Taxpayers often settle claims made by a government that they have engaged in potentially criminal conduct. When such a claim, or, indeed, any claim made by a government under a statute imposing monetary sanctions with a clearly punitive component, is settled, the issue arises whether the full amount of the settlement payment can be deducted for income tax purposes, or whether deduction of all or part of the amount paid in settlement is precluded by the prohibition in Internal Revenue Code (IRC) §162(f) against deducting “any fine or similar penalty paid to a government for the violation of any law.”
Regulations under §162(f) lay out the conceptual groundwork for resolving this question by distinguishing between two types of payments—payments made in settlement of the taxpayer’s actual or potential liability for a fine or penalty, whether civil or criminal, which are not deductible, and payments of compensatory amounts such as actual damages in an antitrust case, which may be deducted.1 Courts have generally determined whether payment of a civil liability is deductible by reference to the purpose or purposes indicated by the statute that is the source of the liability.2
