The Internal Revenue Service has ruled that fines issued by the brokerage industry’s self-regulatory body, the Financial Industry Regulatory Authority, or FINRA, are not tax deductible.
The IRS Office of Chief Counsel issued a memorandum last Friday citing a number of legal cases to back up the opinion, including Guardian Industries Corp. v. Commissioner.
The IRS noted that Section 1.16 2 - 21(a) of the Income Tax Regulations provides that “no deduction shall be allowed under section 162(a) for any fine or similar penalty paid to: (1) The government of the United States, a State, a territory or possession of the United States, the District of Columbia, or the Commonwealth of Puerto Rico; (2) the government of a foreign country; or (3) a political subdivision of, or corporation or other entity serving as an agency or instrumentality of, any of the above.”
The Guardian Industries case involved a test for the meaning of the terms “agency” and “instrumentality,” and the IRS Chief Counsel memorandum used the test to determine that a self-regulatory organization such as FINRA qualified as such an agency.
It noted that the securities industry is generally regulated by a combination of direct regulation by the Securities and Exchange Commission and industry self-regulation with SEC oversight.
“Congress adopted this oversight framework to prevent excessive government involvement in market operations, which could hinder competition and market innovation,” said the IRS. “Also, Congress concluded that self-regulation with federal oversight would be more efficient and less costly to taxpayers. Under this system, privately funded nongovernmental entities, commonly referred to as self - regulatory organizations (SRO), such as national securities exchanges and associations, perform much of the day-to-day oversight of the securities markets and broker-dealers under their jurisdiction. SROs are primarily responsible for establishing standards under which members conduct business; monitoring how that business is conducted; and bringing disciplinary actions against members for violating applicable federal statutes, SEC rules, and SRO rules.”
The IRS pointed out that the SEC oversees SROs such as FINRA to ensure they carry out their regulatory responsibilities. The IRS Chief Counsel memorandum rejected the arguments used to justify why FINRA fines should be considered tax-deductible. “Although there is no case law squarely on point, the Guardian Industries test has been established as binding precedent in the Tax Court, and in non-tax cases the quasi-governmental role of SROs for securities law purposes is well-established…”
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