In a February post, we discussed in detail recent changes to the U.S. tax rules governing the deductibility of settlement payments and court-ordered damages payments. The IRS has now released some limited guidance on this new law (IRS Notice 2018-23), and this post addresses what is in this guidance (the “Notice”).
To recap, under the new law: a settlement or court-ordered payment made to (or at the direction of) a government in relation to the violation of any law (or the investigation or inquiry by such government into the potential violation of any law) is not deductible for U.S. tax purposes unless the payment constitutes “restitution (or remediation of property) ” or “a payment for the purpose of coming into compliance with a law”.
Payments to (or at the direction of) certain specified nongovernmental self-regulatory organizations (“SROs”) are also subject to this rule.
The new rule applies to payments made on or after December 22, 2017 (unless prior to such date there was a binding agreement or court order requiring the payment).
The Notice provides for the following:
Reporting required by payees is suspended until the IRS issues further guidance. The new law imposes an obligation on the relevant government or SRO to ) report to the IRS when a settlement payment or court-ordered payment constitutes restitution or a payment for the purpose of coming into compliance with a law (and therefore may be deductible by the payor). There was no corollary to this under prior law.
The Notice suspends this obligation until the IRS issues further guidance. This suspension responds to questions raised by governments and SROs about the new requirements, and the need for these payees (and the IRS) to design and implement new systems to facilitate this reporting. According to the Notice, this obligation will not come into effect any earlier than January 1, 2019, and the exact date will depend upon when the IRS issues proposed regulations addressing the requirement.
How to comply with the requirement that agreements and court orders identify when a payment is restitution or a payment for the purposes of coming into compliance with a law. Under the new law, one of the prerequisites to obtaining a deduction is that the agreement or court order specify that the payment is restitution or a payment for the purposes of coming into compliance with a law, in addition to the taxpayer establishing that this in fact is true. In response to taxpayers’ requests for guidance on how to satisfy this requirement, the Notice provides that this requirement will be treated as satisfied if “the settlement agreement or court order specifically states on its face that the amount is restitution, remediation, or for coming into compliance with the law”. There is no further guidance in the Notice about this, or any other requirement, of the new law. The Notice emphasizes, however, that all the aspects of the new law are currently in effect, other than the payee reporting requirement.
Requests for comments. Finally, the Notice requests comments from stakeholders and others on how the new law should be interpreted and implemented in forthcoming Treasury Regulations.
The new limits on the deductibility of settlement and damages payments are currently in effect (even though the reporting requirement for payees has been temporarily suspended). If your company is faced with a potential violation of a law or a governmental investigation, you should be considering these new requirements as early as possible so that you can develop a strategy that takes the tax rules into account.
For more details on the new law, please see our prior post.