The Treasury and IRS issued final regulations (T.D. 9946) providing guidance under section 162(f), as amended in 2017 by the TCJA, relating to the deductions of certain fines, penalties and other amounts paid to governmental entities. The regulations also provide guidance with respect to the reporting requirements related to the fines, penalties and other amounts provided for in section 6050X.
The TCJA amended section 162(f) to disallow deductions for amounts paid or incurred to any government or governmental entity, including nongovernmental entities that exercise self-regulatory powers in connection with a qualified board or exchange or as part of performing an essential governmental function, in relation to the violation of a law or the investigation or inquiry into the potential violation of a law. There are, of course, exceptions to the general rule, including exceptions related to amounts constituting restitution or paid to come into compliance with a law, amounts paid or incurred as the result of certain court orders in which no government or governmental entity is a party, and amounts paid or incurred as taxes due.
The TCJA also implemented information reporting requirements through the addition of new section 6050X. Section 6050X requires the appropriate official of any government or governmental entity to report amounts greater than $600, in aggregate, required to be paid as a result of the suit or agreement. The provision also allows the Secretary to increase the $600 threshold for reporting. This is irrespective of whether section 162(f)(1) applies or if the payments constitute restitution or remediation of property or are payments required to come into compliance with law. Section 6050X(b) requires the entity completing the information return to furnish to each party to the suit, agreement, or otherwise a written statement that includes (1) the amount required to be paid as a result of the order or agreement; (2) any amount required to be paid as a result of the order or agreement that constitutes restitution or remediation of property; and (3) any amount required to be paid as a result of the order or agreement for the purpose of coming into compliance with a law that was violated or involved in the investigation or inquiry. The information return must be filed at the time the agreement is entered into.
The final regulations
The final regulations provide clarity and changes based on comments made on the proposed regulations (REG-104591-18). A few of the key aspects of the final regulations include the following:
Section 162(f) regulations
- Clarify that a governmental entity includes a nongovernmental entity treated as a governmental entity
- Provide that amounts paid in routine investigations or inquires, such as audit or inspections, related to the compliance with the rules and regulations of a business or industry are not amounts related to a potential violation of law
- Revise the definition of restitution, remediation of property, and amounts paid to come into compliance to clarify that the definition applies to certain amounts related to environmental remediation
- Do not treat the disgorgement or forfeiture of nets profits as per se nondeductible
- Make clarifications about whether amounts are treated as coming into compliance with a law
- Provide requirements related to the language in an order or an agreement identifying amounts related to restitution, remediation or to come into compliance with a law
- Require documentary evidence to establish that amounts relate to restitution, remediation or to come into compliance with a law
- Clarify the application of section 162(f) to tax payments
Section 6050X regulations
- Maintain the threshold amount of reporting ($50,000) set forth in the proposed regulations and reference the Form 1098-F and instructions for additional guidance
- Require written statements to be provided to the payor on or before January 31 and the filing of the information return on or before February 28 (March 31 if filed electronically)
The regulations related to section 162(f) apply to taxable years beginning on or after the date of publication in the federal register, but generally do not apply to amounts related to a binding order or agreement before such date. The section 6050X provisions apply only to orders or agreements binding under applicable law on or after Jan. 1, 2022, (without regard to whether all appeals have been exhausted or the time for filing an appeal has expired).
Taxpayers facing the possibility of payments to governmental entities need to take affirmative steps during negotiations to preserve the ability to deduct amounts that relate to restitution, remediation or for coming into compliance with the law. Taxpayers are strongly encouraged to check with their tax professionals in negotiating agreements as well as accounting for payments that may be covered by section 162(f).