Before You Agree to a Consent Order, Make Sure You Plan For Your Taxes
Articles by: Richey May, Aug 21, 2020
Increased complexity in state laws has resulted in many mortgage companies struggling to remain in compliance with state regulations. At times taxpayers can become frustrated with this burden of compliance and find it nearly impossible to comply with the increase in regulation. Some mortgage leaders even describe certain failures to comply an unavoidable cost of doing business in the state. However, states are still required to actively enforce the regulations they have in place. During the process, many states will approach the taxpayer about a potential settlement and subsequently issue a consent order binding the taxpayer to pay an amount to the state for a failure to comply with their laws.
Taxpayers will undoubtedly be frustrated with this process, but in order to minimize the financial impact on the company a taxpayer should carefully review draft consent orders before agreeing to the order so that they can sustain the best chance of attaining a tax deduction for the amount paid.
The IRS released proposed regulation §1.162-21 in relation to section §162(f) of the Internal Revenue Code. These regulations address the deduction for certain fines, penalties, and other amounts paid or incurred at the direction of governments, governmental entities, or certain nongovernmental entities in relation to the violation of a law or investigations or inquiries into the potential violation of a law. Internal Revenue Code section §162(f)(1) states that no deduction is allowed for any amount “paid or incurred to, or at the direction of, a government, governmental entity, or nongovernmental entity in relation to the violation of a law or the investigation or inquiry by such government or governmental entity into the potential violation of a law”. However, section §162(f)(2) provides an exception to this general rule if the taxpayer establishes the amount paid or incurred was for restitution, remediation, or to come into compliance with a law. Additionally, these requirements must be identified in the court order or settlement agreement as restitution, remediation, or an amount paid or incurred to come into compliance with a law. Therefore, prior to accepting a consent order a taxpayer should inquire with the state about the possibility of characterizing the amount due in the consent order as restitution, remediation, or an amount paid or incurred to come into compliance with a law.
Proposed regulation §1.162-21 provides guidance concerning new information reporting requirements under section §6050X of the Code. Section §6050X requires government officials involved in a suit or agreement after January 1, 2022 to which section §162(f) applies to file an information return (Form 1098-F) in any case where the resulting amount due is more than $50,000. This information return will include the amount required to be paid as a result of the order or agreement as well as any amount paid that is considered restitution, remediation, or an amount required to be paid to come in compliance with a law. Because the IRS will be made aware of this information, it is important for the taxpayer to approach the state about possibly including language in their order that will characterize any payment as meeting one of these three exceptions when possible.
Before your company leadership agrees to a drafted consent order, please reach out to a Richey May tax team member for additional guidance. It is very difficult for a tax professional to argue a payment made as a result of an executed consent order should be tax deductible if the consent order does not characterize the payment as one of the three exceptions for deductibility mentioned above. Richey May’s tax team can review the language included and provide suggested revisions so that the taxpayer has the best chance possible to sustain a tax deduction for a payment made because of an executed consent order. In addition, our tax team benefits from the experience of our advisory services team, who have experience executing audits required by consent orders. Mortgage leaders struggling with the complexities of consent orders should contact us for expert guidance.