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Internal Revenue Service Building, US

June 02, 2020

Proposed Treasury Regulations Clarify Requirements for Deducting Restitution and Legal Compliance Costs under Section 162(f)


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On May 13, 2020, the Treasury Department and the Internal Revenue Service proposed revisions to the regulations under section 162(f) of the Internal Revenue Code (the “Proposed Regulations”).[1] Generally, section 162(f) governs the deductibility of amounts paid or incurred by a taxpayer to, or at the direction of, a government entity for a violation (or alleged violation) of law. The Proposed Regulations were necessitated by the changes to section 162(f) made by the Tax Cuts and Jobs Act of 2017 (TCJA). The Proposed Regulations and the accompanying preamble implement and provide guidance with respect to the new provisions under amended section 162(f). Several key provisions and clarifications contained in the Proposed Regulations, which can be relied upon until final regulations are promulgated, are summarized below. In addition, we suggest a few ways by which the Proposed Regulations could be improved.


Before the enactment of the TCJA, section 162(f) generally disallowed deductions in computing taxable income for any “fine or similar penalty paid to a government for the violation of a law.” Many disputes arose between taxpayers and the IRS with respect to what constituted a fine or similar penalty[2] and what kind of proof a taxpayer was required to offer to show that an amount did not come within the disallowance provision.[3]

To provide greater certainty, Congress amended section 162(f) by replacing the phrase “fine or similar penalty” with more precise language. As amended, section 162(f) generally disallows deductions for amounts paid or incurred to, or at the direction of, a government, governmental entity, or non-governmental self-regulatory entity in relation to the violation of law or an investigation or inquiry into a potential violation of such law.[4] Section 162(f) contains exceptions to this general disallowance rule for amounts that the taxpayer establishes (1) constitute restitution (including property remediation) for damage or harm caused by the violation or alleged violation, or (2) are paid to come into compliance with any law that was violated or otherwise involved in the investigation or inquiry.[5] With regard to either type of amount, section 162(f) also requires that the amount be so identified in the court order or settlement agreement.[6]

 Further, section 162(f) sets forth two types of nongovernmental self-regulatory entities that are treated as governmental entities. First, entities that exercise self-regulatory powers, including imposing sanctions, in connection with a qualified board or exchange under the mark-to-market provisions of section 1256 (e.g., a national securities exchange) are treated as governmental entitles for purposes of section 162(f).[7] Second, to the extent provided by regulations, other entities that exercise self-regulatory powers, including imposing sanctions, as part of an essential government function, will also be treated as a governmental entity under section 162(f).[8]

 The TCJA also added section 6050X to the Code, which requires entities that require payment of amounts described in section 162(f) to file information returns regarding the amounts involved and to notify the payor of the information reflected on such returns.[9]

 In Notice 2018-23, 2018-15 I.R.B. 474, the IRS published transitional guidance on the identification and information reporting requirements under amended section 162(f) and section 6050X and solicited comments from the public on forthcoming regulations.[10] A number of interested parties submitted comments, some which are discussed in the preamble to the Proposed Regulations. The Proposed Regulations request that further comments be submitted by July 13, 2020.

Proposed Regulations

General Rule of Disallowance and Exceptions

Consistent with the statute, the Proposed Regulations restate the general rule of disallowance by providing that, in computing taxable income, a taxpayer may not take a deduction for amounts (1) paid or incurred “by suit, settlement agreement, or otherwise;” (2) “[t]o, or at the direction of, a government or governmental entity;” and (3) “[i]n relation to the violation, or investigation or inquiry into the potential violation, of any civil or criminal law.”[11] The preamble notes that the rule applies regardless of whether the taxpayer admits guilt or liability or pays the amount for another reason such as to avoid the expense or uncertain outcome of an investigation or litigation.[12] The Proposed Regulations set forth a non-exhaustive list of examples of suits, agreements, and other instruments under which payments may be made.[13]

The Proposed Regulations also describe the exceptions to the general rule, which allow deductions for amounts paid or accrued for restitution, remediation, or to come into compliance with a law, provided that the taxpayer meets the “identification” and “establishment” requirements.[14]

Identification Requirement

To satisfy the identification requirement, an order or settlement agreement must state the nature of, or purpose for, each payment the taxpayer is obligated to pay and the amount of each payment identified.[15] Some commenters observed that it may not be possible to satisfy the identification requirement in an order or agreement that imposes lump-sum judgments or settlements, multiple damage awards, or involves multiple defendants. Others expressed concerns that it is beyond the expertise of the government to place a value on restitution or remediation costs, and that the costs may not be able to be quantified because neither the up-front nor the ultimate costs can be determined. The preamble requested further comments on these situations.[16]

The Proposed Regulations provide that, if an order or settlement agreement does not identify the amount a taxpayer must pay due to the fact that the liability must be discharged in whole or in part through the provision of services or property, the order or agreement must describe the damage done, harm suffered, or manner of noncompliance with a law by the taxpayer, and describe the action required in terms of providing services or property.[17]

Under the Proposed Regulations, the IRS reserves the right to challenge a taxpayer’s identification of amounts qualifying for the exceptions under section 162(f).[18] The reporting of an amount under section 6050X alone will not suffice to satisfy the identification requirement.[19]

Establishment Requirement

Under the Proposed Regulations, a taxpayer can satisfy the establishment requirement by providing documentary evidence (1) that the taxpayer was legally obligated to pay the amount the order or settlement agreement identified as restitution, remediation or to come into compliance with the law, (2) of the amount paid or incurred, and (3) of the date on which the amount was paid or incurred.[20] Among the documents that may be used to establish the taxpayer’s legal obligation to pay are: receipts; the legal or regulatory provisions related to the violation or potential violation of a law; documents issued by the government or governmental entity relating to the investigation or inquiry; documents describing how the amount to be paid was determined; and correspondence exchanged between the taxpayer and the government or governmental entity before the order or agreement became binding under applicable law.[21] As with the identification requirement, the reporting of an amount under section 6050X alone will not suffice to satisfy the establishment requirement.[22]

Definitions and Other Clarifications

Restitution and Remediation. Some commentators had argued that the terms restitution and remediation should include disgorgement and forfeiture. The preamble reviews the case law that led to the amendments of section 162(f) and rejects that argument as contrary to the statute.[23] The preamble concludes that Congress did not intend to extend the meaning of restitution and remediation to encompass disgorgement and forfeiture, which are designed to prevent the “unjust enrichment” of a perpetrator and not “to make victims whole by reimbursing them for their losses.”[24] Thus, the Proposed Regulations explicitly exclude disgorgement and forfeitures from the restitution and remediation exception.[25] To further clarify this point, the Proposed Regulations go on to provide that a restitution or remediation must restore a person, government entity or property harmed by the taxpayer’s violation or potential violation of a law.[26]

Coming into Compliance with a Law. The Proposed Regulations also explain that an amount is paid or incurred to come into compliance with a law if it is paid for the performance of services, taking action, such as modifying equipment, or providing property.[27] The examples in the Proposed Regulations include orders or settlement agreements that require payments under state environmental, securities and consumer protection laws.[28] Notably, the examples do not include a fact pattern involving court-appointed monitors, which are common under deferred prosecution agreements.

Nongovernmental Entities. As authorized by amended section 162(f), the Proposed Regulations treat a nongovernmental entity as governmental if the entity is one that exercises self-regulatory powers, including adopting, administering, or enforcing laws and imposing sanctions, as part of performing an essential governmental function.[29] Although this extension of the treatment of nongovernmental entities as governmental entities is not unexpected, it would be helpful if the final regulations provided further clarification and explanation of the types of entities covered by this provision.


Overall, the Proposed Regulations implement the TCJA’s amendments to section 162(f) in a reasonable manner, though there are a number of areas in the selected provisions discussed above that warrant further development or refinement to make the rules clearer and more workable and administrable. Specifically, the Proposed Regulations could be improved upon in the following respects:

  • The identification requirement as proposed could pose difficulties because government entities and their enforcement attorneys are not always well-positioned to estimate the value of various components of monetary sanctions and have been reluctant to agree to allocations.[30] In those instances, upon written confirmation by a government entity that it is unable to determine a precise allocation, the taxpayer should be allowed to make a reasonable estimate of the amounts allocable to restitution, remediation or to come into compliance with law. The taxpayer’s estimate would be included in the order or settlement agreement.
  • The examples should include fact patterns that involve court-appointed monitors and conclude that costs of such monitors are for coming into compliance with law insofar as such monitors ensure that violations of law are not repeated.
  • The treatment of certain nongovernmental entities as governmental entities (other than those that exercise powers in connection with a qualified board or exchange under section 1256) should be clarified with a non-exhaustive list of the particular types of self-regulatory organizations contemplated and the types of rules they enforce.


[1] 85 Fed. Reg. 28,524 (May 13, 2020).
[2] See, e.g., Stephens v. Commissioner, 905 F.2d 667 (2d Cir. 1990) (holding that restitution of embezzled funds was not punitive, and therefore, deductible); Nacchio v. United States, 824 F.3d 1370 (Fed. Cir. 2014) (holding that forfeiture of insider trading gains was punitive, and therefore, not deductible); Wang v. Commissioner, T.C. Memo 1998-389 (holding disgorgement to SEC of insider trading profits was not punitive, and therefore, deductible).
[3] Talley Industries Inc. v. Commissioner, 116 F.3d 382 (9th Cir. 1997) (where a taxpayer argued that a payment required by a settlement with a governmental agency was deductible, the court held that the burden was on the taxpayer to prove the intent of the parties in reaching the settlement, and that if the settlement agreement itself did not characterize or allocate the settlement to different categories, the taxpayer suffered the consequences). Fresenius Med. Care Holdings, Inc. v. United States, 763 F.3d 64 (1st Cir. 2014) (holding that the fact finder could consider not only the language of the settlement agreement, but also extrinsic factors, such as interest calculations, attorneys’ billing records and the parties’ negotiations, in deciding whether a required payment was deductible).
[4] Section 162(f)(1).
[5] Section 162(f)(2).
[6] Section 162(f)(2)(A)(ii).
[7] Section 162(f)(5)(A).
[8] Section 162(f)(5)(B).
[9] The Proposed Regulations increase the threshold amount for information reporting purposes from the statutorily provided $600 to $50,000. Prop. Reg. § 1.6050X-1(f)(B)(5).
[10] The notice provided that until proposed regulations are issued, the identification requirement would be satisfied if the order or settlement agreement stated on its face that an amount was paid or incurred as restitution, remediation or to come into compliance with a law. The notice further provided that information reporting would not be required until the date specified in future proposed regulations.
[11] Prop. Reg. § 1.162-21(a).
[12] 85 Fed. Reg. at 28,526.
[13] “A suit, agreement, or otherwise includes, but is not limited to, settlement agreements, non-prosecution agreements, deferred prosecution agreements, judicial proceedings, administrative adjudications, decisions issued by officials, committees, commissions, boards of a government or governmental entity, and any legal actions or hearings which impose a liability on the taxpayer or pursuant to which the taxpayer assumes liability.” Prop. Reg. § 1.162-21(f)(4).
[14] Prop. Reg. § 1.162-21(b).
[15] Prop. Reg. § 1.162-21(b)(2)(i).
[16] 85 Fed. Reg. at 28,528.
[17] Prop. Reg. § 1.162-21(b)(2)(iii).
[18] Prop. Reg. § 1.162-21(b)(2)(iv).
[19] 85 Fed. Reg. at 28,528.
[20] Prop. Reg. § 1.162-21(b)(3)(i).
[21] Prop. Reg. § 1.162-21(b)(3)(ii).
[22] 85 Fed. Reg. at 28,527; see also Section 162(f)(2)(A) (flush language).
[23] Id. (discussing Kokesh v. SEC, 137 S. Ct. 1635 (2017) (treating disgorgement as a penalty for purposes of securities law statute of limitations); Nacchio v. United States, 824 F.3d 1370 (Fed. Cir. 2014) (holding that forfeiture of insider trading gains was not deductible).
[24] 85 Fed. Reg. at 28,527 (quoting Nacchio, 824 F.3d at 1378).
[25] Prop. Reg. § 1.162-21(f)(3)(iii)(C) (excluding forfeiture and disgorgement).
[26] Prop. Reg. § 1.162-21(f)(3)(i), (ii) and (iii)(D). Restitution, however, excludes any amounts paid or incurred as reimbursement to a government entity for investigation or litigations costs. Section 162(f)(2)(B); Prop. Reg. § 1.162021(f)(3)(iii)(A).
[27] Prop. Reg. § 1.162-21(f)(3)(ii).
[28] Prop. Reg. § 1.162-21(g)(3), Example 3.
[29] Prop. Reg. § 1.162-21(f)(2)(ii).
[30] See, e.g., Fresenius, 763 F.3d at 70 (“Here, the parties did not agree on the tax characterization of the civil settlement payments (indeed, during the negotiations leading to the settlement, the government apparently refused to discuss tax consequences”).

Authors and Contributors

Mark D. Lanpher



+1 202 508 8120

+1 202 508 8120

Washington DC

Regional Experience