[Congressional Record Volume 151, Number 133 (Wednesday, October 19, 2005)]
[Senate]
[Pages S11565-S11567]
From the Congressional Record Online through the Government Publishing Office [www.gpo.gov]

      By Mr. BAUCUS (for himself, Mr. Grassley, and Mr. McCain):
  S. 1890. A bill to amend the Internal Revenue Code of 1986 to deny a 
deduction for certain fines, penalties, and other amounts; to the 
Committee on Finance.
  Mr. BAUCUS. Mr. President, today my good friends Senators Grassley 
and McCain and I are introducing the ``Government Settlement 
Transparency Act of 2005'', a bill that will put a stop to tax 
deductions for fines and penalties paid by companies to government 
agencies in connection with civil settlements. Over the past several 
years, we have become increasingly concerned about the approval of 
various settlements that allow penalty payments made to the government 
in settlement of a violation or potential violation of the law to be 
tax deductible. Our concerns were heightened this week upon the release 
of a Government Accountability Office Report that confirmed many 
companies deduct these settlements notwithstanding the tax code's 
prohibition against deducting fines and penalties. This abuse shifts 
the tax burden from the wrongdoer onto the backs of the American 
people. This is unacceptable.
  Many government agencies enter into these settlement agreements after 
investigating companies for violations of the law. Every year thousands 
of violations are resolved with settlements totaling tens of billions 
of dollars paid to the Federal Government. Civil settlements serve to 
punish past wrongdoing and to deter future wrongdoing without 
protracted court proceedings. For example, in the past several years 
settlements of various SEC investigations into violations or potential 
violations of the securities laws have been front and center in the 
news. Through civil investigations, Federal and State regulators are 
working hard to hold these firms responsible for their actions. With 
these efforts to achieve greater accountability in the business 
community and ensure the integrity of our financial markets, it is 
important that the rules governing the appropriate tax treatment of 
settlements be clear and adhered to by taxpayers.
  Section 162(f) of the Internal Revenue Code provides that no 
deduction is allowed as a trade or business expense under section 
162(a) for the payment of a fine or penalty to a government for 
violation of any law. The enactment of section 162(f) in 1969 codified 
existing case law that denied the deductibility of fines and penalties 
as ordinary and necessary business expenses on the grounds that 
``allowance of the deduction would frustrate sharply defined national 
or state policies proscribing the particular types of conduct evidenced 
by some governmental declaration thereof.'' Treasury regulations 
provide that a fine or penalty includes an amount paid in settlement of 
the taxpayer's actual or potential liability for a fine or penalty.
  The legislation introduced today modifies the rules regarding the 
determination of whether payments are nondeductible payments of fines 
or penalties under section 162(f). In particular, the bill generally 
provides that amounts paid or incurred whether by suit, agreement, or 
otherwise, to, or at the direction of, a government in relation to the 
violation of any law or the investigation or inquiry in the potential 
violation of any law are nondeductible. The bill applies to deny a 
deduction for any such payments, including those where there is no 
admission of guilt or liability and those made for the purpose of 
avoiding further investigation or litigation.
  An exception applies to payments that the taxpayer establishes are 
either restitution, including remediation of property, or amounts 
required to come into compliance with any law that was violated, and 
that are so identified in the settlement agreement. It is intended that 
a payment will be treated as restitution only if the payment is 
required to be paid to the specific persons, or in relation to the 
specific property, actually harmed by the conduct of the taxpayer that 
resulted in the payment. Restitution does not include reimbursement of 
government investigative or litigation costs, or payments to 
whistleblowers. It is intended that a payment will be treated as an 
amount required to come into compliance only if it directly corrects a 
violation with respect to a particular requirement of law that was 
under investigation. Amounts paid to educate consumers or customers 
about the risks of doing business with the taxpayer or about the field 
in which the taxpayer generally does business, and which are not 
specifically required under the law, are not deductible if required 
under a settlement agreement.
  To ensure that companies do not take unallowable tax deductions for 
settlement payments, the bill requires government agencies to report to 
the IRS and to the taxpayer within thirty days of the settlement the 
amount of each settlement agreement, and to identify whether the 
payment is for fines, restitution, remediation or compliance, where the 
aggregate amount of the settlement is at least six hundred dollars, the 
Secretary of the Treasury will have the authority to adjust the amount 
and deadline for filing. Further, the IRS is encouraged to require 
taxpayers to separately identify such settlements on their tax returns.
  The bill would be effective for amounts paid or incurred on or after 
the date of enactment unless the amounts were under binding order or 
agreement before such date.
  I ask unanimous consent that the Joint Committee on Taxation 
Technical Description and the text of the bill be printed in the 
Record.
  There being no objection, the materials were ordered to be printed in 
the Record, as follows:

  Denial of Deduction for Certain Fines, Penalties, and Other Amounts


                              Present Law

       Under present law, no deduction is allowed as a trade or 
     business expense under section 162(a) for the payment of a 
     fine or similar penalty to a government for the violation of 
     any law (sec. 162(f)). The enactment of section 162(f) in 
     1969 codified existing case law that denied the deductibility 
     of fines as ordinary and necessary business expenses on the 
     grounds that ``allowance of the deduction would frustrate 
     sharply defined national or State policies proscribing the 
     particular types of conduct evidenced by some governmental 
     declaration thereof.''
       Treasury regulation section 1.162-21(b)(1) provides that a 
     fine or similar penalty includes an amount: (1) Paid pursuant 
     to conviction or a plea of guilty or nolo contendere for a 
     crime (felony or misdemeanor) in a criminal proceeding; (2) 
     paid as a civil penalty imposed by Federal, State, or local 
     law, including additions to tax and additional amounts and 
     assessable penalties imposed by chapter 68 of the Code; (3) 
     paid in settlement of the taxpayer's actual or potential 
     liability for a fine or penalty (civil or criminal); or (4) 
     forfeited as collateral posted in connection with a 
     proceeding which could result in imposition of such a fine or 
     penalty. Treasury regulation section 1.162-21(b)(2) provides, 
     among other things, that compensatory damages (including 
     damages under section 4A of the Clayton Act (15 U.S.C. 15a), 
     as amended) paid to a government do not constitute a fine or 
     penalty.


                           Reasons for Chanee

       There is a lack of clarity and consistency under present 
     law regarding when taxpayers may deduct payments made in 
     settlement of government investigations of potential 
     wrongdoing, as well as in situations where there has been a 
     final determination of wrongdoing. If a taxpayer deducts 
     payments made in settlement of an investigation of potential 
     wrongdoing or as a result of a finding of wrongdoing, the 
     publicly announced amount of the settlement payment does not 
     reflect the true after-tax penalty on the taxpayer. Allowing 
     a deduction for such payments in effect shifts a portion of 
     the penalty to the Federal government and to the public.


                        Description of Proposal

       The bill modifies the rules regarding the determination 
     whether payments are nondeductible payments of fines or 
     penalties under section 162(f). In particular, the bill 
     generally provides that amounts paid or incurred (whether by 
     suit, agreement, or otherwise) to, or at the direction of, a 
     government in relation to the violation of any law or the 
     investigation or inquiry into the potential violation of any 
     law are nondeductible under any provision of the income tax 
     provisions. The bill applies to deny a deduction for any 
     such payments, including those where there is no admission 
     of guilt or liability and those made for the purpose of 
     avoiding further investigation or litigation. An exception 
     applies to payments that the taxpayer establishes are 
     either restitution (including remediation of property), or 
     amounts required to come into compliance with any law that 
     was violated or involved in the investigation or inquiry, 
     and that are identified in the court order or settlement 
     as restitution, remediation, or required to come into 
     compliance. The IRS remains free to challenge the 
     characterization of an amount so identified; however, no 
     deduction is allowed unless the identification is made.
       An exception also applies to any amount paid or incurred as 
     taxes due.
       The bill is intended to apply only where a government (or 
     other entity treated in a

[[Page S11566]]

     manner similar to a government under the amendment) is a 
     complainant or investigator with respect to the violation or 
     potential violation of any law.
       It is intended that a payment will be treated as 
     restitution (including remediation of property) only if 
     substantially all of the payment is required to be paid to 
     the specific persons, or in relation to the specific 
     property, actually harmed by the conduct of the taxpayer that 
     resulted in the payment. Thus, a payment to or with respect 
     to a class substantially broader than the specific persons or 
     property that were actually harmed (e.g., to a class 
     including similarly situated persons or property) does not 
     qualify as restitution or included remediation of 
     property. Restitution and included remediation of property 
     is limited to the amount that bears a substantial 
     quantitative relationship to the harm caused by the past 
     conduct or actions of the taxpayer that resulted in the 
     payment in question. If the party harmed is a government 
     or other entity, then restitution and included remediation 
     of property includes payment to such harmed government or 
     entity, provided the payment bears a substantial 
     quantitative relationship to the harm. However, 
     restitution or included remediation of property does not 
     include reimbursement of government investigative or 
     litigation costs, or payments to whistleblowers.
       It is intended that a payment will be treated as an amount 
     required to come into compliance only if it directly corrects 
     a violation with respect to a particular requirement of law 
     that was under investigation. For example, if the law 
     requires a particular emission standard to be met or 
     particular machinery to be used, amounts required to be paid 
     under a settlement agreement to meet the required standard or 
     install the machinery are deductible to the extent otherwise 
     allowed. Similarly, if the law requires certain practices and 
     procedures to be followed and a settlement agreement requires 
     the taxpayer to pay to establish such practices or 
     procedures, such amounts would be deductible. However, 
     amounts paid for other purposes not directly correcting a 
     violation of law are not deductible. For example, amounts 
     paid to bring other machinery that is already in compliance 
     up to a standard higher than required by the law, or to 
     create other benefits (such as a park or other action not 
     previously required by law), are not deductible if required 
     under a settlement agreement. Similarly, amounts paid to 
     educate consumers or customers about the risks of doing 
     business with the taxpayer or about the field in which the 
     taxpayer does business generally, which education efforts are 
     not specifically required under the law, are not deductible 
     if required under a settlement agreement.
       The bill requires government agencies to report to the IRS 
     and to the taxpayer the amount of each settlement agreement 
     or order entered where the aggregate amount required to be 
     paid or incurred to or at the direction of the government 
     under such settlement agreements and orders with respect to 
     the violation, investigation, or inquiry is least $600 (or 
     such other amount as may be specified by the Secretary of the 
     Treasury as necessary to ensure the efficient administration 
     of the Internal Revenue laws). The reports must be made 
     within 30 days of entering the settlement agreement, or such 
     other time as may be required by Secretary. The report must 
     separately identify any amounts that are restitution or 
     remediation of property, or correction of noncompliance.
       The IRS is encouraged in addition to require taxpayers to 
     identify separately on their tax returns the amounts of any 
     such settlements with respect to which reporting is required 
     under the bill, including separate identification of the 
     nondeductible amount and of any amount deductible as 
     restitution, remediation, or required to correct 
     noncompliance.
       Amounts paid or incurred (whether by suit, agreement, or 
     otherwise) to, or at the direction of, any self-regulatory 
     entity that regulates a financial market or other market that 
     is a qualified board or exchange under section 1256(g)(7), 
     and that is authorized to impose sanctions (e.g., the 
     National Association of Securities Dealers) are likewise 
     subject to the provision if paid in relation to a violation, 
     or investigation or inquiry into a potential violation, of 
     any law (or any rule or other requirement of such entity). To 
     the extent provided in regulations, amounts paid or incurred 
     to, or at the direction of, any other nongovernmental entity 
     that exercises self-regulatory powers as part of performing 
     an essential governmental function are similarly subject to 
     the provision. The exception for payments that the taxpayer 
     establishes are paid or incurred for restitution, remediation 
     of property, or coming into compliance and that are 
     identified as such in the order or settlement agreement 
     likewise applies in these cases. The requirement of reporting 
     to the IRS and the taxpayer also applies in these cases.
       No inference is intended as to the treatment of payments as 
     nondeductible fines or penalties under present law. In 
     particular, the bill is not intended to limit the scope of 
     present-law section 162(f) or the regulations thereunder.


                             Effective date

       The bill is effective for amounts paid or incurred on or 
     after the date of enactment; however the bill does not apply 
     to amounts paid or incurred under any binding order or 
     agreement entered into before such date. Any order or 
     agreement requiring court approval is not a binding order or 
     agreement for this purpose unless such approval was obtained 
     before the date of enactment.

                                S. 1890

       Be it enacted by the Senate and House of Representatives of 
     the United States of America in Congress assembled,

     SECTION 1. SHORT TITLE.

       This Act may be cited as the ``Government Settlement 
     Transparency Act of 2005''.

     SEC. 2. DENIAL OF DEDUCTION FOR CERTAIN FINES, PENALTIES, AND 
                   OTHER AMOUNTS.

       (a) In General.--Subsection (f) of section 162 of the 
     Internal Revenue Code of 1986 (relating to trade or business 
     expenses) is amended to read as follows:
       ``(f) Fines, Penalties, and Other Amounts.--
       ``(1) In general.--Except as provided in paragraph (2), no 
     deduction otherwise allowable shall be allowed under this 
     chapter for any amount paid or incurred (whether by suit, 
     agreement, or otherwise) to, or at the direction of, a 
     government or entity described in paragraph (4) 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.
       ``(2) Exception for amounts constituting restitution or 
     paid to come into compliance with law.--Paragraph (1) shall 
     not apply to any amount which--
       ``(A) the taxpayer establishes--
       ``(i) constitutes restitution (including remediation of 
     property) for damage or harm caused by or which may be caused 
     by the violation of any law or the potential violation of any 
     law, or
       ``(ii) is paid to come into compliance with any law which 
     was violated or involved in the investigation or inquiry, and
       ``(B) is identified as restitution or as an amount paid to 
     come into compliance with the law, as the case may be, in the 
     court order or settlement agreement.

     Identification pursuant to subparagraph (B) alone shall not 
     satisfy the requirement under subparagraph (A). This 
     paragraph shall not apply to any amount paid or incurred as 
     reimbursement to the government or entity for the costs of 
     any investigation or litigation.
       ``(3) Exception for amounts paid or incurred as the result 
     of certain court orders.--Paragraph (1) shall not apply to 
     any amount paid or incurred by order of a court in a suit in 
     which no government or entity described in paragraph (4) is a 
     party.
       ``(4) Certain nongovernmental regulatory entities.--An 
     entity is described in this paragraph if it is--
       ``(A) a nongovernmental entity which exercises self-
     regulatory powers (including imposing sanctions) in 
     connection with a qualified board or exchange (as defined in 
     section 1256(g)(7)), or
       ``(B) to the extent provided in regulations, a 
     nongovernmental entity which exercises self-regulatory powers 
     (including imposing sanctions) as part of performing an 
     essential governmental function.
       ``(5) Exception for taxes due.--Paragraph (1) shall not 
     apply to any amount paid or incurred as taxes due.''.
       (b) Reporting of Deductible Amounts.--
       (1) In general.--Subpart B of part III of subchapter A of 
     chapter 61 of the Internal Revenue Code of 1986 is amended by 
     inserting after section 6050T the following new section:

     ``SEC. 6050U. INFORMATION WITH RESPECT TO CERTAIN FINES, 
                   PENALTIES, AND OTHER AMOUNTS.

       ``(a) Requirement of Reporting.--
       ``(1) In general.--The appropriate official of any 
     government or entity which is described in section 162(f)(4) 
     which is involved in a suit or agreement described in 
     paragraph (2) shall make a return in such form as determined 
     by the Secretary setting forth--
       ``(A) the amount required to be paid as a result of the 
     suit or agreement to which paragraph (1) of section 162(f) 
     applies,
       ``(B) any amount required to be paid as a result of the 
     suit or agreement which constitutes restitution or 
     remediation of property, and
       ``(C) any amount required to be paid as a result of the 
     suit or agreement for the purpose of coming into compliance 
     with any law which was violated or involved in the 
     investigation or inquiry.
       ``(2) Suit or agreement described.--
       ``(A) In general.--A suit or agreement is described in this 
     paragraph if--
       ``(i) it is--

       ``(I) a suit with respect to a violation of any law over 
     which the government or entity has authority and with respect 
     to which there has been a court order, or
       ``(II) an agreement which is entered into with respect to a 
     violation of any law over which the government or entity has 
     authority, or with respect to an investigation or inquiry by 
     the government or entity into the potential violation of any 
     law over which such government or entity has authority, and

       ``(ii) the aggregate amount involved in all court orders 
     and agreements with respect to the violation, investigation, 
     or inquiry is $600 or more.
       ``(B) Adjustment of reporting threshold.--The Secretary may 
     adjust the $600 amount in subparagraph (A)(ii) as necessary 
     in order to ensure the efficient administration of the 
     internal revenue laws.
       ``(3) Time of filing.--The return required under this 
     subsection shall be filed not later than--

[[Page S11567]]

       ``(A) 30 days after the date on which a court order is 
     issued with respect to the suit or the date the agreement is 
     entered into, as the case may be, or
       ``(B) the date specified Secretary.
       ``(b) Statements to Be Furnished to Individuals Involved in 
     the Settlement.--Every person required to make a return under 
     subsection (a) shall furnish to each person who is a party to 
     the suit or agreement a written statement showing--
       ``(1) the name of the government or entity, and
       ``(2) the information supplied to the Secretary under 
     subsection (a)(1).

     The written statement required under the preceding sentence 
     shall be furnished to the person at the same time the 
     government or entity provides the Secretary with the 
     information required under subsection (a).
       ``(c) Appropriate Official Defined.--For purposes of this 
     section, the term `appropriate official' means the officer or 
     employee having control of the suit, investigation, or 
     inquiry or the person appropriately designated for purposes 
     of this section.''.
       (2) Conforming amendment.--The table of sections for 
     subpart B of part III of subchapter A of chapter 61 of the 
     Internal Revenue Code of 1986 is amended by inserting after 
     the item relating to section 6050T the following new item:

``Sec. 6050U. Information with respect to certain fines, penalties, and 
              other amounts.''.

       (c) Effective Date.--The amendments made by this section 
     shall apply to amounts paid or incurred on or after the date 
     of the enactment of this Act, except that such amendments 
     shall not apply to amounts paid or incurred under any binding 
     order or agreement entered into before such date. Such 
     exception shall not apply to an order or agreement requiring 
     court approval unless the approval was obtained before such 
     date.
                                 ______