Introduction
The paper addresses tax deductibility issues about a $10 million fine, a $7 million donation to a charitable foundation, and legal bills. The company’s manufacture of pesticides caused environmental pollution, which led to problems with the Environmental Protection Agency. The government agency fined the corporation $18 million for infractions.
The business voluntarily established a $7 million charitable fund to address the environmental effects. Additionally, costs associated with the company incurred legal fees in defense in court that resulted in the fine being lowered from $18 million to $10 million. The $8 million paid to the foundation, as well as the associated legal costs, were deducted by the firm. The IRS treated the payment as a fine against public policy and invalidated both deductions.
Legal Analysis
Deductibility of Fines Under Section 162(f)
The matter being decided upon is covered explicitly by several legal requirements. All ordinary and necessary costs made or incurred during the taxable year in carrying on any trade or business may generally be deducted by a business as stipulated under section 162(a) of the Internal Revenue Service (IRS) Code. The basic rule is that businesses cannot deduct money related to fines for violations under Section 162(f) or Section 1.162-21.
Section 162(f) indicates that amounts paid to or incurred at the instruction of a government, administration entity, or nongovernmental body in connection with the violation of a law, or an investigation into the possibility of a violation, are not eligible for deductions (Forman & Mann, 2018). The sum concerns a legal infraction, government investigation, or inquiry into a possible legal infraction. Legal fees and other relevant costs paid or incurred in defending against a claim in which the nondeductible fine or penalty may be imposed are not included in the amount of a fine or penalty.
According to Section 162(f)(I), the amount also excludes court fees imposed on the taxpayer. Deductions related to breaking any civil or criminal law, or the government’s investigation into a possible breaking of such law, are prohibited by 1.162-21. However, the legislation provides for a deduction relating to charitable contributions. Unless there are established limitations on the amount, percentage, or timing of payment, no deduction shall be allowed. Section 170(a)(1) indicates that each payment made for a charitable contribution (as defined in paragraph (c)) throughout the tax year is qualified for a deduction.
Exceptions for Restitution, Remediation, and Compliance Payments
Additionally, section 162(f)(2) provides an exception to the general rule and allows taxpayers to deduct specific amounts paid or incurred. The amounts may include payments for restitution, remediation, or payment to come into compliance with the law. Section 162(f)(1) shall not disallow a deduction for amounts the taxpayer establishes were paid or incurred as restitution or to comply with the law. Section 162(f)(2)(A)(II) requires an order or agreement to identify an amount paid or incurred as restitution, remediation, or to come into compliance with the law (Wyman, 2019). Under § 1.162-21(b)(2)(I), an order or agreement identifies a payment by stating the nature of, or purpose for, each payment each taxpayer is obligated to pay and the amount of each payment identified.
Furthermore, to the extent that the amount paid would otherwise be deductible under chapter 1, section 162(f)(2)(A)(III), (f)(3), and (f)(4) provide that section 162(f)(1) shall not disallow a deduction for amounts paid or incurred under different circumstances. Such an amount can be restitution for failure to pay any tax imposed under Title 26 had it been paid promptly. It can be under an order or agreement for a suit in which no government or governmental entity is a party or as taxes are due (Wyman, 2019). § 1.162-21(b)(3)(I) provides that the taxpayer may satisfy the establishment requirement by providing documentary evidence.
The proof must demonstrate that the taxpayer was legally required to pay the sum specified in the order or agreement as restitution, remediation, or to comply with the law. Additionally, it must include the sum paid or the expense incurred and the date on which it occurred. A list of papers that taxpayers may use to meet the establishment requirement is provided in 1.162-21(b)(3)(II). It is crucial to remember that the IRS may contest the classification of an amount determined by Section 1.162-21(b)(2)(iv) (2) (Forman & Mann, 2018). Unless the identification criteria are satisfied, no deduction is permitted.
Treatment of Legal Fees as Ordinary and Necessary Business Expenses
As regards the legal fees, section 162(f)(2)(B) states that restitution, remediation, and amounts paid to come into compliance with the law do not include any amount paid or incurred as reimbursement to a government or governmental entity for the costs of any investigation or litigation (Wyman, 2019). The general wisdom is that legal business fees are tax-deductible (Boyer Law Firm, 2021). This applies only if the fee is ordinary and necessary in the business course and can be deducted.
Applying the legal provisions described above relates to the treatment of whether the fine imposed, the amount paid to charity, and the legal fees are tax-deductible. The law indicates that the point of fine paid to a government or specified nongovernmental entity for violation of any law (including settlement payments) is generally not deductible as ordinary and necessary business expenses. The Environmental Protection Agency imposed the fine because Jones Chemical Company released toxic waste into the environment. The $18 million fine was charged because of a violation that caused several employees to suffer toxic poisoning. Section 162(f) clearly states that such a sum is not taxable. Jones Chemical Company violated the provisions for releasing toxic waste, so a fine was imposed.
However, due to the violation, the company set up a voluntary charitable fund to improve the environment. It endowed the fund with $7 million, which can be classified as a form of restitution or remediation. In this regard, the law provides that such a sum is an allowed deduction.
It is further provided that the company provides adequate information to show the money flow into the charity fund. Jones Chemical Company also incurred legal expenses, out of which it managed to defend itself in court, reducing the fine from $18 million to $10 million. It is commonly understood that business-related legal fees can be deducted from taxes, provided they are incurred as part of the regular and essential operations of the business.
Conclusion
In conclusion, no deduction can be taken for fines relating to a violation of the law. The same applies to the legal fees incurred, like the fines and violations of the law. The $7 million paid to a charity fund is deductible as it represents a form of restitution or remediation for a violation. The company must provide adequate proof of payment to the charity.
References
Boyer Law Firm. (2021). What legal expenses are tax deductible for your business? Boyer Law Firm, PL. Web.
Forman, J. B., & Mann, R. F. (2018). Making the Internal Revenue Service work. Florida Tax Review, 17(10). Web.
Wyman, F.A. (2019). United States Income Tax Law simplified for business men. Palala Press.