Provisions Denying a Deduction for Illegal Expenses and Expenses of an Illegal Business Should Be Repealed

Currently, the tax law denies a deduction for business expenses that violate a federal or state law (but only if the state law is generally enforced). In addition, losses, including business losses, cannot be deducted if they arise out of an illegal activity. For example, medical expenses are denied a deduction if they are illegal. Kickbacks, bribes, and rebates given in connection with the Medicaid or Medicare program are nondeductible. Any expenses, legal or not, incurred in connection with the conduct of a business of selling a controlled substance that is prohibited by federal law (or by the law of the state in which the business is conducted) cannot be deducted. It is the contention of the authors that all of those provisions should be repealed and that there should be no restriction on the deductibility of an expense because of its illegality or its connection with an illegal activity. The authors will show in this Article that the current treatment is bad policy and not in accord with the traditional rationale for meting out punishment