Sunday, December 01, 2013

Senate Legislation would Deny Tax Deduction to Companies Settling Government Enforcement Actions

In an effort to protect taxpayers, hold corporate wrongdoers accountable, and deter future fraud, Senators Jack Reed (D-RI) and Charles Grassley (R-IA) introduced legislation to rescind tax deductions under the federal tax code for payments made by companies to remedy illegal corporate behavior.  The bipartisan Government Settlement Transparency & Reform Act, S. 1654, would close a loophole that has allowed some corporations to reap tax benefits from payments made at government direction stemming from settling misdeeds. Senator Reed is a senior member of the Banking Committee; and Senator Grassley is the Ranking Member on the Judiciary Committee.
Federal law currently prohibits companies from deducting public fines and penalties from their taxable income, but offending companies may often write off any portion of a settlement that is not paid directly to the government as a penalty or fine for violation of the law.  This allows some companies to lower their tax bill by claiming settlement payments to non-federal entities as tax deductible business expenses.
The Reed-Grassley Act would require the government and the settling party to reach pre-filing agreements on how the settlement payments should be treated for tax purposes.  The legislation clarifies the rules about what settlement payments are punitive and therefore non-deductible; and increases transparency by requiring the government to file a return at the time of settlement to accurately reflect the tax treatment of the amounts  that will be paid by the offending party.

More specifically, S. 1654 would amend Section 162(f) of the federal tax code to deny tax deductions for certain fines, penalties, and other amounts related to a violation or investigation or inquiry into the potential violation of any law. Amounts paid by corporations, which constitute restitution for damage caused by the violation of any law are exempted and remain deductible.  This section requires that nongovernmental entities which exercise self-regulatory powers be treated as government entities for purposes of disallowing deductions under the section. The bill also requires the government o stipulate the tax treatment of the settlement agreement.