Woodward v. Commissioner

Background

A group of shareholders who controlled a local newspaper voted to extend the company charter, triggering an Iowa law that required anyone who voted for the extension to buy out stockholders who opposed it. Negotiations failed, so the controlling shareholders sued in state court to have a judge set the fair price for the dissenting shares. While the price dispute was ongoing, the controlling shareholders paid lawyers, accountants, and appraisers and then tried to deduct those fees on their federal income tax returns as ordinary business expenses.

Reasoning

The Court examined whether those fees were ordinary deductible expenses or instead part of the capital cost of purchasing the stock. The Justices rejected a rule that would look mainly to the taxpayer’s motive. Instead, they said the right test is where the dispute "originates" — if the claim arises from the process of acquiring the asset, the costs are part of acquisition and therefore capitalized. Because state law required the controlling shareholders to buy the dissenting shares and the appraisal proceeding simply fixed the purchase price, the Court held the fees were acquisition costs and not deductible as ordinary expenses.

Real world impact

The decision means people who must pay to determine the price of stock they are required to buy cannot deduct those legal and professional fees now; they must add them to the stock’s tax basis and recover the cost later through sale or other capital accounting. The ruling resolves conflicting lower-court views and applies to similar buyout and appraisal situations under state law.