a

GAO

United States Government Accountability Office

Report to the Committee on Finance, 

U.S. Senate

September 2005 TAX 

ADMINISTRATION

Systematic 

Information Sharing 

Would Help IRS 

Determine the 

Deductibility of Civil 

Settlement Payments

GAO-05-747
What GAO Found

United States Government Accountability Office

Why GAO Did This Study

Highlights

Accountability Integrity Reliability

www.gao.gov/cgi-bin/getrpt?GAO-05-747.

To view the full product, including the scope 

and methodology, click on the link above. 

For more information, contact Michael 

Brostek at (202) 512-9110 or 

brostekm@gao.gov. 

Highlights of GAO-05-747, a report to the 

Committee on Finance, U.S. Senate 

September 2005

TAX ADMINISTRATION

Systematic Information Sharing Would 

Help IRS Determine the Deductibility of 

Civil Settlement Payments 

The Environmental Protection Agency (EPA), Securities and Exchange 

Commission (SEC), and Department of Justice (DOJ) negotiated civil 

settlements that were among the largest in the federal government in fiscal 

years 2001 and 2002. Also, the Department of Health and Human Services 

(HHS) was involved in negotiating some of the largest dollar False Claims 

Act (FCA) health-care civil settlements for which DOJ has primary 

responsibility. The largest civil settlements at these agencies ranged from 

about $870 thousand to over $1 billion. 

Officials in the four agencies we surveyed said that they do not negotiate 

with settling companies about whether settlement amounts are tax 

deductible. They said it was IRS’s role to determine deductibility. In 

preparing to negotiate environmental settlements, EPA and DOJ may 

consider certain tax issues in calculating the amounts they propose to seek. 

This calculation estimates a company’s economic benefit, that is, the 

financial gain from not complying with the law. Some DOJ environmental 

settlements with civil penalties have language stating that penalties are not 

deductible. DOJ officials said since the law is generally clear that civil 

penalties paid to a government are not deductible, stating so in the 

agreement was merely restating the law and is not necessary. 

The majority of companies responding to GAO’s survey on how they treated 

civil settlement payments for federal income tax purposes deducted civil 

settlement payments when their settlement agreements did not label the 

payments as penalties. GAO received responses on 34 settlements totaling 

over $1 billion. For 20 settlements, companies reported deducting some 

portion or all of their settlement payments. 

IRS does not systematically receive civil settlement information from all four 

agencies. IRS officials said that a permanent system for agencies to provide 

information would be useful. IRS obtains information on a case-by-case basis 

from public sources and agencies. IRS also has two temporary compliance 

projects focusing on tax issues that affect settlement payment deductibility. 

In 2004, IRS introduced a tax schedule to provide information on a 

company’s fines, penalties, and punitive damages. 

Approximate Ranges and Cumulative Values of the 20 Largest Civil Settlement Agreements 

at the Four Agencies Contacted in Each Year for Both Fiscal Years 2001 and 2002 

Agency Smallest Largest Cumulative value 

EPA $1 million $1 billion $4.1 billion

SEC $870 thousand $114 million $607 million

HHS $3 million $790 million $2 billion

DOJ $12 million $471 million $3.3 billion 

Source: GAO analysis of EPA, SEC, HHS, and DOJ data. 

Note: Settlement values include payments to the U.S. government. EPA settlements also include 

estimated costs for any pollution controls, other complying actions and Supplemental Environmental 

Projects. HHS settlements are for FCA cases negotiated with DOJ. EPA settlements led by DOJ are 

included in the EPA category. 

Although some civil settlement 

payments are deductible, their 

deterrence factor could be lessened

if companies can deduct certain 

settlement payments from their 

income taxes. GAO was asked to 

(1) identify federal agencies that 

negotiated some of the largest 

dollar civil settlements, 

(2) determine whether selected 

federal agencies take tax 

consequences into account when 

negotiating settlements and 

officials’ views on whether they 

should address payment 

deductibility in settlement 

agreements, (3) determine whether 

companies with some of the largest 

civil settlement payments deducted 

any of the payments on their 

federal income taxes, and 

(4) determine what information the 

Internal Revenue Service (IRS) 

collects on civil settlements 

reached by federal agencies. 

What GAO Recommends

GAO recommends that IRS work 

with federal agencies to develop a 

cost-effective means of 

systematically obtaining 

information on civil settlements 

that would benefit IRS in ensuring 

the correct tax treatment of 

settlement payments. 

IRS agreed with the 

recommendation and will form an 

executive-led team to implement it. 

EPA generally supported our 

recommendation and the other 

agencies did not address the 

recommendation. 
Page i GAO-05-747 Civil Settlement Payments 

Letter 1

Results in Brief 3 

Background 6 

Civil Settlements Negotiated by EPA, SEC, HHS, and DOJ Were 

among the Largest in Fiscal Years 2001 and 2002 8 

The Four Agencies Do Not Negotiate the Tax Deductibility of 

Settlement Amounts, but Two Agencies Consider Aspects of 

Taxes in Determining Amounts for Negotiations 9 

A Majority of the Surveyed Companies Deducted Civil Settlement 

Payments, Generally When Settlement Agreements Did Not 

Label Payments as Civil Penalties 18 

No Permanent System Is in Place for Agencies to Routinely Inform 

IRS of Civil Settlements or Provide Other Settlement 

Information That IRS Would Find Useful 21 

Conclusions 25 

Recommendation for Executive Action 26 

Agency Comments and Our Evaluation 26 

Appendix I Scope and Methodology 29 

Appendix II Selected IRS Audit Results Information on 

Companies with Civil Settlement Payments 35 

Appendix III Comments from the Internal Revenue Service 36 

Appendix IV Comments from the Environmental Protection 

Agency 38 

Appendix V Comments from the Securities and Exchange 

Commission 44 

Contents 
Page ii GAO-05-747 Civil Settlement Payments 

Appendix VI Comments from the Department of Health and 

Human Services 45 

Appendix VII GAO Contact and Staff Acknowledgments 46 

Tables 

Table 1: Approximate Ranges and Cumulative Values of the 20 

Largest Civil Settlement Agreements at the Four Agencies 

Contacted in Each Year for Both Fiscal Years 2001 and 

2002 8 

Table 2: Practices of Four Federal Agencies regarding Tax Issues 

They Consider during Settlement Negotiations and in 

Settlement Agreements 10 

Table 3: Company Responses on Whether They Deducted Civil 

Settlement Payments from Their Federal Income Taxes 18 

Table 4: Company Responses on Whether They Deducted Various 

Types of Civil Settlement Payments 19 

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Page 1 GAO-05-747 Civil Settlement Payments 

September 15, 2005 

The Honorable Charles E. Grassley 

Chairman 

The Honorable Max Baucus 

Ranking Minority Member 

Committee on Finance 

United States Senate 

The value of civil settlements that federal regulatory agencies annually 

reach with those who violate laws or regulations can exceed billions of 

dollars. Civil settlements,1

 which can be used to avoid litigation, are one of 

the enforcement tools some agencies can use to correct violations and 

punish those who violate laws or regulations by imposing penalties or 

other actions. Many civil settlements with federal agencies may require 

that the entities settling with the agencies make monetary payments. When 

negotiating settlements, agencies consider many factors, which may 

include whether payments are sufficient in size to deter the violator or 

others from violating applicable laws or regulations in the future and 

mitigate any economic benefit that the violator gained from not complying. 

The deterrence effect of monetary payments could be lessened if violators 

are able to deduct the civil settlement payments from their income taxes 

since deductions reduce the amount of tax violators would otherwise pay. 

In general, payments that are intended to punish (punitive payments) a 

violator are not deductible and payments made to compensate 

(compensatory payments) those who were harmed by a violation are 

deductible under federal law. Nevertheless, it may not always be clear 

which payments are deductible, in part because the Internal Revenue Code 

(IRC)2

 does not address the deductibility of all types of payments that may 

be made pursuant to a civil settlement and the statutes imposing the 

payments may be unclear regarding whether they are punitive, 

compensatory, or both. Over the last several years, concerns that some 

companies deducted, or planned to deduct, large civil settlement payments 

 1

In this report, civil settlements are formal legal agreements between agencies and alleged 

violators to resolve a lawsuit or potential lawsuit. The terms agencies use to refer to civil 

settlement agreements may vary. 

2

26 U.S.C. et seq. 

United States Government Accountability Office

Washington, DC 20548 
Page 2 GAO-05-747 Civil Settlement Payments 

from their federal income taxes have heightened Congress’s interest in this 

area. 

Because of your interest in obtaining information on how agencies address 

tax issues for civil settlements and how companies have treated civil 

settlement payments on their federal income tax returns, you asked us to 

review some of the largest settlement agreements and determine how 

some companies have treated their civil settlement payments for federal 

tax purposes. As agreed, the objectives of this report are to (1) identify 

federal agencies that negotiated some of the largest dollar civil settlements 

in recent years, (2) determine whether the selected federal agencies 

having some of the largest civil settlements take tax consequences into 

account when negotiating settlements and officials’ views on whether they 

should address the deductibility of payments in the agreements, 

(3) determine whether the companies that paid some of the largest civil 

settlement payments deducted any of the payments on their federal 

income tax returns, and (4) determine what information the Internal 

Revenue Service (IRS) collects on civil settlements reached by federal 

agencies. 

To identify federal agencies that negotiated the largest dollar civil 

settlements in recent years, we analyzed information from various 

sources, including agencies’ Web sites, annual reports and enforcement 

reports, and other available information. Based on our analysis of the 

information, we concluded that the Environmental Protection Agency 

(EPA), the Securities and Exchange Commission (SEC), and the 

Department of Justice (DOJ) negotiated some of largest civil settlements 

in fiscal years 2001 and 2002. We also included the Department of Health 

and Human Services (HHS) because HHS was involved in negotiating 

some of the largest dollar False Claims Act (FCA) health care civil 

settlements that DOJ has primary responsibility to negotiate.3

 We selected 

this time frame since it would allow the settling companies time to pay the 

settlements; determine the applicable tax treatments, if any; and file 

federal income tax returns. We interviewed officials in these agencies to 

identify and obtain copies of their largest civil settlements. 

To determine whether the four federal agencies having some of the largest 

civil settlements take tax consequences into account when negotiating 

 3

HHS’s role in these negotiations includes recommending an appropriate settlement 

amount to DOJ. 
Page 3 GAO-05-747 Civil Settlement Payments 

civil settlements, we determined whether the agencies negotiate with 

companies about whether civil settlement amounts are tax deductible and 

whether the agencies considered any aspects of taxes when internally 

deciding on what settlement amounts they should present for the 

negotiations. In making these determinations, we reviewed the underlying 

agreements and obtained information on the agencies’ civil settlement 

policies and procedures, including whether they address tax issues, and 

interviewed officials. We also obtained agency officials’ views on whether 

they should address the deductibility of payments in the agreements. 

To determine whether the companies that paid some of the largest civil 

settlement payments deducted any of the payments on their federal 

income tax returns, we developed a questionnaire to survey the 

companies. We did not independently verify the responses of the surveyed 

companies. 

To determine what information IRS collects on civil settlements reached 

by federal agencies, we interviewed knowledgeable officials from IRS and 

the four agencies and reviewed supporting documentation about what 

information, if any, IRS obtains from the four selected agencies regarding 

their civil settlement agreements. 

You also asked us to provide information on whether corporate taxpayers’ 

deductions for settlement payments were being examined in IRS audits 

and the outcome of the audits. To obtain this information, we interviewed 

IRS officials concerning our work and requested information on whether 

corporate taxpayers’ deductions for settlement payments were being 

examined in audits and the outcome of the audits. Appendix II provides 

this information. 

We assessed the reliability of the lists of the largest settlement agreements 

identified by the agencies and found them to be sufficiently reliable for the 

purposes of our reporting objectives. Our work was conducted from 

February 2004 through June 2005 in accordance with generally accepted 

government auditing standards. (See app. I for a more detailed description 

of our scope and methodology.) 

Four agencies—EPA, SEC, HHS,4

 and DOJ—negotiated civil settlement 

agreements that were among the largest negotiated by the federal 

 4

HHS settlements were for FCA cases for which DOJ had primary responsibility. 

Results in Brief 
Page 4 GAO-05-747 Civil Settlement Payments 

government in fiscal years 2001 and 2002. The cumulative value of their 

160 largest settlements exceeded $9 billion. The settlements ranged in size 

from just under $1 million to over $1 billion. For example, the payments 

required under SEC’s civil settlements ranged from about $870 thousand 

to about $114 million, and the estimated value of EPA’s settlements ranged 

from about $1 million to over $1 billion (see table 1 and the table notes). 

Officials in the four agencies we surveyed said that they do not negotiate 

with settling companies about whether settlement amounts are tax 

deductible. Some officials said it was IRS’s role to determine deductibility. 

Before entering into a settlement with the settling companies for 

environmental settlements, EPA and DOJ officials consider tax issues in 

determining the economic benefit a settling company gained from 

noncompliance. This takes into account whether a company would have 

incurred tax deductible costs if it had complied with the law, such as a 

one-time nondepreciable expenditure and applies the violator’s 

appropriate year-specific combined state and federal marginal tax rates to 

the costs. Other than some settlements with civil penalties containing 

language stating that the penalties are not deductible, the settlement 

agreements we reviewed generally did not specify the deductibility of 

settlement amounts, which was consistent with what the agency officials 

told us. As an example of the exceptions, we found that some DOJ 

environmental settlements with civil penalties did include language in the 

agreement between DOJ and the settling company that the penalties would 

not be deducted for federal income tax purposes. DOJ officials said that 

including such language is not standard practice and emphasized that 

since the law is generally clear that civil penalties paid to a government 

are not deductible, stating so in the settlement agreement is merely 

restating the law. 

The majority of the companies responding to our survey on how 

companies treated civil settlement payments for federal income tax 

purposes deducted settlement payments when their settlement 

agreements did not label the payments as penalties. We received 

responses on the companies’ tax treatment of 34 civil settlements with 

total amounts exceeding $1 billion. The companies reported deducting 

some or their entire civil settlement amount for 20 of the 34 settlements. In 

2 of these settlements, company representatives said they erred in 

deducting the civil penalty payments totaling about $1.9 million and told 

us they would file amended tax returns. For 3 of the 15 settlements for 

which companies deducted some or all of their DOJ FCA settlement 

payments, companies reported that language in their settlement 

agreements was a rationale for the deductions, although DOJ told us that 
Page 5 GAO-05-747 Civil Settlement Payments 

language did not pertain to tax deductibility. The total amount of 

deductions taken by these 5 companies exceeded $100 million. DOJ 

changed the language for future FCA settlements based on our findings. 

Furthermore, three companies that deducted FCA settlement payments 

reported that they did so in whole or in part because their settlement 

agreements contained language stating that the company denied 

wrongdoing. Their deductions totaled about $15.5 million. 

IRS does not generally receive civil settlement information in a systematic 

manner from the four agencies we surveyed, although IRS obtains some 

settlement information from those agencies on a case-by-case basis to use 

in determining whether companies properly treated settlement amounts 

for tax purposes. IRS officials told us that a permanent system for 

agencies to provide IRS with timely civil settlement information could 

help, for instance, in selecting firms to audit. Officials of the four agencies 

in our review expressed willingness to work with IRS to provide 

settlement information. IRS has two temporary compliance projects that 

collect information on tax issues that affect the deductibility of settlement 

amounts made pursuant to FCA and environmental settlement agreements 

in part to help IRS address improper deductions during examinations. In 

association with one of the compliance projects, DOJ recently agreed to 

provide information about large FCA settlements shortly after they are 

closed and information on all FCA cases annually for the duration of the 

project. In addition, in 2004, IRS introduced Schedule M-3, which could 

also help IRS in identifying companies with civil settlements because it 

captures some information on fines, penalties, and punitive damages from 

companies with total assets of $10 million or more. 

We are recommending that the Commissioner of Internal Revenue direct 

the appropriate officials to work with federal agencies that reach large 

civil settlements to develop a cost effective means of obtaining 

information on settlement agreements that would be beneficial to IRS in 

ensuring the correct tax treatment of the settlement amounts. 

In commenting on a draft of this report (see app. III), the Commissioner of 

Internal Revenue agreed with our recommendation and will form an 

executive-led team to implement it. EPA also provided comments and said 

they generally supported our recommendation (see app. IV). SEC provided 

written comments but did not address our recommendation (see app. V). 

HHS sent a letter stating they had no comments but provided technical 

comments (see app. VI). DOJ also provided technical comments. We made 

changes to our report to incorporate the agencies’ comments as 

appropriate. 
Page 6 GAO-05-747 Civil Settlement Payments 

Civil settlements are one of several enforcement tools used by some 

federal agencies to help ensure that individuals and companies comply 

with the laws and regulations they enforce. For purposes of this report, 

civil settlements involve negotiations by federal agencies with companies 

to resolve issues about their compliance with laws and regulations. The 

negotiation process can involve discussions between agency officials and 

a company about each party’s proposals to address the compliance 

problem and can end with a written agreement that reflects the terms 

reached by the settling parties. In such cases, the civil settlements 

generally require a company to agree to perform certain activities or stop 

engaging in certain activities. Some settlements also require that monetary 

payments be made to the government and to others. When determining 

settlement amounts, agencies consider various factors, including 

thresholds for fines and penalties set by federal statutes for violations and 

the severity of the violation. 

While some agencies have administrative authority to enter into civil 

settlements, some cases are required to be referred to DOJ for resolution. 

For these cases, DOJ may settle with the defendant or take the defendant 

to court. Of the four agencies we contacted, DOJ is responsible for certain 

environmental settlements on behalf of EPA and certain civil health care 

fraud cases on behalf of HHS. 

Section 162 of the IRC provides a deduction for all ordinary and necessary 

business expenses, including settlements and similar payments. This 

provision is subject to an exception in IRC § 162(f) that denies a deduction 

for any fine or similar penalty paid to the government for the violation of 

any law.5

 The definition of “fine or similar” penalty includes an amount 

paid in the settlement of the taxpayer’s actual or potential liability for a 

fine or penalty (civil or criminal).6

 Furthermore, Treasury regulations 

provide that payments made as compensatory damages paid to a 

 5

Recently, several legislative proposals have been introduced, but not enacted, to modify 

the rules for deducting fines or similar penalties paid to the government for the violation of 

any law. Currently, a proposed provision in S. 1565, 109th Cong. § 207 (2005), would 

provide that amounts paid or incurred (whether by suit, agreement, or otherwise) to or at 

the direction of a government in relation to the violation of any law or the investigation or 

inquiry into the potential violation of any law are nondeductible. The bill contains an 

exception for restitution. Amounts paid to certain self-regulatory entities that impose 

sanctions, such as the National Association of Securities Dealers, are treated similarly for 

purposes of the proposal. 

6

Treas. Reg. § 1.162-21(b)(1)(iii). 

Background 
Page 7 GAO-05-747 Civil Settlement Payments 

government do not constitute a fine or penalty.7 In general, IRS views 

punitive payments as being nondeductible and compensatory payments as 

being deductible. 

Although the terms used to describe a payment required as part of a civil 

settlement may provide an indication of whether the amount is deductible 

or not, according to IRS, often it is necessary to look to the intent of the 

law requiring the payment or the facts and circumstances of the settlement 

to determine whether a payment is deductible. Civil settlement agreements 

we reviewed use terms other than “compensatory” or “punitive” to 

describe settlement payments. For instance, some agencies use terms like 

restitution or disgorgement for payments that are intended to compensate 

the government or others.8

 Even when a term used to describe a payment 

may seem to indicate that a payment is not deductible, in fact, the opposite 

may be the case. For example, a payment labeled as a civil penalty9

 and 

that seems not deductible may be deductible if it is imposed as a remedial 

measure to compensate the government or other party. Or, payments that 

will be used for remedial or compensatory purposes and seem deductible 

may not be so if the law requiring the payment indicates the payment is to 

have a punitive or deterrent effect. IRS and courts look to the purpose of 

the statute, including the legislative history and administrative and judicial 

interpretation, to determine whether a payment serves a punitive or 

compensatory purpose. If the law is unclear, or if the statute serves both 

punitive and compensatory purposes, the facts and circumstances of the 

specific settlement payment, including the terms of the settlement 

agreement, often need to be examined to determine the purpose the 

parties intended the payment to serve. 

Until recently, IRS did not have a tax form that could be used to identify 

whether a fine or penalty had been deducted for tax purposes. Effective 

for any tax year ending on or after December 31, 2004, corporations with 

consolidated assets of $10 million or more that are required to file IRS 

Form 1120, the corporate income tax return, must also file Schedule M-3. 

Schedule M-3 requires companies to reconcile financial accounting net 

income (or loss) with taxable net income and expense and deduction 

 7

Treas. Reg. § 1.162-21(b)(2). 

8

Restitution is the return or restoration of some specific thing to its rightful owner or 

status. Disgorgement is the act of giving up something (such as profits illegally obtained) 

on demand or by legal compulsion. 

9

A civil penalty is a fine assessed for violation of a statute or regulation. 
Page 8 GAO-05-747 Civil Settlement Payments 

items. The 2004 Schedule M-3 line items for reconciliation include fines, 

penalties, and punitive damages. 

In fiscal years 2001 and 2002, EPA, SEC, HHS, and DOJ negotiated some of 

the largest civil settlements in the federal government. The civil 

settlements we examined ranged in size from about $870 thousand to over 

$1 billion. (See table 1.) For example, a 2001 EPA judicial settlement 

related to the Clean Air Act required a utility company to significantly 

reduce harmful air pollution from its power plants at an estimated cost of 

over $1 billion and pay a $3.5 million fine. The cumulative value for the 20 

largest settlements for fiscal year 2001 and the 20 largest settlements for 

fiscal year 2002 at the four agencies—a total of 160 settlements—exceeded 

$9 billion.10

Table 1: Approximate Ranges and Cumulative Values of the 20 Largest Civil 

Settlement Agreements at the Four Agencies Contacted in Each Year for Both 

Fiscal Years 2001 and 2002 

Agency Smallest Largest Cumulative value 

EPAa $1 million $1 billion $4.1 billion

SEC $870 thousand $114 million $607 million

HHSb $3 million $790 million $2 billion

DOJc $12 million $471 million $3.3 billion 

Source: GAO analysis of EPA, SEC, HHS, and DOJ data. 

Notes: For settlements identified by SEC, HHS, and DOJ, the total value of settlements reflects 

payments payable to the U.S. government and other recipients such as the relator, also known as the 

whistleblower. For settlements identified by EPA, the total value of settlements included payments 

payable to the U.S. government; the estimated cost of any Supplemental Environmental Projects; and 

the estimated costs of pollution controls, monitoring equipment, or other complying actions that 

companies are required to take to come into compliance with environmental laws. The penalty portion 

ranged from approximately $500,000 to almost $10 million, and the cumulative value of the penalty 

amount for these settlements was about $124.3 million. 

a

EPA settlements, including those for which DOJ led the negotiations, are included under the EPA 

category. 

b

The settlements identified by HHS include only FCA settlements. HHS officials told us FCA 

settlements, which DOJ negotiates, are the largest of the agency’s civil settlements. 

c

The list of settlements obtained from DOJ was of cases closed in fiscal years 2001 and 2002. The 

dollar values of settlements provided were net of relators’ fees. 

 10This total differs from the sum of the agency cumulative value in table 1 because we 

excluded 7 of the FCA settlements identified by HHS that were also included in DOJ’s list 

of the 20 largest civil settlements for fiscal year 2001 and the 20 largest civil settlements for 

fiscal year 2002. 

Civil Settlements 

Negotiated by EPA, 

SEC, HHS, and DOJ 

Were among the 

Largest in Fiscal Years 

2001 and 2002 
Page 9 GAO-05-747 Civil Settlement Payments 

Officials in the four agencies said that they do not take tax consequences 

into account during negotiations with settling parties, that is, they do not 

negotiate with companies about the deductibility of settlement amounts.11

They said they generally do not have tax expertise and that determining 

deductibility of settlement amounts is IRS’s role. When negotiating, 

officials said they look to the relevant laws and regulations and the facts 

and circumstances of the case, including the severity of the violation and 

the strength of the evidence against the violator to determine the 

settlement amount to seek. In preparing for negotiations, two agencies—

EPA and DOJ—consider certain tax issues in calculating the amounts they 

propose to seek in negotiating environmental settlements. This calculation 

estimates a company’s financial gain from not complying with the law, that 

is, their economic benefit. The agencies factor in whether the company 

would have incurred tax deductible expenses to stay in compliance and 

apply the violator’s year-specific combined state and federal marginal tax 

rates to the costs of complying on time and complying late. Except for 

some settlement agreements stating that civil penalties are not deductible, 

the agencies’ written civil settlement agreements we reviewed generally 

did not specify the deductibility of settlement amounts. As an exception to 

this general practice, we found that some DOJ environmental settlements 

with civil penalties included language indicating that the penalties would 

not be deducted for federal income tax purposes. DOJ Environmental and 

Natural Resources (ENR) Division officials explained that when a 

settlement agreement includes civil penalties, their attorneys have 

discretion about whether to include such language in an agreement. The 

officials emphasized that the law is generally clear that civil penalties paid 

to a government are not deductible and stating so in the agreement is 

essentially restating the law and is not necessary. In addition, in 2003, 

subsequent to the time frame of the settlements we reviewed, SEC 

adopted a policy of requiring settlement agreements with civil penalties to 

include language stating that the settling parties would not deduct civil 

penalties for tax purposes. 

Table 2 describes the four agencies’ practices regarding how they consider 

tax issues during their settlement negotiation processes, including drafting 

the terms of their settlement agreements. The settlement agreements we 

reviewed were consistent with the practices described to us by the 

agencies’ officials. These practices are current as of June 2005. Because 

 11Although DOJ has lead responsibility for negotiating FCA cases on behalf of HHS, HHS is 

involved in the negotiations process, including recommending settlement amounts to DOJ. 

The Four Agencies Do 

Not Negotiate the Tax 

Deductibility of 

Settlement Amounts, 

but Two Agencies 

Consider Aspects of 

Taxes in Determining 

Amounts for 

Negotiations 
Page 10 GAO-05-747 Civil Settlement Payments 

each settlement agreement is unique, settlements negotiated by these 

agencies can have some exceptions to the practices listed in the table. 

Table 2: Practices of Four Federal Agencies regarding Tax Issues They Consider during Settlement Negotiations and in 

Settlement Agreements 

Agency 

Does the agency 

negotiate with settling 

parties about whether 

settlement amounts are 

tax deductible? 

Does the agency consider 

any aspects of taxes when 

calculating its proposed 

settlement amount? 

Does the written settlement agreement 

include specific information about the 

deductibility of the settlement amount? 

EPA 

Administrative 

environmental 

settlements 

No. Yes, if applicable to determine 

the economic benefit portion of 

a civil penalty and if applicable 

as part of valuing 

Supplemental Environmental 

Projects (SEP) a company 

agrees to undertake as part of 

a settlement. 

Yes, when settlements include civil 

penalties, some agreements state that civil 

penalties are not deductible. Also when a 

company has said it will not deduct the 

cost of a SEP, the government takes this 

into account when determining the value of 

the SEP, and the agreement will specify 

that the company will not deduct the costs 

of the SEP. 

SEC settlementsa No. No. Yes, since 2003, settlements that include 

civil penalties are to state that the civil 

penalties are not deductible. 

HHS settlementsb No. No. No. 

DOJ 

FCA settlements No. No. No. 

Judicial environmental 

settlements 

No. Yes, if applicable to determine 

the economic benefit portion of 

a civil penalty and if applicable 

as part of valuing SEPs a 

company agrees to undertake 

as part of a settlement. 

Yes, when settlements include civil 

penalties, some agreements state that civil 

penalties are not deductible. Also when a 

company has said it will not deduct the 

cost of a SEP, the government takes this 

into account when determining the value of 

the SEP, and the agreement will specify 

that the company will not deduct the costs 

of the SEP. 

Source: GAO analysis. 

a

In 2003, SEC implemented a policy that settlements with civil penalties are to include language 

stating that the civil penalties would not be deducted. Agreements negotiated before SEC 

implemented this policy do not include such language. 

b

The HHS settlements we reviewed were FCA civil health care fraud cases negotiated by DOJ. 

As table 2 shows, the selected agencies do not negotiate with companies 

about whether they can deduct any portion of their settlement from their 

income taxes. In determining their negotiating position and any changes to 

agree to during negotiations, officials generally look to factors such as the 

relevant laws and regulations and the facts and circumstances of the case, 

including the severity of the violation and the strength of evidence against 
Page 11 GAO-05-747 Civil Settlement Payments 

the violator. Officials in the four agencies said that determining 

deductibility is IRS’s role, and they generally do not have the expertise to 

address the deductibility of payments during negotiations or to specify the 

tax consequences of amounts in the settlements. IRS staff agreed and said 

that if agencies were to specify whether a settlement amount is deductible, 

there could be a risk that the agencies might concede tax consequences in 

order to reach a settlement. 

The following information summarizes the policies, procedures, and views 

of the agencies on taking taxes into account during negotiations and 

specifying the tax deductibility of settlement payments in the agreements. 

EPA’s mission is to protect the environment and address related human 

health impacts. EPA can reach civil administrative and judicial 

enforcement settlements against violators of environmental laws, and its 

priorities in negotiating settlements are to ensure that violators come into 

compliance with the law, punish past violations and deter future 

violations, obtain restoration of environmental damage resulting from 

violations, and impose civil penalties sufficient to recover any economic 

benefit gained as a result of the violator’s noncompliance and deter future 

violations. EPA negotiated the civil administrative settlements under its 

own authority without a judicial process. Cases that are brought and 

settled by DOJ on behalf of EPA are referred to as civil judicial 

enforcement settlements. DOJ’s policies, procedures, and officials’ views 

for these cases are discussed in the DOJ section of this report. 

All EPA civil settlements we reviewed included payments labeled as civil 

penalties for violations of environmental laws or regulations. In addition, 

the value of the settlements sometimes included estimated amounts a 

company may incur to achieve and maintain compliance with the 

environmental laws and regulations, such as installing a new pollution 

control device to reduce air pollution or prevent emissions of a pollutant. 

Also, some settlements included SEPs, which are projects a company 

agrees to undertake in addition to complying actions. IRS is currently 

reviewing the deductibility of SEPs. 

Civil penalties in EPA settlements are generally composed of two parts: 

economic benefit and gravity. Economic benefit represents the financial 

gains that a violator accrues by delaying expenditures necessary to comply 

with environmental regulations, avoiding them, or both. Under EPA’s civil 

penalty policy, the goal of recovering the economic benefit of 

noncompliance is to place the violator in the same position as if 

EPA 
Page 12 GAO-05-747 Civil Settlement Payments 

compliance had been achieved from the start. The amount EPA includes in 

a civil penalty to account for the seriousness of the violation is referred to 

as the gravity portion of the penalty. EPA includes the gravity portion of 

the penalty to provide deterrence against future noncompliance. When 

calculating the gravity portion of the initial civil penalty amount, EPA 

adjusts the gravity-based penalty on various case-specific factors, 

including the strength of evidence against the company and the company’s 

degree of cooperation and history of noncompliance. 

When calculating the economic benefit portion of civil penalties, EPA uses 

an economic computer model to estimate any financial advantage a 

company gained from not complying with environmental laws. EPA’s 

economic computer model takes into account whether a company would 

have incurred tax deductible costs if it had complied with the law, such as 

a one-time nondepreciable expenditure, in estimating the economic 

benefit a company gained by not complying with environmental laws or 

regulations. The computer model applies the appropriate year-specific 

combined state and federal marginal tax rates of the violator in calculating 

economic benefit along with standard financial cash flow and net present 

value analysis techniques to calculate the costs of complying on time and 

of complying late. 

When calculating the gravity portion of civil penalties, EPA officials 

consider the facts surrounding each violation, including factors such as 

the actual or possible harm caused by the violation, the size of the 

violation, and the goals of the specific environmental program. EPA 

officials acknowledged that they negotiate with violators about the size of 

the gravity portion of the penalty, but said in doing so they consider 

factors such as the strength of their position and not whether the violator 

may be able to claim a tax deduction. 

When EPA settlements include civil penalty payments,12 EPA’s practice is 

to explicitly label these payments as civil penalties. In some settlements 

with civil penalties, the settlement agreements also reference IRC § 162(f), 

which states that penalties payable to a government are nondeductible. 

Officials noted that including language referencing IRC § 162(f) is not 

EPA’s usual practice. EPA officials said that they believe the law is clear 

that civil penalties payable to a government are generally nondeductible, 

 12In some cases, such as when the settlement only requires a company to come into 

compliance, a settlement does not include a civil penalty payment. 
Page 13 GAO-05-747 Civil Settlement Payments 

so they do not see inclusion of such language in settlement agreements as 

necessary. 

As part of some settlements, companies perform SEPs, which are projects 

not required by law, that are voluntarily undertaken by a respondent in 

exchange for possible penalty mitigation.13 EPA may mitigate the civil 

penalty ultimately assessed as part of the settlement, when a respondent 

agrees to undertake a SEP. EPA still collects a civil penalty as part of the 

settlement in accordance with its 1998 SEP policy, which calls for 

collecting the greater of 25 percent of the gravity component of the 

penalty, or 10 percent of the gravity, plus economic benefit. To determine 

the value of SEPs, EPA uses an economic computer model, and if a 

company tells EPA that it plans to deduct the SEP costs, EPA factors the 

company’s decision into valuing the SEP through the model. EPA officials 

said that they are not involved in a violator’s decision to deduct the SEP 

costs and that they take the violator’s decision at face value. 

SEC is responsible for administering and enforcing federal securities laws 

and regulations and fostering fair and efficient markets for the trading of 

securities. SEC enforcement officials told us that in enforcing the 

securities laws, they aim to protect investors and punish violators. In 

performing its enforcement role, SEC may, among other actions, negotiate 

civil settlements with those who violate securities laws. When appropriate, 

SEC provides that violators make monetary payments that generally 

include amounts for civil penalties and disgorgement. The SEC settlement 

agreements we reviewed included penalties for violations of the securities 

laws. These settlements also included disgorgement, in which SEC 

attempts to ensure that violators of securities laws or regulations do not 

profit from their illegal activity, and when appropriate, these disgorged 

profits are returned to investors. 

The IRC does not specifically address the deductibility of disgorgement. 

Although IRS looks at the individual facts and circumstances of a case to 

 13In B-247155 (July 7, 1992) we concluded that EPA lacked authority to settle certain EPA 

actions by entering into SEPs. Further, in B-247155.2 (Mar. 1, 1993) we concluded that the 

Miscellaneous Receipts Act, 21 U.S.C. § 3302, which requires all federal agencies to remit 

all penalties to the U.S. Treasury, was circumvented when alleged violators were allowed 

to make payments to an institution other than the federal government. According to EPA 

officials, subsequent to our decisions, EPA made substantial changes to its SEP policy to 

address our concerns. We did not assess the changes to EPA’s SEP policy. 

SEC 
Page 14 GAO-05-747 Civil Settlement Payments 

determine deductibility, it has generally regarded disgorgement payments 

as compensatory, and therefore tax deductible. As previously discussed, 

Treasury regulations provide that in civil actions, compensatory damages 

paid to a government do not constitute a fine or a penalty.14

SEC’s Chief Counsel for Enforcement emphasized that SEC’s decision on 

how much of a settlement payment is penalty versus disgorgement is 

based solely on the facts and circumstances of the case, including the law 

violated, the degree of harm, and the seriousness of the violation. 

However, the official further said that although SEC does not negotiate 

with settling parties about the deductibility of settlement payments, 

settling parties may initiate negotiations with SEC about how the 

settlement payment is to be allocated between penalty and disgorgement. 

Although settling parties may seek a larger disgorgement amount because 

it is generally tax deductible, SEC staff make recommendations for 

disgorgement and penalties based on their analysis. 

In 2003, SEC implemented a policy requiring all civil settlement 

agreements with penalties to include language that expressly prohibits the 

settling party from taking a tax deduction or seeking to recover from an 

insurance carrier the penalty portions of the settlement payment. SEC 

adopted standardized language prohibiting deductions as a result of the 

Global Research settlement, in which 10 Wall Street companies settled for 

a combined $875 million in civil penalties and disgorgement. There were 

reports that some of the settling companies were planning to take 

deductions for the civil penalty portion of the settlement payments that 

would be placed into funds for investors who were harmed by the 

companies’ violations. The Sarbanes-Oxley Act of 2002 allows SEC, in 

appropriate cases, to add penalties to the disgorgement fund for the 

benefit of harmed investors, pursuant to the “fair fund” provisions of the 

act.15 SEC provides in its standardized settlement language that such 

amounts are to be treated as penalties for tax purposes. SEC’s settlement 

agreements are silent on the tax deductibility of disgorgement. Senior SEC 

officials noted that in their view, decisions about the deductibility of 

disgorgement should be left to IRS. 

 14Treas. Reg. § 1.162-21(b)(2). 

15Pub. L. No. 107-204, § 308, 116 Stat. 745 (2002). 
Page 15 GAO-05-747 Civil Settlement Payments 

HHS is the principal federal agency responsible for protecting the health of 

American citizens and providing essential human services. HHS’s largest 

civil settlements are generally FCA cases relating to civil health care fraud. 

FCA generally provides that anyone who knowingly submits false claims 

to the government is liable for damages up to three times the amount of 

the damages sustained by the government plus penalties from $5,500 to 

$11,000 for each false claim submitted. Although many FCA cases involve 

civil health care fraud against the Medicare and Medicaid programs that 

HHS administers, the act is also used in settling other types of fraud 

perpetrated against the federal government, such as defense contractor 

fraud. A civil health care FCA case, for example, could involve a health 

care provider who grossly overcharged for medical services rendered and 

then filed claims for reimbursement at the overcharged rates. Usually, civil 

health care fraud cases are based on referrals from federal and state 

investigative agencies and private persons.16

DOJ is responsible for representing the United States in FCA cases and 

therefore negotiates the FCA settlements. DOJ’s Civil Division carries out 

those responsibilities along with U.S. Attorneys’ Offices located across the 

country. Accordingly, DOJ sets the overall policy for civil health care fraud 

FCA settlements. For health care settlements, HHS’s Office of Inspector 

General (OIG) provides DOJ assistance in several ways, including 

investigating individuals and companies that may have abused the HHS 

health care programs, and sometimes works with DOJ to determine the 

amount of single damages, that is, the amount of loss sustained by the 

government due to the violator’s actions. 

DOJ negotiates settlement agreements on behalf of other federal agencies, 

including some cases involving HHS and EPA. The DOJ settlement 

agreements we reviewed were limited to FCA settlements negotiated by 

DOJ’s Civil Division and judicial environmental settlements negotiated by 

DOJ’s ENR Division. The FCA cases negotiated by DOJ that we reviewed 

contained a single payment labeled as a settlement amount, which does 

not characterize the extent to which payments are for single or multiple 

damages or civil penalties. All of the DOJ-led environmental settlement 

agreements that we reviewed included amounts labeled as penalties and 

some included SEPs. 

 16Private persons, known as relators, can bring actions for violations of FCA. 31 U.S.C. § 

3730. 

HHS 

DOJ 
Page 16 GAO-05-747 Civil Settlement Payments 

In negotiating FCA civil settlement agreements, DOJ Civil Division officials 

said that they do not consider or discuss any aspects of taxes. In 

calculating the settlement amount for FCA cases, DOJ first assesses the 

amount of damages the violation cost the government and seeks to 

recover the full amount. It also considers the severity of the violation in 

determining whether the settling company should pay a multiple of the 

assessed damages and civil penalties. 

DOJ Civil Division officials stated that they do not include language on the 

deductibility of payments in their written FCA settlement agreements. In 

fact, according to the officials, all FCA settlements contain DOJ’s standard 

settlement agreement language, which states that nothing in the agreement 

characterizes the payments for federal income tax purposes. DOJ Civil 

Division officials said that this language supports the agency’s policy of 

not addressing the tax treatment of settlement payments in settlements 

agreements. 

DOJ Civil Division and IRS officials told us that the agencies came to a 

mutual agreement that DOJ’s tax-neutral practices on the deductibility of 

civil settlement payments are appropriate. Furthermore, officials added 

that the settlement agreements refer to the payments as a settlement 

amount because the negotiations with the settling party usually involved 

agreeing on a lump sum amount without characterizing the payment into 

categories such as single, double, or treble damages and civil penalties. 

Officials said they do not categorize the payments more specifically 

because doing so would add complexity to the negotiation process by 

adding additional factors on which to obtain agreement between the 

parties. Thus, the agreement does not characterize the extent to which the 

settlement payment is punitive or compensatory. According to IRS staff, 

single damages are generally considered compensatory and therefore tax 

deductible, and any multiple damages and civil penalties are generally 

considered punitive and therefore nondeductible. 

Officials in DOJ’s Civil Division and HHS’s OIG said that even though FCA 

allows for the assessment of penalties in addition to multiple damages, 

penalties are not always sought. The HHS officials said that penalties are 

not generally sought in FCA settlements because collecting a multiplier of 

damages is sufficient to compensate the government and provide a 

deterrence. 

DOJ also negotiates environmental cases on behalf of EPA. EPA refers to 

cases it sends to DOJ to settle as judicial cases since they are not resolved 

under EPA’s administrative authority. EPA staff assist DOJ staff in 
Page 17 GAO-05-747 Civil Settlement Payments 

building these cases and EPA’s civil penalty policies generally apply to 

DOJ environmental settlements. However, DOJ—not EPA—has primary 

settlement authority for these cases, and DOJ is not bound by EPA’s 

penalty policies. 

Like EPA, in preparing for negotiations and determining the amount to 

seek at settlement, DOJ considers aspects of taxes in calculating the 

economic benefit a violator received from not complying with 

environmental laws. However, DOJ ENR Division officials told us that 

their position is to be neutral on tax issues. DOJ sometimes uses the EPA 

economic benefit computer model to calculate economic benefit amounts 

but may also obtain outside experts. Similar to EPA’s administrative 

settlements, some DOJ-negotiated environmental settlements may involve 

SEPs, which can be used to offset a portion of the civil penalty that DOJ 

would otherwise seek. The officials reiterated that they do not negotiate 

with the violator about the deductibility of the SEP costs, but would factor 

in the violator’s stated intentions about deducting the SEP costs in 

establishing its value as part of the settlement. 

As with EPA civil administrative settlements, when DOJ-negotiated 

environmental settlements include civil penalties, the practice is to 

explicitly label these payments as civil penalties. Also, in some settlements 

with civil penalties, DOJ-negotiated environmental settlement agreements 

reference IRC § 162(f), which states that fines or similar penalties payable 

to a government are nondeductible. DOJ ENR Division officials said that 

having settlement agreements reference IRC § 162(f) is not standard 

practice and would be at the discretion of officials involved in the 

settlement negotiations. According to these officials, the law is generally 

clear that civil penalties payable to the government are nondeductible and 

stating so in agreements is merely restating the law. The officials said they 

do not negotiate with the settling companies about whether the amounts 

are deductible. 

We observed that one large settlement agreement negotiated by DOJ’s 

ENR Division contained language stating that the settling company was 

not allowed to take a deduction for funding of remediation work and that 

its chief financial officer must submit a certification that deductions were 

not taken. DOJ’s ENR Division officials told us that a case such as this one 

likely involved particular negotiating circumstances and strategies. They 

emphasized that this was an exception rather than their usual practice of 

not specifying the tax treatment of settlement amounts in the settlement 

agreement. 
Page 18 GAO-05-747 Civil Settlement Payments 

In responding to our survey,17 companies that paid some of the largest civil 

settlement payments at the four agencies we reviewed generally reported 

that they deducted civil settlement payments when the settlement 

agreements did not label the payments as penalties. Conversely, when the 

settlement agreements labeled the payments as penalties, the companies 

generally reported that they did not deduct the payments. Overall, for 20 of 

the 34 settlements for which we received survey responses, companies 

stated that they deducted some or all of their civil settlement payments.18

The total value of settlement amounts of the 34 settlements for which we 

received responses was over $1 billion. Table 3 summarizes the overall 

responses from the companies, and table 4 provides survey results on 

deductions categorized according to how the settlement agreements 

labeled the settlement payments. 

Table 3: Company Responses on Whether They Deducted Civil Settlement 

Payments from Their Federal Income Taxes 

Source: GAO. 

Note: We did not verify the companies’ responses with IRS. 

a

Because some companies with SEPs did not report whether they deducted the SEPs, the number of 

settlements listed for which companies did not make any deduction may be overstated. 

b

In table 1, environmental cases handled by DOJ are reported under EPA cases. In this table, they 

are reported as “DOJ environmental settlements.” To the extent that any of these settlements 

contained estimates of compliance costs, those were not among the costs included in our survey. 

 17We sent surveys on 47 civil settlements to companies in which we identified a 

representative who could address our survey questions. Our results are limited to the 34 

settlements for which we received responses. Three of the companies we surveyed 

responded for 2 settlements each. See app. I for more details on our methodology. 

18One surveyed company stated that it planned to take a deduction for the SEP portion of 

its civil settlement payment, but had not yet done so at the time of our survey. For 

purposes of this report, we categorized this company’s response as deducted. 

A Majority of the 

Surveyed Companies 

Deducted Civil 

Settlement Payments, 

Generally When 

Settlement 

Agreements Did Not 

Label Payments as 

Civil Penalties 

Agency 

Company deducted 

some or all 

Company deducted 

nonea

SEC settlements 1 2

DOJ environmental settlementsb 4 11

DOJ FCA settlements 15 1

Total 20 14
Page 19 GAO-05-747 Civil Settlement Payments 

Table 4: Company Responses on Whether They Deducted Various Types of Civil Settlement Payments 

Source: GAO. 

Note: Totals in this table do not add up to 34 because the following settlement agreements contain 

more than one classification of settlement payment: one SEC settlement contains both a civil penalty 

and disgorgement and 10 DOJ-led EPA settlements contain both civil penalties and SEPs. 

a

Settlement amount includes only those settlements in which the entire settlement payment was 

labeled as a settlement amount and was the only payment in the settlement. 

b

For six of the survey responses for settlements with SEPs, the companies did not respond as to 

whether they had deducted SEPs associated with the settlement. 

c

In table 1, environmental cases handled by DOJ are reported under EPA cases. In this table, they 

are reported as “DOJ environmental.” To the extent that any of these settlements contained estimates 

of compliance costs, those were not among the costs included in our survey. 

As shown in table 4, for 15 of the 16 DOJ FCA settlements, companies 

reported deducting their payments. Of these 15 settlements, 12 survey 

responses showed that companies deducted the full amount of the 

payment, while 3 responses showed they deducted a percentage of the full 

amount—ranging from 43 to 89 percent. Consistent with DOJ’s usual 

practice for FCA civil settlements, these FCA settlement agreements 

referred to the settlement payment as the settlement amount, which does 

not characterize whether the settlement amount included a penalty or was 

punitive or compensatory in nature. 

In addition, of the 15 settlements for which companies settled DOJ FCA 

cases and deducted payments, companies in 7 settlements told us that they 

deducted payments because, in their view, the settlement amounts were 

restitution or compensatory in nature. However, minutes of a healthcare 

fraud settlements meeting between IRS and DOJ show that IRS believes 

FCA settlement payments usually include a punitive portion to punish 

violators and to deter future violations. Also, according to DOJ’s technical 

comments on the draft of this report, in most FCA settlements (apart from 

Classifications of settlement payments in settlement agreements 

Civil penalty Settlement amounta

 SEPbDisgorgement

Agency Deducted 

Not 

deducted Deducted

Not 

deducted Deducted

Not 

deducted Deducted

Not 

deducted

SEC 1 2 N/A N/A N/A N/A 1 0

DOJ environmentalc 2 13 N/A N/A 2 2 N/A N/A

DOJ FCA 0 0 15 1 N/A N/A N/A N/A

Total 3 15 15 1 2 2 1 0
Page 20 GAO-05-747 Civil Settlement Payments 

those that recover strictly penalties), some of the amounts paid are in the 

nature of compensatory reimbursement and may be deductible.19

Five companies we surveyed reported that a sentence in their FCA 

settlement agreements indicating that the settlement was not punitive in 

purpose or effect was a basis for them taking deductions. The settlement 

amounts deducted by these five companies totaled over $100 million. 

According to a director in DOJ’s Civil Division, DOJ does not intend for 

the language in FCA settlement agreements that the companies mentioned 

to refer to tax treatment. The DOJ official said that this sentence is not 

intended to imply that the settlement amounts are compensatory for tax 

purposes, but rather to ensure that the amounts are not punitive for 

double jeopardy purposes or prohibitions on excessive fines.20 The DOJ 

official added that a subsequent statement that is standard in all FCA 

settlement agreements articulates DOJ’s position on deductibility, that is, 

that the agreement does not characterize the payment for federal income 

tax purposes. Based on our discussions with DOJ and our survey evidence 

showing that some companies cited this sentence in support of their tax 

deductions, DOJ revised the relevant portions of the FCA settlement 

agreement model language. Effective June 2005, the new language 

removes references to the settlement not being punitive in purpose or 

effect. 

Furthermore, three companies that deducted FCA settlement payments 

reported that they did so in whole or in part because their settlement 

agreements contained language stating that the company denied 

wrongdoing. Their deductions totaled about $15.5 million. Two of these 

three companies also cited the sentence discussed in the prior paragraph 

as another reason for deducting the amounts. 

Also, as shown in table 4, three other companies reported deducting 

settlement payments even though they were labeled as civil penalties. Two 

of these companies reported that our survey made them aware that their 

deductions were improperly taken, and they plan to file amended tax 

returns. These deductions totaled about $1.9 million. The other company 

 19DOJ cited Cook County, Illinois v. U.S. ex rel. Chandler, 538 U.S. 119 (2003). 

20The Double Jeopardy Clause in the U.S. Constitution prohibits anyone from being 

prosecuted twice for substantially the same crime. U.S. Const. amend. V. The Excessive 

Fines Clause of the U.S. Constitution prohibits the imposition of excessive fines. U.S. 

Const. amend. VIII. 
Page 21 GAO-05-747 Civil Settlement Payments 

reported that it deducted the civil penalty because it was paid to a selfregulatory organization, which the company believed was not a 

government agency. This settlement agreement contained language 

indicating that the self-regulatory organization settled with the company 

on behalf of a federal agency. 

Ten companies that responded to our survey had environmental 

settlement agreements negotiated by DOJ that contained SEPs.21 Our 

analysis of the settlement agreements for the 10 companies showed that 

four agreements contained language stating that the SEP costs are not 

deductible. Two companies with settlements that contained this language 

reported to us that they did not deduct the costs, and the other 2 

companies did not respond to the survey question. Of the 6 companies 

with SEPs for which the settlement agreements did not state whether the 

costs were deductible, 2 companies reported deducting the SEP costs and 

the other 4 companies did not indicate whether they deducted SEP costs. 

Some of the companies that reported not deducting any settlement 

payments gave us varying reasons for not taking deductions. The reasons 

included references to IRC § 162(f), which states, in part, that penalties 

paid to a government are not deductible, and provisions in their settlement 

agreements specifying that they would not deduct the settlement 

payments. 

The four federal agencies do not systematically provide IRS with civil 

settlement information that would be useful to IRS for compliance 

purposes, although the agencies do provide such information on a case-bycase basis at IRS’s request, such as for audits of companies with 

settlement agreements. The agencies told us they were willing to work 

with IRS to develop a permanent system for routinely providing 

appropriate information. DOJ Civil Division and EPA have established 

means for providing IRS with information on civil settlement agreements 

as part of IRS’s temporary compliance research projects. In 2004, IRS 

introduced Schedule M-3, which could potentially help IRS identify 

corporations with some settlements because it captures information on 

fines, penalties, and punitive damages from companies with assets of 

$10 million or more. 

 21In settlement agreements for the surveyed companies, some SEPs are referred to as 

Beneficial Environmental Projects or Environmental Beneficial Projects. 

No Permanent System 

Is in Place for 

Agencies to Routinely 

Inform IRS of Civil 

Settlements or 

Provide Other 

Settlement 

Information That IRS 

Would Find Useful 
Page 22 GAO-05-747 Civil Settlement Payments 

In general, the four federal agencies do not routinely notify IRS when a 

civil settlement has been reached or provide other settlement-related 

information that IRS would find useful, although they provide IRS with 

settlement information on a case-by-case basis. To identify settlements 

that have been reached, IRS officials search agency Web sites and press 

releases. DOJ ENR Division, EPA, and SEC officials said that their Web 

sites generally post most of their civil settlement agreements. IRS usually 

contacts the agencies on a case-by-case basis to obtain information to use 

during audits in assessing whether companies properly treated their 

settlement payments on their income tax returns. For example, to 

determine the facts and circumstances of a settlement, IRS contacts DOJ 

officials to obtain information on FCA settlements, including written 

exchanges between the agency and the company and the tracking forms 

that are used by DOJ to allocate settlement amounts to various 

government accounts. According to IRS staff, the tracking form and the 

other information it obtains from DOJ about a settlement can provide 

leads for determining nondeductible punitive damages in FCA cases.22

The agencies have expressed willingness to notify IRS when a settlement 

has been reached and to work with IRS on providing other appropriate 

information. Some steps in this direction have already been taken. For 

example, EPA has designated staff to work with IRS to provide specific 

settlement information. 

IRS officials said that it would help IRS’s compliance efforts if agencies 

systematically notified IRS that a settlement has been reached and 

provided additional information, such as their intent regarding the 

breakdown of the settlement payment by category (i.e., punitive versus 

compensatory). According to an IRS Director in the Large and Mid-Size 

Business Division, such information could play a role in determining 

which firms to audit and, when an audit occurs, whether a settlement 

should be covered. Further, the IRS Director said that in some cases IRS 

 22IRS recently issued a technical advice memorandum, TAM 200502041 (Jan. 14, 2005), that 

concluded that the tracking form was not relevant “since the proper allocation [between 

punitive and compensatory aspects of a FCA recovery] depends on intent at the time the 

settlement was reached, not on events occurring after that time.” A TAM is a written 

response to a technical or procedural question on the interpretation and proper application 

of tax authority to a specific set of facts. A taxpayer may not rely on a TAM issued to 

another taxpayer. 

Settlement Information 

from Agencies Could Help 

IRS with Its Audit Strategy 

and Facilitate Pre-filing 

Agreements 
Page 23 GAO-05-747 Civil Settlement Payments 

would like to offer pre-filing agreements to settling companies,23 which 

would resolve the tax treatment of settlement payments before tax returns 

are filed. The Director focused on large settlements for which IRS 

enforcement action was more likely than on smaller settlements. 

IRS is collecting information on certain settlements through two 

compliance projects. IRS uses compliance projects to collect information 

and conduct research in order to target audits in particular issue areas. It 

intends to use the project results on the degree to which companies 

incorrectly deduct civil settlement payments to make data-driven business 

decisions on how to correct the noncompliance. 

In 2003, IRS initiated a fraud settlements compliance project focusing on 

the deductibility of payments made in the settlements involving fraud, 

primarily FCA settlements. The fraud settlements compliance project 

targets multimillion-dollar settlements where at least part of the 

settlement payment may be punitive although the agreements may not 

specify punitive damages. During February 2005 discussions between IRS 

and DOJ, DOJ officials agreed to notify IRS promptly of FCA settlements 

they reach of $10 million and more and provide a list of smaller dollar FCA 

settlement agreements annually for the duration of the project. DOJ 

officials told us they would be willing to continue providing IRS with this 

information after the completion of this compliance project. IRS officials 

said that this information would be useful to them in targeting and 

conducting audits. According to the compliance project description, IRS 

staff have found that for settlements involving Medicare fraud, companies 

are claiming deductions for the full amount of the settlement. However, 

IRS staff told us that these settlement payments generally contain a 

punitive portion. This compliance project is scheduled to be completed in 

2006. 

In 2004, IRS initiated an environmental settlements compliance project, 

which focuses on four components of environmental settlements that may 

result in an income tax issue—civil penalties; SEP costs; complying 

actions; and other payments and requirements, which may include 

 23IRS’s Pre-filing Agreement Program encourages taxpayers to request consideration of an 

issue before the tax return is filed and thus resolve potential disputes and controversy 

earlier in the examination process. IRS intends such agreements to reduce the cost and 

burden associated with post-filing examinations, to provide companies a level of certainty 

regarding a transaction, and to make better use of taxpayer and IRS resources. 

DOJ and EPA Are 

Providing IRS Settlement 

Information as Part of 

IRS’s Temporary 

Compliance Research 

Projects 
Page 24 GAO-05-747 Civil Settlement Payments 

punitive sanctions. For the project, IRS says it needs access to negotiating 

files, court documents, settlement documents, databases, personnel, and 

attorneys at the relevant settling agencies. EPA has agreed to provide IRS 

with certain case-specific information. To obtain an initial sample of 

approximately 30 recently negotiated significant environmental 

settlements, IRS staff searched agency press releases and Web sites and 

contacted EPA and DOJ staff for settlement information on a case-by-case 

basis. The initial review of this sample suggests that companies may be 

noncompliant when deducting, capitalizing, amortizing, or depreciating 

SEP costs. The compliance initiative description also said that some IRS 

staff have questioned the appropriateness of deducting SEP costs if SEP 

costs are payments in lieu of a penalty because it appears that such costs 

are not deductible under IRC § 162(f).24 IRS officials said that IRS’s 

National Office plans to issue a technical advice memorandum (TAM) that 

will address SEP deductibility and capitalization issues. The compliance 

project staff told us that this compliance project is scheduled to be 

completed in late 2005, although it may be extended. 

According to IRS’s fraud settlements compliance project description, the 

compliance projects also provide IRS with the necessary information to 

evaluate the potential for negotiating pre-filing agreements with settling 

companies. Under pre-filing agreements, IRS and companies resolve 

whether all or a portion of a settlement payment can be deducted before 

the companies file their tax returns. The project description says that for 

those cases for which a pre-filing agreement is not executed, IRS 

examiners can more timely develop the facts and reach a position on 

deductibility, which can reduce examination time on this issue while 

enhancing IRS compliance results. IRS officials told us they are in 

discussions with one company that reached a civil settlement regarding a 

pre-filing agreement and are offering pre-filing agreements to other settling 

companies. 

 24According to EPA, SEPs are projects, not already required by law, undertaken voluntarily 

by a respondent/defendant in an enforcement action. A respondent/defendant’s agreement 

to perform a SEP may be taken into account as a mitigating factor in assessing the ultimate 

civil penalty in a particular case. To calculate the value of an SEP, EPA’s economic model 

considers, among other things, the entity’s tax status, the penalty payment date, the 

estimated project costs, the project’s operation date, the combined state and federal tax 

rate, and the tax deductibility of onetime nondepreciable expenditures. 
Page 25 GAO-05-747 Civil Settlement Payments 

IRS has a new source of information that could help it identify companies 

with settlements. In 2004, IRS introduced Schedule M-3, which is designed 

to reconcile differences in financial accounting and taxable income (or 

loss). The schedule is being used by corporations with assets of 

$10 million or more and is to be phased in for use by other corporations in 

2005 and 2006. Because Schedule M-3 collects information on fines, 

penalties, and punitive damages, it may help IRS identify settlements that 

should be considered if a company is audited. Schedule M-3 as currently 

designed may not capture settlement payments that were not labeled as 

fines, penalties, or punitive damages in the written settlement agreement. 

Based on our discussions, IRS officials responsible for Schedule M-3 said 

that they were considering options to address this situation. 

When settlement agreements specify civil penalties, the law is generally 

clear that they are nondeductible. However, when the settlements do not 

contain penalties, deductibility may be less clear because the IRC and the 

statutes imposing the payments may be silent regarding whether the 

payments are punitive or compensatory in nature. Moreover, many 

settlement agreements do not contain language addressing the tax 

deductibility of settlement payments. To determine the deductibility of 

settlement payments during audits or in reaching pre-filing agreements, 

IRS examines settlement information that would provide the relevant facts 

and circumstances in a particular case. 

Given this situation, one way to help IRS better ensure that companies are 

properly treating settlement payments for tax purposes is to have agencies 

systematically notify IRS when they have reached a settlement that 

requires significant dollar payments and provide information that IRS may 

find useful. With such information, IRS can better determine which 

companies to examine and whether settlement payments should be part of 

the examination. In addition, with a regular flow of information on 

settlements as they are reached, IRS would be able to contact companies 

when appropriate to obtain pre-filing agreements on how the settlement 

payments should be treated on their tax returns. This may be especially 

useful in cases such as the DOJ FCA settlement agreements, which may 

not contain useful information for the settling company and IRS to 

determine the tax treatment of the settlement amounts. 

Schedule M-3 Provides IRS 

with Some Settlement 

Information from 

Companies 

Conclusions 
Page 26 GAO-05-747 Civil Settlement Payments 

We recommend that the Commissioner of Internal Revenue direct the 

appropriate officials to work with federal agencies that reach large civil 

settlements to develop a cost effective permanent mechanism to notify IRS 

when such settlements have been completed and to provide IRS with other 

settlement information that it deems useful in ensuring the proper tax 

treatment of settlement payments. 

We sent a draft of this report to IRS, EPA, SEC, HHS, and DOJ for 

comment. We received written comments from IRS, EPA, SEC, and HHS. 

DOJ provided written technical comments. 

In his August 26, 2005, letter, the Commissioner of Internal Revenue (see 

app. III) said that he agreed with our recommendation and said that it 

would be beneficial for IRS to work with federal agencies to develop a 

systematic method for obtaining information on civil settlements 

contemporaneous with those settlements. He said that IRS will form an 

executive led team to work with each agency with significant civil 

settlements to reach agreement on what information will be provided, the 

format of the information, and the frequency of delivery. IRS also provided 

technical comments which we incorporated in our report. 

EPA’s Assistant Administrator, Office of Enforcement and Compliance 

Assurance stated in an August 26, 2005, letter (see app. IV) that EPA 

generally supports our recommendation and believes that EPA already has 

mechanisms to provide IRS with settlement information useful in 

determining the proper tax treatment of settlement amounts. The Assistant 

Administrator said that EPA’s publicly available Web site contains 3 years 

of information on concluded enforcement settlements and other EPA 

online enforcement databases with settlement information could be made 

available to IRS. EPA believes that these mechanisms are more cost 

effective than developing a specific notification process for IRS. While we 

agree that EPA has mechanisms in place to provide IRS a means to access 

its settlement information, we believe that it would be useful if EPA 

notified IRS directly of its significant settlements contemporaneously so 

IRS could ensure that it is aware of all significant settlements and be 

better positioned to contact companies sooner to initiate pre-filing 

agreements with them. Regarding our reference to IRS officials needing 

access to information such as negotiating files and documents to help 

determine the proper tax treatment of settlement payments, the Assistant 

Administrator expressed concern that making such information available 

to IRS could result in a waiver of any protective privilege associated with 

such information and might jeopardize pending settlements and ongoing 

Recommendation for 

Executive Action 

Agency Comments 

and Our Evaluation 
Page 27 GAO-05-747 Civil Settlement Payments 

enforcement actions. This issue was not within the scope of our study and 

in our view is among the type of issues that can be addressed as IRS and 

agency officials work together to establish information sharing 

arrangements regarding significant settlement agreements. 

The Assistant Administrator also commented on how we characterized the 

value of EPA settlements and, in particular, stated that our comparison of 

EPA settlement values to those of the other agencies we surveyed is 

dissimilar. The Assistant Administrator said that we should only include 

monetary payments for EPA civil penalties in valuing EPA settlements to 

make them comparable to the value of settlements in the other agencies. 

In our view, and as consistently reflected in our report, the value of an 

agency’s settlements includes all components that are reflected in 

settlement agreements. This was also consistent with how the agencies we 

surveyed valued their settlements. We believe it would be misleading to 

show the value of settlements based on civil penalties alone when the 

negotiated settlement agreement clearly included other components. 

Further, some settlements we reviewed, such as DOJ FCA settlements, did 

not contain penalties. EPA also made some technical comments which we 

have incorporated into the report to clarify and more fully present certain 

information. 

In a letter dated September 1, 2005, an SEC Enforcement Division director 

did not specifically comment on our recommendation but said that the 

Commission takes seriously the importance of meaningful sanctions in its 

enforcement program (see app. V). HHS provided a letter stating they had 

no comment on the draft but sent technical comments which we 

incorporated into our report (see app. VI). DOJ provided some technical 

comments which we included in our report to more accurately reflect 

information about their settlements. 

As agreed with your offices, unless you publicly release its contents earlier 

we plan no further distribution of this report until 30 days from its date. At 

that time, we will send copies to interested congressional committees, the 

Secretary of the Treasury, the Commissioner of Internal Revenue, and 

other interested parties. We will also make copies available to others on 

request. In addition, the report will be available at no charge on the GAO 

Web site at http://www.gao.gov. 

If you or your staff have any questions about this report, please contact me 

at (202) 512-9110 or brostekm@gao.gov. Contact points for our Offices of 

Congressional Relations and Public Affairs may be found on the last page 
Page 28 GAO-05-747 Civil Settlement Payments 

of this report. GAO staff who made major contributions to this report are 

listed in appendix VII. 

Michael Brostek 

Director, Tax Issues 

Strategic Issues 
Appendix I: Scope and Methodology 

Page 29 GAO-05-747 Civil Settlement Payments 

The objectives of this report were to (1) identify federal agencies that 

negotiated some of the largest dollar civil settlements in recent years, 

(2) determine whether the selected federal agencies having some of the 

largest civil settlements take the tax consequences of the companies into 

account when negotiating civil settlements and officials’ views on whether 

they should address the deductibility of payments in the agreements, 

(3) determine whether the companies that paid some of the largest civil 

settlement payments deducted any of the payments on their federal 

income tax returns, and (4) determine what information the Internal 

Revenue Service (IRS) collects on companies with civil settlements 

reached by federal agencies. In addition, we sought to identify whether 

companies’ deductions for settlement payments were being examined in 

audits and the outcome of the audits. 

To identify federal agencies that negotiated civil settlements involving 

companies with some of the largest civil settlement payments, we 

analyzed information on settlements reached by various federal agencies 

because we were unable to identify any single, reliably searchable, 

comprehensive source or database that was known to contain such 

information governmentwide. We limited our scope to settlements that 

were negotiated in fiscal years 2001 and 2002 involving companies that file 

IRS Form 1120, U.S. Federal Corporate Tax Return.1

 We selected this time 

frame since it would allow the settling companies time to pay the 

settlements; determine applicable tax treatments, if any; and file federal 

income tax returns. 

As a starting point to identify agencies with large settlements in those 

years, we used information in the 1998 Federal Financial Management 

Status Report and Five-Year Plan that summarized assessments and 

collections of civil monetary penalties by federal agencies for fiscal year 

1997.2

 The information in the report was based on data compiled from 76 

federal agencies and showed which of those agencies were responsible for 

the majority of the civil monetary penalty assessments and collections in 

fiscal year 1997. Consolidated information on federal agency assessments 

of civil penalties was not available for subsequent years because the 

 1

We excluded flow-through entities, such as partnerships that do not file IRS Form 1120. 

We also excluded individuals, governments, and not-for-profit entities. 

2

This document was jointly written by the Chief Financial Officers Council and the Office 

of Management and Budget. 

Appendix I: Scope and Methodology 
Appendix I: Scope and Methodology 

Page 30 GAO-05-747 Civil Settlement Payments 

Federal Reports Elimination Act of 19983 eliminated the annual 

requirements for federal agencies to report this information. 

Generally, we then sought to determine if the same agencies that were 

responsible for the majority of the civil monetary assessments and 

collections in fiscal year 1997 were likely to have some of the largest 

settlement amounts in fiscal years 2001 and 2002. We did this by reviewing 

such material as agency press releases on settlement agreements, annual 

reports, enforcement reports, and other data on agency Web sites. In 

addition, we also performed more general searches of commercially 

available databases that contain archived content from newspapers, 

magazines, legal documents, and other printed sources and other federal 

Web sites that provided information about corporate civil settlements to 

help us gauge whether the settlements we were identifying at these 

agencies were among the largest being reported from various publication 

sources. 

As part of our analysis of this information, we comparatively assessed, to 

the extent possible, whether agencies tended to have relatively fewer 

individual settlements with typically large-dollar assessments (millions of 

dollars per individual settlement) or more numerous individual 

settlements of relatively low-dollar amounts. We chose those agencies that 

appeared to have a larger settlement amount per case. 

We did not include IRS in the agencies we analyzed since tax settlements 

are not tax deductible. We also excluded the Federal Reserve System from 

consideration because its reported total settlement amounts could 

incorporate settlements by multiple agencies. 

By comparing and analyzing such information across the leading agencies 

for overall civil assessments in 1997, we selected the Environmental 

Protection Agency (EPA), the Securities and Exchange Commission 

(SEC), and the Department of Justice (DOJ) for further review after 

concluding that they were among those agencies responsible for 

negotiating the largest individual civil settlements in fiscal years 2001 and 

2002 that we could identify. Also, during these 2 fiscal years, we 

determined that the Department of Health and Human Services (HHS) was 

involved in negotiating some of the largest dollar False Claims Act health-

 3

Pub. L. No. 105-362, § 1301(a), 112 Stat. 3280 (1998). 
Appendix I: Scope and Methodology 

Page 31 GAO-05-747 Civil Settlement Payments 

care-related civil settlements that DOJ has primary responsibility for 

negotiating. 

We contacted each of the four agencies and requested information on its 

largest civil settlements, that is, cases in which the largest dollar amounts 

were to be paid to the federal government or others. In discussing our 

request for lists of settlements, agency officials advised that lists of cases 

based on largest settlements would likely include cases of entities not 

required to file IRS Form 1120. (See table 1 in the body of this report for 

information received from the four agencies on their 20 largest civil 

settlements for fiscal years 2001 and 2002, which includes settlements with 

some entities not required to file IRS Form 1120.) 

We took several steps to assess the reliability of the agencies’ automated 

systems that provided the lists of settlement agreements. We interviewed 

agency officials who were knowledgeable about compiling, entering, and 

checking the data in the databases used to provide the lists; reviewed 

related documentation about the quality and accuracy of the data and the 

systems that produced them; and to the extent possible, cross-checked the 

lists with other sources. For example, we compared selected information, 

such as settlement amount from copies of the actual settlement 

agreements with the amount shown on the list obtained from the agencies. 

We also asked the companies to confirm this information. Likewise, the 

companies confirmed whether they had paid the settlement. We 

determined that the lists of largest settlements and associated settlement 

amount information were sufficiently reliable for the purposes of this 

report. 

To determine whether the federal agencies take the tax consequences of 

the companies into account when negotiating civil settlements and their 

views on whether they should address the deductibility of payments in 

settlement agreements, we interviewed officials in each of the four 

agencies about their settlement policies and negotiation processes. We 

obtained and reviewed the underlying agreements and documentation on 

the agencies’ policies, procedures, and processes for negotiating and 

structuring civil settlements with monetary payments. 

We also interviewed officials in the four agencies to determine if their 

settlement policies and procedures were different now than they were 

during fiscal years 2001 and 2002. We obtained documentation supporting 

any major policy or procedural changes that addressed how settlement 

payments are treated for tax purposes. 
Appendix I: Scope and Methodology 

Page 32 GAO-05-747 Civil Settlement Payments 

To determine whether the companies that paid some of the largest civil 

settlement payments deducted any of their payments on their federal 

income tax returns, we developed a data collection instrument (DCI) to 

collect the information. We collected information from the four agencies 

on their largest dollar civil settlements, that is, cases that included 

payments to the federal government or others. Agency officials advised us 

that the lists of the largest settlements would likely include some 

settlements with entities that were not required to file IRS Form 1120. 

When such a settlement was among the 20 largest, we selected additional 

settlements that otherwise met our criteria.4

 In contrast to SEC, HHS, and 

DOJ, from which we obtained information on the largest civil settlements 

payable to the federal government and other parties such as relators, EPA 

settlement amounts included costs incurred for companies to comply with 

environmental laws and regulations. We selected the largest EPA 

settlements that had a civil penalty because our focus was on how 

payments were treated for tax purposes. We requested copies of 

settlement agreements for the cases appearing on the lists from the 

agencies.5

We sent the DCI we developed to 44 companies for which we were able to 

obtain copies of the settlement agreements and find cognizant 

representatives who were familiar with the settlements and the tax 

treatment of the settlement payments and who agreed to participate in our 

survey. These 44 companies were required to file IRS Form 1120. In the 

end, we received DCI responses from 31 companies concerning 34 of the 

settlements. We told companies that we would only report information we 

collected in summary form so company names are not specifically 

identified. 

We examined the settlement agreements for the 34 settlements reached by 

companies that responded to our DCI to determine if they contained 

specific language that addressed how civil settlement payments are to be 

 4

We selected to survey companies on 5 settlements outside of the 20 largest for 4 DOJ-led 

HHS False Claims Act settlements and 1 DOJ-led EPA settlement —for reasons including 

the following: we were not always able to identify a cognizant representative or obtain a 

settlement agreement for each of the 20 largest for each fiscal year. 

5

In some instances, we did not need to request copies of the EPA settlement agreements 

because EPA posted the agreements on its Web site. 
Appendix I: Scope and Methodology 

Page 33 GAO-05-747 Civil Settlement Payments 

treated for federal income tax purposes.6 In those instances where we 

found specific language that addressed how civil settlement payments are 

to be treated for federal income tax purposes, we followed up with agency 

officials to corroborate how this treatment related to the specific agencies’ 

policies and procedures. 

The settlement agreements we examined are not a representative sample 

of settlements for these agencies in these fiscal years, and the results of 

our examination cannot be generalized to other settlement agreements. 

Likewise, the information we obtained through our DCI represents the 

responses of each company that voluntarily completed the instrument 

with regard to a specific settlement. Their responses cannot be generalized 

to any other population of settlements. Other than verifying the settlement 

amount and that the amount was paid by the companies when possible, we 

did not verify the other company responses to our survey questions. 

To determine what information IRS collects on companies with civil 

settlements reached by federal agencies, we interviewed knowledgeable 

officials from IRS and the four agencies and reviewed supporting 

documentation about what information, if any, IRS obtains from the four 

selected agencies regarding their civil settlement agreements. 

To determine the results of IRS’s audits of companies concerning the tax 

treatment of settlement payments, we obtained information from 

knowledgeable IRS auditing staff.7

 An IRS technical advisor (TA) manager 

provided us readily available information on IRS’s industry groups in its 

Large and Mid-Size Business Division on the results of corporate audits 

where the deductibility of civil settlement payments was an issue.8

 6

We did not examine SEC settlement agreements to determine if they contained specific 

language addressing federal tax treatment of payments because SEC officials told us that 

the agency did not include language addressing tax consequences in settlement agreements 

prior to 2003. 

7

Because IRS databases do not have indicators to track audit cases with settlements, a 

systematically identified set of cases involving settlements was not available for us to 

examine. 

8

According to an IRS TA Manager, IRS examiners are likely to consult TAs and TA 

managers in examining such issues as deduction of settlement amounts. TAs are 

nationwide experts who ensure consistent treatment of all taxpayers’ issues within their 

specific industries or issue areas. 
Appendix I: Scope and Methodology 

Page 34 GAO-05-747 Civil Settlement Payments 

We conducted our work at EPA, SEC, HHS, DOJ, and IRS regional and 

headquarters offices, from February 2004 through June 2005 in accordance 

with generally accepted government auditing standards. 
Appendix II: Selected IRS Audit Results 

Information on Companies with Civil 

Settlement Payments 

Page 35 GAO-05-747 Civil Settlement Payments 

According to selected information IRS provided on 46 companies that 

claimed settlement payment deductions on their income tax returns, IRS 

adjusted or proposed adjustments for approximately half of these 

companies. The 46 companies settled with varying agencies, including 

EPA, HHS, and DOJ. In the 24 cases for which IRS adjusted or proposed 

adjustments to the amount deducted as settlement payments on the tax 

return, the adjustments ranged from “not substantial” to 100 percent, 

according to the IRS examiners’ notes for the cases. 

According to IRS staff, only a portion of the amount listed as a settlement 

payment would be nondeductible. Because these portions would be 

deemed to be penalties, the balance would be a deductible compensatory 

expense. IRS collected this information under compliance research 

projects and from additional information from staff familiar with audits of 

companies in which the deductibility of settlement payments was an issue. 

This information, which covers multiple years, is limited to these 

particular companies. As IRS staff selected the 46 companies for audit or 

research because of potential noncompliance, these audit results cannot 

be projected to other companies with civil settlements. 

Appendix II: Selected IRS Audit Results 

Information on Companies with Civil 

Settlement Payments 
Appendix III: Comments from the Internal 

Revenue Service 

Page 36 GAO-05-747 Civil Settlement Payments 

Appendix III: Comments from the Internal 

Revenue Service 
Appendix III: Comments from the Internal 

Revenue Service 

Page 37 GAO-05-747 Civil Settlement Payments 
Appendix IV: Comments from the 

Environmental Protection Agency 

Page 38 GAO-05-747 Civil Settlement Payments 

Appendix IV: Comments from the 

Environmental Protection Agency 

Note: GAO comments 

supplementing those in 

the report text appear at 

the end of this appendix. 
Appendix IV: Comments from the 

Environmental Protection Agency 

Page 39 GAO-05-747 Civil Settlement Payments 
Appendix IV: Comments from the 

Environmental Protection Agency 

Page 40 GAO-05-747 Civil Settlement Payments 

See comment 1. 
Appendix IV: Comments from the 

Environmental Protection Agency 

Page 41 GAO-05-747 Civil Settlement Payments 

See comment 2. 
Appendix IV: Comments from the 

Environmental Protection Agency 

Page 42 GAO-05-747 Civil Settlement Payments 
Appendix IV: Comments from the 

Environmental Protection Agency 

Page 43 GAO-05-747 Civil Settlement Payments 

1. We reviewed the text in our draft report and believe that it adequately 

distinguishes between monetary payments made directly to a 

governmental entity and costs to be incurred by a defendant as a 

consequence of performing actions required under a civil settlement 

agreement. To illustrate, a note to table 1 in our draft report stated 

that “For settlements identified by EPA, the total value of settlements 

included payments payable to the U.S. government; the estimated cost 

of any Supplemental Environmental Projects; and the estimated costs 

of pollution controls, monitoring equipment, or other complying 

actions that companies are required to take to come into compliance 

with environmental laws.” 

2. As the Assistant Administrator suggested, we have revised our report 

to show that a proposed legislative provision mentioned in a footnote 

to disallow tax deductions for amounts paid to or at the direction of a 

government in relation to a violation was not included in the bill 

signed into law. However, our report shows that a new provision has 

since been introduced. 

GAO Comments 
Appendix V: Comments from the Securities 

and Exchange Commission 

Page 44 GAO-05-747 Civil Settlement Payments 

Appendix V: Comments from the Securities 

and Exchange Commission 
Appendix VI: Comments from the Department 

of Health and Human Services 

Page 45 GAO-05-747 Civil Settlement Payments 

Appendix VI: Comments from the 

Department of Health and Human Services 
Appendix VII: GAO Contact and Staff 

Acknowledgments 

Page 46 GAO-05-747 Civil Settlement Payments 

Michael Brostek (202) 512-9110 

In addition to the contact named above, Thomas Beall, Danielle Bosquet, 

Charlie Daniel, Keira Dembowski, Jeanine Lavender, Cheryl Peterson, 

Michael Rose, Amy Rosewarne, and Jennifer Wong made key 

contributions to this report. 

Appendix VII: GAO Contact and Staff 

Acknowledgments 

GAO Contact 

Acknowledgments 

(450296) 
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