Department plea agreements, non-prosecution agreements, and deferred prosecution agreements, as well as Department civil case settlements, may contain acknowledgements of tax law by the entity entering into the agreement that no tax deduction may be sought in connection with the payment of a penalty or other amounts. The Tax Cuts and Jobs Act, Pub. L. No. 115-97, amended 26 U.S.C § 162(f) to deny, with exceptions, the deductibility of any amount paid or incurred 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 into a potential violation of law. Section 6050X was also added to require the government or governmental entity to report to the Secretary of Treasury amounts required to be paid because of a suit or agreement. The changes to the law are effective for a binding order or agreement entered into or approved by a court on or after December 22, 2017.

On March 27, 2018, the Department of the Treasury and the Internal Revenue Service (IRS) published Notice 2018-23. In addition to announcing Treasury’s intent to develop proposed regulations and requesting comment by May 18, 2018, the notice delays the § 6050X reporting requirement to no earlier than January 1, 2019. Thus, any order or settlement agreement is not currently subject to the reporting requirement, and therefore department attorneys do not have a reporting obligation.

26 U.S.C. § 162(f)(2) outlines the exceptions to non-deductibility. The provision indicates that amounts that constitute restitution or are paid to come into compliance with any law that was violated or otherwise involved in the investigation may be deductible, but only if the amount is identified as restitution or an amount paid to come into compliance in the court order or settlement agreement, as well as meeting other requirements. The Treasury Department is expected to issue regulations on the application of this provision, and the Department is developing internal policy on its application.

Apart from compliance with the foregoing provisions of law and any applicable guidance, or otherwise including a provision in a settlement expressly barring deduction of particular expenses, the Department shall otherwise seek in non-tax cases to remain neutral in any potential dispute between a settling party and the IRS regarding the tax consequences of a settlement, whether the settlement involves payment to or from the private party. To the extent possible and practicable, settlement documents also should not characterize payments made by the United States or its agencies as a substitute for wages or as compensatory damages, etc

Although the Department may identify an amount as restitution or an amount paid to come into compliance, the statute provides that “[t]he identification under clause (ii) alone shall not be sufficient to make the establishment required under clause (i),” so there may be a remaining legal issue as to the application of 26 U.S.C. § 162(f)(2)(A)(i), as to which the Department will seek to maintain neutrality.

[new April 2018]