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TAX FILE MEMORANDUM
TO: Ted Jones, Gray Chemical Company President

FROM: Yessenia Colon, Big 4 Staff Accountant

SUBJECT: Grey Chemical Company Research Conclusion

DATE: October 29, 2015

The Environmental Protection Agency cited Gray Chemical Company for violations of toxic waste contamination of the air and water surrounding the plant due to its toxic pesticides. The judge found Gray guilty and imposed fines of $15 million. Gray voluntarily set up a charitable fund of $8 million with the intent of bettering the environment. Gray incurred legal expenses in its defense and in setting up the foundation. The court later reduced the fine from the initial $15 million to $7 million. Gray deducted the $8 million for the foundation along with legal expenses incurred. The IRS disallowed both deductions on the grounds that these funds were a fine and in violation of public policy.

In regards to your question of the deductibility of these items, $8 million for the foundation and legal expenses, and the $7 million fine §§162 (a) and (f) Trade Business Expenses states “No deduction shall be allowed under subsection (a) for any fine or similar penalty paid to a government for the violation of any law.” Section 1.162-21(b), Treasury Regulations, further provides: (1) For purposes of this section a fine or similar penalty includes an amount —…(iii) Paid in settlements of the taxpayer's actual or potential liability for a fine or penalty (civil or criminal). The preceding Internal Revenue Code disallows the reduced $7 million fine made by the judge, a government official, in regards to the fine as a result of statutory violations. Congress specifically enacted §162(f) in order to codify prior judicial decisions disallowing business expense deductions for fines and penalties resulting from statutory violations.

In regards to the $8 million and legal fees

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