REPORTS OF THE UNITED STATES TAX COURT JULIA R. & ESTELLE L. FOUNDATION, INCORPORATED, Docket No. 6263-76. Filed April 5, 1978. Petitioner, a private foundation, incurred expenses attributable in part to its investment activities and in part to its making distributions to public charitable, educational, and scientific organizations. Held, only the investment-related expenses are deductible in calculating net investment income under sec. 4940, I.R.C. 1954. Albert R. Mugel, for the petitioner. OPINION TANNENWALD, Judge: Respondent determined a deficiency of $1,119.76 in petitioner's excise tax liability under section 4940(a)1 for the taxable year ending December 31, 1973. The sole issue for decision is the extent to which the expenses of petitioner in the conduct of its operations are deductible in determining “net investment income" under section 4940(c). All of the facts have been stipulated, and the stipulation, 'All section references, unless otherwise indicated, amended and in effect during the taxable year in issue. are to the Internal Revenue Code of 1954, as 1 together with the exhibits, is incorporated herein by this reference. Petitioner had its principal office in Buffalo, N. Y., at the time it filed its petition herein. It filed its annual report (Form 990AR) and its private foundation return (Form 990-PF) for the taxable year 1973 with the Philadelphia Service Center, Philadelphia, Pa. During the taxable year in issue, petitioner was exempt from taxation under section 501(a) as an organization defined in section 501(c)(3). It was also a private foundation under section 509(a), but not an "operating foundation" within the meaning of section 4942(j)(3) in that it was not engaged in the active conduct of charitable functions. Its sole charitable activity, during such period, consisted of making distributions to public charitable, educational, and scientific organizations. During 1973, the fair market value (on a monthly average basis) of the securities owned by the petitioner and cash balances was $8,205,058; it owned no assets other than assets held for the production of income subject to excise tax under section 4940, except stationery, stamps, and similar items of inconsequential value; it had gross investment income of $456,618; it received gross contributions, gifts, and grants totaling $704,168, which were entered on its books as "gifts from trusts." Of this latter amount, all but $5,823 was received from the John R. Oishei Appreciation Trust (a private foundation as defined by section 509) in the month of January 1973. During 1973, petitioner made qualifying distributions within the meaning of section 4942(g) in the amount of $1,005,950, of which $410,075 was a distribution of income and $595,875 constituted a distribution of corpus. At all relevant times, petitioner's directors and officers, other than its secretary, served without compensation for services rendered to the petitioner. Its directors determined which public charitable, educational, and scientific organizations were to receive distributions from the petitioner and the amounts thereof and made all ultimate investment decisions. Petitioner paid the following expenses during 1973: The amount paid to Price Waterhouse & Co. was for Examination of the financial statements for the year ended December 31, 1972 including revised financial statement presentation and research and assistance relating to various tax matters, including review of Forms 990-PF and 990– AR. The amount paid for "Legal fee and disbursements" was for legal services in connection with a suit in a United States District Court and appeal to a United States Circuit Court of Appeals in the case of Jackson v. Statler Foundation, Inc., and “various other Foundation matters." That suit purportedly was brought under sections 1981, 1983, and 1985 of title 42 U.S.C. and involved claims that petitioner and other defendants had discriminated against Negroes in the award of grants, in refusing to hire Negroes as employees or as directors, and in investing their assets in white businesses. Various forms of relief were sought, including injunctive relief, a declaratory judgment revoking tax-exempt status, and damages. The suit was ultimately dismissed. The parties have stipulated that gross or for the All the expenses [set forth], above, were ordinary and necessary expenses paid for the production or collection of management, conservation or maintenance of property held for the production investment income, of such income, and in making distributions of income and corpus to qualified public charitable, educational and scientific organizations. The reference to such distribution of income and corpus in the foregoing sentence shall not infer agreement as to whether the expenses of making such distributions are properly includable or excludable as expenses deductible within the meaning of Section 4940(c)(3)(A) of the Code. Section 4940(a) of subtitle D provides as follows: SEC. 4940(a). TAX-EXEMPT FOUNDATIONS.-There is hereby imposed on each private foundation which is exempt from taxation under section 501(a) for the taxable year, with respect to the carrying on of its activities, a tax equal to 4 percent of the net investment income of such foundation for the taxable year. Section 4940(c) of subtitle D provides, in pertinent part, as follows: SEC. 4940(c). NET INVESTMENT INCOME DEFINED. (1) IN GENERAL.-For purposes of subsection (a), the net investment income is the amount by which (A) the sum of the gross investment income and the capital gain net income exceeds (B) the deductions allowed by paragraph (3). Except to the extent inconsistent with the provisions of this section, net investment income shall be determined under the principles of subtitle A. (2) Gross INVESTMENT INCOME.-For purposes of paragraph (1), the term "gross investment income" means the gross amount of income from interest, dividends, rents, and royalties, but not including any such income to the extent included in computing the tax imposed by section 511. (3) DEDUCTIONS. (A) IN GENERAL.-For purposes of paragraph (1), there shall be allowed as a deduction all the ordinary and necessary expenses paid or incurred for the production or collection of gross investment income or for the management, conservation, or maintenance of property held for the production of such income, determined with the modifications set forth in subparagraph (B). (B) MODIFICATIONS.-For purposes of subparagraph (A)— (i) The deduction provided by section 167 shall be allowed, but only on the basis of the straight line method of depreciation. (ii) The deduction for depletion provided by section 611 shall be allowed, but such deduction shall be determined without regard to section 613 (relating to percentage depletion). Section 53.4940-1(e), Foundation Excise Tax Regs., provides, in pertinent part, as follows: Sec. 53.4940-1(e). Deductions-(1) In general. (i) For purposes of computing net investment income, there shall be allowed as a deduction from gross investment income all the ordinary and necessary expenses paid or incurred for the production or collection of gross investment income or for the management, conservation, or maintenance of property held for the production of such income, determined with the modifications set forth in subparagraph (2) of this paragraph. Such expenses include that portion of a private foundation's operating expenses which is paid or incurred for the production or collection of gross investment income. Taxes paid or incurred under this section are not paid or incurred for the production or collection of gross investment income. A private foundation's operating expenses include compensation of officers, other salaries and wages of employees, outside professional fees, interest, and rent and taxes upon property used in the foundation's operations. Where a private foundation's officers or employees engage in activities on behalf of the foundation for both investment purposes and for exempt purposes, compensation and salaries paid to such officers or employees must be allocated between the investment activities and the exempt activities. To the extent a private foundation's expenses are taken into account in computing the tax imposed by section 511, they shall not be deductible for purposes of computing the tax imposed by section 4940. (ii) Where only a portion of property produces, or is held for the production of, income subject to the section 4940 excise tax, and the remainder of the property is used for exempt purposes, the deductions allowed by section 4940(c)(3) shall be apportioned between the exempt and nonexempt uses. (iii) No amount is allowable as a deduction under this section to the extent it is paid or incurred for purposes other than those described in subdivision (i) of this subparagraph. Thus, for example, the deductions prescribed by the following sections are not allowable: (1) the charitable deduction prescribed under section 170 and 642(c); (2) the net operating loss deduction prescribed under section 172; and (3) the special deductions prescribed under Part VIII, subchapter B, chapter 1. Petitioner deducted all of its expenses (totaling $29,399) in computing net investment income. In his deficiency notice, respondent allowed only $1,399 thereof on the ground that petitioner had not established that the disallowed portion had been paid or incurred for purposes permitted by section 4940(c)(3)(A). Although respondent has not specified how he arrived at this allocation of the claimed expenses, it is his contention that the disallowed portion was for nonpermissible purposes and that petitioner has not carried its burden of proof that a different allocation should be utilized. Petitioner's position is founded on the following syllogism: (1) Section 4940 provides that, except where inconsistent with that section, net investment income shall be calculated under the principles of subtitle A; (2) subtitle A includes section 212; (3) the language of section 4940(c)(3)(A) tracks the language of section 212;2 (4) under section 212 and the applicable regulations "That section provides as follows: SEC. 212. EXPENSES FOR PRODUCTION OF INCOME. |