Between the years of 1993 and 1997, whistle blowers brought forth ten cases accusing medical groups of conspiring to defraud Medicare. Normally, a case like this doesn’t grab my attention; however, as a Florida tax attorney, this medical case caught my eye. I was not interested in whether the claims were false, if the medical companies scammed Medicare, or what other potentially unprofessional practices the group engaged in. Rather, from a tax perspective, I was curious if the settlement payment was tax deductible.
Section 162, Internal Revenue Code (“I.R.C.”) allows a deduction for expenses of a business that are necessary and ordinary. Generally, a settlement claim paid by a business can be properly deducted on its federal tax return. See, Comm’r v. Pacific Mills, 207 F. 2d 177, 180 (1st Cir. 1953). However, under section 162(f), I.R.C., if an expense or payment is a fine or similar payment paid to the government, then the expense is not deductible. This makes sense in that the IRS does not want to grant tax incentives to companies for paying fines and the like. Thus, the question in this case is whether a settlement relating to Medicare fraud is a fine or similar payment.
Looking to the Treasury Regulations for guidance, the court determined that a fine or similar penalty is “a civil penalty imposed by Federal, State, or local law.” As many Florida doctors and those nationwide know, under the FCA, a company can be fined $5000-$10,000 and get hammered by 3 times the damages incurred by the government. Reading the first part as a fine and the second part (the 3 times damages provision) as compensatory, the court determined that this payment was compensatory and remedial, not punitive.
Next, the court looked to whether the settlement of a potential liability changed the analysis. In other words, if a business stands to pay a fine and compensatory damages and elects to settle the case, how much of the settlement is punitive and how much is compensatory? In order to determine the split, the court looked to the settlement agreement itself as well as other evidence of intent between the parties. Interestingly, the agreement stated that none of the payments were punitive. Ultimately, the court determined that the agreement was unclear whether the payments were remedial or punitive in nature based on the agreement. Further, relying on the non-contractual evidence, the court determined an issue of fact remained for trial. At trial, the jury determined it was a hybrid of both.
This case serves as a reminder to all professionals, not just tax professionals, that, when settling a case, be sure that your business or your client’s business try to get as much evidence forward to show the compensatory nature of a settlement. In addition, professionals should be aware of potentially ambiguous federal statutes that may create compensatory liability rather than punitive. This can be critical in serving your client to make sure that, if a settlement is paid, at least the business will get a tax deduction.
About the author: Mr. Donnini is a multi-state sales and use tax attorney and an associate in the law firm Moffa, Gainor, & Sutton, PA, based in Fort Lauderdale, Florida. Mr. Donnini’s primary practice is multi-state sales and use tax as well as state corporate income tax controversy. Mr. Donnini also practices in the areas of federal tax controversy, federal estate planning, Florida probate, and all other state taxes including communication service tax, cigarette & tobacco tax, motor fuel tax, and Native American taxation. Mr. Donnini is currently pursuing his LL.M. in Taxation at NYU. If you have any questions please do not hesitate to contact him via email or phone listed on this page.