Massachusetts District Court Explores The United States’ Burden Of Proof Argument On Deductions Of Government Settlements

Keywords: burden of proof, deductions, government settlements

On May 9, 2013, the US District Court of Massachusetts issued a Memorandum and Order in Fresenius Medical Care Holding, Inc. v. United States,1 involving federal income tax deductions related to the settlement of several government Federal False Claims Act (FCA) claims. The court's Memorandum addresses one of the government's principal arguments used to disallow taxpayers' deductions for FCA settlements.

Key Findings

Three important observations about the court's findings can be made. First, if the taxpayer can show that the settlement was for singles damages, i.e., actual losses, the settlement is deductible. Second, by contrast, when multiple damages are included in the settlement amount, the taxpayer should be prepared for the IRS to focus on its burden of proof when examining the deduction. Third, the government will rely on the US Department of Justice's policy of not characterizing a settlement for tax purposes to argue that the taxpayer failed to meet its burden.

In light of these points, taxpayers should consider laying the groundwork during settlement negotiations regarding which portions of a settlement are compensatory or otherwise not punitive and preserving documents and testimony to support their position. On the latter point, because memories fade and papers can become lost, evidence preservation may be critical to surviving an IRS challenge.

In addition, taxpayers may consider various alternatives for resolving a potential tax dispute. One alternative some taxpayers should consider is requesting a Pre-Filing Agreement with the IRS to resolve the issue before they file their tax returns.2

Case Description

The procedural background explains why the court issued its Memorandum.

Before Fresenius commenced litigation, the IRS permitted it to deduct approximately $258 million, including $66 million paid to the whistleblower, on four civil settlements. Fresenius's suit sought a refund of an additional $127 million, the remaining amount it paid under the civil settlements. Last fall, a jury returned a verdict in favor of Fresenius, allowing it to deduct $95 million of the disputed amount. On March 29, 2013, the district court denied the parties' pending motions for judgment as a matter of law. The court explained that it issued the May 9th Memorandum to clarify why it had "view[ed] the jury's fact findingrather than some legal determination by the courtto be...