On January 7, 2014, JPMorgan entered
into a deferred prosecution agreement with the Justice Department. This is
another payment in the ongoing Bernie Madoff saga, and the bank agreed to pay a
$1.7 billion settlement as well as $350 million to the Office of the
Comptroller of the Currency and $543 million to a court-appointed trustee.
Madoff kept significant balances with
JPMorgan. Banks are the first line of
defense against fraud, but JPMorgan never filed suspicious activity reports
with regulators, even though there were significant reservations as to when
they became suspicious. The bank did not admit any criminal activity in the
agreement, but it did allow that it missed red flags from the late 1990s to
late 2000s.
What caught my eye was the following
text from the following joint release by the Manhattan U.S. Attorney and FBI:
… JPMorgan agrees to pay a non-tax deductible penalty of $1.7
billion, in the form of a civil forfeiture, which the Government intends….”
This is unusual language.
The tax code provides a tax deduction
for all of the ordinary and necessary expenses paid or incurred during the
taxable year in carrying on any trade or business.
And then the tax Code starts taking
back. One take back is Section 162(f):
162(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.
Let’s drill down a little bit into
the Regulations:
This prohibition applies to any fines paid by a taxpayer because
the taxpayer has been convicted of a crime (felony or misdemeanor) in a full
criminal proceeding in an appropriate court. The
prohibition also extends to civil fines if the fines are intended by Congress
as punitive in nature.
So, if fines are paid pursuant to a
criminal case, then the taxpayer is hosed. However, if fines are paid pursuant
to a civil case, there is one more step: are the fines punitive in nature?
Attorneys differentiate damages
between those that are remedial and
those that are punitive. A remedial
payment is intended to compensate the government or another party – to “make one
whole,” if you will. It is intended to restore what was disturbed, upset or
lost, and not intended as penalty or lashing against the payer.
Let’s complicate it bit. There is a
court case (Talley Industries Inc v
Commissioner) that allows damages to be deductible if they are remedial in
intent, even if labeled as a fine or
penalty.
EXAMPLE: The NFL fines a player for unnecessary roughness.
The NFL can call this a fine, but it is not a fine per Section 162(f) and will
be deductible to the player involved.
You are seeing how this is fertile
hunting ground for tax lawyers. Unless the payment is pursuant to a criminal
case, odds are good that it is deductible.
Now remember that this agreement is
Madoff related, and that there are hard feelings about JPMorgan’s involvement
with Madoff over the years, and you can see why the Justice Department included
the “nondeductible” language in the agreement.
Let’s take this a step further. Under
Talley, JPMorgan could deduct the $1.7
billion on its tax return. Remember, it is not a fine or penalty under Sec
162(f) just because somebody somewhere called it as such.
Would JPMorgan be likely to do this?
This is a “deferred prosecution”
agreement. If JPMorgan did deduct the
settlement, they might not have an issue with the IRS, but they would likely have
a very sizeable issue with the Justice Department.
