Wednesday, October 24, 2012
Forbes: The Tax Implications of Lance Armstrong's Banishment From Cycling, by Anthony J. Nitti (WithumSmith & Brown, Aspen, CO):
What will be the tax consequence if Armstrong repays race winnings and bonus amounts that were previously included in his taxable income as compensation?
The issue is not one of deductibility. Because the bonuses were originally earned in Armstrong’s trade or business of being a cyclist, any repaid compensation should be deductible as an ordinary and necessary business expense. Rather, the problem Armstrong faces is one of tax benefit.
If the doomsday predictions surrounding Armstrong’s future income stream are to be believed, it’s possible Armstrong may pay out more in bonus restitution during 2013 than he takes in as income. As a result, he may not be able to reap the full tax benefit of the deductions related to his repayments. And even in the event Armstrong is able to fully utilize his deductions in the current year, he may have been subject to a higher tax rate when the bonuses were originally earned — particularly during the pre-Bush tax cut years of 1999-2001 — than he is today. In either scenario, Armstrong would likely enjoy a larger tax benefit if he could travel back in time, exclude the bonus payments from income in the year they were received, and redetermine his prior years’ tax liability.
Fortunately for Armstrong, there is an Internal Revenue Code provision that contemplates such a dilemma. Section 1341 provides that if the facts are right, a taxpayer like Armstrong who is required to repay amounts previously included in income can compute their tax consequences on a “best case scenario” basis. ... Unfortunately for Armstrong, Section 1341 is rife with requirements that must be met before a taxpayer can take advantage of the retroactive reach of the provision. While Armstrong will satisfy the majority of these hurdles with ease, there is one that poses a potentially fatal challenge. ...
The income must have been originally included in the taxpayer’s income because the taxpayer believed he had an unrestricted right to the income. This requirement poses a significant threat to Armstrong’s ability to use Section 1341 to obtain the most advantageous result from any bonus repayments. Because Armstrong has been accused of knowingly violating race rules and the terms of his sponsorship contracts by doping throughout his seven Tour victories, it is difficult to envision the IRS concluding that Armstrong could have believed he had an unrestricted right to his bonus money. Stated in another way, because Armstrong knew his doping was against the rules, he couldn’t have believed he had an “unrestricted right” to the bonus payments. Rather, he would have accepted the bonus money knowing that a subsequent failed drug test — or as it happened, an investigation eight years after his last race — could result in his being forced to forfeit the bonuses.
Previous case law would support this theory, as the courts have made clear that Section 1341 does not apply to any “ill gotten gains,” such as embezzled income, smuggled goods, or illegal kickbacks. Armstrong’s PED use poses a similar problem in that his bonus payments appear to have been earned through “fraud or deceit,” precluding him from using Section 1341 to achieve the most beneficial tax result of any subsequent repayments.
Should Armstrong be unable to utilize Section 1341, he would be limited to merely deducting any bonus repayments in the year they are made, with the tax benefit of those deductions being dictated by the law — and Armstrong’s specific tax picture — in the year of repayment. Of course, given all that Armstrong has been through over the past two weeks, his future tax returns are likely the least of his worries.
(Hat Tip: Ann Murphy, Peter Prescott, Paul Rozek.)