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liabilities, including liabilities for current and pending
litigation. The legal fees associated with Lucky Stores’ current
and pending litigation were required to be capitalized under the
purchase accounting method because they were considered
liabilities that American Stores assumed in the hypothetical
asset purchase, and as such, the legal fees and other liabilities
were treated as additional consideration that American Stores
paid for Lucky Stores’ assets. In addition to the legal fees
related to the State of California’s antitrust suit, petitioner
also capitalized under the purchase accounting method more than
$1 million of Lucky Stores’ legal fees incurred in connection
with employment discrimination suits, torts, and other
litigation. Although petitioner capitalized these legal expenses
for financial accounting purposes under the purchase accounting
method, petitioner claimed them as ordinary and necessary
business expenses on its consolidated Federal income tax returns
for the 1989 and 1990 tax years. With the exception of the legal
fees incurred in connection with the State of California's
antitrust suit, respondent allowed petitioner to deduct for
Federal income tax purposes the legal fees related to Lucky
Stores that petitioner had capitalized under the purchase
accounting method for financial reporting purposes.
In the notice of deficiency, respondent disallowed legal
fees incurred by petitioner in defending against the State of
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