United States

IRS Chief Counsel takes position that FINRA fines are nondeductible

States that FINRA is an agency or instrumentality of the US government


In a recently published Chief Counsel Advice (CCA 201623006), the IRS Office of Chief Counsel concluded that certain fines imposed by the Financial Industry Regulatory Authority (FINRA) are nondeductible ‘fines or similar penalties’ under section 162(f) of the Internal Revenue Code. That provision denies a deduction for fines or penalties paid ‘to a government for the violation of any law.’ Although FINRA is arguably not a government, the regulations define ‘government’ as including any entity acting as an agency or instrumentality of a government. In this case, the IRS concluded that when FINRA imposes certain fines it is doing so as an agency or instrumentality of government, which makes the fines nondeductible. The IRS conclusion is not a binding precedent and does not have the force of law, but the underlying analysis could be persuasive to a court and should be carefully considered by taxpayers and their advisors, particularly in determining whether a penalty could be applied if such fines were deducted on a return and later determined by the IRS to be nondeductible.

The Guardian Industries test

The IRS conclusion was based on Guardian Industries Corp. v. Commissioner, (143 TC 1) where the Tax Court held that the Commission of the European Community (EC), an institution of the European Union, was an entity serving as an instrumentality of the various EC member states. Applying a three-part test, the court held that this agency was a government instrumentality because it was delegated the right to exercise part of the sovereign power of government, it performed an important governmental function, and it had the authority to act with the sanction of government behind it. The IRS noted that FINRA is a self-regulatory organization (SRO), which is a private funded nongovernmental entity authorized under federal law to oversee securities markets and broker-dealers under their jurisdiction, and that SROs are authorized to bring disciplinary actions for violations of federal laws, SEC rules and the rules of the SRO, subject to SEC oversight (SEC Oversight of FINRA, GAO-15-376). Based on its analysis of FINRA’s authority, the IRS concluded that FINRA meets the three-part Guardian test and should be regarded as an agency or instrumentality of government, making at least certain FINRA fines nondeductible.

Some fines not covered

However, the IRS indicated that the nondeductibility rule would not apply to fines paid to FINRA solely for a violation of a ‘house-keeping’ rule, imposed outside of its capacity as a self-regulatory organization. Although the CCA does not define what constitutes a house-keeping rule, it does explain that they are rules arising under private contract law between FINRA in its capacity as a professional association and its members.

Taxpayer arguments

The CCA addresses several arguments raised by the taxpayer. Although the CCA concedes that there is no case law squarely on point, it nevertheless concludes that the taxpayer’s arguments are without merit. Importantly, the CCA indicated that this represented a change from the views expressed in a 1998 document (1998 IRS NSAR 5131), where the Office of Chief Counsel addressed a similar issue for the National Association of Securities Dealers, a predecessor to FINRA, and concluded that “there are considerable litigating hazards with respect to the ‘agency or instrumentality’ theory.”


An IRS CCA memorandum, while indicative of the IRS’s position on a given matter, does not create binding precedent or otherwise have the force of law. Since there is no case law or higher administrative authority directly on point, it is unclear if the courts would ultimately agree with the IRS position. That being said, taxpayers should bear in mind the underlying analysis of the CCA, as well as other relevant authorities, when considering their position on the issue of SRO-imposed fines.


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