Judge Mark V Holmes explores another variety of ambiguity in Edwin L. Gage and Elaine R. Gage, T. C. Memo. 2023-47, filed 4/12/23. Ed and Elaine were personally liable to HUD under a regulatory agreement executed in connection with an HUD insured mortgage on their nursing home, when said mortgage went south. IRS claimed the liability, $4 million, was punitive damages, therefore not deductible per Section 162(f). So when Ed and Elaine settled for $875K and tried to deduct the payment, did they incur the Section 6662 substantial understatement of tax chop?

The Gages did buy an official bank check for the $875K in December and give it to their trusty attorney to give to the AUSA. But the AUSA couldn’t take the check until the settlement papers were approved, and that wasn’t until the following March.

“The record we have shows the Gages are competent, skilled business people able to organize and operate two different corporations, but that they are not learned in tax law. We do find it more likely than not that they delivered the check to their attorney with the intent of fulfilling the terms of the settlement agreement. From their perspective they were out the $875,000 when they bought the check and gave it to their lawyer. We think their reporting position on the timing issue was reasonable under the circumstances, and that they acted in good faith in thinking they’d made the payment in [December].” T. C. Memo. 2023-47, at p. 9.

But that’s not enough. If the $875K is for retributive damages, not compensatory, mox nix when it was paid. So what was the payment for? IRS claims DOJ sued the Gages for equity skimming from the project insured by HUD, , in violation of the regulatory agreement, per the National Housing Act, 12 U.S.C. §§ 1701–1750, and section 421 of the Housing and Community Development Act of 1987, 12 U.S.C. § 1715z-4a.

That enactment allows for “double damages, costs, and fees for breach of a regulatory agreement with HUD. The United States also sought in its complaint recovery under federal common-law theories of unjust enrichment, fraud, disgorgement of profits, recoupment, and restitution.” T. C. Memo. 2023-47, at pp. 10-11.

1 Cir and 2 Cir have slightly different takes on what the statutes are trying to do. 2 Cir says the statute is a deterrent, smacking the bad guys hard. 1 Cir says DOJ can ask for doubles, but USDC decides, and then only for repeated or substantial default.

Judge Holmes is a lawyer’s lawyer. If he can’t find an ambiguity, no one can.

“We conclude from this that the double-damages provision under which the government sued the Gages may serve both to compensate the government and to punish. We also conclude that is not clear from the text of the statute or the caselaw construing it which purpose was present in the Gage’s settlement.” T. C. Memo. 2023-47, at p. 12.

The settlement agreement provides no clues. It just specifies that payment releases the Gages from civil or criminal liability, and expressly excludes any tax characterization. This case went up on Rule 122, fully submitted, so no testimony as to intent or evidence of “intercourse” between DOJ and Gages’ trusty attorneys.

And the settlement was less than HUD’s actual damages. So the Gages were justified in thinking the payment was compensatory.

The Gages did lose the timing issue. Until the USA got the check, the amount of the settlement wasn’t paid. So payment took place in March, not December. Federal law, not State law, decides that; the need for national uniformity trumps any State interest.

So that saves Judge Holmes from having to decide whether the payment was in fact deductible per Section 162. The Gages might think in good faith that the payment was compensatory and not punitive, but thinking doesn’t make it so.