THE TAX MAN COMETH

Posted on February 5, 2019 by Donald Shandy

The 2017 Tax Cuts and Jobs Act (“Act”) has injected considerable confusion into environmental administrative and judicial settlements.

Since 1969, Section 162(f) of the Internal Revenue Code has not permitted the deduction of fines and penalties.  This would include fines and penalties related to environmental settlements including Supplemental Environmental Projects (SEPs).

Prior to the Act, Section 162(f) allowed deductions of “ordinary and necessary” business expenses related to environmental litigation and settlements.  New Section 162(f) permits deductions for expenses “constituting restitution” (e.g. remediation) or costs “paid to come into compliance with law.”  To qualify as restitution/remediation, two requirements must be met:

1.      The amount that is dedicated to restitution must be set forth in a settlement agreement or court order; and

2.      The governmental agency must prepare and file with the IRS and provide the taxpayer a 1099-series form stating the deductible amounts paid by the taxpayer.

It seems fairly clear that cash penalties and SEPs undertaken in lieu of a cash penalty are not deductible.  However, it is far less clear how remediation activities pursuant to CERCLA or RCRA should be addressed.  For example, how should remediation expenses be addressed where a settlement or court order was entered into prior to the effective date of the Act, but the costs are not incurred (paid for) until after the effective date of the Act?  Problematic case specific-issues under the new law seem almost endless. 

To date, the Treasury Department has not provided any guidance related to this issue.  Practitioners should be very careful when negotiating settlements with administrative agencies or entering into judicial orders.  Absent government guidance, careful drafting and execution of settlements and orders, there is a real possibility of an IRS audit or even a tax court case down the road.