Hidden cost: Corporations see lower tax bill when they settle with the government

ANDREW HARRER/BLOOMBERG NEWS - American Express is one of several big banks that can save millions on government settlements by writing off any portion that is not paid directly to the government as a penalty or fine for violation of the law.

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When Bank of America agreed in December to pay $335 million to resolve federal charges that its mortgage-lending arm discriminated against black and Hispanic borrowers, government officials hailed it as the largest fair-lending settlement in history.

But, in fact, the banking giant has the right to a massive discount on the payout. Thirty-five percent of the settlement is deductible. That means Bank of America could wind up saving $117 million on its tax bill.

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Over the past year, federal prosecutors and regulators have lauded a series of multimillion dollar settlements against big corporations that have done everything from duping customers into buying unneeded products to foreclosing on active-duty troops. But little mentioned is a tax law that takes these firms off the hook for a huge chunk of that money.

Corporations can 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. A majority of the settlements that federal regulators announced in the past year include some form of restitution that is eligible for a tax deduction.

That means Wells Fargo could claim its $175 million fair-lending settlement with the Department of Justice as a deductible corporate expense. Or Capital One could write off a portion of the $210 million agreement it reached in July with the Consumer Financial Protection Bureau. And American Express can save millions on the $112.5 million settlement it negotiated last week.

“No corporation should ever save money by violating the rules that are in place to protect people,” said Virginia Robnett, outreach coordinator at OMB Watch, a government watchdog group. “These tax write-offs should be rescinded.”

Consumer advocates say the deduction is a slap in the face to taxpayers, who are ultimately left on the hook for corporate misdeeds. But tax experts and corporate lawyers argue that preventing companies from writing off these expenses could encourage firms to forgo settlements.

“If you were to disallow deductions for settlements, then that would create an incentive for companies to litigate the case all the way to a trial verdict,” Victor Fleischer, a tax law professor at the University of Colorado, said. “If the company had to pay a claim in that instance, it would be deductible. That’s not wise public policy, either.”

Officials at the Justice Department, the CFPB and the Federal Deposit Insurance Corp. declined to comment for this article.

It is not known whether any of the firms involved in recent federal settlements will take advantage of the deduction, as they are months away from filing 2012 taxes.

Bank of America and Wells Fargo declined to discuss whether they will claim the fair-lending settlements on their taxes. Capital One offered no comment on its agreement with the CFPB.

American Express spokeswoman Marina Norville said: “There will be some refund on the taxes paid on income that we are now reversing. These are simply accounting rules that we’re following.”

Few corporations have ever passed up the deduction, and those that have did so under intense public scrutiny, analysts say. Take Boeing, which in 2006 abandoned plans to deduct a $615 million settlement with the Justice Department after several senators raised objections.

Four years later, Goldman Sachs agreed to waive tax deductions it could have claimed in a $550 million settlement with the Securities and Exchange Commission. The agency specifically placed language in the agreement to prevent the investment bank from receiving a tax break. It stipulated that restitution be paid directly to the agency to be distributed to victims.

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.

 
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