Gray Chemical Company manufactured pesticides that were toxic. Over the course o

Question

Gray Chemical Company manufactured pesticides that were toxic. Over the course of several years, the toxic waste contaminated the air and water around the company’s plant. Several employees suffered toxic poisoning, and the Environmental Protection Agency cited the company for violations. In court, the judge found Gray guilty and imposed fines of $15 million. The company voluntarily set up a charitable fund for the purpose of bettering the environment and funded it with $8 million. The company incurred legal expenses in setting up the foundation and defending itself in court. The court reduced the fine from $15 million to $7 million. Gray Chemical Company deducted the $8 million paid to the foundation and the 1 legal expenses incurred. The IRS disallowed both deductions on the grounds that the payment was, in fact, a fine and in violation of public policy. Gray’s president, Ted Jones, has contacted you regarding the deductibility of the $7 million fine, the $8 million payment to the foundation, and the legal fees. Write a letter to Mr. Jones that contains your advice and prepare a memo for the tax file. Gray’s address is 200 Lincoln Center, Omaha, NE 68182. Research aids: IRC §162(a) and (f). Treas. Reg. § 1.162-21(b).

Explanation / Answer

To Ted Jone.

200 Lincoln Center,

Omaha, NE 68182,

subject: ADVICE ON ALLOWANCE OF DEDUCTION OF FINE, PAYMENTS TO FOUNDATION AND LEGAL FEES.

Dear Sir,

this is in reference to your letter seekig advice regarding the allowance of the $7 million fine, the $8 million payment to the foundation, and the legal fees

as per IRC §162(a) and (f). Treas. Reg. § 1.162-21(b)

(a) In generalThere shall be allowed as a deduction all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business, including—

(1) a reasonable allowance for salaries or other compensation for personal services actually rendered;

(2) traveling expenses (including amounts expended for meals and lodging other than amounts which are lavish or extravagant under the circumstances) while away from home in the pursuit of a trade or business; and

(3) rentals or other payments required to be made as a condition to the continued use or possession, for purposes of the trade or business, of property to which the taxpayer has not taken or is not taking title or in which he has no equity.

and

(f) Fines and penalties : No deduction shall be allowed under subsection (a) for any fine or similar penalty paid to a government for the violation of any law.

so as per the law

in the given question

1. the fine of $7million is not at all deductable as its in the nature of fine and penalty which is imposed for the infringment of the law

2.$8 million payment to the foundation is also not allowed as a deduction as its in the nature of fine only. had the company not set up a charitable fund for the purpose of bettering the environment and funded it with $8 million the fine would have been $15 million. the reduction in fine from 15 million to 7 million was only beacuse it had agreed to set up a fund and make ammends for the violations it made. hence the $8 million is also in the nature of fine and penalty and thus not deductible

3. legal expense this is the only expense out of thegiven three which will be allowed as per IRC §162(a) point 3.

as it falls under the ambit of other payments required to be made as a condition to the continued use or possession, for purposes of the trade or business,

Yours sincerely,

XYZ

TAX MEMO

Computation of taxable profit of Gray Chemical Company for the year ending :

NET PROFIT : XXXXX

ADD: fine :$7 million

ADD:payment to the foundation :$8 million

LESS: Legal expenses : xxxxxxx

TAXABLE PROFIT : XXXXXX

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