The Tax Cuts and Jobs Act, Pub. L. No. 115-97 (2017) (“the Act”), effective December 22, 2017, may significantly limit the deductibility of False Claims Act (“FCA”) settlements for defendants going forward. Specifically, the Act prohibits defendants from deducting FCA settlements unless (1) defendants can establish that certain amounts are being paid as restitution or to bring the company into compliance with the law and (2) the amounts are specifically identified as such in the settlement agreement or court order. Therefore, FCA defendants will be precluded from deducting FCA settlement amounts for settlements entered after December 22, 2017 unless the above requirements have been met.
Prior to the Act, FCA defendants have historically been able to deduct settlement amounts that were paid to compensate the government as “ordinary and necessary business expenses” under 26 U.S.C. § 162(a). On the other hand, FCA defendants were precluded from deducting fines or similar penalties under 26 U.S.C. § 162(f). In the past, deductible, compensatory amounts typically included single damages and relator’s fees while double or treble damages could be considered compensatory, punitive, or a combination of both. Moreover, prior to the passage of the Act, FCA settlement agreements have generally not specified the breakdown of compensatory and punitive damages, allowing FCA defendants to argue that the majority or all of the settlement amount consisted of compensatory, single damages that could be deducted for tax purposes. In fact, the Department of Justice generally refused to include any language in settlement agreements that might help establish the deductibility of settlement amounts.
Under the Act, defendants must remember the following points with respect to the deductibility of any FCA settlement amount:
- To deduct any portion of an FCA settlement, defendants must establish that the portion is paid as restitution or to bring the company into compliance with the law. As a result, amounts that are considered as penalties can no longer be taken as deductions.
- The settlement agreement or court order must specify the specific amount that is restitution or paid to bring the company into compliance with the law, and defendants must be able to support the reasons why the amount should be considered as such. Therefore, defendants should negotiate the amount to be deducted at the time of settlement, a potential complication when negotiating an overall settlement amount with the opposing party and government.
- Investigation or litigation costs are no longer deductible. However, the Act does not address whether a relator’s fees are deductible or not.
- Government agencies are required to report what amounts are deductible to the IRS at the time of any settlement agreement and must provide the same information to defendants. To view the law, click here.
It is unclear as to how the Government – which has historically avoided discussions regarding deductibility during the settlement process – will respond to FCA settlement negotiations that will now involve specific discussions of deductibility. What is clear, however, is that in high-dollar cases, the issue of deductibility will take a center role during the settlement process.