The taxpayer referred to in Chief Counsel Email 201513003 argued that the payment he was making under a Deferred Prosecution Agreement (DPA) represented a deductible payment under IRC §162(a). The taxpayer argued that the Department of Justice planned to use the funds to pay restitution to those the DOJ alleged had been defrauded by the taxpayer and thus should represent a business expense.

The IRS, in this email, disagreed with that view, arguing that IRC §162(f) prohibited the deduction. That provision of the IRC states:

(f) Fines and penalties

No deduction shall be allowed under subsection (a) for any fine or similar penalty paid to a government for the violation of any law.

The memorandum notes that “Treas. Reg. section 1.162-21(b)(1)(iii) states that a fine or similar penalty includes an amount paid in settlement of the taxpayer’s actual or potential liability for a civil or criminal fine or penalty.”

The memo notes the following about the DPA:

The deferred prosecution agreement (DPA) states that the taxpayer has violated several criminal statutes and provides for a forfeiture payment in lieu of proceedings that would result in criminal and/or civil forfeiture under 18 U.S.C. sections 981 and 982 and 28 U.S.C. section 2461(c). The DPA is a settlement for purposes of the regulation as it is an agreement between the taxpayer and the government that resolves all issues associated with the taxpayer’s criminal conduct in exchange for certain consideration outlined in the DPA, including a payment in lieu of forfeiture. It is the Service’s longstanding position that a monetary forfeiture under the U.S.C. sections the taxpayer violated, as well as the sections referenced above, is a civil or criminal fine or penalty for purposes of the regulation. As such, the money paid in lieu of forfeiture pursuant to the DPA resolves the taxpayer’s actual or potential liability for a civil or criminal fine or penalty and is not deductible under section 162.

The taxpayer argued that the above should not apply due to two facts:

· The taxpayer had not pled guilty or nolo contender in any court proceeding and

· The payment was earmarked by the DOJ for the restitution of victims

The IRS finds the first point is irrelevant, as Reg. §1.162-21(b)(1)(iii) covers settlement of a taxpayer’s actual or potential liability, thus an actual admission of guilt or even just a no contest plea is not necessary so long as it settled the appropriate liability, which this payment did.

As well, the IRS contended that what the DOJ was going to do with the funds wasn’t relevant, but rather the terms of the DPA controlled. The memo argues:

Likewise, the taxpayer’s second argument that the forfeited funds will be used to compensate victims has no merit, as the DPA specifically states that the payment is in lieu of criminal and/or civil forfeiture. The DPA is a negotiated settlement between the government and the taxpayer that specifically requires a forfeiture payment rather than requiring that part or all of the payment be allocated as restitution. The Department of Justice has the authority to use forfeited funds at its discretion for various uses including payment to victims. DoJ’s stated intention for the use of the funds does not change the character of the payment from a non-deductible forfeiture to a potentially deductible restitution payment.

The memo ends with a reference to briefs the Chief Counsel’s office had filed in another case, that of Nacchio v. United States, 113 AFTR 2d 2014-1288 (115 Fed. Cl. 195). That reference is somewhat interesting, since the IRS actual had already lost on a similar (though not identical) issue at the trial court on this matter in that case (it involved a claimed loss under §165 for actual restitution and the issue of whether a claim of right exists). That case is an interesting study for those who may be facing a similar issue to look at the nuances of how