A federal court may allow the convicted former chief of a telecommunications company to deduct more than $44 million from his taxes after he was forced to forfeit the amount of stock gains he realized from insider trading.

Joseph Nacchio, the former CEO of Qwest Communications International, Inc., was convicted of insider trading in 2007. He was sentenced to 70 months in prison and required to forfeit $44,632,464 in the net gain he derived from the insider trading and a $19 million fine. Nacchio amended his tax return, claiming a deduction for the amount forfeited and a refund for $17,974,832, the amount of taxes he paid on the forfeited gain.

The Court of Federal Claims granted partial summary judgment to Nacchio last week, ruling that he could deduct the $44.6 million he forfeited. Although the Internal Revenue Service did not dispute that the forfeiture is a loss under section 165 of the Tax Code, it contended that the forfeiture is not deductible because the deduction would contravene public policy by reducing the sting of the forfeiture penalty.

Judge Mary Ellen Coster Williams, quoting the Supreme Court in the 1966 case Commissioner v. Tellier, said “the federal income tax is a tax on net income, not a sanction against wronging.” In Nacchio’s case, she said, “There is no reason to compound Mr. Nacchio’s criminal punishment with a tax burden Congress has neither expressly nor impliedly directed.”

“Disallowing the deduction,” she reasoned, “would result in a ‘double sting’ by requiring the taxpayers to both make restitution and pay taxes on income they did not retain. In sum, the public policy against insider trading does not prevent the deduction of the amount forfeited here as a loss under section 165.”

However, to qualify for a tax refund under U.S.C. section 1341, Nacchio must establish both that he believed he had a claim of right to the gain included in his return, and that he was entitled to deduct the amount forfeited. Judge Williams declined to grant summary judgment on the issue since whether Nacchio believed he had a claim of a right to the trading proceeds is a genuine issue of material fact that cannot be resolved on summary judgment.

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