Taxes From A To Z: K Is For Kickbacks

Oh c’mon. You totally knew that I was going to choose kickbacks, right? The rules governing illegal activity and taxes are some of the most entertaining bits of the Tax Code, not that the bar’s terribly high to begin with…

The specific section of the Code that references kickbacks can be found under Itemized Deductions for Individuals and Corporations, §162, Trade or business expense, (c) Illegal bribes, kickbacks, and other payments. The relevant part states:

(1) Illegal payments to government officials or employees. No deduction shall be allowed under subsection (a) for any payment made, directly or indirectly, to an official or employee of any government, or of any agency or instrumentality of any government, if the payment constitutes an illegal bribe or kickback or, if the payment is to an official or employee of a foreign government, the payment is unlawful under the Foreign Corrupt Practices Act of 1977. The burden of proof in respect of the issue, for the purposes of this paragraph, as to whether a payment constitutes an illegal bribe or kickback (or is unlawful under the Foreign Corrupt Practices Act of 1977) shall be upon the Secretary to the same extent as he bears the burden of proof under section 7454 (concerning the burden of proof when the issue relates to fraud).

(2) Other illegal payments. No deduction shall be allowed under subsection (a) for any payment (other than a payment described in paragraph (1)) made, directly or indirectly, to any person, if the payment constitutes an illegal bribe, illegal kickback, or other illegal payment under any law of the United States, or under any law of a State (but only if such State law is generally enforced), which subjects the payor to a criminal penalty or the loss of license or privilege to engage in a trade or business. For purposes of this paragraph, a kickback includes a payment in consideration of the referral of a client, patient, or customer. The burden of proof in respect of the issue, for purposes of this paragraph, as to whether a payment constitutes an illegal bribe, illegal kickback, or other illegal payment shall be upon the Secretary to the same extent as he bears the burden of proof under section 7454 (concerning the burden of proof when the issue relates to fraud).

(3) Kickbacks, rebates, and bribes under medicare and medicaid. No deduction shall be allowed under subsection (a) for any kickback, rebate, or bribe made by any provider of services, supplier, physician, or other person who furnishes items or services for which payment is or may be made under the Social Security Act, or in whole or in part out of Federal funds under a State plan approved under such Act, if such kickback, rebate, or bribe is made in connection with the furnishing of such items or services or the making or receipt of such payments. For purposes of this paragraph, a kickback includes a payment in consideration of the referral of a client, patient, or customer.

Here’s what it says in a nutshell: Illegal kickbacks are wrong. You can get in a lot of trouble if you engage in illegal kickbacks. But even if you don’t get into trouble, you can’t deduct them on your tax return as a business expense.

And it gets even better. You still, under the Tax Code, have to report the payments if they would otherwise be reportable on a form 1099-MISC. The rules for reporting payments as nonemployee compensation on a form 1099-MISC are simply:

• You made the payment to someone who is not your employee;
• You made the payment for services in the course of your trade or business (including government agencies and nonprofit organizations);
• You made the payment to an individual, partnership, estate, or, in some cases, a corporation; and
• You made payments to the payee of at least $600 during the year.

In other words, kickbacks may be subject to form 1099-MISC requirements.

Yes, as income. No, as deductions.

And here’s my quick clarification: not all kickbacks are illegal. And under the rules, only illegal kickbacks are not deductible. But if you receive a kickback, legal or no, you have to report the income.

Fun, right?

Kelly Phillips Erb

Kelly Phillips Erb is a tax attorney, tax writer, and podcaster.

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