Wilhelm Schmidt owns a small business. He purchases weapons in Czechoslovakia and sells them offshore wherever there is an insurgency in Africa or the Middle East. The business is not incorporated, not legal, yet the net income or loss is reported on Kyle's tax return on Schedule C every year based upon the requirement to report world-wide income on one's U.S. income tax return. Schmidts business is the type of business that has significant travel expenses and significant client relations expenses. In 2019, the Internal Revenue Service finally completed their audit of his tax returns for 2013 through 2017. Kyle had to agree to an extension of time for the Internal Revenue Service to complete some of these audits as if he refused, the IRS would have issued a nightmare assessment immediately and the cost of fighting that assessment would be very significant. The ultimate assessment issued by the Internal Revenue Service disallowed many business deductions taken in those tax returns. The tax assessment was substantial for Mr. Schmidt. On January 28, 2022, in addition to paying the deficiency and assessed penalties, he paid $20,000 in interest on the tax owed. He calculated that of the $20,000 in interest, $11,000 was attributable to his lost business expenses and the resulting higher sole proprietorship income and $7,000 was attributable to other adjustments.

Can Mr. Schmidt deduct (1) the deficiency, (2) the penalties and/or (3) all or any portion of the interest expense in the year of payment? (If his business had been incorporated, the answer may not be the same.) Would the answer be different if his business had been delivery of illegal drugs instead of weapons? Should he be able to deduct anything in a conceptual sense? Section 162 IRC, Section 163 IRC, Regulation 1.163-9T, Kikalos v. Comm. 84 AFTR 2d 99-5933