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in satisfaction of Color Q's claim. The S Corporation could have
received the funds to cover that check from a number of sources,
such as loans, capital contributions, income from operations, or
other sources. The source of those funds is not material. What
is controlling is the fact that the S Corporation made the Color
Q payment from its own account. Accordingly, we find it
unnecessary to trace the source of those funds. Consequently, we
conclude that the Color Q payment was an "expense" of the S
Corporation that it "paid or incurred" during 1988 within the
meaning of section 162(a).
Respondent next argues that Mr. Jeffcott's embezzlement
activity was not "ordinary" because embezzlement is not part of
the trade or business of being an employee, citing Yerkie v.
Commissioner, 67 T.C. 388, 393 (1976). We think that
respondent's argument is misplaced in that it focuses on the
wrong party. In the instant case, the issue is not whether Mr.
Jeffcott can deduct the Color Q payment; rather, the issue is
whether the S Corporation is entitled to deduct the Color Q
payment as an ordinary and necessary expense of its business.
We think that the proper analysis of the instant case can be
found in Old Town Corp. v. Commissioner, 37 T.C. at 858-859. In
Old Town Corp., we set forth the standards to decide whether an
expense paid to settle a lawsuit is "necessary" within the
4(...continued)
embezzlement suit.
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