Tax Court in Brief | Ziroli v. Commissioner | Is a Disgorgement Payment a Deductible Business Expense under Section 162?

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Tax Litigation:  The Week of July 11th, 2022, through July 15th, 2022

Ziroli v. Comm’r, T.C. Memo. 2022-75 | July 14, 2022 | Nega, J. | Dkt. No. 1041-20


Short SummaryThis case regards deficiencies determined for Clement and Dawn Ziroli (Zirolis) for adjustments regarding “Other Gains or Losses from Form 4797 – Disgorgement” for taxable year 2016. Specifically, the case focuses on whether the disgorgement of payment to the U.S. Securities and Exchange Commission by Mr. Ziroli constitutes a “fine or similar penalty” within the meaning of section 162(f) of the Code. Mr. Ziroli reached a settlement with the SEC on a federal securities violation. In an underlying Consent with the SEC, Mr. Ziroli made various concessions with respect to the alleged securities violations, which included orders of disgorgement of funds. The Consent also stated that Mr. Ziroli “further agrees that he shall not claim, assert, or apply for a tax deduction or tax credit with regard to any federal, state, or local tax for any penalty amounts that Defendant [Mr. Ziroli] pays pursuant to the Final Judgment, regardless of whether such penalty amounts or any part thereof are added to the distribution fund or otherwise used for the benefit of investors.” Mr. Ziroli paid the disgorgement and related amounts ordered in the SEC proceeding. Then, the Zirolis filed a Form 1040, U.S. Individual Income Tax Return, for the 2016 taxable year, claiming a deduction of $411,422 for “Other gains or (losses).” They attached a Form 4797, Sales of Business Property, reporting that the claimed loss deduction was for the disgorgement portion of the amount Mr. Ziroli paid to the SEC.  The IRS determined that the Zirolis were not entitled to a deduction for the disgorgement.

Key Issues

Primary Holdings:

Key Points of Law:

Insights: The Zirolis had the burden of proving that the disgorgement paid to the SEC was not a “fine or similar penalty” within the meaning of section 162(f). They failed to do so. Disgorgement can serve both a compensatory and a punitive purpose, and the Zirolis failed to show that the disgorgement they paid was compensatory only. Note: The IRS has recently promulgated and adopted new rules addressing the deductibility of disgorgement under section 162. See Treas. Reg. § 1.162-21(e)(4)(B) (as amended by T.D. 9946, 86 Fed. Reg. 4970, 4984 (Jan. 19, 2021)). Those rules apply to taxable years beginning on or after January 19, 2021 (unless paid or incurred under any order or agreement pursuant to a suit, agreement, or otherwise, which became binding under applicable law before such date).