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within the meaning of section 162(a). To qualify as an allowable
deduction pursuant to section 162(a), "an item must (1) be 'paid
or incurred during the taxable year,' (2) be for 'carrying on any
trade or business,' (3) be an 'expense,' (4) be a 'necessary'
expense, and (5) be an 'ordinary' expense." Commissioner v.
Lincoln Sav. & Loan Association, 403 U.S. 345, 352 (1971).
Petitioners contend that the Color Q payment was deductible
by the S Corporation based on the application of the "origin of
the claim" doctrine (see United States v. Gilmore, 372 U.S. 39
(1963)).3 Citing James E. Caldwell & Co. v. Commissioner, 234
F.2d 660 (6th Cir. 1956), revg. 24 T.C. 597 (1955), and Ostrom v
Commissioner, 77 T.C. 608 (1981), petitioners argue that the
Color Q payment was an ordinary and necessary expense of the S
Corporation because the embezzlement suit arose out of the
ordinary business operations of the S Corporation.
Respondent argues that James E. Caldwell & Co. v.
Commissioner, supra, stands for the proposition that a judicial
determination of liability is required for deductibility pursuant
to section 162(a), quoting Judge Bruce’s dissent, "It is not the
petitioner's culpability but his liability that determines his
right to the deduction". James E. Caldwell & Co. v.
3 The Supreme Court 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' and hence whether it is deductible or not under �
23(a)(2)." United States v. Gilmore, 372 U.S. 39, 49 (1963).
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