The Government Accountability Office said that the Internal Revenue Service should work with federal agencies to make sure companies follow rules prohibiting tax deductions for fines and penalties paid in civil settlements.

Federal law says that payments made in compensation can be deducted from a company's taxes, but fines and penalties cannot, though the distinction between the two isn't always clear, the GAO said in a report to Congress.

The GAO, the investigative arm of Congress, said that four agencies that account for many of the largest agreements negotiated $9 billion in civil settlements during 2001 and 2002. Voluntary surveys returned by companies that account for 34 of those 41 settlements revealed that 20 deducted either some or all of their $1 billion in civil settlements from their tax returns. Two companies said that they had made a mistake and would be filing an amended return.

The issue attracted attention two years ago, when 10 Wall Street firms reached a $1.4 billion "global settlement" with the Securities and Exchange Commission over allegations of conflicts of interest in securities research. Senate Finance Committee chairman Sen. Chuck Grassley, R-Iowa, and ranking member Max Baucus, D-Mont., announced that they will introduce legislation to clarify the deductibility of these settlement payments.

The full report is available at www.gao.gov/new.items/d05747.pdf.

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