IRC 162(f) Government Fines and Penalties: Deductibility, Restitution Exception, OBBBA Clarification, and Notice 2025-58

IRC 162(f) sits at the intersection of business deductibility and government enforcement. For any client resolving a regulatory matter, an environmental consent decree, an IRS civil penalty, a False Claims Act settlement, or a criminal enforcement action with a civil component, the practitioner's job begins long before the settlement is signed: the identification and segregation of deductible restitution from non-deductible penalty is a drafting task, not a return-preparation task. This guide is written for enrolled agents, CPAs, and tax attorneys who need a citation-anchored reference for the rule as amended by TCJA (effective for amounts paid on or after December 22, 2017), the OBBBA clarification, and Notice 2025-58 interim guidance.

All statutory citations, descriptions of OBBBA provisions, and characterizations of Notice 2025-58 must be verified against the current text of the Internal Revenue Code, the enacted OBBBA, and any IRS guidance issued at IRS.gov before being relied on in any specific client matter. This guide is for informational purposes only and does not constitute legal or tax advice.

Section 1: The General No-Deduction Rule and Its Scope

IRC 162(f)(1) provides the baseline rule: no deduction is allowed under IRC 162(a) for any fine or similar penalty paid to, or at the direction of, a government or governmental entity for the violation of any law. This rule applies regardless of whether the violation was intentional or inadvertent, whether the penalty was assessed in a criminal or civil proceeding, and whether the payment was made pursuant to a court order, a settlement agreement, or a direct regulatory assessment. Confirm the current statutory text at IRC 162(f)(1) and IRS.gov.

The "Any Law" Language: Federal, State, and Local Coverage

The "violation of any law" language in IRC 162(f)(1) is deliberately broad. It covers violations of federal, state, and local laws equally. There is no distinction based on the severity of the violation or the regulatory regime. Penalties subject to the rule include, but are not limited to:

• IRS civil penalties for failure to file, failure to pay, accuracy-related violations, negligence, and fraud under the Internal Revenue Code.
• OSHA penalties for workplace safety violations.
• Environmental penalties assessed by the EPA or state environmental agencies for violations of the Clean Water Act, Clean Air Act, CERCLA, or state equivalents.
• FDA enforcement penalties for violations of food, drug, and device regulations.
• SEC civil penalties assessed for violations of the securities laws.
• State and local regulatory fines, including professional licensing violations and business license penalties.
• Civil penalty components of settlement agreements with federal, state, or local agencies arising from enforcement actions for violations of any applicable law.

The TCJA (effective for amounts paid on or after December 22, 2017) substantially expanded and clarified the prior rule. For amounts paid before December 22, 2017, hedge to pre-TCJA case law and prior legislative history, which developed significant nuance regarding what qualified as a "fine or penalty" under the prior, simpler version of the rule.

"Government or Governmental Entity" Definition (IRC 162(f)(5))

Under IRC 162(f)(5), a "government or governmental entity" means the United States, any state, any political subdivision of a state (including counties, municipalities, and other local governments), or any instrumentality of any of the foregoing. Foreign governments and international organizations are also included within the definition for purposes of IRC 162(f). Confirm the current statutory scope at IRC 162(f)(5) and IRS.gov.

The scope of what constitutes an "instrumentality" of a government is a facts-and-circumstances determination. Government-chartered entities, public utilities, and quasi-governmental regulatory bodies may qualify; confirm the specific characterization of any particular entity for purposes of IRC 162(f) against IRS.gov and applicable case law before advising a client.

What Is NOT a Fine or Penalty Under IRC 162(f)

Three categories of payments fall outside the IRC 162(f)(1) prohibition entirely:

• Amounts paid to private parties: Penalties, settlements, and damages paid to private plaintiffs (including class action plaintiffs, private qui tam relators in False Claims Act cases, and private parties in civil litigation) are NOT subject to IRC 162(f). Whether such payments are deductible turns on general IRC 162(a) principles (ordinary and necessary business expenses) and public policy limitations developed in case law. Hedge the deductibility of any specific private-party settlement to applicable case law and IRS.gov.
• Voluntary compliance costs: Amounts a taxpayer voluntarily spends to come into compliance with a law -- without being ordered to do so by a government entity -- are generally deductible under IRC 162(a) as ordinary and necessary business expenses, without any need to satisfy the IRC 162(f)(2) exception framework. The IRC 162(f) framework applies to court-ordered and settlement-agreement-mandated payments, not to expenditures the taxpayer undertakes on its own initiative. Hedge the specific deductibility determination to the facts and IRS.gov.
• Compensatory damages paid to private parties: A payment to a private party that compensates for actual loss or damage (compensatory damages) is generally deductible as an ordinary and necessary business expense under IRC 162(a), not a "fine or penalty" for purposes of IRC 162(f). Punitive damages paid to private parties are a separate question subject to public policy limitations in case law; hedge to applicable Tax Court and circuit court case law and IRS.gov. Punitive damages paid TO a government entity may be subject to IRC 162(f) as a "fine or similar penalty"; confirm the treatment of any specific punitive damages payment against the facts and applicable IRS guidance.

Section 2: The Restitution and Remediation Exception (IRC 162(f)(2))

IRC 162(f)(2)(A) carves out from the general no-deduction rule three categories of amounts that ARE deductible, notwithstanding IRC 162(f)(1). Understanding all three categories, and the conditions each must satisfy, is the core practitioner competency for government settlement planning.

Three Categories of Deductible Amounts

Under IRC 162(f)(2)(A)(i)-(iii), a deduction IS allowed (notwithstanding IRC 162(f)(1)) for amounts paid or incurred:

• Category (i): Restitution, including remediation of property. Amounts paid as restitution for damage or harm caused by the violation of law are deductible. Restitution in this context includes environmental remediation of property that was contaminated or damaged as a result of the violation. The remediation must be for damage or harm causally connected to the specific violation; it is not a general license to deduct cleanup costs that are merely related to regulated activities.
• Category (ii): Amounts paid to come into compliance with the law that was violated. Costs of coming into compliance with the specific law whose violation gave rise to the government enforcement action are deductible. Examples include the cost of installing pollution control equipment ordered by the EPA as part of a consent decree, the cost of implementing safety systems ordered by OSHA, or the cost of consumer refunds ordered as part of an FTC consent decree. These compliance costs must be ordered by the government entity as part of the resolution of the enforcement action; costs voluntarily incurred to achieve compliance (without a government order) are deductible under general IRC 162(a) principles instead.
• Category (iii): Amounts paid at the direction of a government entity in response to the violation, where those amounts constitute restitution or remediation. This category covers directed remediation and restitution payments that may be structured as payments to third parties (rather than directly to the government) at the government's direction. The amounts must still constitute restitution or remediation in character; a government direction to pay does not transform an otherwise non-deductible penalty into deductible restitution.

Confirm the current statutory text and scope of all three categories at IRC 162(f)(2)(A)(i)-(iii) and IRS.gov.

The Identification Requirement (IRC 162(f)(2)(B)): The Most Critical Drafting Point

Satisfying one of the three substantive categories above is necessary but not sufficient. Under IRC 162(f)(2)(B), the deductible amounts are allowable ONLY IF two additional conditions are met:

• Condition A: The amounts must be specifically identified as restitution, remediation, or compliance costs in the court order or settlement agreement establishing the payment obligation.
• Condition B: The taxpayer must independently establish that the amounts paid actually constitute restitution or remediation (or compliance costs, as applicable) in character.

The failure of either condition is fatal to the deduction. If the agreement identifies the amounts as restitution but the taxpayer cannot establish that they actually constitute restitution in character, the deduction fails on Condition B. More commonly, and more preventably: if the agreement does not specifically identify any amounts as restitution or remediation -- because it states only a total lump-sum payment with no allocation -- the ENTIRE payment is non-deductible under IRC 162(f)(1), regardless of the economic reality of how the payment was negotiated or what it actually represents.

Documentation Best Practices

In addition to the settlement agreement or court order itself, practitioners should gather and retain supporting documentation establishing the character of the identified restitution or remediation amounts:

• The underlying enforcement complaint, indictment, or administrative notice identifying the specific violation and the harm or damage caused.
• Correspondence between the parties during the settlement negotiation establishing how each component was characterized and calculated.
• Expert appraisals, remediation cost estimates, and third-party damage assessments supporting the remediation component.
• Form 1098-F filed by the government entity (see Section 4): the Box 2 identification of restitution or remediation amounts corroborates the taxpayer's characterization, though it is not binding on the IRS.
• Any IRS determination letters, revenue rulings, or private letter rulings addressing similar fact patterns; confirm current guidance at IRS.gov and by reference to Notice 2025-58.

The sufficiency of any particular identification language or documentation set for satisfying IRC 162(f)(2)(B) is a legal and factual determination that must be evaluated by qualified tax and legal counsel. Hedge all specific determinations to the applicable facts, the agreement language, and current IRS guidance at IRS.gov.

State and Local Tax Penalties: A Separate Note

Penalties assessed in connection with state and local tax underpayments are generally non-deductible under IRC 162(f). The interest on state and local tax underpayments is a separate question: interest may be deductible as a business expense under IRC 162(a) or as investment interest under IRC 163. Hedge the interest deductibility analysis to IRC 163 and IRS.gov. The underlying state income taxes (before penalties and interest) may be deductible under IRC 164, subject to the SALT cap for individual taxpayers; confirm the current SALT cap rules as enacted by OBBBA and any implementing IRS guidance at IRS.gov.

Section 3: OBBBA Clarification and Notice 2025-58

What OBBBA Added to IRC 162(f)

OBBBA added a clarifying provision to IRC 162(f) specifically addressing settlement payments to government entities where the deductible and non-deductible portions are not separately identified in the settlement agreement or court order. The provision addresses the treatment of such lump-sum or unallocated payments for purposes of the IRC 162(f)(1) no-deduction rule and the IRC 162(f)(2) exceptions. All specific mechanics of the OBBBA clarification must be confirmed at IRS.gov and in the enacted OBBBA text; practitioners should not rely on any secondary description of the OBBBA provision without reading the enacted statute.

Notice 2025-58: Interim Guidance

The IRS issued Notice 2025-58 in response to the OBBBA clarifying provision. The Notice provides interim guidance on:

• What constitutes a "qualifying restitution or remediation payment" for purposes of IRC 162(f)(2).
• The documentation required to support the deduction claim for restitution and remediation amounts.
• The treatment of lump-sum settlement payments that are not separately identified as between deductible and non-deductible portions.

Because Notice 2025-58 is interim guidance, it is subject to modification, supersession, or amplification by subsequent IRS guidance, proposed regulations, or final regulations. Practitioners MUST read the current text of Notice 2025-58 at IRS.gov and confirm whether any subsequent guidance has been issued before advising clients on the specific provisions described in the Notice. No description of the Notice's provisions in this guide should substitute for that review.

Lump-Sum Settlements With No Separate Identification

Under the general IRC 162(f)(2)(B) identification requirement (described in Section 2), a lump-sum settlement payment to a government entity that is not allocated between deductible and non-deductible amounts is entirely non-deductible -- the identification requirement is not met, so the IRC 162(f)(2) exception does not apply, and IRC 162(f)(1) bars the full deduction.

Notice 2025-58 may provide some relief or a pathway for specific categories of lump-sum settlement payments in defined circumstances. The precise scope of any such relief must be confirmed by reading the current Notice directly at IRS.gov. Practitioners should not assume that lump-sum payments are now generally deductible or that the OBBBA clarification eliminated the identification requirement; confirm the specific facts against current guidance before advising any client.

Practical Takeaway: The Identification Requirement Remains

The OBBBA clarification does not eliminate the fundamental requirement of IRC 162(f)(2)(B) that deductible amounts be specifically identified in the settlement agreement or court order. The best practice for practitioners advising clients in government enforcement settlements remains unchanged: negotiate and document the explicit allocation between deductible (restitution, remediation, compliance costs) and non-deductible (penalty, fine) amounts in the settlement agreement itself, before execution. The OBBBA clarification and Notice 2025-58 may provide some relief at the margins for historically unallocated payments; they do not substitute for sound settlement drafting practice going forward.

Section 4: Form 1098-F and Information Reporting (IRC 6050X)

The TCJA (effective for amounts paid on or after December 22, 2017) added IRC 6050X, which created a new information reporting obligation designed to help both taxpayers and the IRS track the deductible vs. non-deductible portions of government settlement payments. Understanding Form 1098-F and its limitations is essential for both the planning and the return-preparation phases of any government settlement matter.

Who Must File Form 1098-F

Under IRC 6050X, the following entities that receive payments of $600 or more pursuant to a settlement agreement or court order that includes an amount for the violation of any law must file Form 1098-F and furnish a copy to the payer:

• Government entities (as defined in IRC 162(f)(5): the United States, any state, any political subdivision, and any instrumentality of any of the foregoing).
• Certain nongovernmental entities that exercise self-regulatory powers (including entities described in section 3(a)(26) of the Securities Exchange Act of 1934) when receiving settlement payments in that regulatory capacity.

Confirm the current $600 threshold, filing requirements, and scope of required filers at the current Form 1098-F instructions and IRS.gov. The threshold and requirements are set by statute and regulation and may have been modified.

What Form 1098-F Reports

Form 1098-F identifies and separates the components of a settlement payment:

• Box 1 -- Total amount paid: The total amount the taxpayer paid pursuant to the settlement agreement or court order, including both deductible and non-deductible portions.
• Box 2 -- Amount that is restitution or remediation: The portion of the payment that the government entity has identified as restitution or remediation (potentially deductible under IRC 162(f)(2)(A)(i)).
• Box 3 -- Amount for coming into compliance: The portion of the payment that the government entity has identified as amounts paid to come into compliance with the law (potentially deductible under IRC 162(f)(2)(A)(ii)).

Confirm the current box descriptions, filing deadlines, and instructions at the current Form 1098-F instructions and IRS.gov.

The Form Is Informational -- Not Binding on the IRS

A critical point that practitioners must communicate to clients: Form 1098-F is an information return. The government entity's characterization of amounts in Box 2 or Box 3 is NOT binding on the IRS for purposes of determining whether the taxpayer may actually deduct those amounts. Under IRC 162(f)(2)(B)(ii), the taxpayer must independently establish that the amounts paid qualify as restitution or remediation (the second condition described in Section 2 above). A Form 1098-F identifying $3,000,000 as restitution in Box 2 is helpful corroborating documentation, but it does not guarantee that the IRS will allow the deduction on examination.

The corollary is also important: if Form 1098-F shows no Box 2 or Box 3 amounts (because the government entity characterized the entire payment as a penalty), the taxpayer is not necessarily precluded from establishing that portions of the payment were in fact restitution or remediation, if the settlement agreement itself identifies those amounts and the taxpayer can establish their character. The Form 1098-F reflects the government entity's characterization, not a conclusive IRS determination.

Handling Discrepancies Between Form 1098-F and the Settlement Agreement

If the amounts shown on Form 1098-F differ from the amounts identified in the settlement agreement itself, practitioners should:

• Contact the government entity that filed the Form 1098-F to understand the basis for the discrepancy and request a corrected Form 1098-F if the amounts are incorrect.
• Document the correct characterization from the settlement agreement and maintain the supporting documentation described in Section 2.
• Address the discrepancy in the tax return or an attachment, consistent with the taxpayer's independent establishment of the character of the amounts. Confirm the current IRS guidance on handling Form 1098-F discrepancies at IRS.gov before filing.

Form 1098-F Timing

Form 1098-F is generally due to be filed with the IRS and furnished to the payer by January 31 of the year following the year the settlement agreement or court order is entered into (not necessarily the year payment is made). Confirm the current due dates and furnishing requirements at the Form 1098-F instructions and IRS.gov. Practitioners should coordinate with clients at year-end to ensure timely receipt of Form 1098-F and early identification of any discrepancies that need to be resolved before the return is filed.

Section 5: Planning -- Settlement Negotiations and Deductibility Maximization

The most valuable IRC 162(f) work a practitioner does is not on the tax return -- it is at the settlement table. Because the identification requirement of IRC 162(f)(2)(B) makes the settlement agreement itself the controlling document for deductibility, the practitioner's leverage over the tax outcome is highest before the agreement is signed. The following planning considerations address the key pressure points in government enforcement settlements.

Identifying and Quantifying the Restitution Component Early

In any government enforcement matter, practitioners should identify and begin quantifying the restitution and remediation component as early as possible in the negotiation process -- before the government agency has committed to a characterization in its internal records. The economic components of any settlement (what is the actual damage or harm caused by the violation, and what does it cost to remediate it?) should be separately documented and presented to the government agency, supported by expert analysis where appropriate.

Once the government agency has internally characterized a proposed settlement as a "civil penalty" without a restitution component, it becomes harder (and sometimes impossible) to negotiate a separate identification of restitution or remediation in the final agreement. Front-load this analysis.

The Consent Decree Drafting Check

Consent decrees (the typical vehicle for EPA, OSHA, FTC, and DOJ enforcement resolutions) require careful review of every payment provision before the taxpayer's client signs. For each payment or payment obligation in a proposed consent decree, practitioners should confirm:

• Whether the payment is characterized as a civil penalty, a fine, restitution, remediation, a compliance obligation, or some combination.
• Whether any payment with a potentially deductible restitution or remediation character is separately identified as such in the consent decree, with a specific dollar amount allocated to that category.
• Whether any lump-sum payment provisions can be restructured to include explicit allocation language before the decree is entered by the court.
• Whether the government agency's policies (discussed below) affect the feasibility of obtaining explicit restitution or remediation language for any specific payment.

Agency-Specific Practices: DOJ, EPA, SEC, and IRS

Different federal agencies have developed different practices regarding the characterization of settlement payment components. Practitioners should be aware of these practices and understand how to work within them to obtain the identification language that IRC 162(f)(2)(B) requires:

• Department of Justice (DOJ): DOJ resolutions (deferred prosecution agreements, non-prosecution agreements, and civil settlement agreements) vary widely in how they characterize payment components. Some DOJ agreements explicitly identify restitution and compliance cost components; others characterize the entire settlement as a "penalty" or "forfeiture." DOJ policy on whether to agree to explicit restitution characterization varies by division and matter type. Practitioners must engage with DOJ counsel early on the tax characterization of payment components.
• Environmental Protection Agency (EPA): EPA consent decrees typically contain three types of payment obligations: civil penalties (non-deductible), remediation costs (potentially deductible as restitution), and compliance costs (potentially deductible). EPA generally will separately identify remediation obligations in the consent decree because the remediation is typically performed by the defendant directly (or funded into a remediation trust), making separate identification a natural drafting convention. Practitioners should confirm that the remediation and compliance cost language is explicit and not subsumed within a general penalty provision.
• Securities and Exchange Commission (SEC): SEC settlements typically characterize payments as "disgorgement" (return of ill-gotten gains), "prejudgment interest" on disgorgement, and "civil penalties." Disgorgement is conceptually compensatory (it returns the gain from the violation) and may be characterized as restitution in some contexts; the IRC 162(f)(2) analysis for disgorgement payments is complex and must be analyzed against the specific facts and current IRS guidance, which is actively evolving. Hedge all SEC disgorgement deductibility determinations to the applicable case law, IRS guidance, and IRS.gov.
• Internal Revenue Service (IRS): IRS civil penalties (failure to file under IRC 6651(a)(1), failure to pay under IRC 6651(a)(2), accuracy-related penalties under IRC 6662, negligence penalties, and fraud penalties) are assessments under the Internal Revenue Code and are non-deductible under IRC 162(f)(1). There is no restitution or remediation component in a standard IRS civil penalty that would support a IRC 162(f)(2) exception. Interest on IRS underpayments is deductible under IRC 163 (for business taxpayers); confirm current IRC 163 guidance at IRS.gov. For IRS penalty abatement and penalty defense strategies, see our companion guide on IRS Penalty Abatement: First-Time Abatement, Reasonable Cause, and Administrative Relief.

Environmental Penalties vs. Environmental Remediation: The Critical Distinction

Environmental enforcement matters illustrate the distinction between non-deductible fines and deductible remediation most clearly. When a company violates the Clean Water Act and enters into an EPA consent decree:

• The civil penalty assessed for the Clean Water Act violation is non-deductible under IRC 162(f)(1).
• The cost of cleaning up the contamination caused by the violation (environmental remediation of the damaged property) may be deductible as restitution under IRC 162(f)(2)(A)(i), IF: (a) the consent decree specifically identifies the remediation obligation separately from the civil penalty, and (b) the taxpayer can establish that the remediation constitutes restitution for the harm caused by the violation.
• The cost of installing new pollution control equipment to come into compliance with the Clean Water Act may be deductible under IRC 162(f)(2)(A)(ii) as a compliance cost, IF: (a) the consent decree specifically identifies those compliance costs separately, and (b) the equipment was required by the government agency as part of the enforcement resolution (not voluntarily installed).

Confirm all specific deductibility determinations for environmental settlement payments against the consent decree language, the facts, and current IRS guidance at IRS.gov and by reference to Notice 2025-58.

Frequently Asked Questions

Common questions from enrolled agents, CPAs, and tax attorneys advising clients on the deductibility of government fines and penalties under IRC 162(f).

Related Practitioner Guides

The following guides cover adjacent Code sections and practitioner workflows relevant to government enforcement, penalty defense, and business deductibility.

Internal links verified against existing files in /home/www/americastax/public_html/ as of the publication date of this guide. Files searched: irc-162 (found: irc-162m-executive-compensation-deduction-limit-obbba-practitioner-guide.html, irc-162l-self-employed-health-insurance-deduction-s-corp-2-percent-shareholder-ptc-practitioner-guide.html); penalty-abatement (found: irs-penalty-abatement-practitioner-guide.html, irs-penalty-abatement-guide-tax-preparers.html); audit, tax-controversy, tax-court (found: how-to-handle-irs-audit-preparer.html, irc-6501-audit-statute-of-limitations-practitioner-guide.html, tax-court-petition-practitioner-guide.html). No files matching executive-compensation (other than irc-162m, already listed), first-time-abatement, or irc-6651 were found as standalone files.

• IRC 162(m) Executive Compensation Deduction Limit: OBBBA Guide -- the companion IRC 162 deductibility guide covering the $1 million executive compensation cap, the TCJA repeal of the performance-based exception, and the OBBBA controlled-group expansion effective for tax years beginning after December 31, 2025.
• IRS Penalty Abatement: Practitioner Guide -- covers first-time abatement, reasonable cause relief, and administrative procedures for contesting IRS civil penalties assessed under the Internal Revenue Code; relevant to practitioners advising clients on the non-deductible IRS penalty component of tax enforcement resolutions.
• IRC 6501 Audit Statute of Limitations: Practitioner Guide -- covers the period of limitations for IRS assessment of tax, relevant to practitioners managing the timeline of government enforcement matters that may involve both IRC 162(f) deductibility issues and IRS examination risk.
• Tax Court Petition: Practitioner Guide -- covers the procedure for petitioning the United States Tax Court, relevant for practitioners whose clients receive IRS deficiency notices arising from IRC 162(f) deduction disallowances on examination.
• How to Handle an IRS Audit: Preparer Guide -- covers audit defense workflow, document management, and practitioner responsibilities when representing clients before the IRS, including examinations of government settlement deductions claimed under IRC 162(f)(2).
• IRC 831(b) Captive Insurance Election -- Captive insurance premiums paid to related entities -- distinguishing ordinary business deductions from nondeductible penalties under IRC 162(f).
• IRC 162(a) and 162(e) business expense and lobbying -- Ordinary and necessary standard, lobbying disallowance, Cohan rule, and OBBBA 2026 meal changes.

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