## Facts

- Lee M. Friedman, a Boston attorney, represented Louis H. Wax in bankruptcy.
- A proposed composition required a $7,000 court deposit.
- To secure creditor support, Friedman personally assured creditors’ attorneys the funds would be available, intending not to impose legal liability on Wax.
- Wax and his wife refused to pledge a life insurance policy that Friedman expected would finance the deposit.
- In February 1938, Friedman deposited $7,000 with the bankruptcy court, asserting the funds were not Wax’s property; slightly over $5,000 was Friedman’s own money and the balance was borrowed.
- The composition was later abandoned; Friedman sought return of the deposit in 1939, claiming it was his money and not property of the bankrupt estate.
- In 1941, the bankruptcy court denied Friedman’s request; Friedman then agreed not to oppose transfer of the funds to the trustee while maintaining that over $5,000 was his.
- On his 1941 federal return, Friedman claimed a deduction for the $5,000 (variously characterized as a bad debt, an ordinary and necessary business expense, or a business loss).
- The Commissioner disallowed the deduction and assessed a deficiency; Friedman paid and sued the Collector for a refund.
- A separate $235.19 refund claim was also included but was dismissed by the district court on procedural grounds.

## Issues

1. Whether Friedman’s $5,000 payment connected to a client’s proposed bankruptcy composition was deductible as an ordinary and necessary business expense of practicing law or as a loss incurred in trade or business.
2. If the payment were otherwise deductible, whether the proper year for the deduction was 1938 (when paid) or 1941 (when Friedman’s effort to recover the money was denied).
3. Whether the district court properly dismissed Friedman’s separate $235.19 refund claim without reaching the merits.

## Decision

- The First Circuit affirmed the judgment denying the $5,000 deduction.
- The court held the payment was a voluntary, self-imposed undertaking to third parties, not an ordinary and necessary expense of a law practice and not a business loss proximately resulting from business operations.
- The court further held that, even if deductible, the loss would have been sustained in 1938 when the money was advanced, not in 1941 when the bankruptcy court denied recovery.
- The court vacated the dismissal of the $235.19 claim and remanded for the district court to consider it on the merits.

## Legal Principles

- Federal income tax deductions are allowed only when clearly authorized by statute; claimed deductions are construed strictly.
- An “ordinary and necessary” business expense must be customary or normal in the taxpayer’s trade or business and sufficiently connected to its conduct.
- A “loss incurred in trade or business” requires a direct, proximate relation to business operations; losses from voluntary, gratuitous, or primarily personal undertakings generally fall outside this category.
- Ethical or reputational motives do not, by themselves, convert a voluntary assumption of another’s obligation into a deductible business expense.
- The year of deductibility for a loss generally turns on when the taxpayer’s funds are placed at risk and the economic loss is sustained, not when later events confirm the loss.

## Conclusion

The court held that an attorney’s voluntary payment made to honor a personal assurance regarding a client’s bankruptcy composition was not deductible as a business expense or business loss, and that any loss would have been realized when the funds were advanced; the court also required the district court to consider a separate, smaller refund claim on remand.


Friedman v. Delaney, 171 F.2d 269 (1st Cir. 1948)