A payment made to settle a fraudulent conveyance claim is, in the view of the IRS National Office, a payment made to defend or protect title and thus must be capitalized under Reg. §1.263-2(e)(1). [Chief Counsel Advice 201552028]

The issue arose with regard to claims made against a taxpayer for transfers made between a subsidiary and the parent entity. Various parties with claims against the subsidiary asserted that the transfers of assets violated various fraudulent conveyance provisions and thus those assets (or an equivalent in value) should be made available to pay their claims. The parent paid a sum of money to settle these claims and the question arose regarding whether a deduction can be claimed by the parent for the payments as ordinary and necessary business expenses under IRC §162.

The memorandum concludes that, by necessity, since the claim seeks to divest the defendant of the property. As the memorandum notes:

Fraudulent conveyance claims have their origin in a defense of title to real or personal property under § 1.263-2(e)(1) because they seek to restore improperly transferred property back to the bankruptcy estate; the dispute in each claim is over ownership of, or title to, property. Hauge v. Commissioner, T.C. Memo. 2005-276 (2005) ("we conclude that petitioner paid her share of the settlement payment to preserve or protect her title to real estate and other personal assets against the Government's claim that those assets had been fraudulently conveyed to her."); D'Angelo v. Commissioner, T.C. Memo. 2003-295 ("neither * * * involved a dispute as to the validity of ownership interests, or involved a claim to set aside a fraudulent conveyance, as in Lin where the Court concluded that the origin of the claim was to protect, defend, or restore the taxpayers' interest in the stock of the corporations or in other property), citing Lin v. Commissioner, T.C. Memo. 1984-581 (legal fees in two lawsuits, one to recover real property fraudulently conveyed by deed, and one to protect or defend their proportionate interest in the ownership of the stock of the corporations must be capitalized because the costs were incurred to protect, defend, or restore title to property). In contrast, in Scofield v. Commissioner, T.C. Memo 1997-547, the Court applied the origin of the claim analysis to determine the character of a settlement payment stemming from litigation out of claims the petitioner's business creditors brought against him for payment of debts that arose in the ordinary course of their business dealings with petitioner's corporation. In defending against these claims, petitioner was not defending or perfecting title to property. The legal fees were deductible under § 162 since these fees were related to the ordinary conduct of petitioner's business. The Court distinguishes In re Collins because that case involved settlement payments related to a prepetition transfer of property whereas in Scofield the legal fee paid was to defend against claims of creditors for business debts arising from a legal proceeding separate from petitioner's bankruptcy case.

As the issue with the subsidiary arose from a product liability claim, the other issue to be considered in this ruling was whether the expenses could be treated as a specified liability loss under IRC §172(f)(1)(A). But the ruling holds that, as this provision looks at net operating loss calculations, the loss must be one otherwise deductible under either IRC §162 or §165—something the ruling had already concluded was not the case here. Thus, the specified product liability loss provisions also provide no relief to the taxpayer.