A provision in the recently enacted Tax Cuts and Jobs Act (TCJA) has the potential to significantly impact companies and individuals who have recently settled, or plan to settle, claims related to the violation of laws and regulations brought by federal, state or local agencies. The TCJA changed Section 162(f) of the tax code to state that, as a general rule, no deduction is allowed for:
[A]ny amount 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.
This general rule does not apply to private claims, but instead applies to cases brought under the False Claims Act, Foreign Corrupt Practices Act, and other investigations by the DOJ, the US Securities and Exchange Commission (SEC), or the Equal Employment Opportunity Commission. This provision applies to any payments made or incurred on or after Dec. 22, 2017, unless an enforceable settlement agreement was executed prior to that date. However, if the agreement requires the approval by a court order, the agreement will not be treated as being enforceable until such order is entered by the court.
Please note that there is an exception to this nondeductible rule for amounts that the taxpayer establishes are either (i) restitution (including remediation of property) for damage or harm that was or may be caused by the violation of any law, or (ii) are paid to come into compliance with any law that was violated. However, these amounts must be identified in the court order or settlement agreement as such to be eligible for the exception.
This new law effectively increases the cost of settling conflicts with governmental agencies. As such, it is more important than ever for businesses and individuals considering settlement to consult with counsel and their accountant prior to execution. This will allow counsel to adequately posture the settlement and assess the applicability of any exceptions, thereby minimizing additional and unnecessary cost. Further, it is imperative that any proposed settlement or consent order be analyzed to determine whether it can be structured to limit the application of this new tax law.
