Special Interest Tax Break #9: Calling Payments for Law Breaking Ordinary Business Expenses

When companies “pay” huge amounts of money to settle claims that they broke the law, don’t believe the hype: the bill may be a lot less than advertised.

That’s because we taxpayers may be picking up part of the tab.

How? The tax code allows companies to deduct some or all of the payments as ordinary business expenses, so long as the payments are restitution, compensation or ‘remedial’ penalties.

On that basis Exxon (NYSE: XOM) was able to reduce its $1.1 billion settlement with the government for its Valdez spill to an after-tax $524 million.

Sure, penalties and fines intended to punish cannot be deducted. But whether a penalty is punitive or remedial can be hotly debated. Indeed, Robert W. Wood, a tax lawyer at Wood LLP and author of the book, Taxation of Damage Awards and Settlement Payments, explained the Talmudic scrutiny involved in his 2009 article for Tax Notes.

The Government Accountability Office did a study of this in 2005, and found—among other frustrating details—that 15 out of 16 companies that defrauded taxpayers rubbed salt in those wounds by deducting some or all of the settlement costs. Part of the problem is that settlements are all too often silent on whether the dollars paid are punitive or not.

See also: Taxing Wages Like Capital Gains - Part 10

The situation is even worse when the company is paying individuals to settle claims instead of the government. Then even penalties are deductible. So if General Motors (NYSE: GM) ends up paying eye-popping amount to the families of the 13—or more than 300, depending on who you ask—that died in connection with the recalled cars, and an outraged jury adds punitive damages on top, GM can subtract it all from its taxable income. For more examples and details on the issue, check out USPIRG’s report or its shorter presentations in the consumer ripoff context, the health care fraud context, or the Wall Street wrongdoing context.

Speaking of Wall Street wrongdoing, JPMorgan Chase (NYSE: JPM) will deduct what it can from its $13 billion fraud settlement with the government. Reuters reported that as much as $11 billion could be deductible, making the true cost to JPMorgan Chase $9 billion, after tax. That would mean taxpayers are eating about 30 percent of the headline number.

Making the Subsidies Stop, or at least, Transparent

Unfortunately, Wood is not sanguine the change will come: “I think the transparency bills are a good idea. I think it’s efficient for the public and the tax system. I also don’t think it’s likely to happen. Getting any tax bill passed is tough.”

An important question is: why all the focus on penalties and whether or not they’re punitive or remedial? Every single dime of JPMorgan Chase’s “13” billion dollar settlement is being paid because of its wrongdoing.

Why does the tax code consider compensating people for the harms and losses a company caused them part of a company’s ordinary business expenses?

Representative Peter Welch (D-VT) introduced a bill inspired by the JPM deal called “The Stop Deducting Damages Act of 2013” which currently has 18 co-sponsors, all Democrats, which surely cannot pass the Republican-controlled House. Even if it could, no Senator has introduced a companion bill.

In short, you get to keep on subsidizing companies that harm you.