Room for Improvement in Penalty Deduction Regs, Legal Counsel Says

July 13, 2020

[REG–104591–18]

Re: Comments on IRS Notice of Proposed Rulemaking: Denial of Deduction for Certain Fines, Penalties, and Other Amounts; Information With Respect to Certain Fines, Penalties, and Other Amounts

Dear Sir or Madam:

The following comments are submitted on the referenced Notice of Proposed Rulemaking by the Government of the District of Columbia.

• Proposed § 1.162–21(f)(3)(i) would allow a deduction for restitution or remediation for an amount paid “if it restores, in whole or in part, the person, as defined in section 7701(a)(1); the government; the governmental entity; or property harmed by the violation or potential violation of a law described in paragraph (a)(3) of this section.” The corresponding statutory provision, section 13306(a)(2)(A)(i)(I) of the Tax Cuts and Jobs Act (“the Act”), allows a deduction if the taxpayer establishes that the amount “constitutes restitution (including remediation of property) for damage or harm which was or may be caused by the violation.” The statutory text is not limited to property restoration, but appears to broadly cover harm from the violation or potential violation, which conceivably could include impacts on birds or wildlife or contamination of air, groundwater, or surface water that can move offsite (e.g., natural resource damages).

  • The proposed rule, however, is not precise about what types of harm are covered. The final rule should clarify whether the term “restitution” is intended to cover all harm resulting from the violation, including harm to natural resources.

• Proposed § 1.162–21(f)(3)(iii) excludes specific payments from the definition of restitution and remediation, regardless of whether they are identified as such in the order or agreement. These include (1) payments made at the payor's election, in lieu of a fine or penalty, and (2) any amount paid to an entity; fund, including a restitution, remediation, or other fund; group; government or governmental entity, if they do not otherwise meet the definition of restitution and remediation.

These exclusions may make the rules overly restrictive compared to the Act if the definition of restitution and remediation is construed too narrowly. For example, a violation of law may result in the killing of birds and wildlife. Remediation in this instance is not possible, but a contribution to a wildlife rehabilitation center could effectively provide restitution for the harm, as the Act contemplates. The proposed rules should be revised to clearly allow deductions for natural resource restoration projects and other indirect means of remediation or restitution related to violations of law. Revising the rules along these lines would also be consistent with the goal of restoring the harmed entity to “the same or substantially similar position or condition as before the harm caused by the taxpayer's violation, or potential violation, of a law.”

• Proposed § 1.162–21(f)(4) defines “suit, agreement, or otherwise” to include “settlement agreements, non-prosecution agreements, deferred prosecution agreements, judicial proceedings, administrative adjudications, decisions issued by officials, committees, commissions, boards of a government or governmental entity, and any legal actions or hearings which impose a liability on the taxpayer or pursuant to which the taxpayer assumes liability.”

  • It is unclear whether administrative orders issued by an agency in the form of stop work, cease and desist, and other types of orders issued by government agencies until compliance is achieved would be included in this definition under either “decisions issued by . . . a government or governmental entity,” or “any legal actions . . . which impose a liability on the taxpayer.” If these types of administrative orders are included under the definition, this would significantly expand the reporting burden of government entities. These types of administrative orders should be clearly excluded from the requirements for filing of information by government entities with the IRS under new section 6050X.

• Proposed § 1.6050X–1(e) applies when the costs of restitution/remediation/return to compliance is unspecified. This section says that the governmental entity is required to file an informational return if it estimates this amount to exceed the $50,000 threshold, though it is unclear how the government entity is supposed to make this estimate, or how detailed it is expected to be. The preamble asks for comments on this section as to what factors the government entity should take into account in making this determination.

  • Under Section 13306(a)(2) of the Tax Cuts and Jobs Act, a deduction is allowed only if the taxpayer establishes the amount as restitution, remediation, or a payment to come into compliance. The rules should specify that if the taxpayer anticipates that its costs may exceed the $50,000 threshold, it must provide cost documentation to the relevant government entity. A government entity should be required to file a return only if the taxpayer has provided appropriate documentation, much as it would when justifying deductions to the IRS, upon which the government entity can base its determination. Government entities should not be required to undertake the burden of developing cost estimates for the regulated community, particularly when such cost estimates are more readily available to the taxpayer that would be seeking the deduction.

• Proposed § 1.6050X–1(g)(4) requires government entities to report the amounts of restitution/remediation/compliance costs for “payors,” for which “payor” is defined as “the person (as defined in section 7701(a)(1)) who, pursuant to an order or agreement has paid or incurred, or is liable to pay or incur, an amount to, or at the direction of, a government or governmental entity in relation to the violation or potential violation of a law. In general, the payor will be the person to which section 162(f) and §1.162-21 of the regulations apply.” The definition of “person” includes corporations.

  • While it appears that a tax-exempt non-profit corporation would not be considered a “payor” because they are not subject to the requirements of §1.162-21, it should be made clear in the final rule that reporting under new section 6050X is not required for persons that are exempt from payment of Federal taxes.

• Proposed § 1.6050X-1(a)(1) requires the appropriate official to file an information return if the “aggregate amount the payor . . . is required to pay pursuant to all court orders (orders) and settlement agreements (agreements) with respect to the violation of a law, or the investigation or inquiry into the potential violation” exceeds the threshold amount.

  • Under certain environmental statutes, such as CERCLA and similar statutes that impose liability for releases of hazardous substances, liability for costs of remediation and natural resource damages is strict liability, and potentially responsible parties include current and past owners of contaminated properties, hazardous waste transporters, and those who arranged for disposal or transport of the hazardous wastes. These responsible parties may not have violated the law. The regulations are unclear as to whether the information return requirements apply to settlements or court orders issued under CERCLA and similar strict liability statutes in which the responsible party or parties were not in violation of law.

• Proposed § 1.6050X-1(d)(2) requires that information returns be filed for each of the jointly and severally liable payors. The liability under CERCLA and similar state statutes is joint and several. Government entities may pursue one responsible party or a few major responsible parties for all remediation and natural resource damage costs, and then that responsible party or parties can pursue other responsible parties for contribution. The government entity will not necessarily know who these other responsible parties are at the time of the settlement, and ultimate responsible party payors may not be identified until years after the settlement with the government entity is finalized.

  • The final regulations should make clear that the information returns apply only to costs associated with direct payment of settlement amounts to the government entity, and that there is no continuing requirement for a government entity to monitor and file information returns or to furnish written statements related to third-party contribution settlements arising from the government entity's original settlement.

Thank you for your consideration of these comments.

Sincerely,

Elizabeth Cavendish, Interim Director
Mayor's Office of Legal Counsel
Government of the District of Columbia
Washington, DC