did what any other prudent investor would have done-bought it when its price was low."

I conclude, at least under the now outstanding decisions, that when a corporation buys its stock with a view to future distribution and, in fact, engages in that future distribution at a profit, whether originally so designed or not, it has dealt in its stock as it would in other property and has subjected itself to tax. I respectfully dissent. HILL, J., agrees with this dissent.

NATIONAL ENGRAVING COMPANY, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

Docket No. 112737. Promulgated January 31, 1944.

Held, that attorney fees expended in defense of a suit involving a portion of the proceeds of an insurance policy are allocable to a class of income, insurance proceeds, which is wholly exempt from taxes by virtue of section 22 (b) (1), I. R. C., and are specifically made nondeductible in computing net income by section 24 (a) (5), I. R. C.

George A. Wulff, C. P. A., for the petitioner.

Lester M. Ponder, Esq., for the respondent.

The respondent determined deficiencies of $54.46 and $197.25 in petitioner's income taxes for the years 1939 and 1940, respectively. The question presented is the allowability of deductions of legal fees paid by the petitioner.

FINDINGS OF FACT.

The facts are found as stipulated by the parties. They are substantially as follows:

Petitioner is a corporation existing under the laws of the State of Illinois and in the taxable years was engaged in the business of engraving.

On January 3, 1930, petitioner's stock was entirely owned by F. F. Nellesen, John W. Doerfler, and Rudolph P. Engle. On that date the said Nellesen and petitioner executed an agreement providing that on Nellesen's death his executors or administrators would sell and transfer to petitioner all of his shareholdings in petitioner corporation at a price of $15,000, not later than 60 days after their qualification as executors or administrators; that petitioner would accept and pay for such shares at the agreed price upon the tender made by the executors or administrators; and that as a means of providing funds to petitioner for the purchase of these shares, the petitioner would purchase life insurance on the life of Nellesen in the sum of $15,000 and would pay the premiums on such insurance.

On January 3, 1930, petitioner took out two life insurance policies upon Nellesen's life. Policy No. 107766, issued by the Columbus Mutual Life Insurance Co. of Columbus, Ohio, insured the life of Ferdinand F. Nellesen in the face amount of $10,000 payable to the beneficiary, the petitioner herein, and also provided that the company would pay to the beneficiary the sum of $10,000 in addition to the face amount of the policy if the insured should die as a direct result of bodily injury effected through external, violent, and accidental means, independently and exclusively of all other causes. Policy No. 107767 issued by the same company insured the life of Nellesen in the face amount of $5,000 payable to the beneficiary, the petitioner herein, and contained no provision for any additional payment if the insured died by accidental means. Nellesen was accidentally killed in 1936. All of the premiums on the insurance policies from the date they were taken out until Nellesen's death were paid by petitioner and charged to its surplus account.

On August 17, 1936, the Columbus Mutual Life Insurance Co. paid petitioner the sum of $24,881.50, which was the amount payable to the beneficiary by reason of the death of the insured, Nellesen, under the insurance policies. This amount of $24,881.50 was computed as follows:

Extra post mortem dividend__
Special persistency bonus___.
Interest from date of death.

Face amount of policies if death caused by accident----

Unpaid premium--

$20.88

36.37

89.00

25, 000. 00

[sic] 25, 145. 25

263.75

24, 881, 50

Amount paid to petitioner on August 17, 1936--The amount of $24,881.50 was credited on petitioner's books to its surplus account in 1936 and no part thereof was included in taxable income in petitioner's income tax returns for the year 1936 or for any subsequent year.

On September 1, 1936, petitioner paid the amount of $15,000 to Sue E. Wagner, executrix of the estate of F. F. Nellesen. Coincident with the payment Sue E. Wagner transferred and delivered to petitioner all of the stock of petitioner owned by Nellesen at the time of his death.

On March 3, 1939, a complaint was filed by Sue E. Wagner, as executrix of the estate of F. F. Nellesen, deceased, against petitioner in the Circuit Court of Cook County, Illinois, Chancery Division. The action was a suit to recover from the petitioner the amount collected by petitioner from the Columbus Mutual Life Insurance Co. under Policies Nos. 107766 and 107767, over and above the amount of $15,000, as provided under the agreement executed January 3, 1930,

by the petitioner and Nellesen, less the amount of money paid by petitioner as premiums on Policy No. 107766 for the purpose of obtaining the double indemnity provision. An answer to the complaint was filed by petitioner. On January 19, 1940, a decree was entered in the proceeding in favor of petitioner. The decree was appealed to the Appellate Court of the State of Illinois and was affirmed by that court on December 23, 1940.

During the years 1939 and 1940 petitioner paid an attorney the amounts of $500 and $1,010, respectively, for his services in representing it in the above mentioned proceedings.

The petitioner filed a corporation income and excess profits tax return for the calendar year 1939 and a corporation income, declared value excess profits, and defense tax return for the calendar year 1940 with the collector of internal revenue for the first district of Illinois, on the accrual basis. Petitioner deducted the amounts of $500 and $1,010, respectively, on the returns for the years 1939 and 1940. The Commissioner disallowed the deductions.

OPINION.

VAN FOSSAN, Judge: Petitioner contends that the excess of the insurance proceeds (substantially $10,000) above the amount paid by it for the Nellesen stock became capital in its hands; that the attorney fees expended in defense of the suit were incurred in the conservation of property held for the production of income and are deductible as expenses; and that, in any event, the fees were deductible business expenses. Counsel cites section 23 (a) (2), I. R. C., referring to nontrade or nonbusiness expenses, and Kornhauser v. United States, 276 U. S. 145.

The respondent contends that legal fees expended in defense of a suit involving a portion of the proceeds of insurance policies are allocable to a class of income, insurance proceeds, which is wholly exempt from the taxes imposed by chapter 1 of the Internal Revenue Code, by virtue of section 22 (b) (1), I. R. C.,1 and are specifically made nondeductible by section 24 (a) (5), I. R. C. He also contends that legal

(b) EXCLUSIONS FROM GROSS INCOME.-The following items shall not be included in gross income and shall be exempt from taxation under this chapter:

(1) LIFE INSURANCE.-Amounts received under a life insurance contract paid by reason of the death of the insured, whether in a single sum or otherwise (but if such amounts are held by the insurer under an agreement to pay interest thereon, the interest payments shall be included in gross income).

SEC. 24. ITEMS NOT DEDUCTIBLE.

(a) GENERAL RULE.-In computing net income no deduction shall in any case be allowed in respect of

(5) Any amount otherwise allowable as a deduction which is allocable to one or more classes of income other than interest (whether or not any amount of income of that class or classes is received or accrued) wholly exempt from the taxes imposed by this

fees expended by a corporation engaged in the business of photoengraving in defense of a suit to recover a portion of the proceeds of insurance policies are not ordinary and necessary expenses paid or incurred in carrying on such trade or business, citing Van Wart v. Commissioner, 295 U. S. 112; Stone v. Commissioner, 115 Fed. (2) 853, and other cases.

We are of the opinion that the complete answer to petitioner's case is found in the provisions of sections 22 (b) (1) and 24 (a) (5), I. R. C. Petitioner on brief suggests no answer to their applicability. Section 22 (b) (1), quoted in the footnote No. 1, provides that "amounts received under a life insurance contract paid by reason of the death of the insured * *" "shall not be included in gross income and shall be exempt from taxation * *" Section 24 (a) (5) provides that "no deduction shall in any case be allowed in respect of any amount otherwise allowable as a deduction which is * * wholly exempt

*

classes of income

allocable to from the taxes imposed by this chapter * There is no doubt in our minds that the legal fees here in controversy are allocable in their entirety to the insurance proceeds received by petitioner under the life insurance contract, which proceeds were paid by reason of the death of Nellesen. This being true, the denial of the deduction follows automatically, even though the deduction be "otherwise allowable." As respondent pertinently observes in section 19.24 4 of Regulations 103:

The object of section 24 (a) (5) is to segregate the exempt income from the taxable income, in order that a double exemption may not be obtained through the reduction of taxable income by expenses and other items incurred in the production of items of income wholly exempt from tax. Accordingly, just as exempt items of income are excluded from the computation of gross income under section 22, so section 24 (a) (5) excludes from the computation of deductions under section 23 all items referable to the production of exempt income, other than exempt interest.

Once it be determined that an expense is allocable to exempt income, the item is not deductible and there is an end of the matter. Both sides of the equation must be considered. If the income is exempt from taxation expenses allocable to such income are not to be allowed as deductions. Any other treatment would result in double benefits by double exemption. Respondent's action is wholly within the letter and the spirit of the cited section.

The fact that the deduction in this case is to be so denied, even if otherwise allowable, makes it unnecessary to consider the other contentions advanced on brief by the parties.

Decision will be entered for the respondent.

MIDLAND ELECTRIC COAL CORPORATION, PETITIONER, V. COMMISSIONER

OF INTERNAL REVENUE, RESPONDENT.

Docket No. 104657. Promulgated January 31, 1944.

*

Petitioner, by certain written contracts entered into with its
creditors in 1935, promised that so long as certain of its notes were
unpaid it would "not declare and/or pay any dividends
which would thereby cause a distribution
of any aggre-
gate sum in excess of 50 percent of
net earnings." In
the taxable year it had considerable accumulated earned surplus,
but its notes were still unpaid. Held, petitioner entitled to credit
under section 26 (c) (1), Revenue Act of 1936.

*

Wm. H. Cooke, Esq., for the petitioner.
S. U. Hiken, Esq., for the respondent.

*

Respondent determined a deficiency in petitioner's surtax on undistributed profits for the year 1936, in the amount of $28,798.69, because of his disallowance of a credit claimed by petitioner under section 26 (c) (1) of the Revenue Act of 1936 on account of a certain contract restricting the payment of dividends. Deficiencies were also determined in petitioner's normal income tax for the years 1935 and 1936, but these are not in dispute.

FINDINGS OF FACT.

A partial stipulation of facts was filed herein, and the facts set forth therein are found to be as stipulated. The following findings incorporate the essential parts of the stipulation, and certain other facts derived from the evidence, both oral and documentary, which was introduced at the hearing.

The petitioner was incorporated under the laws of the State of Indiana in 1931, and filed its income tax return for the calendar year 1936 with the collector of internal revenue at Indianapolis, Indiana. Prior to November 19, 1935, the petitioner was indebted in an amount in excess of $1,000,000 on conditional sales contracts and chattel mortgages for equipment. On that date petitioner negotiated a loan, for the purpose of refunding its indebtedness, through the Marion Steam Shovel Co., the Bank of Manhattan Co., and the Continental Illinois National Bank & Trust Co. of Chicago. It issued real and chattel mortgages to secure its notes in the aggregate amount of $1,000,000. Each of the mortgages so executed on that date contained the following clause:

* that until the notes hereinbefore referred to are paid in full, together with all interest due thereon, that it [petitioner] will not declare and/or pay any dividends upon its issued and outstanding shares of stock which would thereby cause a distribution to shareholders of any aggregate sum in excess of fifty