Marsh & McLennan, Goldman Sachs, Morgan Stanley, Jesta Digital and Bank of America allegedly engaged in illegal behavior that mistreated or ripped off consumers. Yet, rather than paying the full price of their misdeeds, these companies agreed to settlements with government regulators that allow them to take a tax deduction for all or part of the cost of the payout.
How can this happen? Though corporations cannot legally write off public penalties or fines as tax breaks, companies may be able to write off payments made to make amends for their bad behavior as a normal business expense. This is because government agencies often fail to define a settlement’s deductibility in the formal agreement. This ambiguity, clouded further by complicated case law, creates a settlement loophole corporations can take advantage of to secure a discount on their payout. The IRS states that “almost every defendant/taxpayer deducts the entire amount” of their financial settlement with the government as a business expense. According to a 2005 government study of 34 companies’ settlements worth more than $1 billion, 20 companies deducted some or all of their payments.
Every dollar in tax savings companies enjoy in this way is ultimately paid for by ordinary Americans in the form of program cuts, increased federal debt, or higher taxes to make up the difference.
Taxpayers should not be forced to subsidize corporations that violate rules designed to protect the public from ripoffs, environmental damage, fraud or the selling of dangerous products.
All settlement agreements should clearly define their tax consequences and communicate that information clearly to the corporation, the IRS and the broader public. In addition, government agencies should:
- Make all settlement payouts non-deductible by default, including standard language in all agreements to that effect. The Environmental Protection Agency often does this and the Securities and Exchange Commission increasingly does the same.
- Publicly disclose all settlements on agency websites and include information about any portion that corporations have not been barred from deducting on their taxes.
- Require corporate filings to the Securities and Exchange Commission to explain whether any settlement payments were written off.
- Ensure “truth in advertising” by requiring regulators and corporations to disclose the after-tax amounts of settlements, a more accurate portrayal of the penalty a company will really pay.