Tax Changes Impacting Government Enforcement: Comments Due November 13, 2018
As described in a blog post on March 13, 2018, Section 13306 Tax Cuts and Jobs Act, P.L. 115-97 (Dec. 22, 2017) revises the longstanding rule on the deductibility as a business expense (or lack thereof) of "any fine or similar penalty paid to a government for the violation of any law." Previously, it was well understood that such costs could not be deducted as business expenses under 26 U.S.C. § 162(f) and many EPA settlement documents specifically included such a prohibition, including characterizing certain payments as falling within the prohibition.
However, this blanket rule was changed by Section 13306 of P.L. 115-97, which amended 26 U.S.C. § 162(f) to provide two exceptions "for amounts constituting restitution or paid to come into compliance with law." "Restitution" includes remediation of property for damage or harm which was or may be caused by the violation of any law or the potential violation of any law. Amounts "paid to come into compliance" includes costs "otherwise involved in the investigation or inquiry" as well, but shall not include "any amount paid or incurred as reimbursement to the government or entity for the costs of any investigation or litigation." As noted, the amounts must be identified as restitution or as an amount paid to come into compliance, as the case may be, in the court order or settlement agreement. In addition, P.L. 115-97 also added Section 6050X to the tax code which obligates the governmental entity involved in the enforcement proceeding to file an information return for all cases in excess of $600 specifying the amounts which fall into the two exceptions as specifically described in the settlement agreement or order.
Given the implementation questions raised by these new provisions, the Internal Revenue Service (IRS) issued Transitional Guidance in March 2018 which essentially suspended the requirement for governmental entities to file informational returns until such a time as the regulations were proposed and not sooner than Jan. 1, 2019. This Transitional Guidance did not affect the requirement that all such payments be memorialized in the settlement agreement or court order. Since then, on Aug. 29, 2018, the IRS also published a draft form 1098-F setting forth the information which will be requested in the filing. At each stage, the IRS solicited comments. Most recently, as required by the Paperwork Reduction Act of 1995, the IRS has again solicited comments by notice in the Federal Register on Sept. 11, 2018, with comments due Nov. 13, 2018.
Unlike other regulatory actions for which a public docket is maintained on www.regulations.gov, there is no public docket for these actions and we will have to wait until the proposed regulations are published to learn the scope of comments received to date by the IRS. A number of open questions remain regarding interpretation of the new statutory provisions, which will be hopefully answered by the proposed regulations. The American Institute of CPAs (AICPA) raise a number of these in their comment letter dated June 13, 2018, filed in response to the Transitional Guidance. Notably, although the new requirements apply to any investigation or inquiry into potential violations, there is no provision on how to deal with such investigations or inquiries which do not result in a settlement agreement or court order. Accordingly, AICPA recommends implementation of a "safe harbor" to ensure that amounts paid in the ordinary course of business will remain fully deductible. This is important when it comes to environmental compliance where the regulated community spends significant sums responding to inquiries and investigations which never result in a formal settlement agreement, court order, or consent decree.