Deductibility of Fines and Penalties: New Guidance Leaves Key Questions Unanswered

Proposed IRS regulations clarify when fines and penalties are deductible but leave important issues unresolved.

The U.S. Internal Revenue Service has released proposed regulations clarifying when fines, penalties, and other payments to the government are deductible under section 162(f) of the Internal Revenue Code. Section 162(f) historically denied deductions for fines or similar penalties paid to the government for violations of law. 

The Tax Cuts and Jobs Act ("TCJA") expanded the scope of section 162(f) to deny deductions for amounts paid to or at the direction of a governmental entity relating to a violation (or investigation of a potential violation) of any law. Payments of restitution or for coming into compliance with the law remain deductible if "identified" as such in a court order or settlement agreement, though these exceptions do not apply to payments reimbursing government investigative or litigation costs. Payments for taxes due also remain deductible. The TCJA also created a reporting requirement under which "appropriate" government officials must report amounts required to be paid as a result of a suit or agreement.

With respect to the identification requirement, the proposed regulations provide that if the relevant order or agreement "specifically states" that an amount constitutes "restitution," "remediation," "an amount paid to come into compliance with a law," or a different form of these words (e.g., "remediate" or "comply with a law"), the identification requirement is presumed to be satisfied. The burden then shifts to the IRS to rebut this presumption.

The proposed regulations also give guidance on when a payment is made "at the direction of" a government. They explain that a taxpayer's agency-ordered payment to customers for violating consumer protection laws is made "at the direction" of the government, but a court-ordered payment in a private lawsuit is not. However, these regulations do not clearly address the deductibility of payments to qui tam relators or payments to the government to the extent they are shared with qui tam relators.

Finally, the proposed regulations delay the governmental reporting requirement, now applicable only to orders and agreements that become binding on or after January 1, 2022, while exempting foreign governments entirely.

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