Proposed regulations released on 162(f) rules on deductibility and reporting of certain fines and penalties
The Treasury Department recently issued proposed regulations under Internal Revenue Code (IRC) sections 162(f) and 6050X to provide guidance on the deductibility and reporting of certain amounts paid to governments, or at their direction, relating to the violation of a law, or investigation or inquiries into the potential violation of a law.
Section 162(f) – originally enacted in 1969 – prevents taxpayers from deducting most fines and penalties. The Tax Cut and Jobs Act (TCJA) amended Section 162(f) to provide clarity around the application of the rule. TCJA provided certain exceptions to the general rule and created new code Section 6050X, which imposes reporting requirements on governmental entities that have imposed fines or penalties.
As amended by TCJA, Section 162(f)(1) provides that no deduction shall be allowed “for any amount paid or incurred (whether by suit, agreement, or otherwise) to, or at the direction of, a government, governmental entity, or nongovernmental entity in relation to the violation of a law or the investigation or inquiry by such government or governmental entity into the potential violation of a law.” The statute provides an exception for amounts if: (1) the amounts are identified (in an order or agreement) as restitution, remediation, or paid or incurred to come into compliance with the law, and (2) the taxpayer establishes that the amount was paid or incurred for one of those purposes.
The proposed regulations were issued to provide “operational and definitional guidance” in connection with the changes made by the TCJA.
Included in the proposed regulations are guidance on the deductibility exceptions in Section 162(f) and rules for complying with the reporting requirements under Section 6050X (“Information With Respect to Certain Fines, Penalties and Other Amounts”).
Proposed regulations are not generally effective until finalized and published in the Federal Register. However, the Prop. Reg. Section 1.162-21 may be relied upon currently until final regulations are published.
After restating the general rule and exception noted above, the proposed regulations under Section 162(f) address the following issues:
1. The definitions of government, governmental entity, or nongovernmental entity treated as a governmental entity.
2. Definitions of restitution and remediation for purposes of the exception under Section 162(f)(2).
3. Clarification of which amounts will be treated as amounts paid or incurred to come into compliance with a law under Section 162(f)(2).
4. Clarification of when a cost is incurred as part of an investigation or inquiry into a potential violation of law.
5. When a change to an order or agreement will be a “material change” creating a new agreement that might subject the order or agreement to the post-TCJA version of Section 162(f).
6. Rules related to a taxpayer’s obligation to “establish” that an amount paid was restitution, remediation, or paid or incurred to come into compliance with the law.
7. Rules related to the requirement that an order or agreement “identifies” the purpose of the payment.
8. Rules related to suits between private parties.
9. Rules related to taxes, tax penalties, and related interest.
What does CohnReznick think?Companies that pay amounts that might be fines or penalties should consult with their tax advisor in order to determine whether those amounts are deductible under the post-TCJA rules – and the new proposed regulations. Given the fact that Section 162(f) permanently denies affected fines and penalties, it is worth analyzing such payments to determine the proper treatment. Additionally, the payor of a fine or penalty should understand the government’s obligations under Section 6050X and the regulations thereunder.
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