Goldman, which gave up as much as $187.5 million in savings, could have contested the arrangement but backed down.
“It was pretty unusual,” said Robert Willens, an expert on tax accounting who runs a firm of the same name. “But there has been a backlash through the years about companies financing their penalty payments on the backs of taxpayers.”
Lawmakers have routinely raised concerns over companies being able to deduct large civil settlement payments. Sens. Max Baucus (D-Mont.) and Charles E. Grassley (R-Iowa) tried unsuccessfully to deny deductions for punitive damages with the introduction of the Government Settlement Transparency Act in 2003 and 2005.
The issue was revisited in 2010 when Sen. Bill Nelson (D-Fla.) called for a congressional inquiry of oil giant BP for claiming a $10 billion tax deduction for cleaning up the gulf oil spill. Around the same time, Rep. Peter Welch (D-Vt.) introduced the Stop Deducting Damages Act, saying the measure would save $315 million over 10 years by closing the loophole.
“This issue has fallen into a sort of regulatory black hole where agencies feel it’s a tax issue and therefore the IRS’s responsibility. And the IRS feels it’s not their responsibility because they follow the strict letter of the law,” said Phineas Baxandall, a senior policy analyst at U.S. Public Interest Research Group. “Unless some legislation passes, it’s unlikely to change.”
Tax policy experts argue that legislative attempts to eliminate the deduction have probably failed because punitive and compensatory damages are essentially business expenses. They say almost all other ordinary business expenses are deductible, and question why damages should be excluded.
“Our tax laws ought to measure tax income. And once we start to depart from the measure of income to pursue social goals, then a variety of complications arise in where do you draw the line,” said Steven Rosenthal, a visiting fellow at the nonpartisan Urban-Brookings Tax Policy Center.
To offset tax deductions on damages, Rosenthal said government agencies could impose higher fines or penalties that cannot be deducted.
Fleischer, of the University of Colorado, said increasing penalties would serve as a more effective deterrent than disallowing deductions.
“The agency negotiating a settlement is happy to get a big number, the company would prefer a lower number and there is no one from the IRS saying, ‘Wait a minute, if this is really intended to be a penalty, let’s treat it as such,’ ” Fleischer said.
In 2005, the Government Accountability Office recommended that the IRS work with other agencies to develop a system for sharing information about settlements. The congressional watchdog said many deductions could be challenged by the IRS, which was often left in the dark about settlements.
It is unclear whether the IRS ever implemented the GAO’s recommendations, as officials from the tax agency did not return repeated calls for comment.