Commissioner v. Sullivan
356 U.S. 27 (1958)

  • Sullivan ran an illegal gambling establishment. He filed a tax return claiming some of his expenses as business deductions under 26 U.S.C. 23(a)(1)(A) (now 26 U.S.C. 162).
    • There was a law making gambling earnings taxable, in order to make illegal gambling a Federal offense (and thus allow the FBI to get involved), so Sullivan was trying to comply with the law.
  • The IRS denied the deduction. Sullivan appealed.
    • The IRS argued that running a business that is totally illegal cannot possibly qualify for a deduction. The IRS argued that found that it is never ordinary and necessary to violate the law. Therefore, there must be an implicit policy limitation that would deny a deduction for violating the law.
  • The US Supreme Court found for Sullivan and allowed the deductions.
    • The US Supreme Court found that the expenses in question did not constitute a penalty. They were normal business expenses (salaries to employees, lease on the building, etc.) that would otherwise normally be deductible.
    • The Court noted that if Sullivan had been fined by the State, then the fines would not be deductible, but this wasn't a fine or a punishment, so it was within the boundaries of an ordinary and necessary business expense.
      • The Court looked to Commissioner v. Heininger, (320 U.S. 467) which said that the "fact that an expenditure bears a remote relation to an illegal act" does not make it nondeductible.
      • Conversely, see Tank Truck Rentals, Inc. v. Commissioner (356 U.S. 30 (1958)), which found that fines and penalties are not deductible as business expenses under 162.