In the case of Welch v. Obispo Oil Co., 1936, the U.S Supreme Court ruled on a dispute regarding tax deductions. The Obispo Oil Company had paid out money to its shareholders as part of an agreement to settle litigation and then claimed these payments as business expense deductions on their federal income taxes. However, the IRS disallowed these deductions and imposed additional tax liabilities upon them. The oil company challenged this decision in court arguing that since it was necessary for them to make those payments in order to continue operating their business, they should be allowed as ordinary and necessary expenses under section 23(a) of Revenue Act. The Supreme Court disagreed with this argument stating that not all expenditures made by a corporation are deductible from gross income; only those which can be considered 'ordinary' or 'necessary' within common understanding are allowable under section 23(a). It held that such settlements were capital transactions rather than regular operational costs because they fundamentally altered the corporate structure by eliminating minority stockholders who could potentially obstruct management decisions. Therefore, these payouts were deemed non-deductible capital expenditures instead of ordinary business expenses.

In the dissenting opinion for Welch v. Obispo Oil Co., Justice Cardozo disagreed with the majority's ruling that a taxpayer could deduct from gross income an amount paid to satisfy a judgment against him, which was based on profits he had made in violation of federal law. He argued that such payments were not ordinary and necessary business expenses under Section 23(a) of the Revenue Act of 1928 because they did not arise from any legitimate business activity but rather resulted from illegal conduct. Furthermore, he contended that allowing deductions for these types of payments would undermine public policy by effectively reducing penalties imposed by courts for unlawful behavior. Therefore, according to Justice Cardozo’s view, taxpayers should bear full responsibility for their illicit gains without receiving tax benefits.