New Tax Law Limits Tax Deductibility of Government Settlement Payments

The new tax law changes the tax deductibility of certain settlements, fines, and penalties paid to the government.  In general, the new law, known as the Tax Cuts and Jobs Act (the Tax Act), prohibits defendants from deducting payments paid to, or at the direction of, the government, except in circumstances where the payment was explicitly made for restitution purposes or to come into compliance with a law.  The new rule is effective for amounts paid or incurred on or after December 22, 2017 (the effective date of the law).

Section 13306 of the new Tax Act amended Section 162(f) of the Internal Revenue Code to provide that no deduction is allowed for any amount paid (whether by suit, agreement, or otherwise) to, or at the direction of, a government or governmental entity in relation to the violation of any law or the investigation by the government into the potential violation of any law.  The reimbursement of government investigation or litigation costs are also nondeductible under the new law.

The amended statute, however, provides an exception to the general rule for amounts the taxpayer establishes are either (i) restitution (including remediation of property) for damage or harm that was or may be caused by the violation of any law or (ii) are paid to come into compliance with any law that was violated.  A taxpayer can only make a deduction if such amounts are specifically identified in the settlement agreement or court order.  However, the amended statute also states that express identification in the settlement is not alone sufficient, indicating that additional evidence may be necessary to support such a deduction.

For those considering settlements with the government, it will be important to consider the implications of the new Tax Act when evaluating potential financial exposure.  Not only has the Tax Act limited deductibility, but affirmative steps must now be taken—including, but not limited to, ensuring settlement agreements with the government identify amounts paid as either (i) restitution or (ii) to come into compliance with the law—so that potential deductions can be taken.

A copy of H.R. 1, the Tax Cuts and Jobs Act, is available here: https://www.congress.gov/bill/115th-congress/house-bill/1/text.