Rev. Rul. 77-204

The purpose of this Revenue Ruling is to update and restate, under the current statute and regulations, the position set forth in I.T. 2004, III-1 C.B. 292 (1924).

The question presented is whether the expenses incurred under the circumstances described below are deductible under section 162 of the Internal Revenue Code of 1954 as ordinary and necessary expenses in carrying on a trade or business.

Situation 1.

M corporation reported its income under the accrual method of accounting and on a calendar year basis. During 1973, M filed a petition for a reorganization under section 126 of Chapter X of the Bankruptcy Act, 11 U.S.C. Sections 501-676 (1970). A was appointed as the trustee of M. Pursuant to the court's authorization, A continued the operation of M's business and incurred business expenses during the remainder of 1973. Various other costs and expenses were incurred by A during 1973 in connection with the institution and administration of the Chapter X proceeding.

Situation 2.

During 1973 X corporation filed a petition in bankruptcy pursuant to the provisions of Chapters 1 through VII of the Bankruptcy Act, which pertain to certain liquidating bankruptcy proceedings. B was appointed as the trustee of X. During the remainder of 1973 B incurred various administration expenses in connection with the liquidating bankruptcy proceeding.

Section 1.641(b)-2(b) of the Income Tax Regulations provides, in part, that a corporation in bankruptcy is not a taxable entity separate from the person for whom the fiduciary is acting.

Section 6012(b)(3) of the Code provides, in part, that where a trustee in bankruptcy, by operation of law or otherwise, has possession of or holds title to all or substantially all the property or business of a corporation, whether or not such property or business is being operated, such trustee shall make the return of income for such corporation in the same manner and form as corporations are required to make such returns.

The trustee in a Chapter X proceeding acquires title to the debtor's assets under section 186 of the Bankruptcy Act, 11 U.S.C. Section 586 (1970). The trustee in a liquidating bankruptcy proceeding acquires title to the bankrupt's property under section 70a of the Bankruptcy Act.

Rev. Rul. 69-600, 1969-2 C.B. 241, holds that the income tax return filed by a receiver appointed during a taxable year should include the income, deductions, etc., for the entire year.

Since the intervention of a proceeding under the Bankruptcy Act into the affairs of a corporation does not create a new taxable entity, it follows that the tax treatment of income received and expenditures made by a trustee for a corporate debtor or bankrupt is the same as if the corporation itself had received the income or made the expenditures outside of bankruptcy. Therefore, the deductibility of the administrative expenses incurred by a trustee for a corporation that has petitioned for a reorganization under Chapter X of the Bankruptcy Act depends upon the extent to which corporations in general are allowed to deduct expenses connected with a reorganization. Similarly, the deductibility of liquidation expenses incurred by a trustee for a corporate bankrupt depends upon the extent to which corporations outside of bankruptcy may deduct costs of liquidation.

Section 162 of the Code provides that 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. Section 263 provides generally that no deduction shall be allowed for capital expenditures.

In regard to Situation 1, expenses connected with a reorganization generally are not deductible under section 162 of the Code because they are capital expenditures that will benefit the corporation in future years. See Rev. Rul. 73-580, 1973-2 C.B. 86. Cases specifically considering the deductibility of expenses incurred in connection with bankruptcy reorganizations have held that such items are nondeductible capital expenditures. Chicago, Milwaukee, St. Paul & Pacific R.R. Co. v. United States, 404 F.2d 960. (Ct. Cl. 1968); Denver & Rio Grande Western Railroad Co., 38 T.C. 557 (1962) and Bush Terminal Buildings Co., 7 T.C. 793 (1946).

Accordingly, in Situation 1 the ordinary and necessary business expenses incurred by A in the operation of M's business are deductible under section 162 of the Code in the same manner and to the same extent they would have been if the Chapter X proceeding had not been instituted. However, the costs and expenses incurred with respect to the institution and administration of the Chapter X proceeding are not deductible since they are capital expenditures that will benefit the corporation in future years.

In regard to Situation 2, the settled rule is that a corporation may deduct under section 162 of the Code the costs connected with its liquidation except costs connected with the sale of assets, which must be charged against the proceeds of the sale. Of Course, Inc. v. Commissioner, 499 F.2d 754 (4th Cir. 1974), rev'g 59 T.C. 146 (1972); Connery v. United States, 460 F.2d 1130 (3rd Cir. 1972); United States v. Morton, 387 F.2d 441 (8th Cir. 1968).

Accordingly, in Situation 2 the expenses incurred with respect to the institution and administration of the liquidating corporate bankruptcy proceeding are deductible under section 162 of the Code in the same manner and to the same extent liquidating expenses are deductible in nonbankruptcy liquidations. As indicated, liquidating expenses generally are deductible under section 162 as ordinary and necessary business expenses. However, expenses incurred in connection with the sale of assets are not deductible under section 162. The expenses of a sale must be offset against the proceeds of the sale in determining gain or loss on the transaction.

In regard to the deductibility of expenses incurred in connection with the administration of the estate of a bankrupt individual or partnership, see Rev. Rul. 68-48, 1968-1 C.B. 301, and section 212 of the Code.

I.T. 2004 is superseded since the position stated therein is restated under current law in this Revenue Ruling.

¹ Prepared pursuant to Rev. Proc. 67-6, 1967-1 C.B. 576.