Richard Penn lives in Harrisburg, Pennsylvania. Richard is the president of an architectural firm. Richard has become known throughout the community for excellent work and honesty in his business dealings. Richard believes his reputation is an integral part of the success of the firm.
Oil was found recently in the area around Harrisburg and some geologists believed the reserves were large. A few well-respected businesspeople organized Oil Company to develop a few wells. Although some oil was being extracted, the oil corporation lacked capital to develop the oil fields to their expected potential. After reading the geologists’ report, Richard felt that Oil Company was a good investment; therefore, he acquired 25% of the company. A short time after Richard’s acquisition, the price of foreign oil decreased sharply. The drop in foreign oil prices caused Oil Company to be unprofitable due to its high production costs. Three months later Oil Company filed bankruptcy.
The bankruptcy proceedings were reported in the local newspaper. Many of Oil Company’s creditors were real estate developers that engaged Richard’s architectural firm to provide designs. After Oil Company declared bankruptcy the architectural firm’s business noticeably decreased.
Richard felt the decline in business was related to the bankruptcy of Oil Company. Richard convinced his partner to use the accumulated earnings of the firm to repay all the creditors of Oil Company.
Richard has asked you whether his firm can deduct the expenses of repaying Oil Company’s creditors. After completing your research explain to Richard why the expenses are or are not deductible.
A partial list of research sources is as follows:
• Sec. 162
• Thomas H. Welch v. Helvering, 12 AFTR 1456, 3 USTC ¶1164 (USSC, 1933)
• William A. Thompson, Jr., 1983 PH T.C. Memo ¶83,487, 46 TCM 1109