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What Still Needs Clarification in TCJA Changes

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Jun 25th 2018
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In comments submitted to the IRS the American Institute of CPAs (AICPA) has asked the agency to clarify changes to the disallowance of fines and penalties under Internal Revenue Code Section 162(f) and the new reporting requirement in Section 6050X under the Tax Cuts and Jobs Act (TCJA).

Here’s a quick summary of what the TCJA changed in the two sections, courtesy of the AICPA’s comments (A more extensive explanation is in the letter link above):

The TCJA significantly changed Section 162(f), and Section 162(f)(1) doesn’t allow a deduction for amounts paid or incurred (whether 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 or inquiry by such government or entity into the potential violation of any law. Section 162(f)(2) provides an exception to the general rule for amounts constituting restitution or for amounts paid to come into compliance with the law.

Section 6050X(a)(1) requires the appropriate official of any government or applicable nongovernmental entity that is involved in a suit or agreement described in section 6050X(a)(2) to make a return in such form as determined by Treasury. According to the AICPA comments, the return should set forth:

  1. The amount required to be paid as a result of the suit or agreement to which paragraph (1) of section 162(f) applies
  2. Any amount required to be paid as a result of the suit or agreement that constitutes restitution or remediation of property
  3. Any amount required to be paid as a result of the suit or agreement for the purpose of coming into compliance with any law which was violated or involved in the investigation or inquiry

Under section 6050X(a)(2), the taxpayer must report the amounts they are required to pay as a result of certain suits or agreements and the aggregate amount involved in all court orders and agreements with respect to the violation, investigation, or inquiry is $600 or more.

So here’s what the AICPA recommends. The AICPA’s letter includes an analysis of each: 

  • Section 162(f)(1) – Disallowance of amounts paid for inquiry by government or governmental entity into the potential violation of any law. The AICPA wants a safe harbor or bright-line rule that limits the application of an “inquiry” into a “potential” violation of the law, to not include amounts paid in the ordinary course of business to comply with the law. The safe harbor should state that a taxpayer is not subject to section 162(f) if the taxpayer does not receive a Form 1099, Miscellaneous Income, for purposes of section 6050X. The AICPA also recommends a requirement that for the applicability of section 162(f) in this context: 1) an inquiry is required in writing; and 2) such written documentation must specify that a potential violation of law is asserted or otherwise investigated.
  • Section 162(f)(2) – Exception for amounts constituting restitution or paid to come into compliance with law. Guidance should create a rebuttable presumption in favor of the taxpayer for purposes of section 162(f)(2)(i) in situations where the requirements of section 162(f)(2)(ii) are satisfied. In cases when a settlement agreement or court order specifically identifies the amount as restitution, this fact would create a rebuttable presumption that the taxpayer has established that the amount constitutes restitution for purposes of section 162(f)(2)(i).
  • Rebuttable presumption of safe harbor. Guidance should provide a rebuttable presumption safe harbor in the following circumstances: 1.) If a settlement agreement or court order specifically designates an amount as restitution, and the taxpayer produces evidence that the amount designated is not more than the highest amount of compensation-related damages calculated and sought by the government in the action and prior to the settlement, that the amount designated as restitution is presumed to satisfy the exception in section 162(f)(2). The presumption is not altered even if evidence exists that the government had or may have had multiple purposes in pursuing and settling the action, including deterring similar conduct and/or punishing the taxpayer’s alleged conduct. 2.) In the case of a settlement or court order resolving an action under the False Claims Act (FCA), an amount designated as restitution is presumed as compensatory. 3.) In the case of a settlement or court order involving a disgorgement of profits, an amount designated as restitution is presumed as compensatory if it equates to the calculated amount of financial injury to victims and is disbursed to the class of victims giving rise to the action.

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