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Attachment II to IDD on Government Settlements Directive #1

Audit Guidelines

Environmental violation enforcement settlements

The settlement assessment of environmental fines and penalties can occur as a result of administrative or judicial enforcement actions brought by EPA, DOJ, the state, tribal authorities or citizen suits.  Generally a penalty is calculated utilizing an EPA penalty framework of two separate components: 1) a-gravity-based component and 2) an economic benefit component.  The gravity component is based on a statutory maximum amount of $27,500 per day, per violation for major violations, but can be as low as $100 per day.  The economic benefit component is an economic model which seeks to quantify the financial gains the violator reaped by being non–compliant or by delaying compliance.  The Gravity component may be adjusted to consider good faith, degree of willfulness, history of non-compliance, etc.  

Courts have found the EPA penalty framework useful in determining the amount of penalty to assess, but are not bound by such policies.  Most actions brought by the DOJ are settled pursuant to a consent decree lodged in federal court.  Environmental enforcement settlements, whether administrative or judicial, will result in very similar looking agreements.  The consent decree typically will include three major components: 1) Civil Penalties, 2) Injunctive Relief / Compliance Projects and, 3) Supplemental or Beneficial environmental projects.   

  • The civil penalty amount will be separately stated, and the violator will typically agree that the penalty amount is non-deductible for income tax purposes under Section 162(f). 
  • Compliance projects are those costs that a violator must incur in order to become compliant with environmental laws and regulations.  Compliance projects required to be performed, as well as their estimated costs to implement, will be separately stated in the order.  Though compliance projects can be significant, compliance projects and their related tax issues are not the subject of this industry directive.
  • Supplemental/Beneficial Environmental Project (SEP) are voluntary projects incorporated into a consent decree in order to negotiate a significant reduction to the proposed penalty amount.  Typically only a portion of the SEP will be used to reduce the penalty amount.  The actual amount paid for a SEP and a reduced penalty may be greater than paying the original proposed civil penalty.  EPA policy prohibits SEP projects from reducing compensatory or remediation liability.  Complete EPA SEP applications, as well as SEP policy, is available on http://www.EPA.gov 

Supplemental Environmental Projects - Tax Issues

  1. Taxpayers may not deduct the portion of the costs incurred by Taxpayer for the performance of a SEP that is an amount analogous to a non-deductible fine or similar penalty as defined under section 162(f), and
  2. Taxpayers may not include in the basis of assets it produces under Section 263A, or as the basis of property under Section 1012, the portion of the SEP costs that is an amount analogous to a fine or similar penalty. 

Supplemental Environmental Projects issue development

The primary question to address in the development of a SEP issue is to determine the amount of mitigated (forgiven) penalty as a result of a taxpayer agreeing to perform a SEP.  At times, this amount can readily be ascertained in the body of the consent decree.  Other times, extensive factual development of the negotiation history is warranted. 

Examination Steps

  • Examiner should contact the Environmental Technical Advisor as soon as it has been determined that the taxpayer agreed to perform a SEP.
  • Request from taxpayer; complete correspondence files between taxpayer and EPA, DOJ, its representative and EPA, DOJ. etc.
  • Request from taxpayer; all settlement proposals or counter proposals either prepared by EPA, DOJ or taxpayer. 
  • Request from taxpayer; all penalty exposure computations either prepared by EPA, Taxpayer or taxpayer’s representative.
  • Request list of all taxpayers’ representatives, officers and employees that participated in the settlement negotiations. 
  • Request a copy of final signed consent orders.
  • Search EPA.gov, DOJ.gov or relevant state environmental web pages under enforcement activity.  Press releases and complete consent orders are public information which may be downloaded free off the appropriate web sites.
  • Perform broad base internet searches by taxpayer name with contaminated site or violation.
  • DOJ and/or EPA contact is not always essential but, when warranted, it must be made through designated IRS liaisons.  The Environmental Technical Advisor should be contacted for procedures.
Page Last Reviewed or Updated: 21-Jan-2014