In many cases, the payment of restitution by a party in a lawsuit involving the government or a governmental entity creates a tax-deductible business expense under Title 26, United States Code, Section 162(f) (hereinafter, “Section 162”). When it comes to violations of the False Claims Act, the Anti-Kickback Statute, Stark Law, or even common law fraud claims and contract disputes, understanding how this statute operates can offer substantial short- and long-term tax-benefits to entities facing stiff financial recoupments. While it is unlikely that the costs of an investigation or restitution order will ever generate a financial net-gain for the entity footing the bill, it is important to appreciate that restitution and proactive remediation costs are viewed differently by both government enforcers (i.e. prosecutors) and tax-collectors, compared with other types of remuneration. Recognizing that there is a difference can, in some cases, help mitigate significant financial burdens.
The key is to appreciate that paying restitution versus other categories of expenditures offers distinct tax advantages for the entity writing the check. Specifically, while restitution costs can result in a tax-deductible business expense, other costs such as fines, penalties and costs associated with a government investigation, (e.g. costs of responding to subpoena or Civil Investigative Demand) or actual litigation involving the government, are not tax-deductible. The takeaway is simple, if given the opportunity to pay restitution or penalties/fines—pay restitution because it is a recognized business expense under the federal tax code.
Additionally, offering to pay restitution can also go a long way toward fostering a collaborative relationship with government prosecutors who are instructed to:
consider the corporation’s willingness to make restitution and steps already taken to do so. A prosecutor may also consider other remedial actions, such as improving an existing compliance program or disciplining wrongdoers, in determining whether to charge the corporation and how to resolve corporate criminal cases.
Justice Manual, 9-28.1000 – Restitution and Remediation.
Furthermore, costs incurred creating or improving an existing compliance program also signal a commitment to ensuring past mistakes do not repeat themselves. Hopefully, along with effective advocacy, such measures will favorably influence a prosecutor’s deliberations about whether to assess other punitive actions like fines and penalties, which are not tax-deductible. Moreover, expenses “to come into compliance with any law which was violated or otherwise involved in the investigation or inquiry,” are also tax-deductible under Section 162. Such expenses may include costs associated with activities like implementing and maintaining corporate integrity agreements and other less regimented compliance and oversight mechanisms focused on addressing the specific concern at the heart of a restitution order.
Finally, to qualify as a Section 162 deduction there must be clear record of the expenses within the operative court records. And, furthermore, it is the taxpayer’s obligation to establish the accounting methodology through documentary evidence beyond just a court order, which means tailoring and preserving the negotiations that informed the settlement process.
For additional information about this issue, including navigating internal investigations which may result in restitution obligations, please contact the author of this post, Clay Lee, or the Epstein Becker Green attorney who regularly assists you.