Source: https://www.currentfederaltaxdevelopments.com/blog/2016/6/12/repayment-of-gains-as-part-of-criminal-prosecution-for-insider-trading-a-nondeductible-amount-under-irc-162f
Timestamp: 2017-09-26 10:49:43
Document Index: 713122913

Matched Legal Cases: ['§162', '§ 981', '§165', '§1341', '§1341', '§1341', '§1341', '§165', '§165', '§ 165', '§ 165', '§ 165', '§ 981', '§ 981', '§ 981', '§ 1', '§ 162', '§ 1', '§ 162', '§ 1', '§ 981', '§ 2461', '§ 20', '§ 1956', '§ 1961', '§ 162', '§ 981', '§ 853', '§ 2461', '§ 853', '§ 162', '§ 162', '§1341']

Repayment of Gains as Part of Criminal Prosecution for Insider Trading a Nondeductible Amount Under IRC §162(f) — Current Federal Tax Developments
The details of this forfeiture are summarized in the decision of the appellate panel:
At the conclusion of the resentencing hearing, Nacchio's attorney inquired whether the district court would “direct that the [forfeited] money go to a fund . . . set up for distribution to [Nacchio's] victims.” J.A. 494-95. In response, the prosecutor advised the court that “the Government's intention is for . . . the forfeiture funds[ ] to be used to compensate victims,” but that the decision would be made by the Asset Forfeiture and Money Laundering Section (“AFMLS”) in Washington pursuant to its regulations. Id.
In January 2011, Nacchio entered into a settlement of a concurrent action against him by the Securities and Exchange Commission. The settlement required that Nacchio disgorge the sum of $44,632,464, less any amounts forfeited and paid to the United States by Nacchio in connection with his criminal case. Nacchio's criminal forfeiture thus satisfied his disgorgement obligation in the SEC civil action. Nacchio's forfeited gain was subject to remission, pursuant to 18 U.S.C. § 981(e)(6). Thus, in September of 2011, the remission administrator retained by the Department of Justice ("DOJ") notified prior participants in private securities class action litigation or SEC civil litigation concerning Qwest stock that they were eligible to receive a remission from Nacchio's forfeiture. J.A. 508. In April of 2012, the Chief of the AFMLS authorized remission of the forfeited funds to eligible victims of Nacchio's fraud. J.A. 251-54.
The Court of Federal Claims had found that this payment did not constitute a fine or similar penalty paid to a government agency for which a deduction is barred by IRC §165(f) but rather a repayment to victims and thus was deductible using the logic in Stephens v. Commissioner, 905 F.2d 667, 671 (2d Cir. 1990). As well, the Court also found he had reasonably believed he had an unrestricted right to the funds, thus allowing him to electively claim a credit (in this case of $17,999,030) in lieu of a deduction in the year of repayment pursuant to IRC §1341.
The government appealed, arguing both that his repayment represented a fine paid to the government, not a repayment directly to victims and, as well, his criminal conviction in the insider trader case meant he was blocked from claiming that he reasonably believed he legally had the unrestricted use of the funds, a key component of being able to claim a credit under IRC §1341.
Under IRC §1341:
So to qualify for this credit the taxpayer would have to show he received income for which it appeared he had an unrestricted right to in a prior year and that the current year’s repayment would give rise to a deduction if the taxpayer decided not to elect to take the credit under IRC §1341. The Court of Appeals panel agreed with the IRS that the taxpayer did not meet either criteria.
In fact, the Court questioned a more basic point—although the IRS had conceded that the loss would be deductible under IRC §165(c)(2) if not blocked the fine or penalty rule of IRC §165(f), the panel questioned that concession, noting:
To begin with, it is questionable whether § 165(c)(2) is even applicable where, as here, the "loss" sustained arose from a mandatory forfeiture of profit pursuant to a criminal conviction. Instead, the "losses" that § 165(c)(2) generally seems to contemplate are losses in the value of assets purchased for investment that failed to bear fruit. See, e.g., Nathel v. Comm'r, 615 F.3d 83, 94 (2d Cir. 2010)(involving deductibility of capital contributions allegedly made to obtain releases from loan guarantees); Chen v. Comm'r, No. 12982-12S, 2014 Tax Ct. Summary LEXIS 6,at *11 (T.C. 2014) (involving deductibility of allegedly abandoned investment property); Seed v. Comm'r, 52 T.C. 880, 884-85 (1969) (involving deductibility of financial contributions to an abandoned venture).
In any event, the government conceded before the Court of Federal Claims that Nacchio's forfeiture was a "loss" under § 165(c)(2), and we do not revisit that question on appeal. Nacchio, 115 Fed. Cl. At 201.
So the Court moved on to the question of whether the payment was in the nature of a fine or if the taxpayer reasonably believed he had unrestricted use of the funds.
Looking at the statute under which the taxpayer was convicted and under which he paid back the proceeds, the panel found that Congress intended the payment to be made with after-tax dollars, just his fine. The Court notes:
First, the plain language of the statutory provision under which the amount Nacchio forfeited was calculated supports the view that Congress intended the forfeiture to be paid with after-tax dollars. The Tenth Circuit held on remand that Nacchio's forfeiture should be calculated in accordance with § 981(a)(2)(B), not § 981(a)(2)(A). Nacchio, 573 F.3d at 1090. Section 981(a)(2)(B) states that:
[T]he term "proceeds" means the amount of money acquired through the illegal transactions resulting in the forfeiture, less the direct costs incurred in providing the goods or services. . . . The direct costs shall not include . . . any part of the income taxes paid by the entity.
18 U.S.C. § 981(a)(2)(B) (emphases added). Thus, the language of the statute suggests that -- by design -- the forfeiture amount does not account for taxes paid on the amount of money acquired through the illegal transactions.
As well, the Court found that the Treasury regulation governing this provision would also treat this payment as a fine:
Next, Treasury Regulation § 1.162-21(b)(1) defines "fine or similar penalty" for the purposes of § 162(f) as including, inter alia, "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." 26 C.F.R. § 1.162-21. In Colt Industries, Inc. v. United States, we looked to the Treasury Regulation's definition of a "fine or similar penalty" in denying deductions a taxpayer sought under § 162(a) for civil penalties it had paid to the state for violations of the Clean Water Act and the Clean Air Act. 880 F.2d 1311, 1313 (Fed. Cir. 1989) ("If there were any doubt about the meaning of the phrase 'fine or similar penalty', it is readily removed by reference to Treasury regulations promulgated in interpretation of the provision.").
Similarly, in this case, Nacchio's criminal forfeiture meets the definition of a "fine or similar penalty" under Treasury Regulation § 1.162-21(b)(1). Nacchio's criminal forfeiture was imposed pursuant to 18 U.S.C. § 981(a)(1)(C) and 28 U.S.C. § 2461(c), as part of his sentence in a criminal case. Section 981(a)(1)(C), as amended by the Civil Asset Forfeiture Reform Act of 2000, Pub. L. No. 106-185, § 20, 114 Stat. 202, 224, authorizes the forfeiture of "proceeds" traceable to numerous felony offenses, including any offense constituting "specified unlawful activity" as defined by 18 U.S.C. § 1956(c)(7)(A). Section 1956(c)(7)(A), in turn, defines "specified unlawful activity" as any act or activity constituting an offense under 18 U.S.C. § 1961(1)(D), which includes "any offense involving . . . fraud in the sale of securities."
But the taxpayer argues that the Stephens decision points out that all repayments in a criminal matter should be treated as a nondeductible fine. But the Appeals panel found that Stephens can be distinguished. In Stephens the payment was made directly back to the affected party as part of the agreement for his partially suspended sentence and that the court specifically set the restitution amount at $0 under the statute because, having already restored the victim, the restitution provision was inapplicable.
In this case the payment was made under the restitution provision and, while the government had indicated it planned to attempt to return these funds to victims, the Court notes the government was under no obligation to do so. As the Court holds:
The Attorney General's post-hoc decision to use the forfeited funds for remission did not transform the character of the forfeiture so that it was no longer a "fine or similar penalty" under § 162(f). The decision to use the forfeited funds to compensate the victims was discretionary. Section 981(e) authorizes the Attorney General to "retain property forfeited pursuant to this section, or to transfer such property on such terms and conditions as he may determine" "(6) as restoration to any victim of the offense giving rise to the forfeiture." 18 U.S.C. § 981 (emphases added). In addition, 21 U.S.C. § 853(i), which describes criminal forfeiture procedures applicable to § 2461(c), empowers the Attorney General to "grant petitions for . . . remission of forfeiture . . . or take any other action to protect the rights of innocent persons" with respect to forfeited property. 21 U.S.C. § 853(i) …
Allowing Nacchio to deduct his forfeiture because the AFMLS decided to distribute it to victims through remission would mean that whether two people convicted of the same crimes could deduct their criminal forfeiture would turn not on their actions, or the statutes governing their sentencings, but on the after-the-fact discretionary decisions of a third party. This is not the law. Instead, "[t]he characterization of a payment for purposes of § 162(f) turns on the origin of the liability giving rise to it." Bailey v. Comm'r, 756 F.2d 44, 47 (6th Cir. 1985) (citing Middle Atl. Distribs. v. Comm'r, 72 T.C. 1136, 1145 (1979); Uhlenbrock v. Comm'r, 67 T.C. 818, 823 (1977)). We think Congress could not have intended to create a scheme in which the applicability of § 162(f) would depend upon how the government, in its discretion, later decided to use the funds generated by a fine or similar penalty.
Having found that no deduction is allowed for this repayment, the Court declined to rule on the question of whether the taxpayer was blocked from claiming he believed he had unrestricted use of the funds due to his criminal conviction, since it was no longer a relevant issue—the available credit is zero because the taxpayer fails to meet the basic condition imposed by IRC §1341(a).