US District Court Rejects Talley and Permits a Business Expense Deduction for Part of Double Damages Payment Under the False Claims Act

In a taxpayer-favorable decision earlier this month, the US District Court for the District of Massachusetts, following a jury verdict, entered judgment for a corporation in a tax refund suit permitting a business deduction for payments made to the government to resolve potential liability under the False Claims Act (“FCA”) (31 U.S.C. §§ 3729-3733), and other statutory and common law causes of action. In Fresenius Medical Care Holdings, Inc. v. US, 2013 WL 1946216, Case No. 08-12118-DPW (D. Mass. May 9, 2013), Judge Douglas P. Woodlock upheld a jury verdict for Fresenius and awarded the taxpayer a refund of $50,420,512.00 plus interest. The award reflected the jury’s finding that the majority of double damages payments that the IRS claimed were punitive and therefore ineligible for a deduction as ordinary and necessary under Internal Revenue Code § 162(a) were, in fact, compensatory and therefore deductible. In permitting the case to proceed to trial, the district court rejected the test to determine if payments constitute compensatory damages set forth in Talley Indus., Inc. v. Commissioner, T.C. Memo 1999-200, aff’d 18 F. App’x 661 (9th Cir. 2001), and allowed Fresenius to present evidence beyond the terms of the settlement agreements to determine if all or some of the payments were made in settlement of non-punitive FCA liability.

Plaintiff Fresenius filed a tax refund suit against the United States in 2008 seeking recovery of $126 million of a $385 million payment to the government as part of a civil settlement, which resolved Fresenius’ potential liability under the FCA. Fresenius claimed that the entire settlement amount was tax deductible as an ordinary and necessary business expense under Internal Revenue Code § 162(a). The IRS had agreed that $258 million was deductible as compensatory but viewed the remaining $126 million at issue as a penalty ineligible for deduction under Code Section 162(f). Section 162(f) of the Code prohibits taxpayers from deducting settlement payments made to pay “a fine or similar penalty.”