Reference no: EM132624039

Richard Penn lives in Harrisburg, PA. Richard is the president of an architectural firm. Richard has become known throughout the community for excellent work and honesty in business dealings. Richard believes his reputation is an integral part of the success of the firm.

Oil was found recently in the area around Harrisburg and some geologists believed the reserves were large. A few well-respected business people organized Oil Company to develop a few wells. Although some oil was being extracted, the oil corporation lacked capital to develop oil fields to their expected potential. After reading the geologists' report, Richard felt that Oil Company was a good investment; therefore he acquired 25% of the company. A short time later after Richard's acquisition, the price of foreign oil decreased sharply. The drop in foreign oil prices caused Oil Company to be unprofitable due to their high production costs. Three months later Oil Company filed for bankruptcy.

The bankruptcy proceedings were reported in the local newspaper. Many of Oil Company's creditors were real estate developers that frequently engaged Richard's architectural firm to provide designs. After Oil Company declared bankruptcy the architectural firm's business noticeably decreased.

Richard believed the decline in business was related to the bankruptcy of Oil Company and his relationship with the company as an owner. He convinced his partner to use the accumulated earnings of the firm to repay all the creditors of Oil Company.

Problem 1: The firm deducted these expenses. The IRS has denied these expenses as deductions noting they were not "ordinary and necessary" for the architectural firm. Who will prevail in court?