On March 27, 2018, the Internal Revenue Service (IRS) issued Notice 2018-23 (the Notice), providing transitional guidance for parties to suits and agreements covered by sections 162(f) and 6050X of the Internal Revenue Code (the Code), which were added by Pub. L. 115-97 (commonly known as Tax Cuts and Jobs Act or TCJA). The Notice provides that:

  • No reporting will be required with respect to amounts required to be paid or incurred under a binding court order or agreement entered into before the date specified in the proposed regulations, which will not be earlier than January 1, 2019, and will not be earlier than the date of publication of the proposed regulations;
  • All other reporting required under section 6050X is deferred until the proposed regulations are issued;
  • Until the proposed regulations are issued, the identification requirement in section 162(f)(2)(A)(ii) is deemed satisfied if either the order or agreement specifically states on its face that the amount is restitution, remediation, or for the purpose of coming into compliance; and
  • Comments may be submitted regarding issues to be addressed in the proposed regulations for sections 162(f) and 6050X.

Eversheds Sutherland Observation: Although taxpayers are yearning for guidance on the myriad issues raised by the TCJA, IRS and Treasury have previously indicated that they will generally forego notices in lieu of more formal regulatory guidance. In issuing guidance for past tax legislation, IRS and Treasury have been criticized for over-reliance on notices rather than the regulatory process. However, when targeted or specific issues need to be addressed, notices allow guidance to be issued quickly. Here, a notice was chosen to provide specific guidance and will also assist in fulfillment of the notice and comment obligations under the Administrative Procedure Act and allow for a potential regulatory retroactive effective date under section 7805(b)(1)(C). The Notice requests comments from taxpayers and government agencies regarding sections 162(f) and 6050X.


Section 162(f) is a long-standing provision that prohibits deductions for the payment of fines and penalties. Enacted in 1969, the statute replaces earlier case law, which had held that allowing deductions for fines and penalties frustrates public policy. Under section 162(f), prior to amendment by the TCJA and the relevant regulations, a fine or penalty paid to a government was non-deductible. However, compensatory payments, or payments not made to governments, were deductible if they otherwise qualified as business expenses under section 162.

The amendments to section 162(f) in the TCJA originated in a bill introduced by Senator Chuck Grassley in 2003 in response to concerns that, to the extent certain settlement payments were deductible, the publicly announced amount of a settlement payment would not reflect the true after-tax penalty amount, and that allowing a deduction for such payments would, in effect, shift a portion of the penalty to the federal government and to the public. See S. Rep. No. 108-292 (2003). The bill was repeatedly reintroduced but did not pass until it was included in the TCJA.

Despite the concerns raised in Congress, under the pre-TCJA section 162(f), many companies argued that settlement payments were compensatory in nature and thus deductible. As a result of the ambiguity on whether particular payments were deductible compensatory payments or non-deductible fines or penalties, and a posture initiated by the Justice Department that settlement agreements would be tax neutral, there has been significant controversy over the last 20 years regarding the treatment of fines and penalties. See e.g., Talley Indus., Inc. v. Commissioner, 116 F.3d 382 (9th Cir. 1997) (holding that the taxpayer failed to establish that False Claims Act settlement payments were compensatory); but see Fresenius Med. Care Holdings Inc. v. United States, 763 F.3d 64 (1st Cir. 2014) (holding that single damages under the False Claims Act were deductible as compensatory damages and, in the absence of any agreement between the parties regarding the characterization of treble damages, remanding the case to the district court for a determination of whether any portion was deductible). See also Nacchio v. United States, 824 F.3d 1370 (Fed. Cir. 2016) (holding that disgorgement of $45 million in insider trading profits was a non-deductible fine or penalty under section 162(f) despite the later use of the funds by the government to compensate the victims of the insider trading).

In response to the concerns raised in Congress and the continuing litigation, the TCJA sought to clarify the scope of non-deductible fines and penalties and also imposed a formal reporting requirement under section 6050X in an effort to ameliorate such disputes. It will be interesting to see whether these statutory changes achieve the desired result.

As amended, section 162(f) disallows a deduction for amounts paid or incurred (whether by suit, agreement, or otherwise) to, or at the direction of, a government or governmental entity (defined to include certain non-governmental regulatory entities) in relation to the violation of any law or the investigation or inquiry by such government or entity into the potential violation of any law. The amended section is an expansion of the prior provision. Section 162(f)(2)(A) provides an exception to this general rule when:

  • The taxpayer establishes the amount (1) constitutes restitution (including remediation of property) for damage or harm which was or may be caused by the violation of any law or the potential violation of any law and (2) is paid to come into compliance with any law (the Establishment Requirement); and
  • The amount is identified in a court order or settlement agreement as either restitution or an amount paid to come into compliance with the law (the Identification Requirement).

In the case of any amount of restitution for failure to pay any tax under the Code, the amount is treated as if such amount were such tax if it would have been allowed as a deduction if it had been timely paid.

To ensure compliance with section 162(f), the TCJA also enacted a reporting regime embodied in section 6050X, providing that the official or entity involved in a suit or agreement must report any settlements that are at least $600. The new information return must be filed with the IRS, and it must be provided to all parties to the suit or agreement when the settlement is reached. Under section 6050X, the settlement payment must be labeled as one of the specified categories (e.g., restitution or remediation of property, and amounts paid for the purpose of coming into compliance with any law) for reporting purposes of section 6050X. Furthermore, the $600 threshold amount may be adjusted by the Secretary as “necessary to ensure the efficient administration of the internal revenue laws.”

The Notice

Timing of Section 6050X Reporting Requirements

The Notice responds to requests from officials of government and governmental entities asking for additional time to comply with the new section 6050X. The Notice also indicates that additional time was needed by the IRS to complete the form process and to make programming changes to put the new reporting requirement into place. In order to accommodate these concerns, the Notice provides that (i) no reporting will be required with respect to amounts required to be paid or incurred under a binding court order or agreement entered into before the proposed regulations are issued; and (ii) all other reporting required under section 6050X is deferred until the proposed regulations are issued. Furthermore, the Notice clarifies that an agreement requiring court approval is binding when that approval is obtained.

Satisfaction of Certain Section 162(f) Requirements

The Notice provides guidance on the Identification Requirement set forth in section 162(f)(2)(A)(ii). The Notice provides that, until the proposed regulations are issued, the Identification Requirement, which is necessary to fall under the exception to non-deductibility in section 162(f)(2)(A), will be considered met if either the order or agreement specifically states on its face that the amount is restitution, remediation, or for the purpose of coming into compliance. The requirement applies to amounts paid or incurred on or after December 22, 2017. Additionally, the Notice states that even if the “identification requirement” is satisfied, the taxpayer must also meet the “establishment requirement” to qualify for the restitution exception.

Requested Comments

Finally, the Notice provides that the IRS and the Treasury Department intend to issue proposed regulations for sections 162(f) and 6050X. They request comments from the public and affected entities on any and all issues relating to these sections, specifically with respect to what entities should be considered “non-governmental entities,” the timing of the reporting requirement, the $600 threshold amount, and any administrative difficulties anticipated to satisfy the reporting requirements. Comments may be submitted by May 18, 2018, by mail, hand or courier delivery, or electronically.

Eversheds Sutherland Observation: The changes to section 162(f) and the addition of section 6050X are expected to significantly impact the resolution of fines and penalty issues in an IRS Exam context. As a threshold matter, taxpayers in a settlement posture will now be required to consider the tax treatment of settlement payments so that treatment may be established and identified as part of the settlement process. Taxpayers will also be required to consider the significance of the tax treatment of settlement payments as the settlement is reached. Further, it is anticipated that the determination of tax-deductible amounts may slow and even complicate resolution. More importantly, the Justice Department and other applicable government officials will be obligated to specify the portion of payments that are characterized as restitution, remediation or payments to come into compliance with the law.

Due to the changes in section 162(f) and the addition of section 6050X, disputes regarding the deductibility of settlement payments will necessarily be accelerated because they will need to be addressed as settlement is reached rather than when the company’s tax return is being reviewed. These tax disputes will be handled by other non-IRS government officials who are tasked with settlement responsibilities. It is curious that determinations regarding tax deductions are being moved to government officials outside of the IRS and Treasury. An unfortunate consequence is that when an agreement is reached and the tax treatment is established and identified, companies will need to be prepared to defend the payments as deductible restitution before the IRS in an Exam context. Even though a payment is labeled as deductible in an agreement, this does not necessarily show that the Establishment Requirement is satisfied, and history would suggest that taxpayers should anticipate that the IRS will challenge the deduction. Companies will be required to substantiate payments with other objective information from the settlement discussions to substantiate the ultimate tax return position.