One of the issues addressed in DPAs and NPAs is the monetary consideration imposed on the offending party. Such monetary consideration might be in lieu of fines, restitution or forfeiture that the offending party might owe of suffer if convicted of the crime. The question that arises is whether these payments may be deductible.
For deductibility, the usual authority invoked is Section 162, which permits deductions for "ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business." Section 162(f) provides that: "No deduction shall be allowed under subsection (a) for any fine or similar penalty paid to a government for the violation of any law." By contrast, depending on the origin of the claim, restitution is not subject to this prohibition and may be deductible if the origin of the claim arises from the party's trade or business.
In LTR 201513003, here, the IRS addressed the question of whether payments in lieu of forfeiture under a DPA are deductible. In relevant part, the LTR reasons and concludes:
The deferred prosecution agreement (DPA) states that the taxpayer has violated several criminal statutes and provides for a forfeiture payment in lieu of proceedings that would result in criminal and/or civil forfeiture under 18 U.S.C. sections 981 and 982 and 28 U.S.C. section 2461(c). The DPA is a settlement for purposes of the regulation as it is an agreement between the taxpayer and the government that resolves all issues associated with the taxpayer's criminal conduct in exchange for certain consideration outlined in the DPA, including a payment in lieu of forfeiture. It is the Service's longstanding position that a monetary forfeiture under the U.S.C. sections the taxpayer violated, as well as the sections referenced above, is a civil or criminal fine or penalty for purposes of the regulation. As such, the money paid in lieu of forfeiture pursuant to the DPA resolves the taxpayer's actual or potential liability for a civil or criminal fine or penalty and is not deductible under section 162.
The taxpayer argues that Treas. Reg. sections 1.162-21(b)(1) and (2) do not prohibit it from deducting the forfeiture payment because (1) it has not pled guilty or nolo contendere in any court proceeding and (2) the forfeiture payment is earmarked for restitution to the victims of the fraud. The first argument requiring a plea of guilty or nolo contendere has no merit, as a settlement of the taxpayer's actual or potential liability is included under section 1.162-21(b)(1)(iii). Likewise, the taxpayer's second argument that the forfeited funds will be used to compensate victims has no merit, as the DPA specifically states that the payment is in lieu of criminal and/or civil forfeiture. The DPA is a negotiated settlement between the government and the taxpayer that specifically requires a forfeiture payment rather than requiring that part or all of the payment be allocated as restitution. The Department of Justice has the authority to use forfeited funds at its discretion for various uses including payment to victims. DoJ's stated intention for the use of the funds does not change the character of the payment from a non-deductible forfeiture to a potentially deductible restitution payment.Of course, this is just the IRS's informal conclusion. I suspect that the actual taxpayer involved will try to get a more favorable resolution.
Now, focusing back on the payments made by the Category 2 banks under the DOJ program, those banks will in many -- perhaps most -- cases not be concerned with U.S. tax deductions for the payments. In any event, if they were, the payments are simply described as a penalty without further elaboration. Since, however, the payment is made to resolve potential criminal exposure (as evidenced by the relevant agreement being a "nonprosecution" agreement), I suspect that the IRS would tkae the position that Section 162(h) applies if it were otherwise applicable.