Proposed IRC §162(f) regulations were a highlight of discussion at an American Bar Association (ABA) Tax Section webinar on June 17, 2020.
Released in early May, the proposed regulations guide taxpayers on the deductibility of fines and penalties paid to governmental entities.
The proposed regs address the changes made to IRC §162(f) by the Tax Cuts and Jobs Act (TCJA).
Speakers at the webinar included Norma Rotunno, IRS Office of Chief Counsel, Branch Chief, Branch 1, and Sharon Horn, IRS Office of Chief Counsel, Branch 1.
This post shares some points made during the webinar about the application of IRC §162(f) and the proposed regulations.
Denied Deductions for Government Fines and Penalties and Exceptions
First, a quick recap of IRC §162(f).
IRC §162(f) denies deductions for fines or penalties paid to any government for the violation of any law. However, three exceptions exist, fines and penalties for:
- remediation; or
- an amount paid to come into compliance with the law.
The three exceptions are sometimes called “RRC”.
To qualify for an exception, a taxpayer must meet both:
- the identification requirement; and
- the establishment requirement.
For example, as noted by Ms. Horn, if a payment is both for restitution and compliance, but the compliance amount cannot be identified, the deduction will not be allowed.
The Wording of Agreements and Court Orders
Taxpayers often enter agreements with governmental entities for the liability of fines and penalties for violations of the law.
Ms. Horn emphasized the importance of the statutory language in determining whether a taxpayer falls under an exception in IRC §162(f)(2).
“Taxpayers must take a careful look at the language of the agreement,” said Ms. Horn. “My understanding is that the statute allows variations of the word (restitution) but not synonyms.
For example, the word “conform” in an agreement could be problematic if it is used instead of “comply.”
Ms. Rotunno agreed that the language of the statute is important in making agreements. However, with regard to foreign settlements, the regulations do not address how a language barrier might be a problem.
The IRS has the authority to address this problem, Ms. Rotunno noted.
Documentation Supporting an Exception
The identification requirement of IRC §162(f) requires taxpayers to identify the nature and purpose of the payment for which they are claiming the exception. To do so, they can provide documentation, and the proposed regulations provide a list of types of documentation.
Ms. Horn and Ms. Rotunno did not confirm whether that list was exhaustive. However, they requested that taxpayers provide more examples of documents that can establish entitlement to the deduction.
When Exact Amounts for RRC are Unknown
One question posed to the IRS counsel was: what if the exact amount of remediation is unknown at the time of the agreement.
Ms. Horn stated that the IRS recognizes that courts often will not allocate dollar amounts for RRC type payments, and that, with regard to multiple taxpayers, the IRS would consider allowing taxpayers to establish the amount allocated to each taxpayer. There is statutory authority to write rules around this issue. Further, Ms. Horn requested comments on when taxpayers pay an amount that is greater than the agreement states.
Letter Rulings for the IRC §162(f) Exception
The discussion turned to whether a question regarding application of the regulations would be appropriate for a letter ruling.
Ms. Horn noted that “the IRS provided guidance to apply [the regulations] broadly to a variety of situations.”
Disgorgement as Punitive Under IRC §162(f)
In response to a question asking why disgorgement and forfeiture are punitive, Ms Horn stated that Congressional intent was to provide an objective measure with the statute, but facts and circumstances still have to be analyzed.
Nevertheless, while the goal of the regulations is to reduce tax controversy, it is best to adhere to the statute.
The Tax Benefit Rule
Ms. Horn noted that, because of the tax benefit rule, IRC §162(f) applies even if a taxpayer successfully appeals a court order. In other words, if the taxpayer gets money back after an appeal, the tax benefit rule applies.
Finally, the governmental entity that fines a taxpayer is required to give the taxpayer a copy of Form 1098-F. If the governmental entity fails to issue a Form 1098-F, “it does not jeopardize things for a taxpayer,” said Ms. Horn.
Finalizing Proposed Regulations
When asked for a timeframe for the issuance of final regulations, Ms. Horn said they are “treating the regulations as a top priority. Also, we are waiting for comments.”
By Lisa Lopata, J.D.