Tax Research of Section 165

Research Project

Section 165 of the Internal Revenue Code states that the losses incurred in a trade or business should be allowed as a deduction during the taxable year. However, under section 162(f) of the code, since the deduction is disallowed for any fine or penalty paid to the government, the individual’s criminal forfeiture is not compensatory. Also, section 1341 of the code allows the deduction to taxpayers who had a gross income in a prior year under the claim of right and were required to return in another year. The special relief, however, is established under a prerequisite that a deduction is confirmed elsewhere in the tax code. Hence, Mr. Wesley may not deduct his forfeiture from the insider trading gain under section 165. Since the forfeiture was required as part of the sentence imposed on him, Mr. Wesley may not be entitled to deduct the loss under section 162. Thus, he cannot pursue a deduction under section 1341 because the deduction is not permitted under any section of the tax code.

In the case of Nacchio v. United States, Qwest Communications International, Inc’s Chief Executive Officer (CEO), Joseph Nacchio exercised his options to purchase and sold shares of the company’s stocks in 2001. In 2005, the SEC alleged that the Nacchio and others defraud the public by misrepresenting the financial performance of the company. Nacchio was convicted in the District Court. The sentence applied included a prison term, a fine and a forfeiture. In 2001, his engagement of unlawful activities resulted in $45 million gain, and he paid $18 million in taxes. Nacchio filed a tax return for 2007 to claim a tax deduction for $18 million. The trial court in 2014 held a conclusion that Nacchio may deduct his forfeiture under section 165 but not under section 162. He is not estopped from pursuing tax relief under section 1341. However, in the 2016 Court of Appeals, the court reverse the trial court’s judgment of deduction under section 165 of revenue code and confirm that he may not deduct forfeiture under section 162. The reason of the reversion is he failed to establish that the forfeiture was not a fine or penalty. Thus, section 162(f) of the Code disallowing for any punitive context is applied. Also, with the consideration of public policy, the deduction of any punitive payments may dilute the punishment’s deterrent. Mr. Wesley’s situation is similar to the Nacchio’s case. The SEC claimed that Mr. Wesley defrauds the investing public by misrepresenting NYC Consulting’s financial performance. As a result, he needs to pay the $19 million fine and forfeit his gain $176.5 million.

However, it is questionable that allowing the deduction of forfeiture under section 165 may destroy the effectiveness of tax law or increase the favour of insider trading. Thus, whether section 165 is applicable when the loss arose from a criminal forfeiture is under discussion now. Section 165 states that losses incurred in any transaction entered for profit shall be allowed as a deduction, even the operation is not connected with a trade or business.

The case of Chen v. Comm'r involves the deductibility of allegedly abandoned investment property under section 165(a) of the Code. A married couple purchased a parcel of land to develop multiple-acre home sites in 2009, but no sales were made because there were no lots to sell. The taxpayers eventually were not allowed to deduct the loss since they failed to prove they abandoned the activity in the year the issue incurred. A taxpayer ceases a transaction entered into for profit when the investment was unable to bear fruit. However, a finding of abandonment has many requirements, and even the petitioners may have abandoned the project after 2009, they didn’t demonstrate they completely abandoned the development. Eventually, the abandonment losses are not deductible under section 165 for 2009.