Changes made to Internal Revenue Code (IRC) Section 162(f) by the Tax Cuts and Jobs Act (TCJA) provide operational and definitional guidance on the deductibility of fines and penalties paid to governmental entities.
TCJA Changes
Under amended IRC Section 162(f), businesses may not deduct fines and penalties that are paid or incurred after December 21, 2017, due to the violation of a law or the investigation of a violation of law, if a government or similar entity is a complainant or investigator. Exceptions are available where the payment was made for restitution, remediation, taxes due, or to come into compliance with a law.
In order for the exceptions to apply, the taxpayer must identify the payment as restitution or compliance in a court order or settlement agreement. In addition, IRC Section 6050X requires that the officer or employee that has control over the suit or agreement, or the individual designated by the government or entity, must file a return with the IRS.
Establishing Restitution or Remediation
Under the proposed regulations, a taxpayer can establish that a payment was made for restitution or remediation by providing documentary evidence showing:
- the taxpayer was legally obligated to pay the amount of the order or agreement identified as restitution, remediation, or to come into compliance with a law;
- the amount paid or incurred; and
- the date on which the amount was paid or incurred.
The proposed regulations provide a list of documents that taxpayers can use to satisfy the establishment requirement. The regulations also clarify that reporting of the amount by a government or governmental entity under IRC Section 6050X alone does not satisfy the establishment requirement.
Identification Requirement
According to IRC Section 162(f)(2)(A), an order or agreement must identify the amount paid or incurred as restitution, remediation, or to come into compliance with a law. The proposed regulations state that an order or agreement should identify a payment by stating both (1) the nature of, or purpose for, each payment, and (2) the amount of each payment identified. Reporting of the amount by a government or governmental entity under IRC Section 6050X does not satisfy the identification requirement.
Taxes and Interest
Under IRC Section 162(f)(4), taxpayers may still deduct any taxes due, including any related interest on the taxes. However, the proposed regulations clarify that taxpayers may not deduct interest related to penalties.
Reporting Requirements
The proposed regulations provide appropriate officials with operational, administrative, and definitional rules for complying with statutory information reporting requirements with respect to IRC Section 162(f). If the aggregate amount a payer is required to pay equals or exceeds the threshold amount under
Proposed Regulation Section 1.6050X-1(g)(5), the appropriate official must file an information return with the IRS with respect to the amounts or incurred paid and any additional information required.
According to the proposed regulations, the appropriate official must provide this information by filing Form 1098-F, Fines, Penalties, and Other Amounts, with Form 1096, Annual Summary and Transmittal of U.S. Information Returns, on or before the annual due date. However, the proposed regulations do not require an appropriate official to file information returns for each tax year in which a payer makes a payment pursuant to a single order or agreement. Instead, the appropriate official must file only one information return for the aggregate amount identified in the order or agreement.
The proposed regulations also require that the appropriate official furnish a written statement to each payer with respect to which it is required to file an information return. The written statement must include the information that was reported on the information return, and a legend that identifies the statement as important tax information that is being furnished to the IRS. They can satisfy this requirement by providing a copy of Form 1098-F to the payer.
For more information about this article, please contact our tax professionals at taxalerts@windes.com or toll free at 844.4WINDES (844.494.6337).