Deduction for Funds Seized in Criminal Forfeiture Disallowed on Public Policy Grounds

(Parker Tax Publishing April 2025)

The Tax Court disallowed on public policy grounds an $855,882 passthrough deduction claimed by a taxpayer who pleaded guilty to charges of bribery, fraud, and money laundering, and whose wholly owned S corporation was ordered to forfeit $2.2 million. The court rejected the taxpayer's argument that the deduction should be allowed because the S corporation was never charged with wrongdoing, reasoning that allowing the loss simply by interposing the S corporation between the taxpayer and the seized assets would violate the public policy doctrine. Hampton v. Comm'r, T.C. Memo. 2025-32.

Background

Douglas Hampton began his career in financial services working for Merrill Lynch and Morgan Stanley. In 2003, Hampton incorporated Hampton Capital Management (HCM). Hampton was a registered representative for three separate broker-dealers from 2004 to 2013: First Montauk Securities Corp. (First Montauk) (2004-08), First Allied Securities, Inc. (2008-12), and First Allied Advisory Services, Inc. (2012-13). In that capacity Hampton provided asset management, financial planning, and college planning services to retail and institutional clients.

Between 2009 and 2013 most or all of Hampton's financial services earnings came in the form of commissions remitted by First Montauk, First Allied, and Viad Corp. Hampton received all commissions from the broker-dealers in his personal capacity. None of the payors ever named HCM as the recipient of a commission. HCM was never registered with the Securities and Exchange Commission or the Financial Industry Regulatory Authority (FINRA). For its part, HCM maintained brokerage accounts with First Allied from at least March 2010 to May 2016, through which it traded on its own account.

From at least 2009 through 2013 Hampton and HCM reported the financial services earnings for tax purposes as follows: (1) Hampton included his commissions as gross receipts on Schedule C, Profit or Loss From Business, of his Form 1040; (2) Hampton then reported exactly the same amount as "Other expenses" on Schedule C and explained the expense deduction as "amounts assigned" to HCM, yielding zero Schedule C net profit; (3) HCM included exactly the same commission "amounts assigned" as gross receipts on its yearly Forms 1120S; (4) Hampton then reported a portion of HCM's assigned commission earnings as wage income on his Form 1040; and (5) HCM deducted as expenses "Compensation of officers" in an amount equal to or greater than the wage income from HCM reported by Hampton. As HCM's sole shareholder, Hampton reported HCM's net profit as income via Schedule E, Supplemental Income and Loss, on his Form 1040.

In 2008 one of Hampton's high school friends was appointed chief financial officer of the Office of the Treasurer of the State of Ohio. In February 2009 that friend was also appointed deputy treasurer of the State of Ohio. Hampton and the deputy treasurer then secretly devised the following plan: The deputy treasurer would ensure that Hampton was included on the list of brokers authorized to conduct securities trades on behalf of the State of Ohio and that a large amount of trading business was directed to Hampton. In return Hampton would send portions of the commissions he earned from trading for the State of Ohio to the deputy treasurer and two other individuals (friends and associates of the deputy treasurer), disguised as legal fees or business loans.

In carrying out the plan Hampton executed a series of trades for the State of Ohio between October 2, 2009, and August 31, 2010, receiving total commissions of approximately $3.2 million. During this same time Hampton paid approximately $524,000 of his commission earnings to the deputy treasurer and the two others involved in the plan. The U.S. Government learned of the misappropriation and filed a criminal Information against Hampton in 2013, charging Hampton with conspiring to commit federal program bribery, honest services wire fraud, and money laundering. Hampton pleaded guilty and in 2014 was sentenced to 45 months of imprisonment, three years of supervised release, a $100 penalty, and forfeiture of approximately $2.2 million. In 2016 while Hampton was incarcerated, a district court issued warrants to seize the contents of seven bank accounts held in the name of either Hampton or HCM.

On its 2016 Form 1120S, U.S. Income Tax Return for an S Corporation, HCM claimed a deduction of $855,882. HCM attached a statement explaining that it lost that amount when the U.S. Marshalls Service processed a forfeiture against it. Because HCM reported $6,547 of gross income for 2016, it reported a net loss of $849,335. Hampton included that loss in his calculation of Schedule E income on his 2016 Form 1040. In a notice of deficiency, the IRS disallowed HCM's $855,882 deduction and accordingly determined an increase in Hampton's Schedule E income by that amount. Hampton took his case to the Tax Court.

Code Sec. 165(a) allows a deduction for any loss sustained during the tax year and not compensated for by insurance or otherwise. For individual taxpayers, Code Sec. 165(c) limits the deduction to losses incurred (1) in a trade or business, (2) in a transaction entered into for profit, or (3) in certain instances of casualty or theft.

In Tank Truck Rentals, Inc. v. Comm'r, 356 U.S. 30 (1958), the Supreme Court applied the "public policy doctrine" to deny deductions under Code Sec. 165 or Code Sec. 162 (relating to ordinary and necessary business expenses) 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 Court clarified that the doctrine virtually always forbids deduction of governmentally imposed fines and penalties, stating that to allow a deduction for fines and penalties would frustrate public policy by reducing the "sting" of the penalty.

Hampton argued that the public policy doctrine had no application to his case, primarily because HCM was never indicted or charged with wrongdoing. Hampton contended that because the doctrine did not prohibit HCM from claiming a 2016 loss on account of the asset seizures, he was entitled to claim that same loss in his capacity as HCM's sole shareholder. Hampton further argued that because the public policy doctrine is an equitable doctrine, the court should take into consideration the fact (or so he claimed) that the government's seizure of HCM's assets violated due process and (given that HCM was not the wrongdoer) was otherwise "over-zealous."

Analysis

The Tax Court sustained the disallowance of Hampton's forfeiture loss on public policy grounds. The court found that, even if HCM were entitled to claim a deduction for the asset seizures (a question the court said it did not need to decide), Hampton is barred by the public policy doctrine from reporting his 100 percent passthrough share of HCM's resulting loss. To hold otherwise, the court reasoned, would be to frustrate the sharply defined policy against conspiring to commit offenses against the United States.

The court reasoned that Hampton was the wrongdoer and HCM's assets were seized as part of the penalty for his wrongdoing. In the court's view, allowing Hampton a deduction on account of HCM's loss would unquestionably reduce the "sting" of the penalty for him. Further, the court found that allowing Hampton to deduct a loss by simply interposing HCM between him and (some of) the seized assets that came from the problematic "assigned" commissions would violate the public policy doctrine as formulated by the Supreme Court in Tank Truck Rentals. The court found that the public policy doctrine is not so formulaic that it may apply only when the convicted person himself hands over a fine or penalty.

In addition, the court saw no legal impropriety in the government's seizure of HCM's assets to satisfy Hampton's forfeiture liability. HCM was not, in the court's view, a separate person from Hampton for purposes of the substitute forfeiture provisions of 21 U.S.C. Sec. 853(p), which under certain circumstances authorize a court to order forfeiture of a defendant's property if the property is involved in or obtained from the defendant's criminal offense is unavailable. The court noted that Hampton wholly owned and controlled HCM and he offered only minimum evidence that corporate formalities were followed. More importantly to the court, HCM's sole source of business income was the commissions generated by Hampton that were "assigned" to HCM. It was those "assigned" commissions that led to the criminal indictment, plea, and forfeiture at issue.

For a discussion of deductions for losses sustained during the tax year and not compensated by insurance or otherwise, see Parker Tax ¶97,101.

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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