This article examines the income tax significance to the insider of his payment in satisfaction of a liability arising under section 16(b). Such taxpayers have usually sought a deduction against ordinary income in the year of payment. When the issue was first raised, the deduction was denied. Section 16(b) liability was held to be in the nature of a penalty; allowance of the deduction, it was found, "would weaken an effective method of enforcing the sharply defined policy expressed in sectin 16(b)...." In 1961 the Internal Revenue Service modified its earlier position by ruling that section 16(b) is not a penal provision. The purpose of the section, the ruling stated, is merely to remove all profit from the insider's transactions, thereby placing him in the position he would have occupied had he not traded. Allowance of the deduction was held consistent with this purpose. The ruling concluded: "The income tax significance of the capital stock dealings giving rise to the payment determines whether it is deductible as an ordinary loss or as a capital loss." The Tax Court's recent refusal to accept this limitation upon the deduction reognized by the ruling gives renewed interest to the topic.
Tax Significance of Payments in Satisfaction of Liabilities Arising Under Section 16(b) of the Securities Exchange Act of 1934
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