Michael T. Sestak, 17285-18

Petitioner Michael Sestak, a U.S. State Department consular officer, received $3,227,501 in bribe proceeds in 2012 and purchased nine properties in Thailand (~$3.2M) to conceal those funds.
He filed a 2012 Form 1040 reporting only wages and did not report the bribery proceeds; the State Department investigation led to his guilty plea to conspiracy and bribery charges and to a preliminary consent order of forfeiture.
Under his plea agreement he agreed to sell the Thai properties and transfer net proceeds to the United States; the U.S. ultimately received $1,551,134 from those sales and other forfeitures (sales occurred 2013–2015).
The IRS audited petitioner’s 2012 return, issued a notice of deficiency, and asserted the civil fraud penalty under I.R.C. § 6663 (with supervisory approval obtained per § 6751(b)).
Petitioner sought a deduction under I.R.C. § 165 for the loss on liquidation of the Thai real estate (arguing the transfers were voluntary/compensatory and citing Stephens), and he contested the fraud penalty (seeking offset/credit for amounts transferred).

Issue	Plaintiff's Argument	Defendant's Argument	Held
Deductibility of loss on sale/transfer of Thai properties under §165	Sestak: sales were voluntary/compensatory (not forfeiture); loss on liquidation of investment property should offset bribery income; Stephens supports deductibility	IRS: proceeds were subject to criminal forfeiture; allowing a deduction would frustrate public policy and undermine forfeiture; sales occurred in later years	Court disallowed the §165 loss deduction: transfers were forfeiture and public-policy bar applied
Civil fraud penalty under §6663 (and supervisory approval under §6751(b))	Sestak: disputed fraud penalty and sought credit for funds transferred; argued mitigation based on cooperation and amended return filing while incarcerated	IRS: proved underpayment and fraudulent intent by clear and convincing evidence (badges of fraud); supervisory written approval for penalty was obtained before communication	Court sustained the §6663 fraud penalty: underpayment and fraud proven; §6751(b) approval satisfied

Stephens v. Commissioner, 905 F.2d 667 (2d Cir. 1990) (allowed deduction for restitution payment in distinguishable restitution—not forfeiture—context)
Wood v. United States, 863 F.2d 417 (5th Cir. 1989) (forfeiture-related deductions may be disallowed where allowance would frustrate public policy)
Tank Truck Rentals, Inc. v. Commissioner, 356 U.S. 30 (1958) (public policy can bar deductions that would blunt punitive government sanctions)
Lilly v. Commissioner, 343 U.S. 90 (1952) (distinguishes ethically questionable but lawful payments from illegal expenditures that implicate public-policy bars)
Commissioner v. Sullivan, 356 U.S. 27 (1958) (illegal enterprises may deduct ordinary and necessary business expenses—limited principle inapplicable where forfeiture and public policy bar apply)
Commissioner v. Tellier, 383 U.S. 687 (1966) (criminal-defense fees deductible as ordinary and necessary business expenses in some contexts)