Tax Characterization of FCA Settlements: First Circuit Says, “No Agreement? No Problem.”

Author: Matt Huffman, Associate Member, University of Cincinnati Law Review

On August 13, 2014, the First Circuit addressed an issue of first impression in Fresinius Medical Care Holdings, Inc. v. United States,[1] holding that a court may consider factors beyond a tax characterization agreement when determining the deductibility[2] of a settlement payment under the False Claims Act (FCA).[3] In so holding, the court rejected the government’s argument that the Ninth Circuit had appropriately adjudicated this issue in Talley Industries, Inc. v. Commissioner[4] and that the only pertinent inquiry in determining the deductibility of an FCA settlement payment is whether a tax characterization agreement exists between the government and the settling parties. The court explained its disagreement with the Ninth Circuit: “[i]f Talley stands for the proposition asserted by the government, then Talley is incorrectly decided and does not deserve our allegiance.”[5] In its decision, the First Circuit correctly parted from Talley and determined that the economic realities of a settlement agreement should be considered in the absence of a tax characterization agreement. Nonetheless, in adopting this test, the First Circuit should have gone further to hold that economic realities should not be ignored even in the presence of such an agreement. Considering that FCA settlements often involve hundreds of millions of dollars, the First Circuit’s decision will have significant tax consequences for companies settling FCA suits in the future.

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