## Facts

- A 1927 trust provided lifetime income to the settlor’s daughter, with remainder interests for her children and further contingent remainders.
- After the life beneficiary died in 1953, the trust’s validity and related dispositions were challenged in New York litigation.
- The trustee sought judicial settlement of its account and construction of the governing instruments; the parties settled in 1954, including a payment to a challenger in exchange for withdrawal of objections.
- The trustee incurred substantial attorneys’ fees in connection with the litigation and settlement.
- For 1954, the trust received taxable income allocable to income, capital gains and other receipts allocable to principal, and tax-exempt interest allocable to principal.
- The trustee deducted the attorneys’ fees as expenses for management or conservation of income-producing property; the IRS disallowed most as title-defense capital expenditures.
- Because the trust earned tax-exempt interest, the parties also disputed how much otherwise deductible expenses had to be disallowed as allocable to tax-exempt income, particularly whether capital gains allocable to principal should be included in the allocation base.
- The trustee also asserted entitlement to a deduction for amounts required to be currently distributed to beneficiaries; the government argued the administrative refund claim did not sufficiently raise that ground.
- The trustee sued for a 1954 income tax refund in the Court of Claims on cross-motions for summary judgment.

## Issues

1. Whether attorneys’ fees incurred by a trustee in litigation challenging the trust and its property interests are deductible under the expenses provision for income-producing property, or must be capitalized as costs of defending or perfecting title.
2. Whether, in allocating expenses between taxable income and tax-exempt interest, capital gains and other items allocated to principal must be included in the denominator used to compute the nondeductible portion.
3. Whether the trustee’s administrative refund claim sufficiently stated a claim for a deduction for income required to be currently distributed to beneficiaries.

## Decision

- The court held the attorneys’ fees were capital expenditures incurred to defend or perfect title to trust property and were not currently deductible.
- The court upheld the government’s allocation method as reasonable, permitting exclusion of capital gains and other principal-allocated items from the allocation base for disallowing expenses attributable to tax-exempt interest.
- The court held the refund claim adequately apprised the IRS of the distribution-deduction ground and allowed that deduction.
- Summary judgment was granted in part to each side; a refund was allowed only to the extent attributable to the distribution deduction.

## Legal Principles

- Legal fees are capital expenditures when the primary purpose of the litigation is to defend, establish, or perfect title to property; they are not deductible as ordinary expenses of managing or conserving income-producing property.
- For trusts with tax-exempt interest, expenses otherwise deductible must be reasonably allocated to tax-exempt income, and the allocated portion is nondeductible.
- In determining a reasonable allocation, items allocated to principal (including capital gains) may be excluded from the allocation base where doing so better reflects the relationship between expenses and the income stream to which they relate.
- A tax refund claim is sufficient if it fairly apprises the IRS of the grounds for recovery; technical specificity is not required when the claim’s content provides adequate notice.

## Conclusion

The Court of Claims treated trust litigation fees incurred to preserve the trust corpus against validity challenges as capital costs, accepted an allocation method that excluded principal-allocated capital gains when disallowing expenses tied to tax-exempt interest, and permitted the trustee to litigate and obtain a distribution deduction because the administrative refund claim gave the IRS adequate notice of that ground.


Manufacturers Hanover Tr. Co. v. United States, 312 F.2d 785 (Ct. Cl. 1963)