Respondent securities dealer was tried and found guilty of
violating the Securities Act of 1933, the mail fraud statute, and
of conspiring to violate those statutes. His conviction was
affirmed on appeal. He claimed a deduction on his income tax return
for legal fees incurred in defending the prosecution. Although the
Commissioner conceded that the fees were ordinary and necessary
expenses of the respondent's securities business within the meaning
of 26 U.S.C. §162(a), and therefore deductible under the literal
requirements of that section, he disallowed the deduction on the
ground of public policy. The Tax Court sustained his position, but
was reversed by the Court of Appeals.
Held:
1. The federal income tax is a tax on net income, and is not a
sanction against wrongdoing. P.
383 U. S.
691.
2. Deductions of expenses encompassed by §162(a), in the absence
of specific legislation, are disallowed only where their allowance
would severely and immediately frustrate sharply defined national
or state policies proscribing particular forms of conduct. Pp.
383 U. S.
693-694.
3. Where, as here, an accused exercises his constitutional right
to employ counsel to defend against criminal charges, there is no
offense to public policy, and deduction of the expenses of his
defense is proper. Pp.
383 U. S.
694-695.
342 F.2d 690, affirmed.
Page 383 U. S. 688
MR. JUSTICE STEWART delivered the opinion of the Court.
The question presented in this case is whether expenses incurred
by a taxpayer in the unsuccessful defense of a criminal prosecution
may qualify for deduction from taxable income under § 162(a) of the
Internal Revenue Code of 1954, which allows a deduction of "all the
ordinary and necessary expenses paid or incurred during the taxable
year in carrying on any trade or business. . . ." [
Footnote 1] The respondent Walter F. Tellier
was engaged in the business of underwriting the public sale of
stock offerings and purchasing securities for resale to customers.
In 1956, he was brought to trial upon a 36-count indictment that
charged him with violating the fraud section of the Securities Act
of 1933 [
Footnote 2] and the
mail fraud statute, [
Footnote
3] and with conspiring to violate those statutes. [
Footnote 4] He was found guilty on all
counts, and was sentenced to pay an $18,000 fine and to serve four
and a half years in prison. The judgment of conviction was affirmed
on appeal. [
Footnote 5] In his
unsuccessful defense of this criminal prosecution, the respondent
incurred and paid $22,964.20 in legal expenses in 1956. He claimed
a deduction for that amount on his federal income tax return for
that year. The Commissioner disallowed the deduction, and was
sustained by the Tax Court. T.C.Memo. 1963-212, 22 CCH Tax Ct.Mem.
1062. The Court of Appeals for the Second Circuit reversed in a
unanimous
en banc decision, 342 F.2d 690, and we granted
certiorari. 382
Page 383 U. S. 689
U.S. 808. We affirm the judgment of the Court of Appeals.
There can be no serious question that the payments deducted by
the respondent were expenses of his securities business under the
decisions of this Court, and the Commissioner does not contend
otherwise. In
United States v. Gilmore, 372 U. S.
39, we held that
"the origin and character of the claim with respect to which an
expense was incurred, rather than its potential consequences upon
the fortunes of the taxpayer, is the controlling basic test of
whether the expense was 'business' or 'personal'"
within the meaning of § 162(a). 372 U.S. at
379 U. S. 49.
Cf. Kornhauser v. United States, 276 U.
S. 145,
276 U. S. 153;
Deputy v. du Pont, 308 U. S. 488,
308 U. S. 494,
308 U. S. 496.
The criminal charges against the respondent found their source in
his business activities as a securities dealer. The respondent's
legal fees, paid in defense against those charges, therefore
clearly qualify under Gilmore as "expenses paid or incurred . . .
in carrying on any trade or business" within the meaning of §
162(a).
The Commissioner also concedes that the respondent's legal
expenses were "ordinary" and "necessary" expenses within the
meaning of § 162(a). Our decisions have consistently construed the
term "necessary" as imposing only the minimal requirement that the
expense be "appropriate and helpful" for "the development of the
[taxpayer's] business."
Welch v. Helvering, 290 U.
S. 111,
290 U. S. 113;
cf. Kornhauser v. United States, supra, at
276 U. S. 152;
Lilly v. Commissioner, 343 U. S. 90,
343 U. S. 93-94;
Commissioner v. Heininger, 320 U.
S. 467,
320 U. S. 471;
McCulloch v.
Maryland, 4 Wheat. 316,
17 U. S.
413-415. The principal function of the term "ordinary"
in § 162(a) is to clarify the distinction, often difficult, between
those expenses that are currently deductible and those that are in
the nature of capital expenditures, which, if deductible at
all,
Page 383 U. S. 690
must be amortized over the useful life of the asset.
Welch
v. Helvering, supra, at
290 U. S.
113-116. [
Footnote
6] The legal expenses deducted by the respondent were not
capital expenditures. They were incurred in his defense against
charges of past criminal conduct, not in the acquisition of a
capital asset. Our decisions establish that counsel fees comparable
to those here involved are ordinary business expenses, even though
a "lawsuit affecting the safety of a business may happen once a
lifetime."
Welch v. Helvering, supra, at
290 U. S. 114.
Kornhauser v. United States, supra, at
276 U. S.
152-153;
cf. Trust of Bingham v. Commissioner,
325 U. S. 365,
325 U. S. 376.
[
Footnote 7]
It is therefore clear that the respondent's legal fees were
deductible under § 162(a) if the provisions of that section are to
be given their normal effect in this case. The Commissioner and the
Tax Court determined, however, that, even though the expenditures
meet the literal requirements of § 162(a), their deduction must
nevertheless be disallowed on the ground of public policy. That
view finds considerable support in other administrative and
judicial decisions. [
Footnote
8] It finds no support, however,
Page 383 U. S. 691
in any regulation or statute or in any decision of this Court,
and we believe no such "public policy" exception to the plain
provisions of § 162(a) is warranted in the circumstances presented
by this case.
We start with the proposition that the federal income tax is a
tax on net income, not a sanction against wrongdoing. That
principle has been firmly imbedded in the tax statute from the
beginning. One familiar facet of the principle is the truism that
the statute does not concern itself with the lawfulness of the
income that it taxes. Income from a criminal enterprise is taxed at
a rate no higher and no lower than income from more conventional
sources. "[T]he fact that a business is unlawful [does not] exempt
it from paying the taxes that if lawful it would have to pay."
United States v. Sullivan, 274 U.
S. 259,
274 U. S. 263.
See James v. United States, 366 U.
S. 213.
With respect to deductions, the basic rule, with only a few
limited and well defined exceptions, is the same. During the Senate
debate in 1913 on the bill that became the first modern income tax
law, amendments were rejected that would have limited deductions
for losses to those incurred in a "legitimate" or "lawful" trade or
business. Senator Williams, who was in charge of the bill, stated
on the floor of the Senate that
"[T]he object of this bill is to tax a man's net income; that is
to say, what he has at the end of the year after deducting from his
receipts his expenditures or losses. It is not to reform men's
moral characters; that is not the object of the bill at all.
Page 383 U. S. 692
The tax is not levied for the purpose of restraining people from
betting on horse races or upon 'futures,' but the tax is framed for
the purpose of making a man pay upon his net income, his actual
profit during the year. The law does not care where he got it from,
so far as the tax is concerned, although the law may very properly
care in another way."
50 Cong.Rec. 3849. [
Footnote
9]
The application of this principle is reflected in several
decisions of this Court. As recently as
Commissioner v.
Sullivan, 356 U. S. 27, we
sustained the allowance of a deduction for rent and wages paid by
the operators of a gambling enterprise, even though both the
business itself and the specific rent and wage payments there in
question were illegal under state law. In rejecting the
Commissioner's contention that the illegality of the enterprise
required disallowance of the deduction, we held that, were we
to
"enforce as federal policy the rule espoused by the Commissioner
in this case, we would come close to making this type of business
taxable on the basis of its gross receipts, while all other
business would be taxable on the basis of net income. If that
choice is to be made, Congress should do it."
Id. at
356 U. S. 29. In
Lilly v. Commissioner, 343 U. S. 90, the
Court upheld deductions claimed by opticians for amounts paid to
doctors who prescribed the eyeglasses that the opticians sold,
although the Court was careful to disavow "approval of the business
ethics or public policy involved in the payments. . . ." 343 U.S.
at
343 U. S. 97.
And in
Commissioner v. Heininger, 320 U.
S. 467, a case akin to the one before us, the Court
upheld deductions claimed
Page 383 U. S. 693
by a dentist for lawyer's fees and other expenses incurred in
unsuccessfully defending against an administrative fraud order
issued by the Postmaster General.
Deduction of expenses falling within the general definition of §
162(a) may, to be sure, be disallowed by specific legislation,
since deductions "are a matter of grace and Congress can, of
course, disallow them as it chooses."
Commissioner v.
Sullivan, 356 U.S. at
356 U. S. 28. [
Footnote 10] The Court has also given effect to a precise
and longstanding Treasury Regulation prohibiting the deduction of a
specified category of expenditures; an example is lobbying
expenses, whose nondeductibility was supported by considerations
not here present.
Textile Mills Securities Corp. v.
Commissioner, 314 U. S. 326;
Cammarano v. United States, 358 U.
S. 498. But where Congress has been wholly silent, it is
only in extremely limited circumstances
Page 383 U. S. 694
that the Court has countenanced exceptions to the general
principle reflected in the
Sullivan, Lilly, and
Heininger decisions. Only where the allowance of a
deduction would "frustrate sharply defined national or state
policies proscribing particular types of conduct" have we upheld
its disallowance.
Commissioner v. Heininger, 320 U.S. at
320 U. S. 473.
Further, the "policies frustrated must be national or state
policies evidenced by some
governmental declaration of
them."
Lilly v. Commissioner, 343 U.S. at
343 U. S. 97.
(Emphasis added.) Finally, the "test of nondeductibility always is
the severity and immediacy of the frustration resulting from
allowance of the deduction."
Tank Truck Rentals v.
Commissioner, 356 U. S. 30,
356 U. S. 35. In
that case, as in
Hoover Motor Express Co. v. United
States, 356 U. S. 38, we
upheld the disallowance of deductions claimed by taxpayers for
fines and penalties imposed upon them for violating state penal
statutes; to allow a deduction in those circumstances would have
directly and substantially diluted the actual punishment
imposed.
The present case falls far outside that sharply limited and
carefully defined category. No public policy is offended when a man
faced with serious criminal charges employs a lawyer to help in his
defense. That is not "proscribed conduct." It is his constitutional
right.
Chandler v. Fretag, 348 U. S.
3.
See Gideon v. Wainwright, 372 U.
S. 335. In an adversary system of criminal justice, it
is a basic of our public policy that a defendant in a criminal case
have counsel to represent him.
Congress has authorized the imposition of severe punishment upon
those found guilty of the serious criminal offenses with which the
respondent was charged and of which he was convicted. But we can
find no warrant for attaching to that punishment an additional
financial burden that Congress has neither expressly nor
implicitly
Page 383 U. S. 695
directed. [
Footnote 11]
To deny a deduction for expenses incurred in the unsuccessful
defense of a criminal prosecution would impose such a burden in a
measure dependent not on the seriousness of the offense or the
actual sentence imposed by the court, but on the cost of the
defense and the defendant's particular tax bracket. We decline to
distort the income tax laws to serve a purpose for which they were
neither intended nor designed by Congress.
The judgment is
Affirmed.
[
Footnote 1]
"(a) In general. -- 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. . . ."
26 U.S.C. § 162.
[
Footnote 2]
48 Stat. 84, § 17, as amended, 15 U.S.C. § 77q(a).
[
Footnote 3]
18 U.S.C. § 1341.
[
Footnote 4]
18 U.S.C. § 371.
[
Footnote 5]
United States v. Tellier, 255 F.2d 441 (C.A.2d
Cir.).
[
Footnote 6]
See Griswold, An Argument Against the Doctrine that
Deductions Should Be Narrowly Construed as a Matter of Legislative
Grace, 56 Harv.L.Rev. 1142, 1145; Wolfman, Professors and the
"Ordinary and Necessary" Business Expense, 112 U.Pa.L.Rev. 1089,
1111-1112.
[
Footnote 7]
See Brookes, Litigation Expenses and the Income Tax, 12
Tax L.Rev. 241.
[
Footnote 8]
See Sarah Backer, 1 B.T.A. 214; Norvin R. Lindheim, 2
B.T.A. 229;
Thomas A. Joseph, 26 T.C. 562;
Burroughs
Bldg. Material Co. v. Commissioner, 47 F.2d 178 (C.A.2d Cir.);
Commissioner v. Schwartz, 232 F.2d 94 (C.A.5th Cir.);
Acker v. Commissioner, 258 F.2d 568 (C.A.6th Cir.);
Bell v. Commissioner, 320 F.2d 953 (C.A.8th Cir.);
Peckham v. Commissioner, 327 F.2d 855, 856 (C.A.4th Cir.);
Port v. United States, 163 F. Supp. 645,
143
Ct.Cl. 334.
See also Note, Business Expenses,
Disallowance, and Public Policy: Some Problems of Sanctioning with
the Internal Revenue Code, 72 Yale L.J. 108; 4 Mertens, Law of
Federal Income Taxation § 25.49 ff.
Compare Longhorn Portland
Cement Co., 3 T.C. 310; G.C.M. 24377, 1944 Cum.Bull. 93;
Lamont, Controversial Aspects of Ordinary and Necessary Business
Expense, 42 Taxes 808, 833-834.
[
Footnote 9]
In challenging the amendments, Senator Williams also stated:
"In other words, you are going to count the man as having money
which he has not got, because he has lost it in a way that you do
not approve of."
50 Cong.Rec. 3850.
[
Footnote 10]
Specific legislation denying deductions for payments that
violate public policy is not unknown.
E.g., Internal
Revenue Code of 1954, § 162(c) (disallowance of deduction for
payments to officials and employees of foreign countries in
circumstances where the payments would be illegal if federal laws
were applicable;
cf. Treas.Reg. § 1.162-18); § 165(d)
(deduction for wagering losses limited to extent of wagering
gains).
See also Stabilization Act of 1942, § 5(a), 56
Stat. 767, 50 U.S.C.App. § 965(a) (1946 ed.), Defense Production
Act of 1950, § 405(a), 64 Stat. 807, as amended, c. 275, § 104(i),
65 Stat. 136 (1951), 50 U.S.C.App. § 2105(a) (1952 ed.), and
Defense Production Act of 1950, § 405(b), 64 Stat. 807, 50
U.S.C.App. § 2105(b) (1952 ed.) (general authority in President to
prescribe extent to which payments violating price and wage
regulations should be disregarded by government agencies, including
the Internal Revenue Service;
see Rev.Rul. 56-180, 1956-1
Cum.Bull. 94).
Cf. Treas.Reg. § 1.162-1(a), which provides
that
"Penalty payments with respect to Federal taxes, whether on
account of negligence, delinquency, or fraud, are not deductible
from gross income;"
Joint Committee on Internal Revenue Taxation, Staff Study of
Income Tax Treatment of Treble Damage Payments under the Antitrust
Laws, Nov. 1, 1965, p. 16 (proposal that § 162 be amended to deny
deductions for certain fines, penalties, treble damage payments,
bribes, and kickbacks).
[
Footnote 11]
Cf. Paul, The Use of Public Policy by the Commissioner
in Disallowing Deductions, 1954 So.Calif.Tax Inst. 715,
730-731:
". . . Section 23(a)(1)(A) [the predecessor of § 162(a)] is not
an essay in morality, designed to encourage virtue and discourage
sin. It 'was not contrived as an arm of the law to enforce State
criminal statutes. . . .' Nor was it contrived to implement the
various regulatory statutes which Congress has from time to time
enacted. The provision is more modestly concerned with 'commercial
net income' -- a businessman's net accretion in wealth during the
taxable year after due allowance for the operating costs of the
business. . . . There is no evidence in the Section of an attempt
to punish taxpayers . . . when the Commissioner feels that a state
or federal statute has been flouted. The statute hardly operates
'in a vacuum' if it serves its own vital function and leaves other
problems to other statutes."