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By: Rebecca K. Wohltman

A little-known provision of the Internal Revenue Code requires governmental agencies (and nongovernmental entities treated as a governmental entity) to report amounts required to be paid according to a “suit, court order, or agreement with respect to any violation of a law or the investigation or inquiry into the potential violation of a law…” Such reporting obligation arises “if the aggregate amount involved… equals or exceeds an amount determined by the Secretary.” As of January 1, 2022, that amount is $50,000.

In other words, if you settle an investigation or suit with a governmental entity for more than $50,000, that governmental entity is required to issue you a Form 1098-F for this amount. If there are multiple payments to be made that are individually less than $50,000, but the total of which is $50,000 or more, the governmental entity is required to issue you Form 1098-F for the aggregate amount.

If the amount of the settlement is not precisely determinable, but the governmental entity reasonably expects the aggregate amount of the payment(s) to be $50,000 or more, the governmental entity is still required to issue you Form 1098-F for $50,000 with a specific code entered in one of the boxes.

If the settlement amount is a joint and several liability of several payers, the governmental entity is to issue each payer a Form 1098-F for that payer’s joint and several liability portion. In other words, if three (3) payers are jointly and severally liable for a total settlement amount of $100,000, each would receive a Form 1098-F for the full $100,000 amount.

There are separate boxes on Form 1098-F for the governmental entity to report restitution amounts as well as amounts required to be paid for the purpose of coming into compliance with a law.

Why does this Form 1098-F matter? Section 162(f) of the Internal Revenue Code allows deductions for restitution, remediation, and payments required to come into compliance with a law. Fines and penalties are not deductible. Form 1098-F specifies which amounts are deductible, at least from the perspective of the governmental entity issuing Form 1098-F.

Settlement agreements often are not clear about how the amounts payable are to be allocated between restitution, remediation, coming into compliance with a law, fines, and penalties. Without this clarity in a settlement agreement (which governmental entities are often unwilling to include), taxpayers are required to determine how much of the settlement payment is deductible and to defend this decision to the IRS (and courts). Since taxpayers have the burden of proving entitlement to deductions, establishing the deductible portion of a settlement payment may be difficult to do, especially by the time the issue reaches the court several years after the settlement. In some situations, Form 1098-F will make establishing the deductible amount easier, but in other cases, it may give a presumption that amounts are not deductible even though the taxpayer believes they are deductible.

When negotiating settlement agreements with a governmental agency, parties should keep the requirement to file Form 1098-F in mind. Ideally, the settlement agreement would specify how the settlement is to be treated and reported on Form 1098-F. Governmental entities may not be willing to agree to the specifics of Form 1098-F, but settling parties should try to include this detail.

Professional Services Disclaimer: Please note that the information presented here is as an educational service, and while it contains information about legal issues, it is not legal advice. No warranty is made regarding the applicability of the information presented to a particular client situation, and the information set forth is not a substitute for original legal research, analysis and drafting for a particular client situation.