Bilar Tool & Die Corp. v. Commissioner, 62 T. C. 213 (1974)

Legal fees incurred in a corporate separation plan aimed at resolving shareholder disputes may be deductible as ordinary and necessary business expenses if the dominant purpose of the plan is related to the conduct of the business.

Summary

Bilar Tool & Die Corp. faced internal friction between its equal shareholders, prompting a plan to split the corporation. The plan involved creating a new corporation, transferring half of Bilar’s assets to it, and exchanging the new corporation’s stock for one shareholder’s shares in Bilar. The Tax Court held that $4,000 of the legal fees incurred in this plan were deductible as ordinary and necessary business expenses under section 162(a), as the dominant purpose was to resolve business-disrupting shareholder friction. However, the court denied deduction for the remaining $7,500 of fees due to lack of evidence on their specific purpose.

Facts

Bilar Tool & Die Corp. , a Michigan corporation, was owned equally by William Markoff and Joseph Sakuta. In 1967, disagreements arose between them regarding the management of the corporation, leading to operational inefficiencies. To resolve this, on September 21, 1967, the board adopted a plan to divide the business. The plan involved creating a new corporation, Four-Way Tool & Die, Inc. , to which half of Bilar’s assets were transferred in exchange for the new corporation’s stock. This stock was then exchanged for Sakuta’s shares in Bilar. The plan was executed on September 30, 1967, resulting in two separate corporations, each owned by one of the original shareholders. Bilar incurred $11,500 in legal and accounting fees for this plan, claiming them as deductions on its tax return.

Procedural History

The Commissioner of Internal Revenue disallowed the deduction, leading Bilar to petition the U. S. Tax Court. The Tax Court reviewed the case and held that $4,000 of the legal fees were deductible, while the remaining $7,500 were not due to insufficient evidence regarding their purpose.

Issue(s)

1. Whether the legal and accounting fees incurred by Bilar Tool & Die Corp. in connection with the plan to split the corporation are deductible as ordinary and necessary business expenses under section 162(a) of the Internal Revenue Code.

Holding

1. Yes, because the dominant purpose of the plan was to resolve shareholder friction that threatened the business, making the $4,000 in legal fees ordinary and necessary business expenses. However, the remaining $7,500 in fees were not deductible due to lack of evidence showing their purpose.

Court’s Reasoning

The Tax Court applied the dominant-purpose test to determine the deductibility of the legal fees. The court found that the primary purpose of the plan was to alleviate shareholder friction, which was directly related to the conduct of Bilar’s business. The court distinguished this case from others involving corporate reorganizations, noting that Bilar did not acquire any new capital assets beneficial to future operations. Instead, the plan resulted in a partial liquidation, as Bilar divested half its assets and continued on a reduced basis. The court cited Gravois Planing Mill Co. v. Commissioner to support its view that the transaction was essentially a partial liquidation, not a reorganization. The court also noted that while the fees for organizing the new corporation might typically be capital expenditures, they were integral to the overall plan and thus deductible. The dissent argued that the plan was a reorganization and all fees should be capital expenditures, but the majority focused on the dominant business purpose.

Practical Implications

This decision clarifies that legal fees associated with resolving internal corporate disputes may be deductible if they are primarily aimed at ensuring the smooth operation of the business. Practitioners should carefully document the purpose of legal fees, especially in complex transactions involving multiple steps, to ensure deductibility. The case highlights the importance of distinguishing between reorganization and liquidation aspects of a plan, as this can affect the tax treatment of expenses. Businesses contemplating similar separations should consider structuring the plan to emphasize the business necessity of the separation to maximize the potential for deducting related expenses. Subsequent cases have cited Bilar when analyzing the deductibility of fees in corporate restructuring scenarios, often focusing on the dominant purpose and the nature of the underlying transaction.