Payments that a business makes are generally deductible if they are “ordinary and necessary” under Internal Revenue Service regulations unless, that is, they are specifically denied deductibility.

Fines and penalties paid to a government for violation of a law are nondeductible under Reg. section 1.162-21(b)(1).

In a case decided last Friday by the U.S. Court of Appeals for the Federal Circuit, former Qwest CEO Joseph Nacchio was denied a deduction for $45 million in trading profits he was ordered to forfeit to the government following his conviction for insider trading. The IRS opposed the deduction, contending that the forfeiture payment was a nondeductible penalty or fine.

The Court of Federal Claims held that Nacchio may deduct his forfeiture payment under the loss provision of Section 165 but not under Section 162. The Federal Circuit reversed, finding that Nacchio failed to establish that his criminal forfeiture was not a “fine or similar penalty.” The forfeiture was nondeductible under both Sections 165 and 162, the court held. And since establishing deductibility under another section of the Tax Code is a prerequisite to pursuing special tax relief under section 1341, Nacchio cannot pursue a deduction under that section.

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