Frank v. Commissioner
1953 U.S. Tax Ct. LEXIS 128, 20 T.C. 511 (1953)
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Rule of Law:
Expenses incurred in the search for or investigation of a new business venture are not deductible as ordinary and necessary business expenses under the Internal Revenue Code because the taxpayer is not yet engaged in 'carrying on' a trade or business.
Facts:
- In 1946, the petitioners expended $5,965 on travel, telephone, telegraph, and legal fees.
- These expenses were incurred while traveling through various states to find a newspaper or radio property to purchase and operate.
- At the time the expenses were incurred, the petitioners were not engaged in any trade or business.
- The petitioners did not have an established home during the period of their travels.
- The petitioners' search eventually led to the purchase of a newspaper in Canton, Ohio, though this occurred after the expenses were incurred.
Procedural Posture:
- The petitioners filed their 1946 income tax return, claiming a deduction for $5,965 in business expenses.
- The Commissioner of Internal Revenue, the respondent, disallowed the deduction and determined a deficiency in the petitioners' tax liability.
- The petitioners challenged the Commissioner's determination by filing a petition with the Tax Court of the United States.
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Issue:
Are expenses for travel, legal fees, and communication incurred while searching for and investigating a potential new business to acquire deductible as 'ordinary and necessary' business expenses, expenses for the production of income, or as losses under the Internal Revenue Code?
Opinions:
Majority - Van Fossan, J.
No. Expenses incurred while searching for a new business to purchase are not deductible. Under § 23(a)(1), these expenses are not deductible as trade or business expenses because the petitioners were not yet 'carrying on' a trade or business. The statutory term 'in pursuit of' a business presupposes an existing business, not the search for a new one; these were preparatory expenses. Under § 23(a)(2), the expenses are not deductible as costs for the production of income, as there is a distinction between expenses to produce income from an existing interest and expenses to create a new interest, as was the case here. Finally, under § 23(e)(2), the costs cannot be deducted as losses from a transaction entered into for profit. Merely investigating and rejecting potential businesses does not constitute entering into and abandoning a transaction; rather, it is a refusal to enter into a transaction.
Analysis:
This case establishes a fundamental distinction between pre-opening (start-up) expenses and operational business expenses for tax purposes. It solidifies the principle that a taxpayer must be 'carrying on' an active trade or business before expenses can be deducted as ordinary and necessary. The decision mandates that investigatory and preparatory costs incurred before a business begins operations must be capitalized rather than expensed immediately. This precedent significantly impacts tax planning for new ventures, clarifying that the costs of 'testing the waters' are not currently deductible.
