Dr. Seat, ACCT 4500-A
Fall 2003 Gray Chemical Company has been taken to court over the health and environmental risks of their toxic pesticides manufactured at their facilities. Traces of this toxin have been traced in the air and water, and several employees of the chemical company has suffered from toxic poisoning. Now that the Environmental Protection agency has cited violations against Gray Chemical Company leading to a fifteen million dollar fine in court. The company has voluntarily set up a charitable foundation funding eight million dollars especially to help improve the environment. Gray Chemical took the case back to court resulting in an eight million dollar reduction in the fine due to the environmental foundation they have set up. Now Gray Chemical Company is trying to deduct the eight million spent on setting up the foundation and legal expenses along with the seven million the court fined the company with. First of all, fines and penalties are nondeductible. You cannot deduct fines you pay to a governmental unit for violating a law. This includes an amount paid in settlement or your actual or potential liability for a fine or penalty. So Gray Chemical Company cannot deduct the seven million dollars the court has fined them with for contaminating the air and water with the chemicals used to produce their products. Secondly, the eight million dollars used to set up foundation to improve the environment could be perceived in more than one way. One way to look at it is a way to improve the company�s reputation. If this were the case, an expense to improve a professional reputation is nondeductible. Since Gray Chemical Company used this money to set up a foundation to specifically improve the environment, this could be seen as a way to make their reputation better since it is the toxins used in the products that are contaminating the air and water. The other way, in terms of splitting up the eight million into the legal fees and the funding of the foundation, there would have to be two explanations for the money being nondeductible if it were not a effort to improve the companies reputation. For a legal fee to be deductible, it would have to be a fee charged (for example, by an accountant) for a ordinary and necessary service expense directly related to operating your business. Since the legal fees in this situation are for purposes to defend the company in court in order to recover from the violation filed by the Environmental Protection Agency, this is not a regular occurrence that would be considered an expense to directly operate Gray Chemical Company. Therefore the legal expenses incurred by Gray Chemical are nondeductible. The part of the eight million used to fund the foundation to help the environment is nondeductible for reasons described in Code Sec. 162. This code says a company is not allowed a business expense deduction for amounts funded to a private environmental fund formed to remedy the effects of a toxic pesticide manufactured by the corporation because the payment was in essence a fine or similar penalty paid to a government for the violation of a law. So Gray Chemical Company could not use the charitable funding as a deduction because the difference of the original fifteen million fine set by the court was reduced the amount of what the company used to fund the environmental foundation. A similar court case is US-CT-APP-3, [95-1 USTC �50,151] , Allied-Signal, Inc., as Successor by Merger to Allied Corporation, (formerly Allied Chemical Corporation) v. Commissioner of Internal Revenue Service, Allied-Signal, Inc. (formerly Allied-Signal, Inc.), Appellant , Trade or business, (Feb. 23, 1995). Allied developed a highly toxic chemical pesticide known as Kepone. In addition to poisoning sixty-two employees, the operations of Life Science resulted in deleterious consequences for the environment. The United States Environmental Protection Agency ("EPA") reported Kepone particulate in the atmosphere at Richmond (20 miles from Hopewell), as well as Kepone contamination of the Life Science plant, the soil at the plant site, a section of the Hopewell landfill, and a lagoon adjacent to the Hopewell waste treatment facility. Allied contributed eight million to the Virginia Environmental Endowment Fund and it is not deductible as an ordinary and necessary business expense under section 162(a) of the Internal Revenue Code, but rather was in substance a "fine or similar penalty paid to a government for the violation of any law" that is disallowed pursuant to section 162(f), we will affirm the decision of the Tax Court. Fines that Gray Chemical Company paid to the government is not deductible under the following terms: Reg � 1.162-21(a) In general says no deduction shall be allowed under section 162(a) for any fine or similar penalty paid to the government of the United States, a State, a territory or possession of the United States. Reg � 1.162-21(b)(1) For purposes of this section a fine or similar penalty includes an amount� (ii)Paid as a civil penalty imposed by Federal, State, or local law, including additions to tax and additional amounts and assessable penalties imposed by chapter 68 of the Internal Revenue Code of 1954; (iv) Forfeited as collateral posted in connection with a proceeding which could result in imposition of such a fine or penalty. Also, if a taxpayer pays a nonconformance (NCP) penalty assessed by the Environmental Protection Agency under section 206(g)(1) of the Clean Air Act (Act), 42 U.S.C. section 7525(g)(1), the NCP that was assessed by the EPA is not a �fine or similar penalty� for purposes of section 162(f) of the Code, and, therefore, section 162(f) does not preclude deduction of the NCP as a business expense under section 162(a). In conclusion, the fines, expense, and funding paid by Gray Chemical Company are nondeductible for the fact that these events do not occur regularly and are not needed to operate the company. The seven million dollar fine paid to the government is nondeductible, any fines or fees required to be paid to a government agency is going to be nondeductible under these situations.