On May 13, the IRS and the U.S. Department of the Treasury published proposed regulations to implement amendments made by the Tax Cuts and Jobs Act of 2017 (TCJA) to IRC Section 162(f), which, except in certain limited circumstances, disallows a deduction for the payment of government fines and penalties. In addition, the proposed regulations implement Section 6050X, also enacted by the TCJA, which requires information reporting relating to amounts subject to Section 162(f). These provisions generally apply to amounts paid or incurred on or after Dec. 22, 2017.
Under Section 162(f)(1), no deduction is allowed for any amount paid or incurred (whether by suit, agreement, or otherwise) to a government, governmental entity, or nongovernmental entity for violating a law or for a governmental or nongovernmental entity’s investigation or inquiry into a potential law violation. Nongovernmental entities generally are those that exercise self-regulatory powers, including sanctions, in connection with certain qualified boards or exchanges or as part of performing essential government functions.
Sections 162(f)(2) and (3) provide an exception to the general rule, allowing a deduction for amounts otherwise deductible if both of the following are satisfied:
- The taxpayer establishes that the amount paid or incurred constitutes restitution or remediation of property or is paid to come into compliance with any law (the establishment requirement).
- The amount paid or incurred is identified as restitution, as remediation, or as an amount paid to come into compliance with a law in the order or agreement (the identification requirement). Meeting the identification requirement is not sufficient to meet the establishment requirement.
Section 6050X requires an appropriate official of a government or nongovernment entity involved in a suit or agreement to which Section 162(f) applies to report to the IRS and to the payer the aggregate amount of $600 or more for all orders or agreements with respect to the violation, investigation, or inquiry. The statute provides the IRS with authority to raise the $600 reporting threshold. Information required to be reported includes the amount required to be paid because of the order or agreement, any amount that constitutes restitution or remediation of property, and any amount paid to come into compliance with the law.
Notice 2018-23 generally delayed reporting until the later of Jan. 1, 2019, or the date proposed regulations are published. The notice also provided that until proposed regulations are published, the identification requirement is satisfied if the agreement or order specifically states on its face that the amount is restitution, remediation, or for coming into compliance with the law. The notice makes clear that the limited exception to disallow the deduction for fines and penalties applies to binding orders and agreements entered into after Dec. 22, 2017, even though government reporting is postponed.