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Proposed Regulations Provide Guidance On Deducting Fines And Penalties Paid To The Government: Important Questions Still Remain

By Kevin M. Flynn
The CPA Journal
September 2020 Edition

Since 1969, Internal Revenue Code (IRC) section 162(f) has disallowed an ordinary and necessary business deduction in computing taxable income for any civil or criminal fine or similar penalty paid to a government or governmental entity for the violation of a law [Public Law No. 91-172, 83 Stat. 487 (1969)]. This provision codified case law that denied a taxpayer a business expense deduction for conduct that was considered by courts to frustrate well-defined national or state public policies. Treasury Regulations promulgated by the U.S. Treasury Department and the IRS in 1975 modified this rule to provide that compensatory damages paid to the government did not constitute a fine or penalty.

It is not surprising that disputes abounded between taxpayers and the IRS regarding what constituted a fine or penalty, or what constituted the payment of compensatory damages. Imprecise language and conflicting terms in criminal plea agreements and civil settlement agreements between private litigants and the government often fueled these disputes. Taxpayers claimed business deductions for payments to the government that they maintained were compensatory or remedial in nature. When the IRS disallowed many of these deductions, litigation regarding the proper characterization of the payments frequently ensued.