Appellate court affirms $50 million tax refund to FCA defendant, holding that the “economic realities” of settlement payments determine whether they are compensatory.

Civil False Claims Act (FCA) settlements, which often involve hundreds of millions — or even billions — of dollars, have significant tax consequences for companies facing fraud suits. The First Circuit Court of Appeals’ recent decision in Fresenius Medical Care Holdings, Inc. v. United States, 2014 U.S. App. LEXIS 15536 (1st Cir. Aug. 13, 2014), upheld a jury verdict allowing the deduction of a significant portion of an FCA settlement amount beyond single damages. This is the first appellate decision addressing the tax deductibility of FCA settlements since the 1997 case Talley Industries Inc. v. United States, No. 13-2144, 116 F.3d 382 (9th Cir. 1997). In Fresenius, the First Circuit rejected the Government’s reading of Talley, which the Government contended required an FCA defendant to show an explicit agreement between the parties as to the tax characterization of the settlement amount. The Fresenius Court held that instead the “economic realities” of FCA settlement payments determine whether the amounts are compensatory and therefore deductible.

The Fresenius decision has significant implications for FCA defendants entering settlement negotiations with the Department of Justice (DOJ). Under the First Circuit’s approach to deductibility, the entirety of the record related to settlement negotiations will be relevant to determining what is compensatory. FCA defendants therefore should be mindful throughout the settlement process as to the characterization of the parties’ settlement offers, and should introduce calculations, analysis, and additional evidence indicating that the purpose of all or the majority of the settlement payments is to make the Government whole.