Commissioner v. Tellier
1966 U.S. LEXIS 2912, 383 U.S. 687, 16 L. Ed. 2d 185 (1966)
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Rule of Law:
Legal expenses incurred in the unsuccessful defense of a criminal prosecution are deductible as ordinary and necessary business expenses under § 162(a) of the Internal Revenue Code, provided the prosecution arises from the taxpayer's trade or business.
Facts:
- Walter F. Tellier was engaged in the business of underwriting the public sale of stock and purchasing securities for resale.
- As a result of his business activities, Tellier was indicted on 36 counts, including securities fraud and mail fraud.
- In 1956, Tellier incurred and paid $22,964.20 in legal expenses to defend himself against these criminal charges.
- Tellier's defense was unsuccessful, and he was convicted on all counts.
- On his 1956 federal income tax return, Tellier claimed a deduction for the legal expenses he paid.
Procedural Posture:
- Walter F. Tellier was convicted of fraud in a federal trial court and the conviction was affirmed on appeal.
- Tellier claimed his legal fees as a business expense deduction on his tax return, which the Commissioner of Internal Revenue disallowed.
- Tellier challenged the disallowance in the U.S. Tax Court, which ruled in favor of the Commissioner.
- Tellier, as appellant, appealed to the U.S. Court of Appeals for the Second Circuit.
- The Court of Appeals, en banc, reversed the Tax Court's decision, holding that the expenses were deductible.
- The Commissioner, as petitioner, was granted a writ of certiorari by the U.S. Supreme Court.
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Issue:
Does a public policy exception to § 162(a) of the Internal Revenue Code disallow a deduction for legal expenses incurred in the unsuccessful defense of a criminal prosecution that arises from the taxpayer's trade or business?
Opinions:
Majority - Justice Stewart
No. A public policy exception does not disallow a deduction for legal fees from an unsuccessful criminal defense where the charges originated from the taxpayer's business. The federal income tax is a tax on net income, not a sanction against wrongdoing. The legal expenses were 'ordinary and necessary' and their origin was in Tellier's business, meeting the literal requirements of § 162(a). The Court has only disallowed deductions on public policy grounds in the narrow circumstance where allowing the deduction would 'frustrate sharply defined national or state policies,' such as deducting a fine or penalty, which would dilute the punishment itself. Hiring a lawyer to defend against criminal charges is not a proscribed act; it is a constitutional right. To deny the deduction would amount to an additional financial punishment that Congress has not authorized, the severity of which would depend arbitrarily on the cost of the defense and the defendant's tax bracket rather than the seriousness of the offense.
Analysis:
This case significantly limits the scope of the public policy exception for disallowing tax deductions under § 162(a). It establishes a strong precedent that the purpose of the tax code is to accurately measure net income, not to enforce other laws or penalize wrongdoing. By refusing to use the tax law to impose an additional, congressionally unapproved sanction, the Court reinforced a clear separation between tax administration and criminal justice. This decision ensures that expenses directly arising from a trade or business are generally deductible, even if that business involves illegal acts, thereby preventing the government from taxing such enterprises on gross receipts rather than net income.
