses related to stock ownership are

deductible only as itemized deductions.      Here, if the settlement


       5
      Petitioners apparently accept respondent’s concession that
they may deduct the settlement under sec. 162(a); we assume they
do so because that is the section they argue applies. They
object, however, to respondent’s concession under sec. 212(2),
asserting that they are “surprised and prejudiced by this new and
confusing claim”. Even if respondent’s concession were a new
matter raised on brief, however, that would not make it an
“impermissible * * * argument”, as petitioners assert; rather,
respondent would simply bear the burden of proving it. See Rule
142(a)(1). Yet petitioners do not seek to shift the burden of
proof, which is understandable, since respondent has conceded
something to petitioners--i.e., that they do have a ground for
deducting the settlement (something respondent denied altogether
in the notice). A deduction under sec. 212(2) may not be the
concession petitioners would have liked, but it is a concession,
nonetheless.
                                  - 9 -

is such an employment- or shareholder-related expense, then it is

a “miscellaneous itemized deduction”.     See sec. 67(b).

     B.   Respondent’s Argument

     Respondent argues that petitioner paid the settlement

neither in connection with his trade or business as a self-

employed consultant nor in connection with his trade or business

as a real estate developer.   Rather, respondent argues,

petitioner paid the settlement in connection with either his

employment by Eastmont or his status as an Eastmont shareholder.

According to respondent, in both cases the result is the same:

Petitioners may deduct the settlement only as a miscellaneous

itemized deduction under section 67.

     Respondent also denies that petitioner himself paid the

legal fees, asserting that petitioner’s lawyers issued bills to

“the Gralia Group”, i.e., all the defendants in the District

Court case, and that Gralia Construction paid those bills.

     C.   Petitioners’ Argument

     Petitioners assert that Mr. Maurer’s claims in the District

Court case were “against * * * [petitioner] directly for * * *

business opportunities * * * [petitioner] personally” usurped

from Eastmont.   Petitioners argue that petitioner settled a claim

against himself as a real estate developer and not any claim

against himself as a mere officer or shareholder of a real estate

developer.   First, petitioners argue that, because in the State

court case Mr. Maurer did not make any derivative claim as a

shareholder of Eastmont, “res judicata” (claim preclusion) barred
                               - 10 -

him in the District Court case from making any similar claim.

Second, petitioners argue that Mr. Maurer’s claim for his share

of the “benefits of stock ownership in Eastmont” fails to state a

“damage claim” because Eastmont never made any dividends,

profits, or distributions.   Because Mr. Maurer made only those

two claims, petitioners argue that, to understand the reason

petitioner settled, we must look through the stated claims to

“determine the essence of Mauer’s [sic] claim”.    Petitioners find

“the true substance of Mauer’s [sic] claim” in paragraph 39 of

the third amended complaint:   “[Petitioner] has ignored the

corporate form, [and] engaged in self-dealing by usurping

corporate opportunities rightfully belonging to Eastmont”.

According to petitioners, “There is no money in the claims of

Mauer [sic] against * * * [petitioner] other than those which can

be traced to the Partnership Equity.”   Thus, the claim petitioner

settled for $600,000 was a claim against himself personally for

“the benefits”, i.e. “partnership equity”, petitioner “obtained

at Mauer’s [sic] expense”.

     Petitioners assert that, although Gralia Construction paid

the legal fees in 2001, Gralia Construction issued petitioner a

Schedule K-1, Shareholder’s Share of Income, Credits, Deductions,

etc., causing petitioners to report as income the legal fees

Gralia Construction paid on petitioner’s behalf.
                                 - 11 -

     D.   Analysis

           1.   The Settlement

     We agree with respondent that petitioner has failed to show

that he paid the settlement in connection with his trade or

business as a real estate developer.

     In effect, petitioners argue that, although Mr. Maurer

failed to state a valid claim in the District Court case,

petitioner settled because Mr. Maurer could have made a valid

claim.6   Petitioners suggest that, because of the “laxity of

notice pleading,” petitioner did not bother to move for summary

judgment, but rather, after almost two decades of litigation,

preemptively settled.    The plausibility of their argument

notwithstanding, petitioners have failed to show that Mr. Maurer

had any claim against petitioner personally other than to enforce

the fiduciary duty that the superior court had concluded that

petitioner, as a majority shareholder, owed to Mr. Maurer, as a

minority shareholder.7

     6
      We note that the allegation in which petitioners find the
“true substance” of Mr. Maurer’s claim, i.e., that petitioner
“engaged in self-dealing by usurping corporate opportunities
rightfully belonging to Eastmont”, is a classic ground for a
derivative claim. See, e.g., Farber v. Servan Land Co., 662 F.2d
371 (5th Cir. 1981) (holding that the corporation was entitled to
profits defendant stockholders made by improperly seizing a
corporate opportunity).
     7
      We have set forth supra the relevant part of the second
State court ruling in which the superior court, in defining
petitioner’s duty to Mr. Maurer, cited Donahue v. Rodd
Electrotype Co. of New England, 328 N.E.2d 505 (Mass. 1975). In
that case, the Supreme Judicial Court of Massachusetts treated
the plaintiff’s complaint, although in part presenting a
derivative action, as “in substance” one “presenting a proper
                                                    (continued...)
                               - 12 -

     Petitioners argue the following:      (1) Petitioner usurped

corporate opportunities of Eastmont; (2) Mr. Maurer, in his own

right, had a claim to those corporate opportunities; therefore,

(3) petitioner settled the claim with Mr. Maurer.      Petitioners

imply that, because petitioner improperly took corporate

opportunities in which Mr. Mauer had a right to participate (and

petitioner personally profited therefrom), Mr. Maurer, for that

reason, and for no other reason, had a direct claim against

petitioner.    Petitioners are mistaken.

     To prove that Mr. Maurer had a claim against petitioner

personally for the usurpation of joint opportunities, petitioners

must show that Mr. Maurer was personally entitled to participate

in the “usurped” corporate opportunities.      Petitioners must show

that Mr. Maurer and petitioner were partners or coadventurers and

that petitioner took for himself something belonging to the joint

venture.    See generally Meinhard v. Salmon, 164 N.E. 545 (N.Y.

1928).    That is, petitioners must show that Mr. Maurer had a

claim that did not derive from his one-third ownership of

Eastmont.    Except obliquely, petitioners do not even suggest Mr.

Maurer had any right to participate in the partnerships.

Petitioners come closest to making that averment in the

conclusion of their reply brief:    Petitioner and Mr. Maurer

“specifically contemplated partnership equity ownership in their

names”.    Petitioners, however, offer no evidence that Mr. Maurer

     7
      (...continued)
cause of suit in the personal right of the plaintiff.”      Id. at
508 n.4.
                             - 13 -

had any right to participate in the partnerships (or any other

“usurped” corporate opportunities, which petitioners fail to

specify) except through Eastmont.

     In conclusion, petitioners have failed to show that Mr.

Maurer was entitled to recover against petitioner personally on a

claim of usurpation of any joint opportunity.    They have failed

to show that petitioner settled any claim other than a claim Mr.

Maurer had as a one-third owner of Eastmont.    On the evidence

considered so far, they have failed to show that the settlement

was deductible as other than an employment-related section 162(a)

expense or a shareholder-related section 212(2) expense; they

have therefore failed to show that it is deductible as other than

a miscellaneous itemized deduction.

     2.   The Legal Fees

     Although petitioners assert that they reported as income the

legal fees Gralia Construction paid on petitioner’s behalf, they

have failed to satisfy their burden of proof.    Petitioners have

provided no Schedule K-1 received from Gralia Construction, and

the Schedule E, Supplemental Income and Loss, attached to their

2001 Form 1040, reports only a loss from Gralia Construction.

Although Schedule B, Interest and Ordinary Dividends, reports a

$15,365 ordinary dividend from Gralia Construction, petitioners

have failed to establish any connection between the legal fees

and that ordinary dividend ($148 more than the legal fees).

Nevertheless, on brief, respondent appears to concede that
                                  - 14 -

petitioners may deduct the legal fees as a miscellaneous itemized

deduction.      We accept that concession and so hold.

       E.    Conclusion

       On the evidence considered so far, petitioners may deduct

the settlement and the legal fees only as miscellaneous itemized

deductions.

III.    The Claim of Right Doctrine and Section 1341(a)

       A.    Introduction

       Petitioners make an alternative argument with respect to the

settlement that avoids its classification as a miscellaneous

itemized deduction.       They argue that they may deduct the

settlement under section 1341(a)(4) as the restoration of an

amount received under a so-called claim of right.        Section

67(b)(9) excludes from the definition of “miscellaneous itemized

deductions” “the deduction under section 1341”.

       B.    Section 1341

       Section 1341(a) addresses the computation of tax where a

taxpayer restores a substantial amount held under a claim of

right.      In pertinent part, section 1341 provides:

              SEC. 1341(a).   General Rule.--If--

                   (1) an item was included in gross income
              for a prior taxable year * * * because it
              appeared that the taxpayer had an
              unrestricted right to such item;

                   (2) a deduction is allowable for the
              taxable year because it was established after
              the close of such prior taxable year * * *
              that the taxpayer did not have an
              unrestricted right to such item or to a
              portion of such item; and
                                - 15 -

                  (3) the amount of such deduction exceeds
             $3,000,

     then the tax imposed * * * [shall be the lesser of the
     tax computed with such deduction, sec. 1341(a)(4), or
     the tax for the year without the deduction reduced by
     the amount the taxes were increased in the year of
     receipt because the item in dispute was included in
     gross income, sec. 1341(a)(5)].

     C.   Respondent’s Argument

     With respect to the settlement, respondent concedes that

petitioners satisfy the requirements in paragraphs (2) and (3) of

section 1341(a); i.e., respondent concedes that petitioners may

deduct the settlement and that the deduction exceeds $3,000.

Respondent contends only that petitioners have failed to prove

that they included any item in gross income for a prior taxable

year because it appeared that they had an unrestricted right to

that item.    Respondent argues that petitioners have not provided

“any explanation or evidence to support that they reported items

of income under a claim of right.”       Respondent disputes that

petitioners could have “reasonably believed that they had an

unrestricted right to income” from the partnerships after October

5, 1994, when the appeals court entered its order affirming the

holding of the superior court that Mr. Maurer was entitled to a

one-third interest in Eastmont.8

     D.   Petitioners’ Argument

     Petitioners argue that they “can and do demonstrate the

necessary income inclusion, and income inclusion in an amount


     8
      Further appellate review was denied Nov. 28, 1994. See
Maurer v. E.A. Gralia Constr. Co., 644 N.E.2d 225 (Mass. 1994).
                                 - 16 -

sufficient to dispose of this matter, by two taxable years, * * *

1995 and 1997.”    Petitioners then detail the income they reported

from the partnerships in those years, dividing the total by 3 to

reflect the value of the one-third interest in the “overall

‘partnership’” between petitioner and Mr. Maurer that petitioners

allege the superior court found.     Because one-third of the income

petitioners included from the partnerships in those years exceeds

the settlement, petitioners claim they have demonstrated that

they included in a prior year an item of income corresponding to

the settlement.9     For that reason, petitioners assert they have

“satisfied the * * * three requirements” of section 1341(a).

     E.   Analysis

     We agree with respondent.     Even if we agreed with

petitioners that they have shown they included in gross income

items corresponding to the settlement (which we do not10),

     9
      Petitioners advance that argument in their opening brief.
In their reply brief, petitioners argue that considering only the
income they reported from Chestnut House, “some quick math”,
i.e., dividing that reported income by 3, “gets you pretty close
to $600,000”.
     10
      Petitioners’ simple division by 3 of the income they
reported from the partnerships in 1995 and 1997 does not
accurately reflect the amount to which Mr. Maurer was entitled as
a one-third owner of Eastmont. Petitioners state that the
superior court granted Mr. Maurer a one-third interest in an
“overall ‘partnership’” between him and petitioner. Yet that
manifestly is not what the State court rulings hold. Petitioner
was a general partner of the partnerships; Mr. Maurer was not and
was not entitled to be. Mr. Maurer participated in three
partnerships only indirectly through Eastmont and did not
participate in Chestnut House at all. Mr. Maurer thus had no
claim whatsoever to any Chestnut House profits. (For that reason
alone, petitioners’ second argument, see supra note 9, has no
merit.) The problem for petitioners is that the lion’s share of
                                                    (continued...)
                                - 17 -

petitioners have nonetheless failed to explain how they could

have reasonably believed they had an unrestricted right to income

from the partnerships after the conclusion of the State court

case.     Petitioners have failed to satisfy their burden of proof

with respect to section 1341(a)(1).

     Section 1.1341-1(a)(2), Income Tax Regs., provides in part:

“For the purpose of this section ‘income included under a claim

of right’ means an item included in gross income because it

appeared from all the facts available in the year of inclusion

that the taxpayer had an unrestricted right to such item”.

Petitioners assert that in 1995 and 1997, they included in gross

income items from the partnerships under a claim of right.    Yet

petitioners do not explain how they could have reasonably

     10
      (...continued)
the income from the partnerships was the result of the sale of
Chestnut House in 1997. Indeed, that sale was the source of more
than 92 percent of the income petitioners reported from the
partnerships in 1995 and 1997. Thus, petitioners’ arithmetic is
not an accurate (or even a rough) estimate of the amount to which
Mr. Maurer was entitled. We assume petitioners rely on 1995 and
1997 to make their argument because in few (if any) other years
did they receive such large amounts of income. According to the
appeals court: “Much of the value of the general partnership
interests in the years in question (1978 through 1987) was in the
form of losses”. Maurer v. E.A. Gralia Constr. Co., 640 N.E.2d
484, 488 (Mass. App. Ct. 1994). Although those losses had real
value (and could by themselves have been grounds for the
settlement), a settlement for deductions improperly claimed can
never qualify for the tax benefits of sec. 1341(a). Further,
petitioner likely had many reasons for settling the case; indeed,
to save himself the costs and fees associated with another trial,
petitioner may well have agreed to pay Mr. Maurer more than he
was strictly entitled to receive. In short, petitioners have
failed to show that the settlement represented anything other
than the value of losses improperly deducted and litigation costs
and attorney’s fees saved. Petitioners thus have failed to show
that they included in gross income items corresponding to the
settlement.
                              - 18 -

believed, in the light of all the facts available in those years,

that they had an unrestricted right to those items.   Indeed,

petitioners undermine their own argument.    If, as they argue, the

superior court granted Mr. Maurer a one-third interest in an

“overall ‘partnership’” between petitioner and Mr. Maurer, then

petitioners knowingly misappropriated the items they claim are

associated with the settlement.   Petitioners are thus not

entitled to the tax benefits of section 1341(a).   See, e.g.,

Kraft v. United States, 991 F.2d 292, 299 (6th Cir. 1993)

(“Furthermore, 26 U.S.C. § 1341 does not apply to a taxpayer who

has embezzled or otherwise knowingly misappropriated funds which

he is later required to return because the taxpayer never had an

unrestricted right to the money so obtained.”).

      F.   Conclusion

      With respect to the settlement, petitioners are not entitled

to the tax benefits of section 1341(a).   Section 67(b)(9)

therefore does not apply.

IV.   Conclusion

      Petitioners may deduct the settlement and the legal fees

only as miscellaneous itemized deductions.


                                          Decision will be entered
                                    under Rule 155.
