                          T.C. Memo. 1999-69



                     UNITED STATES TAX COURT



            DANIEL FRANCIS KELLY, JR., Petitioner v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent


     Docket No. 750-97.                           Filed March 8, 1999.


     Timothy F. Kelly, for petitioner.

     Ann M. Welhaf, for respondent.



                          MEMORANDUM OPINION


     COUVILLION, Special Trial Judge:       This case was heard
                                  1
pursuant to section 7443A(b)(3)       and Rules 180, 181, and 182.

     Respondent determined deficiencies of $3,850 and $1,063 in

petitioner's Federal income taxes for 1991 and 1992,

respectively.

1
      Unless otherwise indicated, section references are to the
Internal Revenue Code in effect for the years at issue. All Rule
references are to the Tax Court Rules of Practice and Procedure.
                                - 2 -


     The sole issue for decision is whether, for 1991 and 1992,

petitioner is entitled to deduct, under section 162(a), as trade

or business expenses, legal expenses incurred in defending a

criminal sexual assault charge against him.

     Some of the facts were stipulated, and those facts, with the

annexed exhibits, are so found and are incorporated herein by

reference.    At the time the petition was filed, petitioner's

legal residence was Phoenix, Arizona.

     During the years at issue, petitioner was employed as the

chief financial officer of Gosnell Builders Corp. (GBC), an

Arizona corporation whose principal business was the ownership

and development of resort properties in Arizona and Southern

California.    One of the several upscale golf resorts owned by GBC

in the Phoenix, Arizona, metropolitan area was known as The

Pointe South Mountain Resort (The Pointe).

     The incident that gives rise to the issue in this case

occurred on the evening of June 12, 1991, when petitioner and two

other executives of GBC were entertaining two GBC clients at the

Sports Club located at The Pointe.      During the course of the

evening, the group consumed a considerable amount of alcoholic

beverages.    Petitioner and his group encountered three women, who

were also patrons at the Sports Club and who, themselves, had

imbibed a considerable amount of alcoholic beverages.      Petitioner

and his group purchased several rounds of drinks for the women.

In the course of the evening, petitioner paid particular

attention to one of the three women, who is referred to as Jane
                                - 3 -

    2
Doe.    As the evening progressed, it became evident to petitioner

that the three women should not drive home from the Sports Club

because of their inebriation.   GBC had a company policy that

allowed employees to arrange for a complimentary room at a hotel

that was part of The Pointe complex for patrons who were

intoxicated.   The parties referred to this policy as the "take

the elevator home" policy, and it was intended to protect GBC

from liability should such guests cause harm to themselves or

others after leaving the Sports Club intoxicated.      Petitioner

suggested to the women that he procure such a complimentary room

for them, which they initially declined.      Petitioner and his

group continued socializing with the women and purchased them

additional drinks.   Later in the evening, Jane Doe became sick

due to her consumption of alcohol.      The women agreed to accept

petitioner's complimentary room offer and suggested that he

reserve the room and bring them the key.      Petitioner declined to

do that, insisting that the women accompany him to procure the

room.   After a few more rounds of drinks and socializing, one of

the women, a Ms. Gavirati, observed petitioner leaving the Sports

Club with his arm around a groggy and stumbling Ms. Doe.      Ms.

Gavirati suggested to their third woman companion, a Ms. Johnson,

that Ms. Johnson pursue petitioner and Ms. Doe.      Ms. Johnson did

that, and, after being advised that they were going to procure


2
     Jane Doe was the alleged victim of the alleged sexual
assault. That name is fictitious as the Court, for reasons of
privacy, does not use the actual name of the alleged victim.
                                 - 4 -


the room, she and Ms. Doe rode with petitioner in his car for the

short distance to the hotel lobby, where petitioner checked out a

room, in his name, for use by the three women.   Petitioner

returned to his car, where the two women waited, and, together,

they walked to the hotel room.    Petitioner and Ms. Johnson had to

assist Ms. Doe to the hotel room, where she was placed in bed.

After a few minutes, Ms. Johnson and petitioner left in

petitioner's car to return to the Sports Club.   On the way,

however, petitioner stopped at the hotel lobby and stated to Ms.

Johnson "wait right here, I need to take care of something" and

proceeded to the registration desk, where he conversed briefly

with the clerk.   Although petitioner denies this, it is alleged

that petitioner obtained a second key to the hotel room at that

time.   Petitioner did not disclose to Ms. Johnson the object or

purpose of his conversation with the desk clerk.   Following this

stop, petitioner drove Ms. Johnson back to the Sports Club, and

she exited the car.    Petitioner advised Ms. Johnson that he was

going home and would not return to the bar.   Upon returning to

the Sports Club, Ms. Johnson reunited with Ms. Gavirati and some

of the other persons with whom they had been socializing earlier

in the evening.   By this time, the other GBC executives and

clients had departed.   Ms. Johnson and Ms. Gavirati continued to

socialize at the Sports Club for anywhere from 20 minutes to an

hour and then suggested to some of their new found friends that

they go to the hotel room to party, since there was a stocked

minibar in the room.
                                 - 5 -


     When the group arrived at the hotel room, Ms. Gavirati

decided she would go home and called a taxi to take her home.

Just prior to Ms. Gavirati leaving the room, Ms. Doe began

calling out for Ms. Johnson to come and talk to her.     Ms.

Gavirati paid little attention to Ms. Doe because she thought Ms.

Doe was upset because of her intoxication.     Ms. Gavirati left

without seeing Ms. Doe.     When Ms. Johnson entered the bedroom,

Ms. Doe was crying hysterically and kept saying "I thought you

were him coming back".    After further inquiries from Ms. Johnson,

Ms. Doe replied that, sometime after petitioner and Ms. Johnson

left the hotel room, Ms. Doe thought she heard the door to the

room open and close.     Ms. Doe explained further that she then

groggily awakened to find petitioner hovering over her.     Ms. Doe

detailed acts of sexual assault and rape that she alleges

petitioner perpetrated on her.     Ms. Doe stated that she tried to
                                                                   3
scream and kick petitioner but he completely overpowered her.

Ms. Doe stated that she wanted to get out of that room

immediately, and Ms. Johnson agreed.

     Ms. Johnson informed her new-found friends that they were

all going to leave the room and asked them for a ride to her car,

which had been left in the parking lot at the Sports Club.     The

friends took Ms. Johnson and Ms. Doe to their car.    Ms. Johnson

drove home and immediately called the police to report the


3
     Ms. Doe was approximately 5 feet 2 inches tall and weighed
96 pounds. Petitioner, on the other hand, was approximately 5
feet 10 inches tall and weighed about 260 pounds.
                                 - 6 -


alleged sexual assault and rape.    The two women then proceeded to

a hospital where Ms. Doe was examined with a "rape kit", and both

were questioned by the police.    The police obtained a search

warrant for the hotel room where they seized certain pieces of

evidence.

     Petitioner was arrested and charged with the sexual assault

of Ms. Doe and was indicted by a grand jury on charges of sexual

assault.    In March 1992 the prosecutor's office filed a motion to

dismiss the sexual assault charges against petitioner due to a

lack of "sufficient evidence at this time to present to a jury

and prove the case beyond a reasonable doubt".    The prosecutor's

motion was granted, and the court entered an order dismissing the

charges.    Petitioner spent $45,431 of his personal funds

defending the criminal charges against him.    No part of these

expenses were reimbursed by petitioner's employer, GBC.

     On June 12, 1992, Ms. Doe filed a civil action against

petitioner, GBC, The Pointe, various insurance companies, and

other entities and individuals owned or employed by GBC or any of

its subsidiaries.    In her civil suit, Ms. Doe alleged various

injuries and damages incurred by her as a result of the sexual

assault by petitioner.    After the filing of various pleadings and

completion of discovery, the defendants made out-of-court

settlements with Ms. Doe.    On November 3, 1993, petitioner and

his personal liability insurance company, United Services

Automobile Association (USAA), entered into an out-of-court

settlement with Ms. Doe that called for the payment of $30,000 to
                                 - 7 -


Ms. Doe.   The entire $30,000 was paid by USAA, as well as

petitioner's legal expenses incurred in defending the civil suit.

On that same date, GBC and its insurance companies and other

related entities and employees entered into an out-of-court

settlement with Ms. Doe that called for the payment of $90,000 to

Ms. Doe, the full amount of which was paid by the insurance

companies.

     On Schedule C, Profit or Loss From Business (Schedule C), of

his 1991 Federal income tax return, petitioner claimed a

deduction of $13,737 for legal expenses incurred in the defense

of the criminal sexual assault charges.   On Schedule C of his

1992 Federal income tax return, petitioner claimed a deduction of

$31,694 for legal expenses incurred in the defense of the

criminal sexual assault charges.

     In the notice of deficiency respondent disallowed

petitioner's $13,737 legal expense deduction for 1991 and the

$31,694 legal expense deduction for 1992.   Respondent made

several additional adjustments to petitioner's 1992 return that
                                 4
are not at issue in this case.



4
     For 1992, respondent disallowed $1,749 of petitioner's
claimed $5,000 Schedule C "travel/meals/entertainment" expense
and disallowed petitioner's $3,780 Schedule E "commissions"
expense. Petitioner did not dispute these adjustments, and,
thus, they are considered conceded by petitioner. Rule 34(b)(4);
Jarvis v. Commissioner, 78 T.C. 646, 658 n.19 (1982). Also in
the notice of deficiency, respondent allowed petitioner
additional deductions for Schedule C auto expenses of $2,142,
Schedule C depreciation of $2,083, and Schedule E expenses of
$166.
                               - 8 -


     Petitioner contends that the disallowed legal expenses were

incurred by him while he was engaged in the course and scope of

his employment with GBC, and, thus, such expenses are deductible

as ordinary and necessary business expenses under section 162(a).

Respondent argues, on the other hand, that the disallowed legal

expenses were personal expenses of petitioner that are not

deductible pursuant to section 262.

     Expenses incurred by an employee in the course of employment

that are not reimbursed by the employer may be deductible under

section 162(a), which allows a deduction for all ordinary and

necessary expenses paid or incurred during the taxable year in
                                   5
carrying on a trade or business.       Primuth v. Commissioner, 54

T.C. 374, 377 (1970).   To qualify for the deduction, an expense

must be both ordinary and necessary within the meaning of section

162(a).   Deputy v. duPont, 308 U.S. 488, 495 (1940).     Whether an

amount claimed constitutes an ordinary and necessary expense as

an employee business expense is a question of fact to be


5
     Petitioner's Federal income tax returns for 1991 and 1992
included a Schedule C for a "Financial Services" activity. This
activity, while not addressed at trial, was apparently unrelated
to petitioner's employment with GBC. Petitioner was paid a
salary by GBC, which he reported on his income tax returns as
salary or wage income. The sexual assault matter was not claimed
by petitioner to have arisen out of petitioner's Schedule C
financial services activity; nevertheless, petitioner's expenses
for the defense of the sexual assault charge were claimed as
Schedule C deductions. As was noted by counsel for respondent at
trial, if petitioner is allowed a deduction for the legal
expenses at issue, such expenses would constitute unreimbursed
employee business expenses and would be deductible as itemized
deductions, subject to the 2-percent limitation of sec. 67(a).
Petitioner did not challenge this assertion.
                                - 9 -


determined from the evidence presented.    Rule 142(a); Welch v.

Helvering, 290 U.S. 111 (1933); Allen v. Commissioner, T.C. Memo.

1988-166.   Personal expenses are not deductible.   Sec. 262.

     In United States v. Gilmore, 372 U.S. 39, 48 (1963), the

Supreme Court held that the test as to whether legal fees are

business or personal expenses depends upon whether the claim

arises in connection with the taxpayer's profit-seeking

activities or his personal activities.    For example, under this

"origin of the claim" test, the Supreme Court held that legal

expenses incurred to defeat claims arising from a marital

relationship were personal and nondeductible.     Id. at 51.    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.

     Petitioner contends that the action that gave rise to the

sexual assault claim was his procuring of a hotel room for Ms.

Doe, Ms. Johnson, and Ms. Gavirati.     Petitioner contends further

that his procurement of the hotel room for the ladies was in

connection with his business activity because he was complying

with a written standard operating procedure of GBC referred to

and described at trial as the "take the elevator home" policy

(elevator policy).    Petitioner argues that the elevator policy

required any employee of GBC who noticed that a particular patron

at a GBC bar or restaurant was intoxicated should use all means

available to encourage that person to "take the elevator home"
                              - 10 -


and procure for the intoxicated customer a room at a GBC hotel at

the reduced employee rate.

     Respondent argues that the action that gave rise to the

sexual assault claim was not the procurement of the hotel room

but, rather, was petitioner's second visit to the hotel room, at
                                                    6
which time he and Ms. Doe were alone in the room.       This second

visit, respondent contends, did not arise because of any business

activity of petitioner but, rather, was motivated strictly by

personal desires.   Respondent argues additionally that, even

should the Court determine that the initial procurement of the

room was the action that gave rise to the sexual assault claim,

petitioner did not procure the room pursuant to GBC's elevator

policy but, rather, obtained the room in the hopes of engaging in

a romantic interlude with Ms. Doe or one of her companions.

     In support of his position, petitioner relies primarily on

Clark v. Commissioner, 30 T.C. 1330 (1958), in which this Court

held that the taxpayer's expenses incurred in the defense of a

criminal sexual assault charge, and amounts paid in settlement of

a civil claim for damages arising from an alleged sexual assault,

were deductible as ordinary and necessary business expenses.      The

facts of Clark v. Commissioner, supra, are distinguishable from

the facts of this case.   Petitioner's reliance in Clark is

misplaced.


6
     Petitioner admits that he did make a second visit to the
hotel room, at which time he and Ms. Doe were alone. The details
of this second visit are discussed hereafter.
                              - 11 -


     In Clark, the taxpayer was employed as branch manager in the

regional office of a periodical publishing company.    In this

position, the taxpayer's duties included, in part, the hiring of

solicitors for magazine subscriptions.   In the event an applicant

for an outside solicitor's position was a married female, the

taxpayer's policy was to interview the applicant's husband to be

certain the husband understood the conditions in which his wife

would be working and to obtain the husband's approval before

employing the applicant.   Every husband of every female applicant

was interviewed either by the taxpayer or a person on his staff.

     The incident at issue in Clark involved a female applicant

for an outside solicitor's position (the applicant).    The

taxpayer interviewed the applicant and informed her that her

husband would have to be interviewed prior to her being hired.

Subsequently, by telephone, the applicant arranged a specific

date and time for the taxpayer to interview her husband at their

home because the husband's work schedule made it impractical for

him to be interviewed at the taxpayer's office.

     The taxpayer arrived at the applicant's home at the agreed

date and time and was invited inside by the applicant.    The

applicant informed the taxpayer that her husband was not at home,

and the taxpayer left a few minutes thereafter without agreeing

to employ the applicant.   The taxpayer did not see the applicant

again that day.

     Later that same day, the applicant swore out a warrant

against the taxpayer accusing him of assault with intent to rape.
                              - 12 -


The taxpayer incurred legal expenses in defending the criminal

charges, which were later dropped.     Additionally, on the advice

of his attorneys, the taxpayer paid a specific amount to the

applicant and her husband in release of any potential claim of

civil liability in connection with the aforementioned series of

events.

     In holding that the taxpayer's legal expenses, as well as

the settlement amount paid to the applicant and her husband, were

deductible by the taxpayer as ordinary and necessary business

expenses, the Court stated:


     We think it clear that both matters proximately
     resulted from petitioner's business as a branch
     manager, whose duties included interviewing prospective
     outside subscription solicitors, and, if such prospects
     were married women, to interview their husbands with
     the purpose of finding out whether the husbands
     approved such employment for their wives. Petitioner
     placed himself in jeopardy by pursuing a proper
     business objective, i.e., visiting the home of the
     prospective employee and her husband in order to
     interview the husband with the objective already
     described. * * * [Clark v. Commissioner, supra at
     1335.]


In Clark v. Commissioner, supra, the Court held that the action

giving rise to the claims against the taxpayer were carried out

by the taxpayer in the course and scope of his employment and for

a legitimate business purpose.   In the instant case, there are

attendant facts that did not exist in Clark, satisfying this

Court that the actions giving rise to Ms. Doe's claim of sexual

assault were carried out by petitioner not within the course of
                              - 13 -


his employment or with a valid business purpose but, rather, were

carried out for petitioner's personal purposes.

     Petitioner admitted that, after he dropped Ms. Johnson off

at the Sports Club, he returned to the hotel room where Ms. Doe

was sleeping.   He contends he returned out of fear for Ms. Doe's

severely intoxicated condition because many years earlier, while

on active duty in the U.S. military, a fellow soldier passed out

from intoxication and later choked to death.   Petitioner feared

the same consequence for Ms. Doe and contends he returned to the

room for that reason and also to protect GBC from any liability

resulting from such an injury to Ms. Doe.   Petitioner further

contends that, at the time he and Ms. Johnson left Ms. Doe in the

room initially, Ms. Doe asked that petitioner return later to

check on her.

     Petitioner's version of his return to the hotel room differs

somewhat from that of Ms. Doe.   Petitioner contends that he

returned to the hotel room without a key, and, when he knocked on

the door, Ms. Doe answered in a stable and coherent condition and

invited petitioner in.   Petitioner contends further that, upon

his entry to the room, Ms. Doe closed the door and started

kissing and groping him.   Petitioner admits reciprocating Ms.

Doe's advances only briefly and then pushed her away because Ms.

Doe's friends would be back any minute, and, furthermore, he had

a business meeting early in the morning and needed to go home and

rest.   Petitioner contends he left the hotel room and proceeded

directly to his home.
                                 - 14 -


     Leaving aside whether petitioner's initial act in procuring

the room was primarily for his personal purposes, the Court is

satisfied from the record that petitioner's second trip to the

hotel room, at which time a sexual offense purportedly occurred,

was the action that gave rise to the sexual assault claim, and

such action was driven primarily by petitioner's personal

motives.   The Court so finds.    At this second visit, petitioner

and Ms. Doe were admittedly alone in the room.     If petitioner

made this second visit out of his concern for Ms. Doe, he did not

indicate that he would do so to Ms. Johnson, whom he had just

dropped off at the Sports Bar.     On the contrary, petitioner

stated to Ms. Johnson that he was going home.

     Moreover, while in the room, petitioner admitted to contacts

between him and Ms. Doe that were clearly well beyond the realm

of ascertaining Ms. Doe's well-being and clearly unrelated to

petitioner's trade or business.

     GBC's elevator policy in effect at the time of the incident,

with which petitioner contends he was complying, stated as

follows:


     I.    OBSERVANCE OF INTOXICATION

           A.   Previous intoxication

                1.   Personnel are directed to closely
                     observe all patrons at any Pointe bar.
                2.   Insure that our bartenders are not serving
                     alcoholic beverages to already intoxicated
                     individuals
                               - 15 -


           B.   Current legal interpretations

                1.    The Pointe Resort can be held financially
                      liable if one of our customers who is
                      drinking in a Pointe bar causes personal
                      injury to a third party
                2.    The results are disastrous

     II.   GENERAL RULES

           A.   Anyone who seems intoxicated

                1.    Bring this to the attention of the bartender
                      and/or manager
                2.    If it is determined that the individual may
                      drive home, then every effort should be made
                      to encourage him/her to either take a taxicab
                      home or "take the elevator home", utilizing
                      the employee preferred rate

           B.   In our legalistic society, it is the
                responsibility of all management personnel to
                assist in insuring that legal liability to all of
                the Pointe and Gosnell entities be held to a
                minimum


If petitioner's primary concern was compliance with his

employer's elevator policy, petitioner failed to adhere to the

initial directive of the policy to insure that bartenders did not

serve alcohol to already intoxicated patrons; i.e., Ms. Doe, Ms.

Johnson, and Ms. Gavirati.    Petitioner admitted that he believed

the women were intoxicated when he first met them.    Nevertheless,

not only did petitioner fail to prevent further service of

alcohol to the women, he actually provided more alcohol to them,

including rounds of "kamikaze shots", which are concentrated

shots of alcohol.    Petitioner admittedly contributed to the

further inebriation of Ms. Doe, Ms. Johnson, and Ms. Gavirati.

Moreover, in the civil suit filed by Ms. Doe, GBC clearly
                              - 16 -


maintained the position that petitioner was not acting in the

course and scope of his employment during any portion of the

evening in question.   The attorney who represented GBC and

related defendants in the civil suit testified at trial.    The

attorney testified that the settlement by GBC and related

defendants should not be interpreted to suggest that petitioner

was acting in the scope of his employment during the evening in

question, but, rather, the settlement was the result of separate

and independent allegations of negligence against GBC and related

defendants that involved claims such as failure to properly

supervise or reprimand an employee and other similar allegations.

The settlement was not based on an acknowledgment by GBC that

petitioner was acting within the course and scope of his

employment.

     Finally, in connection with his defense of the civil suit,

petitioner filed a claim for coverage under his homeowner's

insurance policy and personal liability umbrella policy

(homeowner's policy), which was provided by USAA.   The

homeowner's policy contained the following specific exclusion

from coverage:


     Coverage E - Personal Liability and Coverage F -
     Medical Payments to Others do not apply to bodily
     injury or property damage:

     a. which is expected or intended by the insured;

     b. (1) arising out of or in connection with a business
     engaged in by an insured. This exclusion applies but
     is not limited to an act or omission, regardless of its
     nature or circumstance, involving a service or duty
                              - 17 -


     rendered, promised, owed, or implied to be provided
     because of the nature of the business;


Initially, USAA informed petitioner that it was denying coverage

under the homeowner's policy and, subsequently, filed a complaint

for declaratory judgment asking the Superior Court of Maricopa

County, Arizona, to enter a judgment declaring that petitioner

was not entitled to coverage under his USAA homeowner's policy

for the claims set out in Ms. Doe's civil suit.   Petitioner

opposed USAA's attempt to deny coverage and claimed that he was

entitled to coverage for liability as well as the costs of

defending the civil suit.   Eventually, USAA dropped its attempt

to deny petitioner coverage and paid not only the full amount of

the settlement between petitioner and Ms. Doe but also

petitioner's expenses in defending the civil suit.   Thus, both

petitioner and USAA effectively took the position that Ms. Doe's

claims that were the subject of the civil suit did not arise out

of, nor were they connected with, petitioner's business.

     Petitioner has seen fit to alter his position on classifying

the origin of the sexual assault claim (i.e., business or

personal) based solely on which theory happens to prove

financially advantageous to him in any given situation.

Unfortunately for petitioner, he has completely failed in his

attempt to make transformations reminiscent of a chameleon.

     In conclusion, under the Gilmore test, the Court holds that

the origin of Ms. Doe's claim against petitioner did not arise

from any business or profit-seeking activity or motivation of
                              - 18 -


petitioner.   Consequently, the Court holds that the legal

expenses of $13,737 for 1991 and $31,694 for 1992 disallowed by

respondent are nondeductible personal expenses of petitioner.

Respondent is, therefore, sustained on this issue.



                                         Decision will be entered

                                    for respondent.
