Government doing more to prevent corporations from deducting settlements

Federal agencies are taking greater steps to prevent companies from claiming tax deductions on settlements reached with the government, though loopholes in the tax code persist, according to a new study by U.S. Public Interest Research Group.

In the past year, the government has exacted a series of multimillion-dollar settlements on companies that have rigged global interest rates, preyed on consumers or endangered the environment. Yet a number of these firms are entitled to write off as much as 35 percent of their payout as an ordinary business expense.

Consumer advocates and lawmakers have long pressed federal agencies to stop big corporations from receiving tax breaks on payments to victims. Researchers at U.S. PIRG say some agencies are heeding the call.

“Government agencies are beginning to realize that they’ve been asleep on the job when it comes to the tax implications of these settlements,” said Phineas Baxandall, a senior policy analyst at U.S. PIRG.

An early copy of the group’s report obtained by The Washington Post applauds the Justice Department for explicitly forbidding BP in November from deducting any of the $4 billion the oil company agreed to pay over the drilling disaster in the Gulf of Mexico.

Prosecutors included language in the agreement that clearly defined the damages as a punitive penalty. Justice took similar measures this month in the $500 million settlement with Swiss banking giant UBS AG, which was accused of manipulating the benchmark interest rate known as Libor.

Corporations cannot write off any portion of a settlement that is paid directly to the government as a penalty or fine for violation of the law. But agencies rarely spell out whether the entire monetary figure should be regarded as punitive, according to the study due out in January.

“We are committed to ensuring that criminal resolutions have clear, unambiguous consequences for corporate wrongdoers,” Assistant Attorney General Lanny A. Breuer said in an e-mail. “Criminal penalties are a price paid for bad behavior, and it isn’t fair to get a break on that debt at the taxpayers’ expense.”

Many settlements announced in 2012, however, include some form of restitutionthat is eligible for a tax deduction. Take, for example, the fair-lending agreement the Justice Department reached with Wells Fargo in July. The behemoth bank agreed to spend at least $175 million to resolve allegations that it steered black and Latino borrowers into high-cost loans and charged excessive fees. Because a portion of that money is considered compensatory, Wells Fargo could claim the settlement as a deductible corporate expense.

It is not known whether any of the firms involved in recent federal settlements will take advantage of the deduction, as they are at least a month away from filing 2012 taxes.

There is no uniform approach among agencies for addressing tax deductions. The Securities and Exchange Commission in 2003 instituted a policy of stating in its settlements that penalty payments are not deductible, but no other agency consistently spells out its position on tax treatment, according to the study.

The Internal Revenue Service, under recommendations from the Government Accountability Office, is working with agencies to develop a system for sharing information about settlements. Many deductions could be challenged by the IRS, which is often left out of the loop about the agreements.

“For recent settlements that weren’t explicitly nondeductible, it’s not too late for the IRS to step in and prevent it,” Baxandall said. “They don’t need to sit on their hands just because the agency didn’t spell out what the tax consequences are supposed to be.”

Officials at the IRS did not respond to requests for comment.

Lawmakers, including Sens. Max Baucus (D-Mont.) and Charles E. Grassley (R-Iowa), have introduced legislation to deny deductions for all punitive damages. It would prevent companies from writing off punitive damages in private settlements, which is currently allowed. U.S. PIRG would like to see Congress revisit the issue or at least clarify ambiguities in the tax law.

Tax policy experts say legislative attempts to abolish the deduction have probably failed because damages are essentially business expenses, and one expense should not be treated differently than another.

Noel Brock, an assistant professor at West Virginia University and former partner at Grant Thornton, added that “being denied a tax deduction . . . may impact how much banks are willing to agree to pay to settle a dispute.”

Tax policy experts say deductions serve as a vital incentive for firms to settle claims out of court and forgo lengthy litigation that winds up costing taxpayers. But consumer groups contend that tax breaks are a slap in the face to taxpayers, who are ultimately left on the hook for corporate wrongdoing.