The IRS released Notice 2018-23 on March 27, 2018, providing guidance on when governments and governmental entities must report payments received from taxpayers for penalties, fines and remedying violations under section 6050X. Notice 2018-23 provides that reporting will not be required earlier than Jan. 1, 2019, and will not be earlier than the date of the publication of forthcoming proposed regulations. The transitional guidance related to reporting under section 6050X does not impact the applicability of section 162(f).
The Tax Cuts and Jobs Act (TCJA), amended section 162(f) of the Internal Revenue Code and added section 6050X. Under section 162(f)(1) as amended, taxpayers generally cannot deduct amounts paid or incurred to a government or governmental entity in response to a violation of law or potential violation of law.
Section 162(f)(2), however, provides an exception to the general rule of section 162(f)(1) if three requirements are met. First, a taxpayer must show that the amount (i) constitutes restitution for damage or harm that may have been caused by the violation of law or the potential violation of law, or (ii) is paid to come into compliance with any law at issue (the ‘establishment requirement’). Second, the court or settlement agreement must identify the amount as restitution or as paid to come into compliance with the law (the ‘identification requirement’). Finally, for any amount of restitution for failure to pay any tax imposed by the Internal Revenue Code, the amount must be treated as if such amount were such tax if it would have been allowed as a deduction had it been timely paid.
TCJA added section 6050X in parallel, requiring governments and governmental entities to report amounts received from taxpayers for which section 162(f) applies. Section 6050X(a)(2) requires that the reports specify (1) the amount of the nondeductible payment, (2) any amount that constitutes restitution or remediation of property, and (3) any amount paid for the purpose of coming into compliance with any law that was violated or involved in the investigation or inquiry.
The Notice announces that the Department of the Treasury and IRS plan to publish proposed regulations under both sections 162(f) and 6050X, but the new laws technically applied when TCJA was passed on Dec. 22, 2017. After enactment, many governments, governmental entities, and even the IRS, indicated a need for additional time to effectively implement section 6050X. Accordingly, Notice 2018‑23 provides transition relief to make clear that reporting under section 6050X will not be required until the dates specified in the proposed regulations. The additional time will allow for clarification of the reporting requirement and reporting entities to develop their systems to implement the new reporting requirements.
Importantly, Notice 2018-23 specifies that it does not delay the applicability of section 162(f). The identification requirement of section 162(f)(2) applies to amounts paid or incurred after Dec. 22, 2017, unless the amounts were paid or incurred under any binding order or agreement before that date. The Notice provides that until proposed regulations are issued, the identification requirement is satisfied if the settlement agreement or court order states on its face the amount is restitution, remediation, or for coming into compliance with the law.
The delays to the reporting requirements under section 6050W do not provide relief to taxpayers with amounts subject to section 162(f). Such taxpayers seeking a deduction under section 162(f)(2) must obtain a settlement agreement or court order that specially states if an amount is paid for restitution, remediation, or for coming into compliance with the law. Taxpayers are strongly encouraged to check with their tax professionals in negotiating agreements as well as accounting for payments that may be covered by section 162(f).