## Facts

- Williams and Reynolds operated a hardware business in Corning, New York, and formed a partnership allocating profits two-thirds to Williams and one-third to Reynolds.
- The partnership agreement set capital accounts and provided interest adjustments and a book-value buyout option upon a partner’s withdrawal.
- Reynolds died in 1940; Williams settled with Reynolds’s estate by paying cash and assuming the business’s liabilities, thereby acquiring Reynolds’s one-third interest.
- Later in 1940, Williams sold the entire business to a corporate buyer as a going concern; the assets included cash, receivables, fixtures, and substantial inventory, net of modest liabilities.
- On the overall series of transactions, Williams incurred a loss attributable to his original two-thirds interest and a small gain attributable to the acquired one-third interest.
- Williams reported the gain and loss as ordinary items; the Commissioner treated them as capital items, assessed a deficiency, and Williams paid and sued for a refund.
- Williams also paid $700 in attorneys’ fees to obtain refunds of his 1936 and 1937 income taxes and claimed a deduction; the deduction was disallowed in the refund litigation.

## Issues

1. Whether legal fees paid to obtain refunds of prior-year federal income taxes are deductible under I.R.C. § 23(a)(2) (as amended in 1942).
2. Whether the sale of a going business is treated as the sale of a single “capital asset,” or must be separated into its component assets so that each component’s gain or loss is characterized under the capital-asset exclusions in I.R.C. § 117.

## Decision

- The court held the $700 legal-fee expense deductible under § 23(a)(2).
- The court held that the sale of the going business was not the sale of a single capital asset; the transaction had to be separated into its component assets.
- The court ruled that assets excluded from capital-asset status under § 117 (including inventory/stock in trade and depreciable business property) produce ordinary, not capital, gain or loss even when transferred as part of a business sale.
- The court reversed the district court’s dismissal in substantial part and remanded for treatment consistent with the asset-by-asset approach.

## Legal Principles

- Expenses paid for the production or collection of income, including legal fees incurred to obtain income-tax refunds, are deductible under § 23(a)(2).
- For capital-gain purposes, “property” is generally a capital asset unless it falls within statutory exclusions, including inventory/stock in trade, property held primarily for sale to customers, and depreciable business property.
- A sale of a going concern is analyzed as a sale of separate assets; each asset retains its own character for determining whether resulting gain or loss is capital or ordinary.
- The form of a single contract for the whole business does not convert excluded property (e.g., inventory) into a capital asset.

## Conclusion

The court required asset-by-asset characterization when a business is sold, producing ordinary treatment for excluded operating assets such as inventory and depreciable property, and it allowed a deduction for legal fees incurred to obtain federal income-tax refunds.


Williams v. McGowan, 152 F.2d 570 (2d Cir. 1945)