Tax Court in Brief | Ziroli v. Commissioner | Is a restitution payment a deductible business expense under Section 162? | law of the free man
Tax litigation: The week of July 11, 2022 to July 15, 2022
Ziroli v. Comm’r, TC Memo. 2022-75 | July 14, 2022 | Nega, J. | Dekt. No. 1041-20
Short summary: This case concerns deficiencies determined for Clement and Dawn Ziroli (Zirolis) for adjustments relating to “Other gains or losses from Form 4797 – Restitution” for the 2016 tax year. Specifically, the case concerns whether the restitution of payment to the United States Securities and Exchange Commission by Mr. Ziroli constitutes a “fine or penalty similar” within the meaning of section 162(f) of the Code. Mr. Ziroli has reached a settlement with the SEC over a federal securities violation. In an underlying consent agreement with the SEC, Mr. Ziroli made various concessions regarding the alleged securities violations, which included orders for the return of funds. The consent also stated that Mr. Ziroli “further agrees not to claim, affirm or claim any tax deduction or tax credit in respect of any federal, state or local taxes for any penalty amount that the defendant [Mr. Ziroli] pays in accordance with the final judgment, whether such penalty amounts or part thereof are added to the distribution fund or otherwise used for the benefit of investors. Mr. Ziroli paid the restitution and related amounts ordered in the SEC proceedings. Next, the Zirolis filed a Form 1040, United States Personal Income Tax Return, for the 2016 taxation year, claiming a deduction of $411,422 for “Other gains or (losses)”. They attached a Form 4797, Sales of Business Property, showing that the loss deduction claimed was for the forgiven portion of the amount Mr. Ziroli paid to the SEC. The IRS determined that the Zirolis were not entitled to a deduction for the refund.
- Are the Ziroli entitled to a deduction under section 162(a) for reimbursement that Mr. Ziroli paid to the SEC in settlement of his potential civil liability for alleged violations of federal securities?
- The Ziroli have failed to meet their burden of proving their right to the claimed deduction. Specifically, the Zirolis have failed to demonstrate that the repayment in the SEC proceeding and the consent were imposed as a remedy to indemnify another party.
Main points of law:
- The IRS determinations set forth in a Notice of Deficiency are presumed to be correct and the taxpayer bears the burden of proving them to be wrong. Rule 142(a)(1); Welch versus Helvering290 US 111, 115 (1933).
- Section 162(a) provides the general rule that taxpayers are entitled to a deduction for all ordinary and necessary expenses paid or incurred during the tax year in carrying on a trade or business. a company. However, as an exception to this general rule, Section 162(f) provides that “[n]o a deduction is allowed under paragraph (a) for any fine or similar penalty paid to a government for the violation of any law. »
- A “fine or similar penalty” is defined, in the relevant part, as follows: (1) For the purposes of this section, a fine or similar penalty includes an amount— . . . . (ii) Paid as a civil penalty imposed by federal, state, or local law. . .; [or] (iii) Paid in settlement of the taxpayer’s actual or potential liability for a fine or penalty (civil or criminal). See Treasury Regulations § 1.162-21(b).
- Treasury Regulation § 1.162-21(b)(2), on the other hand, provides that “[c]compensatory damages. . . paid to a government do not constitute a fine or penalty”.
- Whether section 162(f) prohibits the deduction of restitution in this case depends on “the purpose which the statutory sanction is to serve”. Pac. Trans. Co. c. Commissioner, 75 TC 497, 653 (1980). Civil penalties “imposed for the purpose of applying the law and as a penalty for the violation of the law” are “similar” penalties under section 162(f). Identifier. at 652; see Huff v. Commissioner, 80TC 804, 824 (1983). Some civil payments, although labeled “penalties”, remain deductible if they are “imposed to encourage prompt compliance with a requirement of law, or as a remedy to compensate another party”. Blow80 TC to 824; S.Pac. Trans. Co.75 TC at 652. “Where a payment ultimately serves each of these purposes, i.e. law enforcement (non-deductible) and compensation (deductible), our task is to determine what purpose the payment was designed for.” Waldman v. Commissioner88 TC 1384, 1387 (1987).
- Courts have long recognized disgorgement of profits resulting from wrongful conduct as an equitable remedy available to the SEC under 15 USC § 78u(d)(5). Restitution can serve both compensatory and punitive purposes, functioning both as potential compensation for victims and as a financial penalty intended to deter securities fraud.
- Deductions are a matter of legislative grace, and taxpayers bear the burden of proving entitlement to any deduction claimed and must demonstrate that they fully comply with the terms of the law conferring the benefit sought. See Rule 142(a); INDOPCO, Inc. c. Commissioner503 US 79, 84 (1992); New Colonial Ice Co. vs. Helvering292 U.S. 435, 440 (1934); Welch versus Helvering290 US to 115.
- The onus is on the taxpayer to demonstrate that the restitution payment was intended to be compensatory rather than penal. See Talley Indus. Inc. v. Commissioner116 F.3d 382, 387 (9th Cir. 1997).
- Any post hoc exercise of discretion by the government to use returned funds to compensate victims does not transform the payment of a penalty into compensatory damages.
- Denial of a deduction is not punishment and therefore does not violate the Eighth Amendment. Cal. Small bus. Assistants, Inc. v. Commissioner153 TC 65, 71–72 (2019); see, for example, Alpenglow Botanicals, LLC v. United States894 F.3d 1187, 1202 (10th Cir. 2018); Murillo v. Commissioner, Memo TC. 1998-13, aff’d166 F.3d 1201 (2nd Cir. 1998); Bermingham v. Commissioner, Memo TC. 1994-69; King c. United States, 949 F. Supp. 787, 791 (ED Washington 1996).
Knowledge: The Zirolis bore the burden of proving that the restitution paid to the SEC was not a “fine or similar penalty” within the meaning of Section 162(f). They failed to do so. Restitution can serve both compensatory and punitive purposes, and the Zirolis have not demonstrated that the restitution they paid was merely compensation. To note: The IRS recently enacted and adopted new rules regarding the deductibility of refund under Section 162. See Treasures. Reg. § 1.162-21(e)(4)(B) (as amended by TD 9946, 86 Fed. Reg. 4970, 4984 (January 19, 2021)). These rules apply to tax years beginning on or after January 19, 2021 (unless paid or incurred pursuant to an order or agreement under a lawsuit, agreement or otherwise, which became enforceable under applicable law before that date).