Tax Legal Services · Primary-source case analysis

Sullivan: Illegality Alone Did Not Bar Ordinary Rent and Wage Deductions

By Aneeta Mishra and Timothy Chan

Published August 16, 2026

Commissioner v. Sullivan considered whether bookmakers could deduct the rent and wages used to conduct gambling enterprises that violated state law while the federal tax system still required reporting the enterprises’ income.

The businesses reported income but claimed operating expenses

The disputed costs were ordinary premises rent and employee compensation, not fines, bribes, or the cost of contraband. The Commissioner disallowed them because the enterprises were unlawful under state law.

The deduction provision did not contain a general illegality exception

The Court declined to create a blanket rule that every expense of an illegal business was nondeductible when Congress taxed the income and had not expressly withdrawn these ordinary deductions.

Rent and wages remained ordinary and necessary on the record

The costs were conventional inputs to carrying on the businesses. Allowing them did not mean that every payment connected to unlawful activity would qualify.

Current law contains additional express restrictions

The Court affirmed the deductions under the 1939 Code. Modern analysis must include sections 162(c), 162(f), 280E, capitalization rules, substantiation, and other provisions that specifically deny or limit particular costs.

Key takeaways

• Classify each payment by what it purchased and why it was made.
• Separate ordinary operating expenses from fines, bribes, penalties, and contraband costs.
• Check current express statutory disallowances before relying on Sullivan.
• Maintain complete records even when the underlying activity creates separate legal exposure.