## Facts

- James A. Cavanaugh, Jr. was CEO and sole shareholder of Jani-King International, Inc., an S corporation whose items flowed through to his individual return.
- In November 2002, Cavanaugh took his girlfriend to St. Maarten for a Thanksgiving vacation at his villa, accompanied by his bodyguard and another company employee.
- The parties stipulated the trip was for pleasure and not to conduct or further any company business.
- Cavanaugh’s girlfriend died during the trip after ingesting a large amount of cocaine; the coroner concluded the drugs were the likely cause of death.
- In 2003, the decedent’s mother sued Cavanaugh and Jani-King in Texas state court for wrongful death and related tort theories, alleging Cavanaugh (personally and through the two accompanying individuals) supplied the drugs that caused death and that Jani-King was liable on a scope-of-employment theory.
- Jani-King settled the case for $2.3 million, paying most directly and reimbursing Cavanaugh for a $250,000 contribution.
- Jani-King also paid nearly $180,000 in legal fees for the defense and settlement.
- The S corporation deducted the settlement and legal fees under I.R.C. § 162(a), and the deductions flowed through to Cavanaugh.
- The IRS disallowed the deductions as not “ordinary and necessary” business expenses because the origin of the claims was personal conduct on a personal trip.

## Issues

1. Whether the $2.3 million wrongful-death settlement paid (and reimbursed) by the S corporation was deductible as an ordinary and necessary business expense under I.R.C. § 162(a).
2. Whether the related legal fees of nearly $180,000 were deductible as ordinary and necessary business expenses under I.R.C. § 162(a).

## Decision

- The Tax Court sustained the Commissioner’s disallowance of the deductions.
- The $2.3 million settlement was not deductible under § 162(a).
- The related legal fees were not deductible under § 162(a).
- The court declined to allocate any portion of the settlement or fees to business-related claims on the record presented.

## Legal Principles

- Under I.R.C. § 162(a), deductible expenses must be ordinary and necessary and incurred in carrying on a trade or business.
- The “origin of the claim” doctrine controls: deductibility turns on the origin and nature of the claim giving rise to the expense, not the taxpayer’s motive or the anticipated business consequences.
- Expenses that are primarily personal are nondeductible under I.R.C. § 262, even if paid by a corporation and even if adverse publicity might affect the business.
- Corporate payment or reimbursement does not convert an expense into a business expense when the underlying claim arises from personal conduct unrelated to business operations.

## Conclusion

Because the wrongful-death litigation arose from alleged personal conduct during a stipulated personal vacation rather than from Jani-King’s business activities, the settlement payment and related legal fees were treated as nondeductible personal expenses, and the Commissioner’s disallowance was upheld.


Cavanaugh v. Commissioner, T.C. Memo. 2012-324 (2012)