Phoenix Suns Owner’s $10 Million NBA Fine Should Be Deductible

In a recent Bloomberg Tax Insight, author Richard L. Fox concludes that Robert Sarver, the majority owner and managing partner of the Phoenix Suns, has little chance of sustaining a tax deduction of a $10 million “fine” levied by the NBA following reports of harsh treatment of Suns employees. The article stated that “Sarver would clearly be hard-pressed to assert that the conduct for which his fine arose is within the norm of common business practice and, indeed, was quite the opposite.”

However, it is my view that the article focused too much of his attention on the moral aspects of Sarver’s conduct and that emphasis led to the conclusion that the fine did not meet the exacting standards of Internal Revenue Code Section 162(a), most notably that a deductible expense be one that is ordinary.”

Section 162(a) provides that “there shall be allowed as a deduction all of the ‘ordinary and necessary’ expenses paid or incurred during the taxable year in carrying on any trade or business.” While an expense is considered necessary if it is merely “appropriate and helpful”—a relatively low bar—the question of whether an outlay is ordinary has been where most of the action in interpreting Section 162(a) has arisen.

Helvering Decision

A seminal case regarding this issue was decided in 1935 but is still cited by taxpayers and the IRS alike as the source of what it means to be ordinary, particularly when judging whether an expense arising out of a private wrongdoing might be characterized as ordinary. In Helvering v. Hampton, the issue was the deductibility of an amount paid in settlement of a judgment against the taxpayer, and in favor of a lessee, upon the cancellation of a lease for fraud in a prior tax year in negotiating for the lease.

The IRS commissioner asked the court to regard the outlay “as something to be condemned as against public morals.” The court was unmoved, noting that “there is no analogy between payment of a fine for a public offense [which, of course, is not deductible by reason of Section 162(f) of the Code] and the restitution by a real estate dealer of the gains made in a prior tax year by his tortious conduct in a private transaction in the course of his business. … Even if restitution for wrong in a private business transaction were regarded as infected by the wrong it seeks to cure, there are no decisions holding that no deduction for the amount restored should be denied.”

I believe Fox’s article overemphasized the nature of the conduct which precipitated the fine’s assessment. The Helvering court makes it clear that even where the unethical conduct is extraordinary—the principal point on which Fox bases his opinion—the focus should be elsewhere. The court observed: “We cannot agree that private wrongdoing in the course of business is extraordinary within the meaning of the taxing statute allowing deductions for ‘ordinary and necessary expenses.’”

The court continued: “We hold that, even if unethical conduct in business were extraordinary, restitution therefor is ordinarily expected to be made from the person in the course of whose business the wrong was committed.”

The assessment of whether an expenditure is ordinary should be not on whether the conduct that necessitated it was ordinary but rather on whether it was “normal, usual, and customary” for one engaging in such conduct to make restitution therefor.

Rothner Ruling

This distinction, in fact, was made in one of the cases cited in Fox’s article. In Rothner v. Commissioner, the taxpayer, a member of the Chicago Mercantile Exchange, was forced to pay a fine as a consequence of a trading infraction he was found to have committed. In allowing the taxpayer a deduction for the fine, the court rebuffed the IRS’ principal theory, that “engaging in transactions in violation of the CME’s rules was not ‘an ordinary part’ of petitioner’s business.” The court, citing Helvering with approval, said, “a private wrongdoing in the course of conducting a business is not extraordinary” and, more importantly, “even if improper conduct were extraordinary in business, the payment of a settlement or judgment attributable to the conduct is generally expected to be made by the person in the course of whose business the conduct occurred.”

The case can be made that whether or not Sarver’s conduct was extraordinary is very much beside the point. What is important in gauging whether his fine should be construed as an ordinary expense of carrying on his trade or business is whether a fine or other similar exaction is ordinarily expected to be made from the person whose conduct, however objectionable, gave rise to the penalty.

It is well known that professional sports leagues closely monitor their athletes for conduct that is not in the best interests of the sport and are more than happy to extract monetary restitution from those athletes whose conduct, either on or off the playing field, casts aspersions on the league. Since, in the words of the Rothner court, “the payment of a settlement or judgment attributable to the conduct is generally expected to be made by the person in the course of whose business the conduct occurred,” it is apparent to me that Sarver will be doing precisely what is expected from persons in his position—paying a fine in respect of disciplinary proceedings arising from conduct that violated the rules of the organization of which he and his franchise were members. When he pays his fine, Server will be doing what is ordinarily expected from a person in the course of whose business the wrong was committed.

Even the IRS seems to agree that the nature of the conduct that precipitates the payment is not the issue. Rather, what is determinative is whether a payment in respect of such conduct is normative. In Revised Rule 80-211, amounts paid by a corporation as punitive damages that arose from a civil lawsuit against the corporation for breach of contract and fraud in connection with the ordinary conduct of its business activities was found to be deductible.

Making such restitution by one who has committed such heinous acts is ordinarily to be expected. The fact that committing such acts might not be so expected does not matter. Similarly, Sarver’s conduct may have been the antithesis of ordinary, but his response of paying a fine was decidedly ordinary. Thus, Sarver should be able to secure a deduction for his outlay.

This article does not necessarily reflect the opinion of The Bureau of National Affairs, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.

Author Information

Robert Willens is president of the tax and consulting firm Robert Willens LLC in New York and an adjunct professor of finance at Columbia University Graduate School of Business.

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