Tax Reform Law’s Impact on Environmental Settlements

Tax Reform Law’s Impact on Environmental Settlements

The landmark tax reform law signed by President Donald Trump may make environmental settlements more expensive for New Jersey businesses. Under the Tax Cuts and Jobs Act of 2017, it will be more difficult to deduct settlement payments made to federal, state or local governmental entities.

Section 162(f) Limits Tax Deductions

Under Section 162 of the U.S. Tax Code, companies are authorized to deduct ordinary and necessary expenses of conducting business, with certain exceptions. Accordingly, companies are generally able to deduct the payment of a judgment or settlement of a suit or claim arising out of a business matter, including environmental claims. Businesses have also relied on this deduction to cover the costs of counsel defending such claims.

Prior to the tax reform law, Section 162(f) did prohibit the deduction of civil and criminal fines or similar penalties paid to a government for the violation of any law. However, businesses were generally allowed deductions for amounts paid to a government entity as compensatory damages, including remediation of property.

Section 162(f)(1) now disallows a deduction for amounts 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. The rule includes an exception for restitution payments and payments paid to come into legal compliance, provided that certain requirements are satisfied.

Section 162(f)(2)(A)(i) specifically requires that the taxpayer establish that the amount paid or incurred (1) constitutes restitution (including remediation of property) for damage or harm that was or may be caused by violation of any law or the potential violation of any law, or (2) is paid to come into compliance with any law that was violated or otherwise involved in the investigation or inquiry into the potential violation of any law. Section 162(f)(2)(A)(ii) further requires that the amount paid or incurred be identified as restitution or as an amount paid to come into compliance with such law in the court order or settlement agreement. Notably, the exception does not apply to any amounts paid “as reimbursement to the government for the costs of any investigation or litigation.”

New Reporting Requirements under Sec. 6050X

The tax reform law also includes a new provision that requires government entities to file an information return with the Internal Revenue Service (IRS). Section 6050X(a)(1) requires the appropriate official of any government entity that is involved in a settlement agreement to make a return setting forth (1) the amount required to be paid as a result of the suit or agreement to which § 162(f)(1) applies; (2) any amount required to be paid as a result of the suit or agreement that constitutes restitution or remediation of property; and (3) any amount required to be paid as a result of the suit or agreement for the purpose of coming into compliance with any law that was violated or involved in the investigation or inquiry.

The reporting requirement of § 6050X is not yet in effect. Under transitional guidance provided by the IRS, reporting will not be required until the agency publishes proposed regulations and will be no earlier than January 1, 2019.

Considerations for New Jersey Businesses

The tax reform law adds another layer of analysis for businesses seeking to resolve environmental claims with public entities. While many payments related to environmental liability may still be deductible, businesses may no longer justify the deduction on their own, but must expressly address the issue during settlement negotiations with government entities.

If you have questions, please contact us

At Scarinci Hollenbeck, our corporate tax and environmental law groups are working together to ensure that all future environmental settlements take the new tax provisions into account while protecting the best interests of our clients. If you have any questions or if you would like to discuss how you may be impacted, we encourage you to contact one of our experienced attorneys at 201-806-3364.