Fines or Sanctions Paid to FINRA Are Not Deductible

In CCA 201623006 the IRS concluded that the payment of a fine or similar penalty to the Financial Industry Regulatory Authority (FINRA), a non-government entity, is not deductible as an ordinary and necessary business expense.

Fines & Penalties Non-Deductible ..WHY??

The law is clear that fines and penalties paid to government entities for violation of the law are not deductible. The interpreting regulations go further to say that this includes fines or payments to a “corporation or other entity serving as an agency or instrumentality of” the government. It is not clear whether this language covers a non-government entity such as FINRA, thereby making fines or penalties paid to FINRA non-deductible.

As noted by the IRS in CCA 201623006, the U.S. Tax Court has previously addressed this language in the regulations. The court concluded that the question turns on whether the corporation or other entity has the authority of government behind it when it tries to collect its fines or enforce its decisions. The CCA then goes on to examine various aspects of FINRA, concluding that it has the authority of government behind it when it tries to collect its fines or enforce its decisions.

What Can Happen If You Ignore The Sanctioned Or Fine?

It is not clear that FINRA has this power. In the event that a FINRA member is sanctioned by FINRA or ordered to pay a fine to FINRA and the member simply ignores the sanction or fine, FINRA would have to sue the member in court to enforce its rules. This is the same process as any private citizen would have to go through to enforce their contract terms or to protect their rights under other law.

Some may argue that FINRA could suspend or expel the member or firm and that this gives FINRA the authority of government in enforcing its decisions. This may be for some individuals and firms. But there are cases when individuals and firms may not care if they are suspended or expelled by FINRA as they do not intend to maintain their membership anyway. This can come up when a member or firm is moving to a business model that is not governed by FINRA, such as being a registered investment advisor.

This also does not address that FINRA serves to promote the interests of its members. Its membership draws from a few of the largest banks, etc. Unlike the government, there is less of a focus on protecting the interests of the minority members. The resulting fines and sanctions no doubt reflect this.

Even then, as noted in CCA 201623006, the U.S. Tax Court has previously concluded that this exception to deductibility did not apply to a fine or sanction imposed by the Chicago Mercantile Exchange (CME). The IRS conceded this point in this prior case. The IRS does not typically do this absent some basis for doing so. The IRS’s CCA 201623006 does not explain why it previously reached this conclusion or what basis it had for doing so. Instead, the CCA merely says that the IRS has “not researched the then applicable law and the facts developed at the trial to make our own determination at this time.” It seems like this is exactly what the CCA needed to do to answer the question presented in the CCA.

Until further guidance is issued, it appears that the IRS will assert that fines and penalties paid to FINRA are not deductible. It will be up to taxpayers to show that the fines or penalties are for a violation of a “house-keeping” rule that is a matter of private contract between FINRA in its capacity as a professional association and its members, rather than its role as a government regulator.