By Sam Brunson
In the beginning of August, Elon Musk tweeted that he had secured financing to take Tesla private at $420 per share. It turned out that he, um, hadn’t. In the meantime, though, his tweet moved the market; on the day of his tweet, Tesla shares closed up 11%.[fn1]
It wasn’t only investors who noticed the tweet, though. The SEC was watching, too. And on Thursday, the SEC charged Musk with securities fraud. In its complaint, the SEC requested that the court:
- enjoin Musk from violating section 10(b) of the ’34 Act and Rule 10b-5;
- order Musk to disgorge any gains from his securities fraud and pay civil penalties under the ’34 Act; and
- prohibit Musk from being a director or officer of any publicly-traded corporation.
Two days after the SEC filed its complaint, Musk settled. In the settlement, he agreed to a number of terms, including:
- being enjoined from violating section 10(b) and Rule 10b-5;
- resigning as Chairman of the Tesla board of directors, and not seeking reelection or appointment for at least 3 years; and
- paying a $20 million fine.
Given that I’m a tax prof, and this is a tax blog, it should be unsurprising that what caught my attention was the fine. See, along with the fine, Musk agreed that “the civil penalty shall be treated as a penalty paid to the government for all purposes, including all tax purposes.” What’s that all about?
Well, generally speaking, section 162(f) of the Code prohibits taxpayers from deducting fines paid to a government in relation to the violation of any law, even if the fine would otherwise be deductible as an ordinary and necessary trade or business expense.
If governmental fines are generally nondeductible, why did Musk explicitly agree not to deduct those amounts? It looks like his agreement is the result of section 162(f)(2). Section 162(f)(2) is an exception to the general nondeductiblity rule: it provides that an otherwise-deductible fine can be deducted if the fine is used to provide restitution to people who were harmed.
And, it turns out, the fine could be used for restitution. See, section 308(a) of the Sarbanes-Oxley Act gives the SEC authority to use civil penalties to create a fund to benefit victims of the securities law violation. And, in fact, the settlement agreement explicitly provides that the SEC can use the $20 million to recompense victims. And absent this agreement, to the extent it did so, Musk could deduct the fine, reducing the after-tax cost of the fine.[fn2]
But under the terms of his settlement agreement, whether or not his fine reimburses victims of the securities fraud, Musk gets no deduction, and bears the full cost of the fine.
[fn1] The announcement also created huge mark-to-market losses for short sellers.
[fn2] Assuming Musk is in the highest tax bracket—probably a fair assumption—a $20 million deduction would reduce the after-tax cost of the penalty by $7.4 million.
The Surly Subgroup 