Deductibility of Illegal Payments, Fines, and Penalties (Portfolio 524)

Tax Management Portfolio, No. 524, Deductibility of Illegal Payments, Fines, and Penalties, consists of two elements, broadly speaking.

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Tax Management Portfolio, No. 524, Deductibility of Illegal Payments, Fines, and Penalties, consists of two elements, broadly speaking.

In Parts I through VI, the Portfolio explores the requirements of §162(c) and (f), which specifically address the deductibility of bribes, kickbacks, other illegal payments, and fines and penalties. Broadly speaking, payments made to officials or employees of a foreign government are not deductible if the payments are unlawful under the Foreign Corrupt Practices Act of 1977. Payments made to officials or employees of any government other than a foreign government are not deductible if the payments constitute an illegal bribe or illegal kickback. Similarly, no deduction is allowed for any payment made to a person who is not an officer or employee of a government if the payment constitutes an illegal bribe, an illegal kickback, or other illegal payment under any law of the United States, or under any generally enforced law of a state, that subjects the payor to a criminal penalty or the loss of a license or privilege to engage in a trade or business. Deductions are also not allowed for any bribes, kickbacks, or rebates by any person who furnishes items or services for which payment is or may be made under Medicare, or in whole or in part out of federal funds under Medicaid, if such bribes, kickbacks, or rebates, are made in connection with the furnishing of such items or services or the making or receipt of such payments. Finally, deductions are disallowed for fines or similar penalties paid to a government for the violation of any law.

In Part VII, the Portfolio briefly describes the general requirements that are applicable to all expense deductions, including those for bribes, kickbacks, illegal payments, fines, and penalties. The Portfolio explores the meaning of “ordinary and necessary” under §162(a) (trade or business expenses) and §212 (investment or tax-related expenses). It also considers the extent to which expenditures must be capitalized, deducted as a loss, treated as cost of goods sold, or treated as something other than a currently deductible expense.

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Christopher G. Stoneman, B.A. (law), Cambridge University (1949); LL.B., University of Virginia (1957); M.A., New York University (1989); member, New York and Vermont Bars. Lecturer, Vermont Law School (1986–1995); fellow, American College of Trusts and Estates Counsel; author of several Portfolios in the estate planning field.

Thomas D. Sykes, B.A., magna cum laude, University of Wisconsin-Eau Claire (1976); J.D., The Ohio State University College of Law (1979); member, Illinois, District of Columbia, and Wisconsin Bars; Assistant United States Attorney, Western District of Wisconsin (Madison), U.S. Department of Justice, 1982-1984; Trial Attorney, Senior Trial Attorney, Reviewer, or Assistant Chief, Tax Division, U.S. Department of Justice, Washington, D.C., 1984-1998; partner, Scribner, Hall & Thompson LLP, Washington, D.C., 1998-2002; partner, McDermott Will & Emery LLP, Chicago, Illinois, 2002-2010; shareholder, Greenberg Traurig, LLP, Chicago, Illinois, 2010-; contributor to numerous legal and tax periodicals; revisor of 523 T.M., Deductibility of Legal and Other Professional Fees; 3850 T.M., Examination: Audits, Assessments, and Appeals (Tax Practice Series) 2005.


Detailed Analysis

I. Deductibility of Illegal Payments, Fines, and Penalties: Background and General Principles

II. Deductibility under § 162(c)(1) of Illegal Payments to Foreign and Non-Foreign Government Officials and Employees

Introductory Material

A. Illegal Payments to Foreign Government Officials or Employees

B. Illegal Bribes or Kickbacks to Government Officials or Employees Who Are Not Officials or Employees of a Foreign Government

III. Deductibility under § 162(c)(2) of Illegal Payments to Persons Other Than Government Officials or Employees

Introductory Material

A. The Requirement That the State Statute Be “Generally Enforced”

B. Violation of Federal Law under § 162(c)(2)

C. “Other Illegal Payment”: Payments Illegal in and of Themselves

D. Burden of Proof under § 162(c)(2)

IV. Deductibility under § 162(c)(3) of Kickbacks, Rebates, or Bribes under the Medicare or Medicaid System

V. Deductibility of Fines and Similar Penalties under § 162(f)

VI. The “All-Inclusiveness” of the Public Policy Considerations Set Out in § 162(c), (f) and (g)

A. Public Policy Considerations as Applicable to Deductions under § 165 and § 212

B. Public Policy Considerations as Applicable to Inclusions in Basis under § § 263A and 1012

C. Public Policy Considerations as Applicable to Exclusions from Gross Income

VII. Overview of General Requirements for an Expense Deduction

A. Introduction

B. Expense Deduction under § 162

1. Expense Must Be Incurred in Carrying on a Trade or Business

2. Expense Must Be Ordinary and Necessary

3. Expense Must Be Reasonable in Amount

4. Expense Must Be Paid or Incurred During Taxable Year

5. Expense Must Be Paid by Person to Whom Services Are Rendered

C. Expense Deduction under § 212

1. Introduction

2. Expense Paid or Incurred in Connection with the Production or Collection of Income

a. Production or Collection

b. Distinction between Disposition of Property and Collection of Income

c. Distinctions between Acquisition, Perfection of an Undefined Income Interest, and Collection of Income

d. Expense Incurred in Involuntary Dispositions

e. Treatment of Expense Where Sale Not Consummated

3. Expense Paid or Incurred in Connection with the Management, Conservation, or Maintenance of Property for the Production of Income

4. Expense Paid in Connection with the Determination, Collection, or Refund of Any Tax

D. Expense Must Not Be Personal Expense or Capital Expenditure

1. Personal Expense

2. Capital Expenditure

3. Origin-of-the-Claim Test

E. Allocation of Expenses That Are Partly Personal and Partly Capital


Working Papers

Table of Worksheets

Worksheet 1 Senate Report to the Tax Reform Act of 1969 (H.R. 13270), S. Rep. No. 552, 91st Cong., 1st Sess. p. 274 (1969), 1969-3 C.B. 596

Worksheet 2 Senate Report to The International Anti-Bribery Act of 1998, S. Rep. No. 277, 105th Cong., 2d Sess. (July 30, 1998)

Worksheet 3 Aerospace Industry Coordinated Issue Paper - Deductibility of Illegal Bribes, Kickbacks and Other Payments

Worksheet 4 Internal Revenue Manual (IRM), MSSP Training Guide

Worksheet 5 Field Service Advice 200128004

Worksheet 6 Technical Advice Memorandum 200502041

Worksheet 7 General Counsel Memorandum 38547

Worksheet 8 General Counsel Memorandum 39465 - Deductibility of Legal Fees Incurred by Corporation in Defending Its Employees Against Civil and Criminal Charges

Worksheet 9 General Counsel Memorandum 39596

Worksheet 10 Technical Advice Memorandum 200629030



Legislative History:

Treasury Rulings: