The IRS has noted that SEPs are often proposed and implemented by a corporation as part of a larger settlement project, and often result in a reduction of the total penalty payment. The IRS requires its examiners to determine any reduction in penalty resulting from the inclusion of a SEP in the total settlement package, and to disallow any deduction for the amount of the reduction in penalty attributable to including the SEP in the settlement.

IRS examiners are using press releases on the Department of Justice Web site and news articles to identify settlements with federal and state agencies. In addition, the IRS directs examiners in charge of cases to request from the target corporation and the relevant internal government agencies draft settlement proposals, draft penalty exposure calculations, and the complete correspondence file for the case, which suggests that companies should exercise caution when exchanging potential settlement positions, as the calculations can be used later by the IRS to deny deductions of portions of the settlement amounts.  

In light of the IRS’s activity in this area and the guidelines given to its auditors, corporations should consult knowledgeable tax counsel in advance of completion of an environmental settlement agreement on the tax consequences of the settlement structure. Especially in cases involving SEPs, corporations may need to consider the tax consequences in order to determine whether the SEP actually offers additional value. Corporations may also consider seeking explicit language in settlements with federal and state agencies specifically addressing the characterization of penalties under the agreement. In cases where actual penalties are incurred, the settlement agreement should specifically state that there was a penalty assessed, and the amount paid. At minimum, accounting departments should consult closely with attorneys handling any environmental settlements to determine the tax status of those settlements. Corporations entering into settlements with significant amounts involved may also want to consult with the IRS in advance to determine how payments under a settlement will be treated.

George Schutzer is a partner with Patton Boggs in the firm’s Washington, D.C., office, focusing on tax, business, and political law. He can be reached at 202-457-5273 or at gschutzer@pattonboggs.com.

Ora Sheinson is an associate with Patton Boggs in the firm’s Newark,N.J., office, focusing on environmental litigation, environmental compliance counseling, and industrial crisis management. He can be reached at 937-848-5600 or at osheinson@pattonboggs.com.