When deductions are permitted for restitution payments

On May 13, the IRS issued proposed regulations (REG-104591-18) on the deductibility of fines, penalties, and certain other amounts after Sec. 162(f) was amended by the law known as the Tax Cuts and Jobs Act (TCJA), P.L. 115-97. The rules expand on the interim guidance in Notice 2018-23.

Sec. 162(f), as amended by the TCJA, disallows a deduction for the payment of fines, penalties, and certain other amounts. Under Sec. 162(f)(1), taxpayers may not deduct amounts that, under court orders or settlement agreements, are paid to, or at the direction of, governments in relation to the violation of any law or the investigation or inquiry into the potential violation of any law.

However, this disallowance may not apply to amounts that taxpayers establish, and court orders or settlement agreements identify, are paid as restitution, remediation, or to come into compliance with a law, so long as the amounts otherwise qualify as deductible under the Code (Sec. 162(f)(2)).

The proposed regulations contain definitions of “restitution,” “remediation,” and “paid to come into compliance with a law.” They also define which nongovernmental entities are treated as governmental entities subject to the reporting requirements.

Prop. Regs. Sec. 1.162-21(f)(3)(iii) lists amounts that will not be treated as paid or incurred to come into compliance with a law. These include reimbursements paid to the government for investigation or litigation costs and forfeitures or disgorgements. The IRS also requested comments about specific examples of audits, inspections, or reviews conducted in the ordinary course of business that are not investigations or inquiries of potential violations of law intended to fall under Sec. 162(f).

Governments are required to report these amounts to the IRS and taxpayers under Sec. 6050X, which was also added by the TCJA. The proposed regulations provide guidance to governments on these reporting requirements.

The Sec. 162(f) regulations are proposed to apply to tax years beginning on or after the date they are published as final in the Federal Register, except for binding agreements that were entered into before that date. Until that date, taxpayers that apply the proposed rules consistently may rely on them.The reporting requirement of Prop. Regs. Sec. 1.6050X-1 will apply only to orders and agreements that become binding on or after Jan. 1, 2022.