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Tax Treatment of Fines and Penalties
Abraham N.M. Shashy Jr. And Nathan E. Clukey, King & Spalding
Examples of jaw-dropping fines and penalties for corporate wrongdoing abound in the recent press. They include reports that JPMorgan Chase has agreed to settle multiple actions for a record $13 billion.
Rarely mentioned in these accounts is the tax treatment of the fines and penalties, but the amounts can be huge, potentially 35 percent of the total settlement or judgment. When faced with allegations of impropriety, corporate counsel must not only weigh the risks of litigation, but also determine early on whether any portion of a possible settlement might be deductible.
Internal Revenue Code section 162(a) permits businesses to deduct certain everyday expenses, deemed “ordinary and necessary.” Other sections define disfavored expenses. Section 162(f) provides that “no deduction shall be allowed for any fine or similar penalty paid to the government for the violation of any law,” reflecting the wish of Congress that payments in connection with alleged wrongdoing shouldn’t receive what is essentially a taxpayer funded discount.
The authors advise that both the payment and the statute at issue be analyzed to determine whether the payment is truly a “fine” or a “similar penalty.” Courts often ignore the label attached to any given payment, meaning that even if the parties have called a particular settlement payment a fine or penalty, that alone doesn’t make it non-deductible.
The authors list factors that courts consider in making the tax determination and suggest negotiating settlements with those factors in mind.