Citigroup, UBS, JPMorgan Chase and TD Bank allegedly engaged in illegal behavior that ripped off consumers and investors and jeopardized the health of the financial system. Yet, rather than paying the full price of their misdeeds, federal law opens the door for companies that agree to settlements with government regulators 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 whose lawyers cut a deal to avoid trial may be able to write off payments made to settle allegations of wrongdoing by treating such payments as an ordinary and necessary business expense. They can do so 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 payouts. 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 Accountability Office study of 34 companies’ settlements worth more than $1 billion, 20 companies deducted some or all of their payments.
Experts believe that Citigroup and UBS could find a way to dodge some of the financial hit in their settlements. And neither JPMorgan Chase nor TD Bank entered into settlement agreements that prohibited them from deducting the cost of their payouts on their taxes, leaving the door open for these banks to hand much of the bill for their misdeeds to everyday taxpayers.
Every dollar in tax savings companies enjoy this way must ultimately be 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 financial chicanery, environmental damage, fraud or the selling of a dangerous product.
The federal government should require all settlement agreements to clearly define their tax consequences and to 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.