Commissioner v. Sullivan

Background

The taxpayers were people who ran bookmaking establishments in Chicago and received income from taking wagers. The Tax Court found their operations and the acts of their employees illegal under Illinois law and ruled that payments for wages and rent could not be deducted. The Court of Appeals reversed that decision, and this case reached the Supreme Court to resolve whether those payments are deductible for federal income tax purposes.

Reasoning

The Court addressed whether money paid to lease premises and to hire employees for bookmaking are “ordinary and necessary” business expenses under the federal tax law. The opinion notes that federal regulations treat the federal excise tax on wagers as a deductible business expense and thus recognizes a gambling enterprise as a business for tax purposes. The Court explained that ordinary wages and rent fit the common meaning of business expenses and should be allowed unless the deduction would be a device to avoid the consequences of illegal conduct or would conflict with an explicit federal statute or regulation. The Court declined to adopt a rule that would tax these operations on gross receipts without action by Congress.

Real world impact

As a result, people who receive income from bookmaking in these circumstances may deduct ordinary wages and rent from their federal taxable income, reducing reported net income. This decision governs federal tax treatment only and does not legalize the underlying state crimes; the operations remain illegal under Illinois law. The Court also made clear that deductions can be denied when they clearly violate federal policy or are used to evade legal consequences.