Legal Settlement Tax Deduction

Technical topics regarding tax preparation.
#1
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I have a client who is being slapped on the wrist for some inadequate documentation related to their business. A no fault settlement is being negotiated where the federal agency will settle prior to litigation. Is any of this deductible? Would this be considered a 162 expense or a settlement in lieu of a nondeductible penalty and therefore not deductible? No penalty has been issued or will be issued but the client is settling with a Federal Agency.
 

#2
NYea  
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I think there would be no deduction under 162(f). You can read the final regulations in T.D. 9946 and I believe these regs would not allow the deduction given your facts.
 

#3
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It looks deductible to me under 162(f)(2)(A)(i)II -- "is paid to come into compliance with any law which was violated or otherwise involved in the investigation or inquiry described in paragraph (1)".
Steve
 

#4
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Thank you!
 

#5
MilesR  
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gatortaxguy wrote:It looks deductible to me under 162(f)(2)(A)(i)II -- "is paid to come into compliance with any law which was violated or otherwise involved in the investigation or inquiry described in paragraph (1)".


It sounds like the payment being made is payment to settle under a settlement agreement to prevent trial, which is denied a deduction under (f)(1).

The quoted subclause II is regarding costs of complying with a law, not a settlement. This is defined in the regs as costs to get into compliance with a law that was violated. For example, I was sued because I didn't have handicap ramps; I paid to settle with the client and I also paid to get handicap ramps to get into compliance with the law. The settlement is not deductible, but the cost to build handicap ramps to get into compliance is deductible.
 

#6
sjrcpa  
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Step 1 - read the settlement agreement and see how the payment is described.
 

#7
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Thank you. The settlement agreement is not final. We are trying to help the attorney to potentially make it deductible but from what it sounds like: it's not deductible or cannot be worded as such?
 

#8
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Show post #3 to the attorney. He or she does not need to improve the facts. He or she just needs to avoid the subject or at least be aware of the statutory language.
Steve
 


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