A pair of senators, Jack Reed, D-R.I., and Chuck Grassley, R-Iowa, have introduced bipartisan legislation aimed at preventing companies from deducting the penalties that have been agreed to in settlements with the government from their taxes.

The lawmakers contend the bill, known as the Government Settlement Transparency & Reform Act, would protect taxpayers, hold corporate wrongdoers accountable, and deter future fraud and abuse. The proposed legislation would rescind tax write-offs for illegal corporate behavior and prevent corporations from gaining tax benefits from the payments they make at the government's direction to settle their prior misdeeds.

Corporations accused of illegal activity routinely settle legal disputes with the government out of court because it allows both the company and the government to avoid the time, expense, and uncertainty of going to trial, the lawmakers noted. Federal law prohibits companies from deducting public fines and penalties from their taxable income. But under current law, companies may often write off any portion of a settlement that is not paid directly to the government as a penalty or fine for violation of the law. This allows some companies to lower their tax bill by claiming settlement payments to non-federal entities as tax deductible business expenses, the senators noted.

The Reed-Grassley bill would require the government and the settling party to reach pre-filing agreements on how the settlement payments should be treated for tax purposes. The bill would clarify the rules about which settlement payments are punitive and thus non-deductible and increase transparency by requiring the government to file a return at the time of settlement to accurately reflect the tax treatment of the amounts that will be paid by the offending party.

“Preying on consumers or defrauding investors shouldn’t be classified as a business expense,” Reed said in a statement. “If a company is paying thousands, millions, or even billions in fines, it shouldn’t get a tax break for those same misdeeds, it should be held accountable. The current tax loophole is the worst kind of special-interest tax giveaway because it is allowing bad actors to subsidize their misdeeds. The law needs to change to ensure the punishment fits the crime. Congress needs to close this settlement loophole. Federal agencies can take a more active, effective role in protecting taxpayers. Several federal entities have included specific clauses in their settlement agreements to prohibit penalties associated with the settlement from being deducted as a business expense. I urge more agencies to follow suit and publicly disclose the true value of these agreements.”

Under the federal tax code, the tax write-off for a $100 million settlement agreement could be worth as much as $35 million for the corporation being punished.

“A penalty should be meaningful or it won’t have the deterrent effect it’s supposed to have,” said Grassley. “Federal agencies too often don’t consider the tax implications, but you can be sure the company does. The government should understand this. The public should be accurately informed of the real penalty even when taxes are considered. This bill will ensure that government agencies think of the tax consequences in settlements going forward and increase transparency for the public.”

BP Deepwater Horizon Penalties
The bill many have been spurred in part by recent reports that British Petroleum may be able to write off much of the amount it paid in penalties to victims of the Deepwater Horizon oil spill in the Gulf of Mexico.

The U.S. Public Interest Research Group noted that in 2010, BP claimed a $32.2 billion charge for anticipated business losses in connection with the spill. This number includes $28 billion in cleanup costs and damages, $4 billion in Department of Justice criminal penalties, and $535 million in payments to the SEC. BP is still anticipating several billion more in Clean Water Act penalties and other regulatory penalties, as well as an anticipated $18 billion more in damages

Over 80 percent of the total money BP has paid in connection with the Gulf oil spill so far qualifies for tax deductions. Only the Department of Justice’s $4 billion criminal fine and the SEC’s $535 million penalty were explicitly non-deductible by law. Any Clean Water Act payments will likely be non-deductible, because they will qualify as legal penalties, and the EPA, unlike many agencies, tends to be explicit that such payments be regarded as penalties.

“There are billions of dollars on the line here,” said Michelle Surka, a program associate with the U.S. Public Interest Research Group, in a statement.“It should be completely explicit how much of its Deepwater Horizon payments BP can claim as a tax deductible business expense. If the public is ultimately footing the bill, the public should, at the very least, be informed.”

Federal tax law forbids fines and penalties to the government from being treated as tax deductions, but settlements negotiated with agencies often fail to spell out whether a payment is technically a penalty, and even some penalties can be deducted if companies can argue that they are not meant to be punitive, PIRG pointed out.

Even after the current Clean Water Act charges are resolved, BP also has to settle its liabilities through the Natural Resources Damage Assessment process, which will likely cost the company several billion more dollars. Unlike the EPA, payments made under the NRDA process do not follow EPA processes, and have in the past been tax deductible. Therefore, any payment made through the NRDA process will likely have a significantly lowered value after taxes.

In 2011, BP claimed from $10 billion to $13 billion in tax credits and therefore paid no federal taxes that year. Because corporations aren’t required to report the details of tax deductions they claim, and settlement agreements don’t need to specify which payments will qualify for tax deductions, the public can’t determine how much BP has already claimed and how much they might claim in future years. BP’s total expenditure on addressing the Gulf oil spill has already exceeded the initial charges claimed in 2010, and thus BP will likely be able to file for additional tax credits.

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