Merlin A. and Dee D. Steger v. Commissioner

113 T.C. No. 18

• Court: United States Tax Court
• Decided: October 1, 1999
• Docket: 19824-98
• Status: Unknown

Opinion

113 T.C. No. 18

UNITED STATES TAX COURT

MERLIN A. AND DEE D. STEGER, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 19824-98. Filed October 1, 1999.

P, a lawyer, retired from the practice of law in 1993. That year, P purchased a nonpracticing malpractice insurance policy (the Policy) to cover him for an indefinite period of time for acts, errors, or omissions in professional services rendered before the date of P's retirement. Ps claimed a Schedule C deduction for the entire cost of the Policy on their 1993 return. R determined that the Policy is a capital asset providing a substantial future benefit and that Ps were only entitled to deduct 10 percent of the cost of the Policy in 1993. Held: Ps are entitled to deduct the entire cost of the Policy in the year of termination of P's business.

James R. Monroe, for petitioners.

George W. Bezold and Christa A. Gruber, for respondent. - 2 -

WELLS, Judge: This case was assigned to Special Trial Judge

Robert N. Armen, Jr., pursuant to Rules 180, 181, and 182.1 The

Court agrees with and adopts the Opinion of the Special Trial

Judge, which is set forth below.

OPINION OF THE SPECIAL TRIAL JUDGE

ARMEN, Special Trial Judge: Respondent determined a

deficiency in petitioners' Federal income tax for the taxable

year 1993 in the amount of $1,260. After concessions by

petitioners,2 the issue for decision is whether petitioners are

entitled to deduct the entire cost of nonpracticing malpractice

insurance paid during the year in issue. We hold that they are.

FINDINGS OF FACT

This case was submitted fully stipulated under Rule 122, and

the facts stipulated are so found. Petitioners resided in Des

Moines, Iowa, at the time that their petition was filed with the

Court.

Petitioner husband (petitioner) is a lawyer. During the

year in issue, he practiced as a self-employed attorney and

reported his income for the year on a Schedule C.

1 All Rule references are to the Tax Court Rules of Practice and Procedure, and all section references are to the Internal Revenue Code in effect for the taxable year in issue. 2 Petitioners concede: (1) They failed to report interest income in the amount of $207, and (2) respondent properly reduced petitioner husband's Schedule C deduction by the amount of $1,447. - 3 -

Petitioner retired from the practice of law in 1993. During

that year, he was insured against malpractice under a lawyer's

professional liability insurance policy. On December 22, 1993,

he exercised an option under this policy to purchase

nonpracticing malpractice insurance coverage (the Policy) for the

amount of $3,168. The nonpracticing insurance covered him for an

indefinite period of time "but only by reason of an act, error or

omission in professional services rendered before

* * * [his] date of retirement or termination of private

practice".

On their 1993 return, petitioners claimed a Schedule C

deduction for the entire cost of the Policy. Respondent

determined that the Policy was a capital asset and that

petitioners were entitled to deduct only 10 percent of the cost

of the Policy for the year in issue.

OPINION

Respondent contends that petitioners are not entitled to

deduct the entire cost of the Policy on their 1993 return because

the Policy possesses "a useful life of indefinite duration beyond

one year." Respondent therefore asserts that the Policy is a

capital asset and that petitioners are entitled to deduct the

cost of the Policy only over its useful life. In this regard,

respondent determined that petitioners were entitled to deduct 10

percent of the cost of the Policy during the year in issue. - 4 -

We disagree with respondent's determination. For reasons

stated below, because petitioner ceased to conduct business in

the year in issue, petitioners are entitled to deduct the entire

cost of the Policy in 1993, irrespective of whether or not the

Policy is a capital asset. We therefore do not decide whether

the Policy is a capital asset.

Section 162(a) allows taxpayers to deduct "all the ordinary

and necessary expenses paid or incurred during the taxable year

in carrying on a trade or business." To qualify as a deduction

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

the taxable year; (2) for carrying on any trade or business; (3)

an expense; (4) a necessary expense; and (5) an ordinary expense.

See Commissioner v. Lincoln Sav. & Loan Association, 403 U.S.

345, 352 (1971). An expense is not "ordinary", and therefore not

currently deductible, if it is in the nature of a capital

expenditure. See Commissioner v. Tellier, 383 U.S. 687, 689-690

(1966); see also sec. 263. Rather, a capital expenditure is

amortized and depreciated over the life of the asset.3 INDOPCO,

3 Although we need not decide whether the Policy is a capital asset, we note that a business asset is a capital asset if it provides a significant long-term benefit to the taxpayer. INDOPCO, Inc. v. Commissioner, 503 U.S. 79 (1992). Thus, insurance premiums that constitute prepayment of future insurance coverage provide significant benefits to the taxpayer beyond the year in issue and therefore constitute a capital expenditure. See Black Hills Corp. v. Commissioner, 73 F.3d 799, 806 (8th Cir. 1996), affg. 102 T.C. 505 (1994). Such premiums, therefore, are (continued...) - 5 -

Inc. v. Commissioner, 503 U.S. 79, 83-84 (1992). The primary

effect of characterizing a payment as either a business expense

or a capital expenditure concerns the timing of the taxpayer's

cost recovery. See INDOPCO, Inc. v. Commissioner, supra.

The cost of a capital asset is deductible only over the

useful life of the asset because "The Code endeavors to match

expenses with the revenues of the taxable period to which they

are properly attributable, thereby resulting in a more accurate

calculation of net income for tax purposes." INDOPCO, Inc. v.

Commissioner, supra at 84.

By the same token, it is a longstanding rule of law that if

a taxpayer incurs a business expense, but is unable to deduct the

cost of the same either as a current expense or through yearly

depreciation deductions, the taxpayer is allowed to deduct the

expense for the year in which the business ceases to operate.

See INDOPCO, Inc. v. Commissioner, supra at 83-84 (holding that

"where no specific asset or useful life can be ascertained, * * *

[a capital expenditure] is deducted upon the dissolution of the

enterprise."); Malta Temple Association v. Commissioner, 16

B.T.A. 409 (1929) (holding that the cost of a business asset, no

part of which has been returned to the taxpayer through

exhaustion deductions or as ordinary and necessary expense

3 (...continued) not deductible as a current expense. - 6 -

deductions, may be deducted in the year the taxpayer's business

ceases to operate); see generally sec. 336 (corporate taxpayer

entitled to recognize loss in the year of liquidation); sec. 195

(allowing a taxpayer to deduct the unamortized portion of

deferred startup expenditures for the year in which the trade or

business is completely disposed of). Here, respondent does not

contend that the cost of the Policy is not a necessary expense.

Rather, respondent contends that the cost of the Policy is not

"ordinary" because it is a capital expenditure given its

indefinite useful life. However, even if we assume that the

Policy is a capital asset, petitioners are nevertheless entitled

to deduct the cost of the Policy in the year in issue. The

Policy has no ascertainable useful life but rather is an

intangible asset providing petitioner with malpractice coverage

for an indefinite term of years. Although as a capital asset

with an indefinite useful life the Policy would not be currently

deductible, it is deductible upon dissolution of petitioner's

business. See INDOPCO, Inc. v. Commissioner, supra at 83-84.

Thus, even if the Policy is a capital asset, because petitioner

purchased the Policy in the same year that he ceased to operate

his business, petitioners are entitled to deduct the cost of the

Policy in that year.

In contrast, if we assume that the Policy is not a capital

asset, then the cost of the Policy would be deductible as an - 7 -

expense incurred by petitioner in closing his business. It has

long been established that the cost of dissolution and

termination of a business constitutes "an everyday happening in

the business world, and in this sense it is quite an ordinary

affair under the test of the Welch case [Welch v. Helvering, 290

U.S. 111 (1933), defining what constitutes an "ordinary" and

"necessary" business expense]" and is therefore deductible when

"directly connected with, or, as otherwise stated

* * * proximately resulted from the taxpayer's business."

Pacific Coast Biscuit Co. v. Commissioner, 32 B.T.A. 39, 43

(1935).

There is no dispute that petitioner ceased to operate his

business and that he retired from the practice of law in 1993.

There is also no dispute that the expenditure was directly

connected with petitioner's business, nor that the cost was

necessary in the course of petitioner's business. Under the

facts of this case, as an attorney ceasing to practice law, it

was also "ordinary" for petitioner to purchase nonpracticing

malpractice insurance upon ceasing to practice law. Welch v.

Helvering, 290 U.S. 111, 113-115 (1933). Thus, if the Policy is

not a capital asset, petitioners would be entitled to deduct its

cost as an ordinary and necessary closing expense in 1993. - 8 -

To reflect our disposition of the disputed issue, as well as

petitioners' concessions,

Decision will be entered

under Rule 155.