Sued by customer

[cathe]

I have a client who was sued by a customer for fraud. He was in construction, own business, and she did not like the way he was doing the job, and not happy with the time it took. She took him to court for fraud and won. My client is now asking me if he can deduct the payment he had to make to her. Because of this incident, which was early last year, he had no income in his business and closed it immediatley. He basically has no business showing on this year's return. I am having a hard time finding if his payment to her is deductible as a business expense and where I would show it (Sch C or A) if it is.

Any help out there?

Cathe

[Black Bart]

Hard times

Yeah, I couldn't find anything on it either. Nothing on the Web seems to address it specifically.

The government just fined Boeing $500 million for civil fraud. Although the company decided to "do the right thing" (they aren't deducting it), their lawyers believed that it was deductible. Senator McCain reprimanded the Dep't. of Justice for not addressing this issue ("the possiblility of taxpayers subsidizing misconduct"). So anyway, on a big scale, it sounds as if the jury is still out on whether or not fraud can be deducted. As to whether the question would trickle all the way down to small clients; who knows?

The safest/best thing would be simply to send him on his way to a lawyer -- "I can't find anything on this situation. The law's unclear, this is my rush season, and I don't have time right now (quite true) to get into researching regulations on it" -- whatever it takes to make him go away. This kind of stuff is okay after 4-15, but right now you're trying to make your "volume" money -- it's the last thing you want to get into when you're running ninety to nothing on regular "no-unusual-problems" work.

If I did deduct it; I'd list it right out in plain sight on a C "other expenses" line as "civil fraud judgment" or something of the sort. While it seems like waving a red flag and screaming "AUDIT ME," chances are good it would sail right on through. I've seen taxpayers put the worst, most outrageous expenses ever claimed on a C and...nothing (one listed "car-$8,000" there and was never audited). The alternative is to "bury" it (Commissions and fees/Legal and professional services/etc.), but that kind of seems like fraud itself. If taking the shot; I'd do it so an auditor couldn't later say I was trying to sneak it by as a "legitimate" expense.

Still, I'd send him away if I could. Taxpayers' interests are important, but don't overlook your own either (you're a businessperson, not a crusader). He scammed the homeowner and should be prepared to pay a lawyer to soften the blow. They do taxes too and, besides, they'll write off almost anything without a second thought; thus avoiding a Supreme Court showdown and your involvement in it.

[dyne]

I believe this would come under the heading of penalties and fines, page 8-8 of
the TaxBook. IRC 162(f). Not deductible.

[Black Bart]

Maybe so,

Not deductible.

but those Boeing tax attorneys must have had some basis for advising the company to argue the deductibility of taxes on the $500 million fine (assuming their only cut would be a share of the proceeds contingent on their success).

[jainen]

taxpayer subsidies

>>Because of this incident, which was early last year, he had no income in his business and closed it immediatley<<

Are you saying the ONLY activity of his so-called business was fraud? Well, no question about the profit motive but did he commit fraud in a regular and on-going manner? Restitution is certainly necessary, but is it an ordinary expense? Was the judgment against him personally or against the business entity--would the owner have been liable if an employee had committed such fraud?

He needs to take responsibility for his own misdeeds and not ask for taxpayer subsidies.

[Luis Mopeo]

Nobody has any idea how to treat this payment.

"The payment he had to make" gives zero information about what the payment was for.

Was the payment a fine? Was the payment for punitive damages? Was the payment a refund for amounts already paid? Combination?

Don't make assumptions. The payment wasn't for "fraud." Find out what the judgement was for.

[GIMoe]

Good point

Nobody has any idea how to treat this payment.

"The payment he had to make" gives zero information about what the payment was for.

Was the payment a fine? Was the payment for punitive damages? Was the payment a refund for amounts already paid? Combination?

Don't make assumptions. The payment wasn't for "fraud." Find out what the judgement was for.

That's a very good point. You really should find out what the judgement was for. It's very likely that it was a combination payment which would most likely included a refund of any monies paid by the customer. I would think that at the very least the TP would be able to deduct the portion that was a refund.

[jainen]

Don't make assumptions.

>>Don't make assumptions. The payment wasn't for "fraud."<<

Well, of course we can't assume for sure that the original post was an accurate statement of reality. But we can at least respond to the scenario in that post, which was, "She took him to court for fraud and won."

[Snaggletooth]

Litigious Society

No one has raised this question yet.

At what point in our litgious society do legal awards become so commonplace that they can no longer be denied "ordinary and necessary" business expenses?

Same argument for tax penalties. If I wanted to defend the deductibility of a penalty, I would do the following:

1) Show that the penalty is too routine to be considered a whipping of the taxpayer. IRS readily admits that they cannot remove certain penalties and they are "automatic" in nature.

2) Show that the taxing authority depends on penalty revenue as an integral part of their operating budgets, not as a "bonanza" when a taxpayer has been errant.

3) In our politically correct world, document that no tax agents are treating the taxpayer as a derelict to be chastised with a penalty. Instead, demonstrate that the agent is mollycoddling the taxpayer by referring to the penalty as just another part of what happens sometimes in the tax structure.

I submit that many items less worthy to be considered "ordinary and necessary" are not questioned, when in reality are weaker than legal awards and penalties.

[veritas]

This is a civil suit

not a government imposed fine or penalty. I'm going with deduct it as a business expense. I agree with BB on identifying it as a judgement on the sch c.

[jainen]

checking for predators

>>the penalty is too routine<<

That's a great point, Snaggletooth. Not too long ago I got a little traffic ticket that was TOTALLY unfair. (You can just imagine what a law-abiding citizen I am.) Well, my insurance agent wupped me in the head and said, "Don't you DARE contest it--you pay the fine and go to traffic school so it doesn't show up in this office." Of course she was right. Whether I had done anything was totally irrelevant. It's a cost of doing business.

And there is a whole industry of bogus-harassment suits. Civil rights, environmental whatsit, soft-tissue injury--all the fuzzy politically correct jargon that science can't disprove. It's like a protection racket, and the cheapest way through it is to pay the bribes.

Still, I don't think it will ever be deductible. Pass the cost on to customers as higher prices or workers as lower wages, but don't ask for a government handout just because you weren't checking for predators around every corner.

[veritas]

You are tough

The question is, is the expense ordinary and necessary.


Here is an excerpt from senate debate of the 1913 income tax code. Senator Smith:

"[T]he object of this bill is to tax a man's net income; that is to say, what he has at the end of the year after deducting from his receipts his expenditures or losses. It is not to reform men's moral characters; that is not the object of the bill at all. The tax is not levied for the purpose of restraining people from betting on horse races or upon 'futures,' but the tax is framed for the purpose of making a man pay upon his net income, his actual profit during the year. The law does not care where he got it from, so far as the tax is concerned, although the law may very properly care in another way." 50 Cong. Rec. 3849. 9

[Black Bart]

Mr. Smith Goes To Washington

...senate debate of the 1913 income tax code. Senator Smith:

The law does not care where he got it from, so far as the tax is concerned, although the law may very properly care in another way." 50 Cong. Rec. 3849. 9

Great quote, Veritas.