Get It in Writing: Deducting False Claims Act Payments

Whether or not such payments are deductible as business expenses under section 162(a) of the Internal Revenue Code is an important consideration when negotiating a settlement with the government since the corporate tax rate is still at 21%, even with the passage of the Tax Cuts and Jobs Act in December 2017. See, 26 U.S.C.A. §11(b); 26 U.S.C. §162(a).

Historically, DOJ has steadfastly declined to include in its settlement agreements language regarding the tax treatment of such payments, causing uncertainty. Most states likewise have refused to deal with deductibility in settlements. However, the new tax bill specifically addresses the issue and has altered the way parties negotiate and draft FCA settlement agreements.

Prior Law

Section 162(a) of the Internal Revenue Code allows a company to deduct “all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business.” 26 U.S.C. §162(a). Prior to Dec. 22, 2017, section 162(f) expressly excluded “any fine or similar penalty paid to a government for the violation of any law” from a company's deductible expenses. But federal regulations provided that “[c]ompensatory damages … paid to a government do not constitute a fine or penalty.” See, 26 C.F.R. §1.162-21(b)(2). Deductibility thus depended on whether the settlement payment was deemed a penalty (and nondeductible) or compensatory (deductible). This distinction often became a matter of dispute with the IRS and courts split on their approach to the issue.