CIR v. Polk, 6202.

• Decision Date: 17 March 1960
• Docket Number: No. 6202.,6202.
• Parties: COMMISSIONER OF INTERNAL REVENUE, Petitioner, v. Frank POLK and Marie Polk, Respondents.
• Court: U.S. Court of Appeals — Tenth Circuit

276 F.2d 601 (1960)

COMMISSIONER OF INTERNAL REVENUE, Petitioner, v. Frank POLK and Marie Polk, Respondents.

No. 6202.

United States Court of Appeals Tenth Circuit.

March 17, 1960.

John J. Pajak, Department of Justice, Washington, D. C. (Howard A. Heffron, Acting Asst. Atty. Gen., Lee A. Jackson and Harry Baum, Attorneys, Department of Justice, Washington, D. C., on the brief), for petitioner.

Ranel Hanson, Oklahoma City, Okl., for respondents.

Before BRATTON, HUXMAN and PICKETT, Circuit Judges.

HUXMAN, Circuit Judge.

This is an appeal by the Commissioner of Internal Revenue from a decision of the Tax Court holding that interest on a personal income tax deficiency assessed against an individual taxpayer is a deduction "attributable to the operation of a trade or business" for the purpose of computing a net operating loss under Section 122(d) (5) of the Internal Revenue Code of 1939, 26 U.S.C.A. § 122(d) (5), where the deficiency on which the interest was paid resulted from an understatement by the taxpayer of his business income. The facts are without dispute and the sole question is one of law.

At all relative times, the taxpayer, Frank Polk, was engaged as an individual in the business of raising and producing livestock. He filed his income tax return on the accrual basis. On his books he carried large livestock inventories which were a substantial factor in determining net income, if any, from the operation of his business. As a result of a revaluation of the taxpayer's livestock inventories, the Commissioner determined a very substantial deficiency in his 1948 income tax on which penalty interest was assessed. In 1952, he treated the item of interest as a business expense arising out of the operation of his business. In his 1953 return, he claimed the item as an operating loss carryover from the previous year under applicable provisions of the Revenue Code.

We are concerned here solely with the taxpayer's right to treat this item of interest as an item of expense attributable to the operation of his business of raising and producing livestock. Whether the penalty interest may be deducted as a business expense must be determined from a consideration of Section 23(a) (1) (A) of the 1939 Code, 26 U.S.C.A. § 23(a) (1) (A). That Section permits deduction of "all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business." The Section is general in its terms. It does not attempt to define or lay down a yardstick by which can be determined what specific items constitute business expense. A considerable discretion must be exercised in determining that question under the facts of each particular case.

In its opinion upholding taxpayer's right to deduct the penalty interest as an ordinary and necessary expense of doing business, the Tax Court said, "We think it is clear that the deficiency assessed by respondent in 1948 arose in connection with petitioner's business, and was proximately related thereto, and that the same must be said of the interest paid thereon." The court also concluded that this case was controlled by Commissioner of Internal Revenue v. Standing, 4 Cir., 259 F.2d 450. The Standing case involved both attorneys' fees and penalty interest. In reaching its conclusion in the Standing case that penalty interest on a deficiency assessment of income taxes was deductible as a business expense, the court relied on a line of cases holding attorneys' fees deductible as a business expense.

An item of expense is not deductible as a business expense merely because it arose in connection with the taxpayer's business and was proximately related thereto. To be deductible, it must be an ordinary and necessary expense incurred in the operation of the business. The decision in Kornhauser v. United States, 276 U.S. 145, 48 S.Ct. 219, 72 L.Ed. 505, upholding the allowance of attorneys' fees in defending a suit against a taxpayer, was on the grounds that such fees were an ordinary and necessary expense of doing business and not that they were connected with the business and proximately related thereto. That expenses must be ordinary...