In a recent decision by the United States Court of Appeals for
the Internal Revenue Service ("IRS") the Court ruled that
payments by a New Jersey physician to an insurance company to
settle a civil suit for insurance fraud and to two undisclosed
governmental entities in exchange for dismissal of criminal
insurance fraud charges were deductible for federal income taxes as
nonbusiness deductions. This means that the physician can deduct
the amount paid on the physician's individual income tax return
in the year of payment, but that the deduction will be limited
based on the physician's adjusted gross income for that
In reaching its conclusion, the IRS found that the loss was not
deductible as a business expense since fines or similar penalties
for the violation of any law are not deductible under this tax
provision. However, the payments can be deducted as a nonbusiness
expense under a separate tax provision, which allows a deduction
for any sustained loss that is not compensated by insurance or
otherwise. In support of its conclusion, the IRS relied on its
prior ruling that payments made by a convicted arsonist for the
repayment to the insuror of insurance proceeds received as a result
of the arson were deductible as a nonbusiness expense if the
arsonist included the insurance payments in income when they were
received. Thus, payments in the nature of restitution to the payor
of improperly received payments that had previously been included
in income of the payee are deductible under this tax provision.
The IRS found that the physician's payments to the insurance
company were in the nature of restitution since as a result of the
settlement payment, the insurance company dismissed its civil case
for insurance fraud and released its claims for restitution in the
pending criminal action. In resolution of the criminal charges, one
of the physician's practice entities pled guilty and the
physician agreed to pay an undisclosed amount to the two
governmental entities. The deductibility of the payments by the
physician to the governmental entities was a much closer question;
as a matter of public policy, payments to a governmental entity as
a fine or penalty are not deductible. However, since in this
instance, the consent agreement (titled "Consent Order for
Restitution") recited that the purpose of the restitution
payments was to enable "the citizens of New Jersey and the
United States...[to] recognize significant recoupment of the
illgotten billings of the Company [the physician's practice
entity]", the IRS concluded the payments were intended to be
compensation to a governmental entity and thus deductible as
restitution payments. The lesson to be learned from this ruling is
that physicians and other healthcare providers that are required to
repay to a governmental agency or private payor amounts previously
received by them for improperly billed services should try and
characterize the repaid amounts as restitution so as to be tax
deductible. By contrast, if the payments are characterized as a
fine or penalty, the amounts paid will not be tax deductible.
The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.
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Information returns and payee statements subject to these penalties include Forms 1099, 1098, W-2, 1042-S, as well as the new Forms 1094-B, 1095-B, 1094-C, and 1095-C required under the Affordable Care Act.
Form 8938 (Statement of Foreign Financial Assets), introduced in 2011 as part of the Foreign Account Tax Compliance Act (FATCA), requires taxpayers to report their foreign assets, subject to minimum values, and indicate where the related income is picked up on their tax return.