When individual citizens are investigated and prosecuted for white collar crimes or other wrongdoing, they often agree to pay a financial settlement to the federal government as a way to avoid prison time or criminal charges. When corporations are in similar situations, they often go on to claim the settlement payments as tax-deductible business expenses, something individuals cannot do.

In effect, such corporations get taxpayers to foot the bill for their misconduct, according to a new study released by the U.S. Public Interest Research Group (U.S. PIRG) following a record year of corporate settlements.

“When corporations treat the financial payments they must make as a result of their wrongdoing as ordinary costs of doing business, they force taxpayers to pick up the tab,” explained study co-author Ryan Pierannunzi, a tax and budget expert with U.S. PIRG. “While debate rages over how to address our deficit, we can ill-afford to subsidize the misdeeds of corporations like BP and UBS.”

As the study details, federal law clearly states that punitive penalties and fines exacted by government agencies are not tax-deductible, but settlement agreements rarely specify what portion of the amount levied is regarded as punitive and what portion is compensatory.

Compensatory damages, i.e., dollar amounts to make up for actual losses, are tax-deductible. Corporate tax lawyers can take advantage of this ambiguity—and probably actively seek it—by treating the entire amount as compensatory and thus deductible. Both the Internal Revenue Service and the various agencies negotiating the agreements believe it is the responsibility of the other to clear up the ambiguity, according to the report.

Recent examples cited in the report include the $1.5 billion UBS settlement that could cost taxpayers as much as $245 million; BP’s 2011 $10 billion windfall arising from its tax write-off of $37.2 billion for Gulf oil spill disaster expenses; and the fact that Exxon used tax deductions so that it had to pay only a fraction of its $1.1 billion settlement related to the 1989 Exxon Valdez oil spill in Alaska. 

The report offers several recommendations for reform, including that agencies should determine which portions of a given settlement are compensatory and which are punitive, and that they should publicize the expected after-tax amounts of settlements.

“The tax treatment of settlements has a very real impact on peoples’ lives. Every dollar that doesn’t get paid to the Treasury means another dollar in debt, cutbacks, or higher taxes that the rest of us must bear,” said Pierannunzi.

-Matt Bewig

To Learn More:

Taxpayers Bear Cost of Corporate Settlements (Corporate Crime Reporter)

Subsidizing Bad Behavior: How Corporate Legal Settlements for Harming the Public Become Lucrative Tax Write Offs, with Recommendations for Reform (Phineas Baxandall and Ryan Pierannunzi, U.S. PIRG Education Fund) (pdf)

BP Slithers away with Light Penalty for Gulf Explosion and Oil Spill Disaster (by Noel Brinkerhoff, AllGov)

Justice Dept. Defends Not Prosecuting Corporate Leaders for White-Collar Crime (by Noel Brinkerhoff and David Wallechinsky, AllGov)