The IRS, reacting to the Supreme Court’s decision in Kokesh v. S.E.C., 137 S. Ct. (2017), has issued a memorandum (CCA 201748008) taking the position that amount paid as a disgorgement for violating a federal securities falls under IRC Section 162(f)’s prohibition of a deduction for a fine or similar penalty.
Specifically, IRC §162(f) provides:
(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.
Reg. §1.62-21(b) provides the definition of a “fine or similar penalty,” stating:
(1) For purposes of this section a fine or similar penalty includes an amount--
(i) Paid pursuant to conviction or a plea of guilty or nolo contendere for a crime (felony or misdemeanor) in a criminal proceeding;
(ii) Paid as a civil penalty imposed by Federal, State, or local law, including additions to tax and additional amounts and assessable penalties imposed by chapter 68 of the Internal Revenue Code of 1954;
(iii) Paid in settlement of the taxpayer's actual or potential liability for a fine or penalty (civil or criminal); or
(iv) Forfeited as collateral posted in connection with a proceeding which could result in imposition of such a fine or penalty.
The memorandum outlines the Supreme Court’s holding in Kokesh as follows:
In Kokesh v. SEC, 137 S. Ct. 1635 (2017), the United States Supreme Court held that disgorgement imposed as a sanction for violating a federal securities law was a penalty for purposes of the 5-year statute of limitations in 28 U.S.C. § 2462 (applicable to an action for the enforcement of any civil fine, penalty, or forfeiture). In its analysis, the Supreme Court stated that “SEC disgorgement . . . bears all the hallmarks of a penalty: It is imposed as a consequence of violating a public law and it is intended to deter, not to compensate.” Kokesh, 137 S. Ct. at 1644. The Court also stated that “courts have consistently held that '[t]he primary purpose of disgorgement orders is to deter violations of the securities laws by depriving violators of their ill-gotten gains.'” Id. at 1643 (citing SEC v. Fischbach Corp., 133 F.3d 170, 175 (2d Cir. 1997)).
The memorandum discusses the proper test to determine if a deduction is barred by IRC §162(f):
It is also important to clarify that, although the issue under section 162(f) is often referred to as whether a payment is punitive or compensatory, the scope of section 162(f) is not restricted to payments that are “punitive” in the narrow sense that they are imposed solely as retribution for past wrongdoing. The scope of “punitive” in this context includes the purpose of enforcing the law by deterring the proscribed conduct in the future: “Thus, it is clear that, if the deduction of a civil fine (or similar penalty) is to fall within the proscription of section 162(f), the fine must be one which punishes and/or deters.” Middle Atlantic Distributors, Inc. v. Commissioner, 72 T.C. 1136, 1143 (1979) (emphasis added); see also True v. United States, 894 F.2d 1197, 1205 (10th Cir. 1990) (amounts paid for violating the Federal Water Pollution Control Act were not deductible because they served "a deterrent and retributive function similar to a criminal fine"). Therefore, a payment imposed primarily for purposes of deterrence and punishment is not deductible under section 162(f).
The memorandum concludes the payment described in Kokesh meets the requirements to be barred under IRC §162(f), noting:
Because, as the Supreme Court held, disgorgement payments are penalties and are not compensatory, section 162(f) prohibits a deduction under section 162(a) for an amount paid as disgorgement for violating a federal securities law.