Think about it carefully, then give me your thoughts based on the Tax Courts footnote in the Cavanaugh case, the one saying that our analysis might be different [emphasis added] if the circumstances had been as described there. Put yourself in the shoes of a Tax Court judge in a case where the facts actually were different in either of the ways mentioned. Would you conclude that the settlement payments were deductible as ordinary and necessary business expenses? Why or why not?

CASE: November 26, 2012 Twenty-seven-year-old Colony Anne (Claire) Robinson left Texas in November 2002 for a Thanksgiving vacation in the Caribbean with her boyfriend, his bodyguard, and another employee of the company that he had spent decades building. She did not return home alive. The coroner's report showed a massive amount of illegal drugs in her body and concluded that they were the likely cause of her death. Robinson's mother sued the boyfriend and his company for wrongful death. The parties settled. The company paid a $2.3 million settlement, then claimed the entire $2.3 million, plus $180,000 in legal fees, as a deduction. The boyfriends company is a corporation that elected long ago to have its income and deductions flow through to its owners individual return. Background James Cavanaugh is the CEO and sole shareholder of Dallas-based Jani-King International, Inc., which he founded in 1969 and built into one of the most successful janitorial-services franchisors in the world. For the 2002 Thanksgiving holiday, Cavanaugh decided to rest from his entrepreneurial chores by going on a vacation to the Caribbean with Robinson. They traveled to Cavanaugh's villa in St. Maarten, accompanied by Cavanaugh's bodyguard, Ronald (Rock) Walker, and Erika Fortner, another Jani-King employee. The trip was for pleasure. On November 28, Robinson suffered fatal cardiac arrest after ingesting a large amount of cocaine. In August 2003 Robinson's mother, Linda Robinson, sued Cavanaugh and Jani-King in Texas state court, seeking damages for her daughters wrongful death. Cavanaugh and his company each retained counsel for what quickly became contentious and emotionally charged litigation. Robinson alleged that Cavanaugh caused Robinson's death because he supplied the drugs that killed her.1/ - - - - - - - - - - - - - - Footnotes - - - - - - - - - - - - - - - 1/ Linda Robinson alleged that Cavanaugh preyed on young women, plied them with drugs, and forced them to participate in diverse debaucheryhelped by his "vice man" Rock Walker. - - - - - - - - - - - - End Footnotes- - - - - - - - - - - - - - The Jani-King board of directors called a special meeting in September 2004. Cavanaugh insisted that the case was frivolous. (Cavanaugh was only one of Jani-King's four directors, but he was its sole shareholder and had the power to remove any director for any reason.) Jani-King's lawyers agreed with Cavanaugh that both he and the corporation would likely win the case. But the lawyers warned that juries are unpredictable and Jani-King's reputation could be soiled if the case dragged on or became more notorious. According to the board minutes, the remaining directors were quite worried that Jani-King franchisees would jump in for a second helping of litigation if they thought Robinson's suit would hurt their own businesses. As a corporate franchisor, Jani-King's income depends on a stream of royalties, so this is plausible. The case trudged forward until August 2005, when Linda Robinson settled it for $2.3 million payable over two years. Jani-King on its 2005 and 2006 tax returns deducted the settlement along with its attorney's fees as ordinary and necessary business expenses. In 2009 the IRS disallowed deductions. Discussion It is an unfortunate fact of life that corporations and prominent individuals get sued, sometimes on dubious facts and theories. Settling such suits may be distasteful, but even a small chance of an enormous payout may justify a deal that protects assets from the uncertainty of litigation and protects a business reputation from scandal. But the Commissioner argues that the price paid for the death of the boss's girlfriend cannot be a deductible corporate business expense. Under section 162, a business may deduct ordinary and necessary business expenses. Broken into its parts, section 162 allows a deduction for any expense that is paid or incurred during the tax year, "ordinary", "necessary", and a "business" expense. It's the last requirementthat the deduction be a "business" expensethat is the key issue. As to the deductibility of the settlement and the legal fees, the Commissioner argues that the trip to St. Maarten involved no business conduct. Cavanaugh says that claims against company employees are nearly certain to arise in business today and that this makes them proximately related to business operations. Cavanaugh could have tried to analogize to cases where we allowed deductions for the costs of litigation. See, e.g., Naporano Iron & Metal, Inc. v. United States, 6 Cl.Ct. 422 (1984) (costs of suit resulting from fight on company property during business hours). But these cases do not help Cavanaugh's position. Even if Jani-King employees gave Robinson the drugs that killed her, Cavanaugh hasn't shown how those actions arose from Jani-King's business. We therefore hold that the settlement costs and legal fees are not deductible.2/ - - - - - - - - - - - - - - Footnotes - - - - - - - - - - - - - - - 2/ If the Jani-King employees had been attending a conference in St. Maarten, or if they had given Robinson the drugs that killed her back in Dallas, at Jani King's offices, and during business hours, our analysis might be different. - - - - - - - - - - - - End Footnotes- - - - - - - - - - - - -