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Civil Penalties by the Colorado Attorney General under the Colorado Consumer Protection Act (CCPA) And Recent Changes to the Federal Tax Code’s Treatment of Deduction for Penalties

Recent changes to the federal tax code by the Tax Cuts and Jobs Act of 2017 (P.L 115-97) have important consequences for businesses’s ability to deduct payments for criminal and civil penalties—and could increase the cost of settlements. Businesses need to be aware of this change before considering settlements with governmental entities. This change could have important implications for many consumer protection actions by state attorneys general, including the Colorado Attorney General’s enforcement of the Colorado Consumer Protection Act (CCPA). This change also implicates payments by businesses to governmental agencies for securities, false claims, and antitrust cases. This article first addresses this important change and then discusses civil penalties by the Colorado Attorney General under the CCPA.

The relevant affected provisions of the tax code are 26 U.S.C § 162(f) and 26 U.S.C. § 650X. While penalties previously were not deductible, businesses could classify payments to the government for purposes other than penalties and take advantage of the deduction. Under the old law, businesses attempted to make any settlements with enforcement agencies heavy on tax-deductible payments and make payments for fines minimal or silent. The new changes in the law make that approach more challenging. The federal regulations define a “fine or similar penalty” under 26 U.S.C. § 162(f) as amounts “[p]aid as a civil penalty imposed by Federal, State, or local law” and amounts “paid in settlement of the taxpayer’s actual or potential liability for a fine or penalty (civil or criminal).” 26 C.F.R. § 1.162-21(b)(1). But “[c]ompensatory damages ... paid to a government do not constitute a fine or penalty.” 26 C.F.R. § 1.162-21(b)(2).

            The old version of 26 U.S.C § 162(f) provided: “No deduction shall be allowed . . . for any fine or similar penalty paid to a government for the violation of any law.” Under this version compensatory damages were deductible but not payments expressly for a civil or criminal penalty. The new version contains much broader language and provides: “[N]o deduction shall be allowed for any amount paid or incurred (whether by suit, agreement, or otherwise) to, or at the direction of, a government or governmental entity in relation to the violation of any law or the investigation or inquiry by such government or entity into the potential violation of any law.” The significant exception to this provision is money paid for restitution, remediation, or to get into compliance with the law, which are still deductible. But this exception now must be clearly set forth in the settlement documents or court order. 26 U.S.C. § 650X will eventually require governments to report these payments to the I.R.S.

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            In addition to seeking injunctive relief, disgorgement, restitution, and attorney fees and costs for consumer protection violations, the Colorado Attorney General is authorized by statute to impose civil penalties for violations of the CCPA if the AG proves a violation in court. Section 6-1-112(1)(a), C.R.S. (2018), of the CCPA provides:

(1) The attorney general or a district attorney may bring a civil action on behalf of the state to seek the imposition of civil penalties as follows:

 (a) Any person who violates or causes another to violate any provision of this article shall forfeit and pay to the general fund of this state a civil penalty of not more than two thousand dollars for each such violation. For purposes of this paragraph (a), a violation of any provision shall constitute a separate violation with respect to each consumer or transaction involved; except that the maximum civil penalty shall not exceed five hundred thousand dollars for any related series of violations.

             Under this law, courts have discretion to impose penalties for each consumer involved or for each transaction by the business. An example of a transaction involved would be the number of deceptive advertisements that were disseminated by the business or each deceptive sale. While civil penalties are capped at $2,000 for each violation and at a maximum of $500,000 for any related series of violations, the amount increases up to $10,000 for each violation involving persons 60 years of age or older. See Section 6-1-112(1)(c), C.R.S. Many of the Colorado Attorney General’s enforcement actions involve cases with a large number of transactions or consumers so the $500,000 cap is easily met in these cases even if the court does not impose the maximum $2,000 for each violation. An issue that remains unclear—and rarely tested—is what constitutes for purposes of the $500,000 cap on penalties “any related series of violations.”

A civil penalty under the CCPA is mandatory and is designed to “punish and deter the wrongdoer and not to compensate the injured party.” May Dep’t Stores v. State ex rel. Woodard, 863 P.2d 967, 976 (Colo. 1993). Thus, “the CCPA does not require proof of an actual injury or loss before a civil penalty can be awarded.” Id. at 973.  In the determination of the amount of civil penalties under Section 6-1112(1)(a), the Court should consider several factors, including: “(1) the good or bad faith of the defendant; (2) the injury to the public; (3) the defendant's ability to pay; and (4) the desire to eliminate the benefits derived by violations of the CCPA.” People v. Wunder, 371 P.3d 785 (Colo. App. 2016).

Conclusion

Civil penalties remain an important enforcement tool by the Colorado Attorney General (and other state attorneys general and federal enforcement agencies), and the recent changes in the federal tax code require that businesses considering settlement of enforcement actions evaluate carefully how to structure these settlements to avoid the significant tax consequences. Whether these changes to the tax code eventually result in a decrease in settlements remains to be seen but could be a consequence.

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Erik Neusch was a former assistant attorney general with the Colorado Attorney General’s office from 2009 to 2018 in the consumer protection section, where he served as lead counsel on some of the largest investigations and trials, leading to the recovery of the most restitution, attorney fees, and fines and the largest collected judgment in the history of consumer protection cases brought by the Attorney General.