Pre-Released Final Regs Provide Guidance on Penalty Deduction Provisions

Pre-Released Final Regs Provide Guidance on Penalty Deduction Provisions

Internal Revenue Service

The IRS has issued a pre-released version of final regulations (T.D. 9946) that provide guidance on section 162(f) regarding the deduction of specified fines, penalties, and other amounts and on the information reporting requirements under section 6050X for those amounts. The final version of the regs will be posted on the Federal Register website at a later date and will incorporate any changes made during the government’s review process. The final regs adopt, with changes, proposed regs (<a href="/lr/resolve//2cj06">REG-104591-18</a>) issued in May 2020. The final regs generally disallow a deduction for amounts paid or incurred to, or at the direction of, a government or governmental entity for a violation, or an investigation into a potential violation, of any civil or criminal law. That general rule applies regardless of whether the taxpayer admits guilt or liability or pays the amount imposed for any other reason, including to avoid the expense or uncertain outcome of an investigation or litigation. For purposes of the general rule, the final regs clarify the definition of a nongovernmental entity treated as a governmental entity and a violation of any law. Under the final regs, section 162(f)(1) will not apply to disallow an otherwise deductible business expense for amounts paid or incurred for required routine investigations or inquiries to ensure compliance with applicable rules and regulations, which aren’t related to any evidence or suspicion of wrongdoing.  The final regs provide definitions and other guidance on the operation of the exception to the general disallowance rule for specified amounts paid or incurred for restitution, remediation, or to comply with a law. In response to comments, the regs provide a special restitution and remediation rule to address amounts paid or incurred for harm to the environment, natural resources, or wildlife. Also, in response to comments, the regs will not treat disgorgement and forfeiture of net profits as, per se, nondeductible under section 162(f)(1). A taxpayer’s claim for a deduction for amounts paid or incurred through disgorgement or forfeiture will not be disallowed if the amount is otherwise deductible under chapter 1 and other conditions are met. The regs remove a per se exclusion for amounts paid or incurred to a specified entity or fund to the extent that it wasn’t harmed by the taxpayer’s violation or potential violation of a law. However, the final regs provide that restitution and remediation do not include specified amounts paid or incurred under an order or agreement for general enforcement efforts or other discretionary purposes or amounts paid or incurred that do not meet specified requirements. Further, if specified amounts paid or incurred under an order or agreement are subsequently returned to the taxpayer, the taxpayer will be required to include those amounts in income under the tax benefit rule. For purposes of the exception to the general disallowance rule, the final regs list amounts that will not be treated as paid or incurred to comply with a law. The regs clarify that the services performed, actions taken, and the provision of property must be done to comply with the law that has been violated or potentially violated. An order or agreement must identify an amount paid or incurred as restitution, remediation, or to comply with a law. The final regs modify the proposed rule for payment amounts not identified and incorporate some suggestions to address when the identification requirement is met. A taxpayer must establish that an amount was paid as restitution, remediation, or to comply with a law. The final regs clarify when that establishment requirement is met and expand the list of documentary evidence that may be used to meet the requirement. The general rule that disallows a deduction also does not apply to any amount paid or incurred under an order in a private party suit. The regs clarify the rules that apply in those cases in response to comments. The preamble addresses pre- and post-judgment interest and the final regs provide that if penalties are imposed for otherwise deductible taxes, a taxpayer may not deduct the penalties or the interest paid for those penalties. The final regs also do not include the proposed material change rule under which some orders issued, or agreements entered, before December 22, 2017, were subject to section 162(f)(1) as amended by the Tax Cuts and Jobs Act. Generally, under the final regs, if the aggregate amount a payer must pay under an order or agreement for a violation, investigation, or inquiry to which section 6050X applies equals or exceeds the threshold amount, the appropriate official must file an information return to the IRS for specified amounts paid or incurred under the order or agreement and other required information. The appropriate official must also furnish a written statement with the same information to the payer. The regs maintain the proposed threshold amount and provide that reporting is required for payment amounts equal to or more than $50,000. The regs include some changes regarding the requirement to file an information return to minimize burdens on governments and governmental entities. As requested, the final regs provide that information returns filed with the IRS on paper are due by February 28 of the year following the calendar year in which the order or agreement becomes binding under applicable law. Information returns filed electronically are due by March 31 of such year. However, the regs require the appropriate official to furnish the written statement to payers by January 31 of such year. The final regs also provide rules describing the application of the information reporting requirements to multiple payers. The rules of reg. section 1.162-21 apply to tax years beginning on or after the date the final regs are published, but they do not apply to amounts paid or incurred under any order or agreement that became binding under applicable law before that date, regardless of whether all appeals have been exhausted or the time for filing an appeal has expired. The rules of reg. section 1.6050X-1 apply only to orders and agreements that become binding under applicable law after December 31, 2021, regardless of whether all appeals have been exhausted or the time for filing an appeal has expired.

T.D. 9946, which was posted on the Federal Register website on January 14, 2021, is the <a href="/lr/resolve//2l646">official version</a> of the final regs.

The IRS has issued a pre-released version of final regulations (T.D. 9946) that provide guidance on section 162(f) regarding the deduction of specified fines, penalties, and other amounts and on the information reporting requirements under section 6050X for those amounts.

The IRS has issued a pre-released version of final regulations (T.D. 9946) that provide guidance on section 162(f) regarding the deduction of specified fines, penalties, and other amounts and on the information reporting requirements under section 6050X for those amounts. The final version of the regs will be posted on the Federal Register website at a later date and will incorporate any changes made during the government’s review process. The final regs adopt, with changes, proposed regs (REG-104591-18) issued in May 2020. The final regs generally disallow a deduction for amounts paid or incurred to, or at the direction of, a government or governmental entity for a violation, or an investigation into a potential violation, of any civil or criminal law. That general rule applies regardless of whether the taxpayer admits guilt or liability or pays the amount imposed for any other reason, including to avoid the expense or uncertain outcome of an investigation or litigation. For purposes of the general rule, the final regs clarify the definition of a nongovernmental entity treated as a governmental entity and a violation of any law. Under the final regs, section 162(f)(1) will not apply to disallow an otherwise deductible business expense for amounts paid or incurred for required routine investigations or inquiries to ensure compliance with applicable rules and regulations, which aren’t related to any evidence or suspicion of wrongdoing.  The final regs provide definitions and other guidance on the operation of the exception to the general disallowance rule for specified amounts paid or incurred for restitution, remediation, or to comply with a law. In response to comments, the regs provide a special restitution and remediation rule to address amounts paid or incurred for harm to the environment, natural resources, or wildlife. Also, in response to comments, the regs will not treat disgorgement and forfeiture of net profits as, per se, nondeductible under section 162(f)(1). A taxpayer’s claim for a deduction for amounts paid or incurred through disgorgement or forfeiture will not be disallowed if the amount is otherwise deductible under chapter 1 and other conditions are met. The regs remove a per se exclusion for amounts paid or incurred to a specified entity or fund to the extent that it wasn’t harmed by the taxpayer’s violation or potential violation of a law. However, the final regs provide that restitution and remediation do not include specified amounts paid or incurred under an order or agreement for general enforcement efforts or other discretionary purposes or amounts paid or incurred that do not meet specified requirements. Further, if specified amounts paid or incurred under an order or agreement are subsequently returned to the taxpayer, the taxpayer will be required to include those amounts in income under the tax benefit rule. For purposes of the exception to the general disallowance rule, the final regs list amounts that will not be treated as paid or incurred to comply with a law. The regs clarify that the services performed, actions taken, and the provision of property must be done to comply with the law that has been violated or potentially violated. An order or agreement must identify an amount paid or incurred as restitution, remediation, or to comply with a law. The final regs modify the proposed rule for payment amounts not identified and incorporate some suggestions to address when the identification requirement is met. A taxpayer must establish that an amount was paid as restitution, remediation, or to comply with a law. The final regs clarify when that establishment requirement is met and expand the list of documentary evidence that may be used to meet the requirement. The general rule that disallows a deduction also does not apply to any amount paid or incurred under an order in a private party suit. The regs clarify the rules that apply in those cases in response to comments. The preamble addresses pre- and post-judgment interest and the final regs provide that if penalties are imposed for otherwise deductible taxes, a taxpayer may not deduct the penalties or the interest paid for those penalties. The final regs also do not include the proposed material change rule under which some orders issued, or agreements entered, before December 22, 2017, were subject to section 162(f)(1) as amended by the Tax Cuts and Jobs Act. Generally, under the final regs, if the aggregate amount a payer must pay under an order or agreement for a violation, investigation, or inquiry to which section 6050X applies equals or exceeds the threshold amount, the appropriate official must file an information return to the IRS for specified amounts paid or incurred under the order or agreement and other required information. The appropriate official must also furnish a written statement with the same information to the payer. The regs maintain the proposed threshold amount and provide that reporting is required for payment amounts equal to or more than $50,000. The regs include some changes regarding the requirement to file an information return to minimize burdens on governments and governmental entities. As requested, the final regs provide that information returns filed with the IRS on paper are due by February 28 of the year following the calendar year in which the order or agreement becomes binding under applicable law. Information returns filed electronically are due by March 31 of such year. However, the regs require the appropriate official to furnish the written statement to payers by January 31 of such year. The final regs also provide rules describing the application of the information reporting requirements to multiple payers. The rules of reg. section 1.162-21 apply to tax years beginning on or after the date the final regs are published, but they do not apply to amounts paid or incurred under any order or agreement that became binding under applicable law before that date, regardless of whether all appeals have been exhausted or the time for filing an appeal has expired. The rules of reg. section 1.6050X-1 apply only to orders and agreements that become binding under applicable law after December 31, 2021, regardless of whether all appeals have been exhausted or the time for filing an appeal has expired.

Sec. 162 Trade or business expenses

Sec. 6050X Information With Respect to Certain Fines, Penalties, and Other Amounts

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Pre-Released Final Regs Provide Guidance on Penalty Deduction Provisions