IN THE UNITED STATES COURT OF APPEALS

FOR THE FIFTH CIRCUIT

No. 18-60299

Consolidated with 18-60304

JAMES A. CAVANAUGH, JR., 

 Petitioner - Appellant

v.

COMMISSIONER OF INTERNAL REVENUE, 

 Respondent - Appellee

Appeals from a Decision of the

United States Tax Court

T.C. No. 30825-09

T.C. No. 29194-11

Before CLEMENT, GRAVES, and OLDHAM, Circuit Judges.

PER CURIAM:*

This case requires us to answer the question whether a settlement

payment to avoid liability arising from the death of a sole shareholder’s 

girlfriend is a deductible business expense for his S corporation. The IRS and 

Tax Court have said it is not. We affirm. 

 

* Pursuant to 5TH CIR. R. 47.5, the court has determined that this opinion should not 

be published and is not precedent except under the limited circumstances set forth in 5TH 

CIR. R. 47.5.4.

United States Court of Appeals

Fifth Circuit

FILED

March 29, 2019

Lyle W. Cayce

Clerk

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FACTS AND PROCEEDINGS

James Cavanaugh, Jr. is the CEO and sole shareholder of Jani-King 

International, Inc., a commercial cleaning franchisor operating as an S 

corporation. In November 2002, Cavanaugh went on a Thanksgiving vacation 

to the Caribbean island of St. Maarten, where he owned a residence. With him 

were his girlfriend, Colony Anne (Claire) Robinson, and Jani-King employees 

Ronald Walker (his bodyguard) and Erika Fortner (his employee and former 

girlfriend). On November 28, 2002, Claire died at the residence, likely of a 

cocaine overdose. 

Claire’s mother Linda Robinson sued Cavanaugh and Jani-King, 

alleging that Claire’s death was caused by the Jani-King employees acting in 

the course and scope of their employment. Robinson alleged that Cavanaugh, 

Walker, and Fortner facilitated Claire’s access to and ingestion of cocaine, 

causing her death. 

After some discovery, Jani-King’s board of directors met to discuss the 

suit. Cavanaugh explained to the board that he believed the claims were 

frivolous but was willing to personally contribute his own defense costs, 

estimated to be $250,000. Jani-King’s corporate counsel explained to the board 

that Robinson would likely not prevail in her suit, but a negative outcome was 

possible. They acknowledged the “substantial possibility of a negative impact 

on the company’s relationship with its franchisees and the company’s business” 

that could result from negative publicity arising from the suit. Jani-King’s 

counsel ultimately recommended that the company settle, and the board 

authorized a settlement payment of up to $5 million. 

The parties settled the lawsuit for $2.3 million to be paid over the course 

of two years. Cavanaugh paid $250,000 toward the settlement, Jani-King the 

remainder. Jani-King reimbursed Cavanaugh for his portion of the settlement. 

Jani-King then deducted its settlement payment, the reimbursement payment, 

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and its related legal expenses as ordinary and necessary business expenses. 

Because Jani-King is an S corporation, its deductions flow through to and are 

reflected on Cavanaugh’s personal tax returns.

The IRS disallowed the claimed deductions. And despite having paid $2.3 

million ostensibly to avoid protracted litigation and the attendant negative 

publicity, Cavanaugh decided to fight for the deductions, contesting the IRS’s 

determination that the expenses did not qualify as ordinary and necessary 

business expenses. 

The Tax Court eloquently articulated the parties’ basic dispute:

From Cavanaugh’s perspective, it is an unfortunate 

fact of business life that corporations and prominent 

individuals get sued, sometimes on dubious facts and 

theories of liability. Settling such suits may be distasteful, 

but even a small chance of an enormous payout may justify 

a deal that protects assets from the uncertainty of 

litigation and protects a business reputation from scandal.

The Commissioner has a different view--he argues 

that however jumbled and wrinkly the legal topography 

created by the collision of Code, regulations, and caselaw 

may sometimes seem, it cannot possibly hide a crevice dark 

enough to successfully shelter an argument that the price 

paid for the death of the boss’s girlfriend is a deductible 

corporate business expense.

The Tax Court held that Jani-King could not deduct the settlement 

payment, reimbursement payment, or related legal expenses. The court first

held that United States v. Gilmore, 372 U.S. 39 (1963), controls. In Gilmore, 

the Supreme Court held that when determining the deductibility of litigation 

expenses as business expenses, “the origin and character of the claim with 

respect to which an expense was incurred, rather than its potential 

consequences upon the fortunes of the taxpayer, is the controlling basic test.” 

372 U.S. at 49. If the claim “arises in connection with the taxpayer’s profit-

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seeking activities,” related expenses may properly be characterized as a 

business expense rather than a personal expense. Id. at 48. 

The Tax Court found that Cavanaugh did not show that Robinson’s suit 

arose in connection with Jani-King’s profit-seeking activities. Therefore, JaniKing’s settlement payment and related legal expenses were not deductible as 

ordinary and necessary business expenses. The court also found that Jani-King 

was not obligated to reimburse Cavanaugh, Cavanaugh was not unable to 

cover his part of the settlement, and the reimbursement was not an ordinary 

and necessary business expense, so the reimbursement payment was not 

deductible. Again, Cavanaugh appealed.

STANDARDS OF REVIEW

The Tax Court’s legal conclusions are reviewed de novo and its factual 

findings for clear error. Harris v. Comm’r of Internal Revenue, 16 F.3d 75, 81 

(5th Cir. 1994). “A factual finding is clearly erroneous only if, based on the 

entirety of the evidence, the reviewing court is left with the definite and firm 

conviction that a mistake has been made.” United States v. Cordova-Soto, 804 

F.3d 714, 718 (5th Cir. 2015).

DISCUSSION

I. Disallowance of Jani-King’s deduction for its settlement 

payment and related legal expenses

A. Applicability of Gilmore 

Cavanaugh first argues that Gilmore is inapposite because it does not 

address a situation where a corporation is directly named in the underlying 

suit. Relying primarily on Kopp’s Co., Inc. v. United States, 636 F.2d 59 (4th 

Cir. 1980), Cavanaugh argues that the court must give significant weight to a 

corporation’s direct exposure to a monetary judgment, rather than examining 

the origin of the claim. In response, the Commissioner contends that Gilmore 

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controls even when corporations are named as defendants in the underlying 

litigation. 

Section 162 of the Internal Revenue Code “permits an individual or 

corporate taxpayer to deduct all ordinary and necessary expenses paid or 

incurred in carrying on a trade or business.” Estate of Meade v. Comm’r of 

Internal Revenue, 489 F.2d 161, 164 (5th Cir. 1974). When determining 

whether litigation expenses were “incurred in carrying on a trade or 

business,”1 this court generally looks to the origin of the claim from which the 

expenses arose. Id. at 165–66 (relying on Gilmore); see also Marcello v. Comm’r 

of Internal Revenue, 380 F.2d 499, 504–05 (5th Cir. 1967). “Legal expenses do 

not become deductible merely because they are paid for services which relieve 

a taxpayer of liability.” Lykes v. United States, 343 U.S. 118, 125 (1952). 

Importantly, “[w]hen a taxpayer claims a Section 162(a) deduction, he has the 

burden to prove that the expense in question has a business origin.” Marcello, 

380 F.2d at 504. 

We decline Cavanaugh’s invitation to follow the scarce out-of-circuit 

cases since Gilmore that have distinguished its origin-of-the-claim test when 

the taxpayer corporation is named in the underlying suit. See Kopp’s, 636 F.2d 

at 60–61; Dolese v. United States, 605 F.2d 1146 (10th Cir. 1979). Those cases 

directly conflict with Gilmore, which is binding on this court. Each 

concentrates on the consequences of the litigation rather than the underlying 

claim’s origin. See Kopp’s, 636 F.2d at 61 (focusing on the company’s “direct 

exposure to the risk of a monetary judgment”); Dolese, 605 F.2d at 1151–52 

(focusing on the restraining order that arose out of a divorce action). This

circuit has repeatedly confirmed that it follows Gilmore, which has not 

otherwise been confined to its facts. See Meade, 489 F.2d at 164; Marcello, 380 

 

1 The parties do not dispute that the expenses at issue are ordinary and necessary. 

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F.2d at 504–05; see also Northwestern Indiana Telephone Co. v. Comm’r of 

Internal Revenue (NITCO), 127 F.3d 643 (7th Cir. 1997) (applying Gilmore

even though the taxpayer corporation was directly named in the underlying 

litigation).2

We are bound by Gilmore and must apply its origin-of-the-claim test. 

Simply being named in the Robinson suit is insufficient to prove that JaniKing’s expenses are deductible business expenses.

B. Origin of the Claim

Under Gilmore, “[w]e must identify the claim that gave rise to the legal 

fees whose deductibility is here in question, and then determine whether the 

claim was proximately related to the trade or business of” Jani-King. Peters, 

Gamm, West & Vincent, Inc. v. Comm’r of Internal Revenue, 71 T.C.M. (CCH) 

2789, 1996 WL 182545, at *5 (T.C. 1996). This inquiry “does not contemplate 

a mechanical search for the first in the chain of events which led to the 

litigation but, rather, requires an examination of all the facts.” Id. (quoting 

Boagni v. Comm’r of Internal Revenue, 59 T.C. 708, 713 (T.C. 1973)).

The Tax Court found that the “claim” was undisputed: the Robinson suit 

against Cavanaugh and Jani-King. The court further found that the origin of 

the claim was that Claire was allegedly provided cocaine by Jani-King 

employees. The court found that providing cocaine does not arise from, further, 

or use property directly employed in Jani-King’s franchising business. This is 

a finding of fact that is reviewed for clear error. See Marcello, 380 F.2d at 505 

 

2 Even were we to follow Kopp’s, Cavanaugh would not prevail. In the Kopp’s line of 

cases, the corporations showed that the litigation directly threatened or inhibited their ability 

to engage in profit-seeking activities. See Kopp’s, 636 F.2d at 60; Dolese, 605 F.2d at 1149, 

1151–52; Naporano Iron & Metal Co. v. United States, 6 Cl. Ct. 422, 431 (Cl. Ct. 1984); see 

also Comm’r of Internal Revenue v. Heininger, 320 U.S. 467, 469 (1943) (owner of mail-order 

false-teeth business was deprived of access to the mails by a fraud order). Cavanaugh made 

no such showing.

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n.16; Heininger, 320 U.S. at 475 (“Whether an expenditure is directly related 

to a business and whether it is ordinary and necessary are doubtless pure 

questions of fact in most instances.”).

Cavanaugh contends that because Jani-King engages only in profitseeking activities, its employees’ actions—alleged to have been within the 

course and scope of their employment—must have arisen from profit-seeking 

activities. The Commissioner argues that simply because a corporation’s 

possible liability rests on an activity alleged to have been within the course and 

scope of employment does not make that activity related to a corporation’s 

profit-seeking activity for the purposes of tax deductibility. 

Cavanaugh ignores the “basic principle of examining each activity to 

ascertain whether its objective was to make a profit.” Synanon Church v. 

Comm’r of Internal Revenue, 57 T.C.M. (CCH) 602, 1989 WL 59409, 1989 Tax 

Ct. Memo LEXIS 270, at *90 (T.C. 1989). Even when the underlying suit 

includes allegations of employees acting within the course and scope of their 

employment, the court must determine whether their activities arose from or 

were connected to the corporation’s profit-seeking activity.

Take, for example, the Seventh Circuit’s opinion in NITCO. NITCO was 

a closely held, independent telephone company. NITCO, 127 F.3d at 645. The 

primary shareholder’s son formed a cable television company, NICATV. Id. In 

the shareholder’s attempt to help his son, NITCO paid his salary, NITCO 

employees “constructed and operated NICATV,” NITCO paid NICATV’s utility 

bills, and NITCO wrote off a $100,000 debt from NICATV. Id. at 646. One of 

NICATV’s competitors filed a complaint with the FCC alleging NICATV was 

illegally affiliated with NITCO, which was prohibited from offering cable 

services. Id. at 645. The FCC eventually brought an enforcement action against 

the companies, and NITCO and the son brought a separate suit alleging 

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constitutional violations. Id. NITCO deducted the attorneys’ fees for these 

actions as business expenses. Id. at 645–46.

The Seventh Circuit affirmed the Tax Court’s finding that the origin of 

the claims giving rise to NITCO’s legal expenses did not involve its profitmaking activities. Id. at 646. The court found that NITCO’s activities

supporting NICATV—including those by employees presumably acting within 

the course and scope of their employment—were not undertaken with a profit 

motive. Id. Therefore, the court found that the claims “originated with the 

nonbusiness activity of underwriting” NICATV and affirmed that NITCO’s 

legal expenses were not ordinary and necessary business expenses. Id.

Similarly, in Synanon Church, the Tax Court examined all the relevant 

activities undertaken by a formerly nonprofit church to determine whether 

each constituted a trade or business and was undertaken with a profit motive. 

1989 WL 59409, 1989 Tax Ct. Memo LEXIS 270, at *89–102. The Tax Court 

affirmed the disallowance of deductions for litigation expenses arising from 

activities it found not to be profit-seeking, even expenses arising from suits 

alleging that church employees “committed tortious acts” in the course and 

scope of their employment. Id. at *139–40. The court held that Synanon failed 

to show that the tort claims “arose from, or were proximately related to, any 

specific business activity.” Id. at *139.

Cavanaugh does not argue that providing cocaine to Claire was done 

with a profit-seeking motive. Nor does he argue that the alleged actions arose 

from or were proximately related to any specific Jani-King business activity. 

The Tax Court’s finding that the Jani-King employees’ alleged actions were not 

profit-seeking is not clearly erroneous.

Cavanaugh also contends that “all expenses incurred in defending 

against a [non-collusive] suit founded on a theory of respondeat superior would 

be deductible as a business expense . . . even where . . . the origin of the suit 

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has no connection to the corporation’s profit-seeking activities.” He argues that 

the “nexus with the business is the allegation that the employee is acting 

within the course and scope of his employment.” 

This is a novel argument, but Cavanaugh marshals no legal support for 

it. And he runs up against Gilmore and the cases just discussed, where courts 

have affirmed the disallowance of deductions when employees are alleged to 

have been acting in the course and scope of employment if their actions did not 

involve the company’s profit-making activities. See NITCO, 127 F.3d at 646; 

Synanon Church, 1989 WL 59409, 1989 Tax Ct. Memo LEXIS 270, at *139–40; 

cf. Cummins Diesel Sales of Or., Inc. v. United States, 207 F. Supp. 746, 748–

79 (D. Or. 1962) (finding that the salary of a nurse hired by a company to care 

for its principal officer and stockholder was “predominantly personal” and “not 

chargeable to a corporation as an ‘ordinary and necessary’ business expense”) 

(cited favorably by Jack’s Maint. Contractors, Inc. v. Comm’r of Internal 

Revenue, 703 F.2d 154, 156–57 (5th Cir. 1983)). 

Cavanaugh’s argument would also have the court ignore all the facts and 

allegations of the underlying claim and look only at the alleged theory of 

liability. We must look not only at the allegation that Jani-King employees 

were acting within the course and scope of their employment, but also at the 

allegation that they provided cocaine leading to Claire’s death. The origin of 

the claim is the employees’ providing cocaine, not their employment by JaniKing. The Tax Court’s findings are not clearly erroneous. The settlement 

payment and related legal fees arose from a claim originating in non-business 

activity and Jani-King’s business-expense deductions were properly 

disallowed.

II. Disallowance of deduction for reimbursement payment

Cavanaugh contends that Jani-King’s reimbursement payment to him is 

deductible because settling the lawsuit was in Jani-King’s best interests. He 

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also argues that the corporation’s bylaws make indemnification obligatory, and 

Jani-King’s primary motives for reimbursement were to protect its business 

and uphold its corporate obligations. The Commissioner responds that 

Cavanaugh does not contest the Tax Court’s interpretation of the bylaws 

finding that Jani-King was not obligated to make the reimbursement payment. 

The Commissioner also argues that the record is devoid of evidence showing 

that Cavanaugh was unable to make the $250,000 payment or that 

indemnification was necessary to protect Jani-King’s business. 

A. Required Payment

A company’s payment under an indemnification agreement can be an 

ordinary and necessary business expense. See Union Inv. Co. v. Comm’r of 

Internal Revenue, 21 T.C. 659, 663 (T.C. 1954). Article 9.01 of Jani-King’s 

bylaws provides for corporate indemnification of: 

any . . . Director, officer or employee . . . against any and all 

liability and reasonable expense that may be incurred by 

him in connection with or resulting from any claim . . . in 

which he may become involved as a party . . . by reason of 

being or having been such a Director, officer, or employee . . . 

provided such person acted, in good faith, in what he 

reasonably believed to be the best interests of the 

corporation . . . . 

Under Article 9.03, if the person is “wholly successful” in the suit, he is entitled 

to indemnification as a matter of right. Otherwise, indemnification is “at the 

discretion of the corporation” upon a finding by the board of directors or its 

counsel that the person met the standards of conduct set forth in Article 9.01. 

Although he generally asserts that Jani-King was legally obligated to 

indemnify him, Cavanaugh does not argue that the requirements of the bylaws’ 

indemnification provision were met. Thus, he has waived the argument that 

Jani-King was contractually obligated to reimburse him. See, e.g., Willis v. 

Cleco Corp., 749 F.3d 314, 319 (5th Cir. 2014) (“A party that asserts an 

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argument on appeal, but fails to adequately brief it, is deemed to have waived 

it.” (quoting United States v. Scroggins, 599 F.3d 433, 446 (5th Cir. 2010))). 

B. Voluntary Payment

Generally, paying another’s debt is not an ordinary and necessary 

business expense. See Welch v. Helvering, 290 U.S. 111, 114 (1933). The Tax 

Court has recognized an exception when such a payment is made to “protect or 

promote [the taxpayer’s] own business.” Lohrke v. Comm’r of Internal Revenue, 

48 T.C. 679, 684–85 (T.C. 1967). When a corporation pays a controlling 

shareholder’s expense, this test “is more likely to be satisfied if the shareholder 

is unable to pay the expense, thus requiring the corporation to pay the expense 

in order to protect its own interests.” HIE Holdings, Inc. v. Comm’r of Internal 

Revenue, 97 T.C.M. (CCH) 1672, 2009 WL 1586044, at *96 (T.C. 2009); see also 

Hood v. Comm’r of Internal Revenue, 115 T.C. 172, 179 (T.C. 2000). Even if the 

taxpayer meets the “protect and promote” test, it must also show that the 

expense is an ordinary and necessary business expense. Lohrke, 48 T.C. at 688. 

This second inquiry is still governed by Gilmore. See, e.g., Capital Video Corp. 

v. Comm’r of Internal Revenue, 311 F.3d 458, 464–65 (1st Cir. 2002). 

Cavanaugh argues only that the settlement was necessary to protect 

Jani-King’s business, not that the reimbursement payment was necessary to 

do so. Nor does he contend that he was unable to make the payment, and the 

record shows the opposite. Further, as discussed above, the Tax Court’s finding 

that the Robinson suit did not arise in connection with Jani-King’s profitseeking activities is not clearly erroneous. Therefore, Cavanaugh has not 

shown that the Tax Court’s findings regarding Jani-King’s reimbursement 

payment are clearly erroneous. The reimbursement payment is not deductible

as a business expense.

CONCLUSION

For the foregoing reasons, we affirm.

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