The Public Policy Doctrine

Jeremy Springer
Aug 4
4 min read

Here is the first thing you need to know before reading on. Internal Revenue Code (IRC) section 165(a) allows a deduction for any loss sustained during the tax year and not compensated for by insurance or otherwise. For individual taxpayers, the deduction is limited to losses incurred:

In a trade or business,
In a transaction entered into for profit, or
In certain instances of casualty or theft.

Before 1969, courts applied the “Public Policy Doctrine” to deny taxpayers a deduction for which they otherwise qualified for under IRC sections 165 or 162 in cases where allowing the deduction would “frustrate sharply defined national or state policies proscribing particular types of conduct, evidenced by some governmental declaration thereof.” The Supreme Court clarified that the doctrine virtually always forbids deduction of governmentally imposed fines and penalties, stating that the “deduction of fines and penalties uniformly has been held to frustrate state policy in severe and direct fashion by reducing the ‘sting’ of the penalty prescribed by the state legislature.”

The Tax Reform Act of 1969 codified this doctrine by disallowing a deduction for “any fine or similar penalty paid to a government for the violation of any law.” [IRC §162(f)]

In 2013, the taxpayer in this case pleaded guilty to charges of bribery, fraud, and money laundering. The U.S. District Court for the Southern District of Ohio ordered the taxpayer to forfeit approximately $2.2 million of the resultant accretions to income and wealth. In 2016, the U.S. Marshals Service seized money from the taxpayer’s wholly owned S corporation in part to settle this judgment. The S corporation then claimed a loss for the asset seizures, and the taxpayer deducted the corresponding passthrough loss on his 2016 individual income tax return. The IRS disallowed the loss.

In court, the taxpayer argued that the public policy doctrine has no application to this case, primarily because the S corporation was never indicted or charged with wrongdoing. He argued that because the doctrine did not prohibit the S corporation from claiming a 2016 loss on account of the asset seizures, then he was entitled to claim that same loss in his capacity as the S corporation’s sole shareholder.

The court stated that even if it is assumed that the S corporation was entitled to claim a deduction for the asset seizures, the taxpayer is barred by the public policy doctrine from reporting his 100% passthrough share of the loss. To hold otherwise would be to frustrate the sharply defined policy against conspiring to commit offenses against the United States. The taxpayer was the wrongdoer, and the S corporation assets were seized as part of the penalty for his wrongdoing. The seized and forfeited assets were clearly “property constituting, or derived from, proceeds obtained, directly or indirectly, as a result of the violations” that caused the taxpayer to plead guilty to charges of bribery, fraud, and money laundering. Allowing him a deduction on account of the S corporation loss would unquestionably reduce the “sting” of the penalty for him. Allowing the taxpayer to deduct a loss by simply interposing his S corporation between him and some of the seized assets would violate the public policy doctrine as formulated by the Supreme Court.

The public policy doctrine is not so rigid or formulaic that it may apply only when the convicted person himself hands over a fine or penalty. The taxpayer claims that because the public policy doctrine is an equitable doctrine, the court should take into consideration the fact that the United States’ seizure of his S corporation’s assets violated due process, and (given that the S corporation was not the wrongdoer) was otherwise over-zealous. However, the court stated it sees no legal impropriety in the seizure of the S corporation’s assets to satisfy the taxpayer’s forfeiture liability. A corporation is not a person other than the defendant when it is wholly owned and controlled by the defendant. The law allows a court to order forfeiture of any other property of the defendant if the property involved in or obtained from the defendant’s criminal offense is unavailable.

Over the years the S corporation’s sole source of business income was the commissions

generated by the taxpayer that were assigned to the S corporation. It was those assigned commissions that led to the criminal indictment, plea, and forfeiture at issue in this case. It is impossible to see how the S corporation was independent of the taxpayer such that the forfeiture loss deduction should be allowed.

The court ruled that the taxpayer was not allowed to deduct the passthrough losses from his S corporation.

For more information on this case, please reference Hampton, T.C. Memo. 2025-32

Legal Disclaimer: This post contains general information for taxpayers and should not be relied upon as the only source of authority. Taxpayers should seek professional tax advice for more information. This information was current at time of posting; we are not responsible for updating this or any blog post/article for subsequent changes in the law or its interpretation.