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deduct as a business bad debt that part of the settlement payment
attributable to petitioner's guaranty.
3. Whether Petitioners May Deduct the Settlement Payment
under Section 162
Petitioners argue in the alternative that they may deduct
under section 162 their payments to settle the Northeast
litigation and the adversary proceeding. A taxpayer may deduct
ordinary and necessary expenses paid or incurred in carrying on a
trade or business. Sec. 162(a). Petitioners argue that O'Malley
v. Commissioner, 91 T.C. 352, 361-362 (1988), supports their
contention that they may deduct the settlement payment since they
paid it to settle an action against petitioner that proximately
resulted from his business activity. We agree as to the portion
of the settlement not allocable to the guaranty because bad debts
cannot be deducted under section 162. See Horne v. Commissioner,
59 T.C. 319, 336 (1972), affd. 523 F.2d 1363 (9th Cir. 1975);
Smith v. Commissioner, 55 T.C. 260, 267 (1970), vacated on other
grounds and remanded 457 F.2d 797 (5th Cir. 1972) (section 162
does not apply to debts resulting from a taxpayer's loan
guaranty). The taxpayer in O'Malley made payments which were
directly connected with his trade or business as an employee of a
trucking company. Similarly, petitioner's payment to settle
claims brought against him by Northeast's creditors other than
the bank originated in petitioner's conduct of his duties as an
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