First Circuit Rejects Talley And Allows A Business Expense Deduction For Settlement Payments Made Under The False Claims Act

On August 13, 2014, the United States Circuit Court for the First Circuit rejected the United States' request to deny Fresenius Medical Care Holdings Inc. from deducting a portion of a settlement payment to settle civil claims brought under the False Claims Act. Fresenius Medical Care Holdings, Inc. v. United States, 114 A.F.T.R. 2d 2014 - ___ (1st Cir. 2014) In affirming the Massachusetts federal judge's decision to permit the tax deduction, the First Circuit disagreed with the Ninth Circuit's decision in Talley Industries Inc. v. Commissioner, 116 F.3d 382 (9th Cir. 1997), and held, that a court may consider factors aside from the presence or absence of a tax agreement between the government and the settling party in determining the tax treatment of a False Claims Act civil settlement.

In a taxpayer-favorable decision, the US District Court for the District of Massachusetts, following a jury verdict, entered judgment for Fresenius in a tax refund suit permitting a business deduction for payments made to the government to settle a suit under, inter alia, 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. U.S., 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 approximately $50 million plus interest. The award reflected the jury's finding that the majority of double damages payments that the IRS claimed were punitive and, therefore, non- deductible 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 Industries 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...