Page 3 - Proposed Regulations Provide Guidance on Deducting Fines and Penalties Paid to the Government: Important Questions Still Remain

COLUMNS I Tax Practice & Procedure

costs of restitution, remediation, or to come into compliance settlements with the government to prove their entitlement
with the law. The proposed regulations also do not address to a deduction under IRC section 162(f).
the situation where the taxpayer ultimately pays more as
restitution, remediation, or to come into compliance with the Material Change
law than is stated in the court order or settlement agreement. The proposed regulations provide that if the parties to a
Is the taxpayer entitled to a deduction for the greater amount court order or settlement agreement that became binding
without first obtaining a modification to the order or agree- before the effective date of the TCJA make a material change
ment? The proposed regulations are silent on this question. to the terms of the order or agreement on or after the date
The establishment requirement in the proposed regulations that final regulations under IRC section 162(f) are issued,
provides that the taxpayer must prove–or substantiate–the then the amended section applies to this change. A material
taxpayer’s legal obligation to pay the amount in the court change to the terms of the order or agreement may include
order or settlement agreement identified as restitution, reme- changing the nature or purpose of the payment obligation,
diation, or to come into compliance with a law, the amount or removing or adding an obligation to make a payment or
actually paid, and the date that the amount was paid. The to provide services or property. A material change does not
proposed regulations state that a taxpayer can use a broad include changing the date that a payment is due.
range of documents to establish the legal obligation to pay
the amounts due, including receipts; the legal or regulatory Information Return Reporting
The TCJA enacted new IRC section 6050X, which requires
that the officer or employee of the governmental unit who
has control of the suit or investigation must file an informa-
tion return (Form 1098-F) with the IRS. A copy must also
Taxpayers’ representatives will be provided to the taxpayer that reports the amount paid
need to use foresight and under IRC section 162(f). The information return is due on
January 31 following the calendar year in which the order
creativity in drafting court orders or agreement becomes binding, even if all appeals have not
been exhausted. Under the proposed regulations, information
and settlement agreements returns are only required for amounts of $50,000 or more.

to optimize the likelihood that
Effective Date
deductions for these payments The rules set forth in the proposed regulations under IRC
section 162(f) are to apply to taxable years beginning on or
will pass muster in IRS audits after the date that the regulations are finalized and published
and in tax litigation. in the Federal Register. The information reporting rules under
IRC section 6050X apply to orders and agreements that
become binding on or after January 1, 2022.

Planning for Deductibility
provision related to the violation or potential violation of The TCJA amended IRC section 162(f) in a way that
law; documents issued by the government or governmental restricts the ability of taxpayers to claim business expense
entity related to the investigation; documents describing how deductions for civil and criminal fines and penalties paid
the amount was determined; and correspondence exchanged to the government for violations of the law. Taxpayers’
between the taxpayer and the government or the govern- representatives will need to use foresight and creativity in
mental entity before the order or agreement became binding drafting court orders and settlement agreements to optimize
under applicable law. the likelihood that deductions for these payments will
While the establishment requirement may appear on its pass muster in IRS audits and in tax litigation. The new
face easy to satisfy, taxpayers and the IRS have long battled substantiation requirements under IRC section 162(f) will
over the question of whether a taxpayer’s substantiation also place a burden on taxpayers and their representatives
for a deduction is sufficient. An IRS audit of a deduction to thoroughly document deductible fines and penalties paid
reported by a taxpayer under IRC section 162(f) may not to the government. ■
occur until years after the court order was entered or the
settlement agreement was executed. Taxpayers must be vig- Kevin M. Flynn, JD, LLM, is a partner at Kostelanetz &
ilant in obtaining and maintaining documentary evidence of Fink, LLP, New York, N.Y.

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