The Tax Cuts and Jobs Act of 2017 makes it harder to take tax deductions for some payments to governmental entities. The change may impact settlements between private entities and federal, state and local environmental agencies. In most cases, it will not affect environmental settlements between private parties.
Section 162(f) of the Tax Code has long prohibited deductions for fines and penalties paid to the government. The new law makes the tests for deduction of certain payments to a governmental agency more stringent. The amended Section 162(f) substantially limits the tax deduction available for (1) any settlement or other payments, (2) made to or incurred at the direction of a governmental entity, (3) related to a violation of any law or governmental investigation or inquiry into the potential violation of any law.
There is an exception to this rule, which allows a deduction for the following payments: (1) restitution, including remediation of property; or (2) an amount paid to come into compliance with a violated law or involved in an investigation or inquiry. To be deductible, the payment has to be expressly identified under a court order or settlement agreement as a restitution or compliance payment. This exception does not apply to amounts paid “as reimbursement to the government for the costs of any investigation or litigation.”
Under the statute, the limitation applies only to payments made to, or at the direction of, a governmental entity. A deduction, therefore, remains available for remediation expenses paid to private parties without governmental direction.
Finally, a new provision under Sec. 6050X requires government agencies involved in settlements to report to the Internal Revenue Service (IRS) the portions of the settlement payment that are and are not deductible under Section 162(f).
Our tax and environmental groups can advise on the implications of the new law, including factoring into negotiations the potentially higher tax cost of government settlements and ensuring that the settlements reached are well-drafted and as tax-efficient as possible.