Oil Spill Compensation Could Be Taxable

Gulf Coast residents contending with the oil washing up on their shores could find that the checks from BP come with a few mucky strings attached.

One of them could be the taxes they might well find themselves owing next year. The Obama administration won a battle of sorts last week when the president convinced BP to set up a $20 billion escrow fund to compensate victims of the oil spill. But as the Associated Press has reported, some are now worried that the payments from BP could be taxable, just like the lost wages and other earnings they are meant to replace.

The Internal Revenue Service is already starting to come under pressure to provide some guidance related to oil spill compensation. If the compensation is considered taxable, some would like to see the taxes withheld ahead of time, so oil spill victims don’t get hit with a massive tax bill next year just as they try to recover in the aftermath of the spill.

After Hurricane Katrina hit in 2005, many Louisiana and Mississippi residents claimed casualty loss deductions on their 2006 tax returns. But then when they received federal money to rebuild their damaged homes, the IRS at first required them to add the value of the deductions as taxable income on their 2007 returns, the AP noted. It took an act of Congress to reverse the IRS decision in 2008.

The IRS is likely to tread more carefully this time around before it issues any regulations on how much of the oil spill compensation is taxable, just in case Congress decides to second-guess it again.

Ironically, while Gulf residents are faced with the dilemma of what to do about the oil spill compensation they have yet to receive (not to mention those from other parts of the country who are likely to claim a piece of the compensation funds as victims of collateral damage from the spill), the company that caused the spill may be able to write off those same funds as a business expense.

BP would be able to claim the funds as an ordinary and necessary expense and have taxpayers indirectly pay for the cost of the $20 billion fund, which the company plans to set aside at a rate of $5 billion per year over the next four years so as not to damage its bottom line too heavily. Not only that, but as the TheStreet.com noted, if the company incurs a net operating loss for the year, BP would be able to carryback the loss and use it to offset some of its mammoth profits from the past two years.

If Congress decides to extend the NOL carryback again to five years, and apply it to large companies, as it did last November, BP might be able to use its oil spill expenses to offset its profits from the past five years. No doubt that would be a boon to BP, but not to the taxpayer or the residents of the Gulf.