A District Court in Virginia recently ruled in Altria Group, Incorporated v. United States (2022 U.S. Dist. LEXIS 10612) that the portion of punitive damages that the defendant paid that were redirected to the state of Oregon were deductible business expenses under Section 162.
The taxpayer in Altria initially received an unfavorable judgment and assessment for punitive damages in a wrongful death case brought by the estate of an Oregon resident. At the time, Oregon’s split-recovery statute was in effect, which allowed the state to take 60% of all punitive damages awarded to the prevailing party (in this case, the estate of an Oregon resident). As described in the case, the intention of the split-recovery statute generally was to eliminate a perceived windfall while maintaining a deterrent effect by redistributing a portion of the award to the state for a fund providing assistance to victims of crime. The taxpayer timely deducted the total cost of the punitive damages paid on its 2012 tax return—both the amount to the prevailing party and the amount redistributed to Oregon. The IRS disallowed the portion paid to Oregon, citing Section 162(f), and assessed tax and penalties. The taxpayer received a subsequent denial of refund request, resulting in the present case.
Section 162(f), as enacted during the year at issue, generally states that no deduction is allowable for any fine or similar penalty paid to a government for the violation of any law. As the parties stipulated that the amount in question was paid to a government, the crux of the case relied on whether this amount was a fine or similar penalty for the violation of any law. The court fixated on the origin of the liability for payment to Oregon.
The court concluded that the origin of the liability was the split-recovery statute—which merely made Oregon a judgment creditor—instead of the initial wrongful death case. Further, the court highlighted that without the split-recovery statute, the entire amount of the punitive damages would have gone to the prevailing party. Similarly, the court concluded that the split-recovery statute does not include a violation of law element and the factual basis of the underlying litigation has no bearing on the statute—thus, the amount paid to Oregon was not a fine or similar penalty paid to the government for the violation of any law. After this analysis, the court concluded, the full payment of punitive damages was deductible under Section 162.
The court additionally opined that if it were to consider this matter while reviewing the current version of Section 162—after the 2017 Tax Cuts and Jobs Act (Pub. L. No. 115-97)—the same conclusion would apply.
Sharon Kay is the National Managing Partner of Grant Thornton LLP's Washington National Tax Office. Sharon has over 25 years of tax experience and primarily advises clients on federal income tax issues such as accounting method changes, income and expense recognition, inventories, tangible and intangible asset capitalization and recovery, and certain business credits.
Washington DC, Washington DC
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