Welch v. Helvering
290 U.S. 111 (1933)

  • Welch's business went bankrupt. As part of the bankruptcy process, the court said that the business was "discharged from its debts."
    • That means they were not legally obligated to pay them.
  • While trying to get the business back on its feet, Welch decided to reestablish goodwill and credit by voluntarily paying back the debts anyway (or at least part of them).
  • Welch deducted the cost of these voluntary payments on his taxes as a business expense. The IRS denied the deduction. Welch appealed.
    • The IRS argued that these were not business expenses at all, but money spent in order to increase the company's goodwill.
    • Business expenses are covered in 26 U.S.C. 162.
  • The Tax Court found for the IRS. Welch appealed.
    • The Tax Court found that the payments were not deductible as a business expense because they were not ordinary and necessary.
      • Basically, the payments were voluntary, not a required part of doing business, so they didn't count as business expenses.
  • The Appellate Court affirmed. Welch appealed.
  • The US Supreme Court affirmed.
    • The US Supreme Court found that in order to be deductible as a business expense, the payments need to be ordinary and necessary.
      • The Court suggested that ordinary and necessary could be determined by looking at the prevailing practice in the business world.
    • The Court found that in this case, the payments were not ordinary or necessary, so they did not qualify as a business expense.
      • In this case, it was not the prevailing practice in the business world to pay off debts you didn't have to pay off. This was more similar to a capital expenditure, and those are not deductible (see 26 U.S.C. 263(a)).
  • In dictum, the Court defined the term necessary as "appropriate and helpful [in] the development of the [taxpayer's] business."