Tax Legal Services · Primary-source case analysis

Sullivan: Rent and Wages of an Illegal Gambling Business Were Deductible

By Aneeta Mishra and Timothy Chan

Published May 17, 2026 · Updated October 18, 2026

Decision: Comm’r v. Sullivan, 356 U.S. 27 (1958).

Commissioner v. Sullivan considered whether a bookmaker could deduct rent and employee wages incurred in operating a business prohibited by state law.

Illegal income remained taxable

The federal income-tax system included the gambling operation’s receipts despite state-law prohibition.

Rent and wages were ordinary operating costs

The Tax Court had found not just that the enterprise was illegal, but that employees’ work and the payment of rent also violated Illinois law. The Supreme Court nevertheless rejected illegality alone as a reason to disallow these ordinary operating costs under the 1939 Code. The decision did not depend on calling the rent and wages lawful. Sullivan, 356 U.S. at 28–29.

The Code did not then disallow these categories

The Court declined to create a broad public-policy exception that Congress had not enacted for the specific rent and wage payments.

Other unlawful payments could be treated differently

The Court distinguished payments that would defeat a statutory or regulatory policy, including the companion fine cases. Modern statutes also control independently. In particular, current section 165(d) limits wagering losses for tax years beginning after December 31, 2025 to 90% of those losses, capped by wagering gains, and includes otherwise allowable expenses incurred in carrying on wagering transactions. The historical rent-and-wages holding is not a blanket current deduction for every gambling-business cost.

Key takeaways

• Report income regardless of the activity’s legality.
• Trace each expense to the income-producing operation.
• Separate ordinary costs from fines or illegal payments.
• Apply current express disallowance provisions before claiming a deduction.