In Kornhauser v. United States (1927), the Supreme Court ruled that a taxpayer could not deduct legal expenses incurred in a lawsuit over the division of profits from his former law partnership as business expenses. Morris Kornhauser, who had been expelled from his law firm, sued for an accounting and distribution of assets. The court held that these costs were personal rather than business-related because they arose after he was no longer part of the firm and thus did not relate to any trade or business he was involved in at the time. Therefore, under Section 214(a) of Revenue Act 1918 which allows deductions only for "ordinary and necessary" expenses paid during taxable year "in carrying on any trade or business," such legal fees are non-deductible.

In the dissenting opinion for Kornhauser v. United States, Justice Holmes argued that the majority's decision was incorrect because it failed to properly interpret and apply tax law. He contended that a loss incurred in a business transaction should be deductible from gross income, regardless of whether or not it is connected with one's trade or business. In his view, the majority had wrongly interpreted Section 214(a)(5) of the Revenue Act of 1918 by limiting deductions to losses directly tied to one’s profession or occupation. Holmes believed this interpretation contradicted both common sense and legal precedent which allowed for broader interpretations of what constituted “losses” under tax law.