Rev. Rul. 62-175

Reconsideration has been given to G.C.M. 24377, C.B. 1944, 93, relating to the deductibility of legal expenses incurred in an unsuccessful defense of a suit brought for violation of the Sherman Anti-Trust Act.

G.C.M. 24377 holds, inter alia, that legal expenses incurred by a corporation in defense of a suit brought against it for violation of the Sherman Anti-Trust Act, in which suit the corporation was found guilty, are deductible as ordinary and necessary business expenses to the extent that such expenses were incurred in its own behalf. The holding of G.C.M. 24377 was based, in large measure, upon the decision of the Supreme Court of the United States in the case of Commissioner v. S.B. Heininger, 320 U.S. 467 (1943), Ct. D. 1596, C.B. 1944, 484, and upon the decision of the Tax Court of the United States in the case of Longhorn Portland Cement Co. v. Commissioner, 3 T.C. 310 (1944), acquiescence, in part only, C.B. 1944, 18, reversed on another issue, 148 Fed. (2d) 276 (1945), Ct. D. 1665, C.B. 1946-1, 53, certiorari denied, 326 U.S. 728 (1945).

Section 162(a) of the Internal Revenue Code of 1954 provides, in part, that, in general, there shall be allowed as a deduction all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business.

As a general rule, legal expenses incurred in the unsuccessful defense of a criminal prosecution are not deductible for Federal income tax purposes. See Burroughs Building Material Co. v. Commissioner, 18 B.T.A. 101 (1930), affirmed, 47 Fed. (2d) 178 (1931), Ct. D. 297, C.B. X-1, 397 (1931); C. W. Thomas v. Commissioner, 16 T.C. 1417 (1951); and Thomas A. Joseph et ux v. Commissioner, 26 T.C. 562 (1956). G.C.M. 24377 represents a departure from that general rule.

In the Heininger decision, supra, the Supreme Court affirmed a decision of the United States Circuit Court of Appeals for the Seventh Circuit which held that lawyers' fees and related legal expenses incurred by the taxpayer in contesting the issuance of a fraud order by the Postmaster General were deductible as ordinary and necessary business expenses. The taxpayer was in the business of making and selling false teeth by mail.

After concluding that the taxpayer's legal expenses were both "ordinary and necessary," as those words are used in the Code, the Court stated that if the taxpayer was to be denied a deduction it must be on the ground that the allowance of the deduction would frustrate the sharply defined policies of the statutes authorizing the Postmaster General to issue fraud orders. The Court determined that that would not be the result of permitting the taxpayer the deduction. The Court stated on pages 474 and 475:

* * * to allow the deduction of respondent's litigation expenses would not frustrate the policy of these statutes; and to deny the deduction would attach a serious punitive consequence to the Postmaster General's finding which Congress has not expressly or impliedly indicated should result from such a finding. We hold therefore that the Board of Tax Appeals was not required to regard the administrative finding of guilt under 39 U.S.C. sections 259 and 732 as a rigid criterion of the deductibility of respondent's litigation expenses. [Emphasis added.]

In the Longhorn case, supra, the Tax Court considered the question whether certain payments made in compromise of a suit brought by the State of Texas against the taxpayers for alleged violations of its anti-trust laws, and attorneys' fees and related expenses paid in connection therewith, were ordinary and necessary expenses paid in carrying on the taxpayer's business. It was held that both the compromise payments made by the taxpayer and his attorneys' fees were properly deductible. The Internal Revenue Service acquiesced on the issue of the deductibility of the attorneys' fees, but appealed on the issue of the deduction of the compromise payments made in settlement of the suit. On this issue the United States Circuit Court of Appeals for the Fifth Circuit later reversed the Tax Court. See Commissioner v. Longhorn Portland Cement Co., 148 Fed. (2d) 276 (1945), Ct. D. 1665, C.B. 1946-1, 53.

In both the Heininger and the Longhorn cases the taxpayers were threatened with a severe if not complete diminishment of their businesses and neither case involved a taxpayer who has unsuccessfully defended a criminal prosecution. Although the taxpayer in the Heininger case was unsuccessful, in the sense that the Postmaster General ultimately issued a fraud order which had the effect of drastically restricting, if not destroying, the taxpayer's mail order business, the taxpayer was the subject of only an administrative finding of guilt. In the Longhorn case the ultimate result of the State's prosecution was not an admission or proof of the taxpayer's guilt, but a compromise settlement. In both cases the threat to the taxpayers' business was clearly apparent but no criminal action was involved.

G.C.M. 24377 erroneously applied the rationale of the Heininger and Longhorn decisions in allowing deduction of legal expenses incurred in the unsuccessful defense of a criminal prosecution. The deduction for legal expenses incurred in the unsuccessful defense of a criminal action brought under the Sherman Anti-Trust Act would frustrate the sharply defined national policy as expressed in such Act.

Accordingly, it is held that attorney's fee and related legal expenses incurred in an unsuccessful defense of a criminal action brought for a violation of the Sherman Anti-Trust Act are not deductible as ordinary and necessary expenses of doing business.

G.C.M. 24377, C.B. 1944, 93, is hereby modified to the extent inconsistent with the foregoing.

¹ Also released as Technical Information Release 400, dated October 1, 1962.