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The Government Settlement Transparency & Reform Act (S.803): Are the Tax Benefits of Corporate Settlements in Jeopardy?

By Michael A. Villa, Jr. on April 6, 2017

On April 3, 2017, Senators Jack Reed (D-RI) and Chuck Grassley (R-Iowa) introduced bipartisan legislation that may impact or deny tax deductions for settlement payments regarding corporate regulatory violations. In recent years, the federal government has increased enforcement efforts against corporations for regulatory violations, whether it be for healthcare, banking, or environmental violations. Although the federal government carries a big stick when it comes to regulatory enforcement (i.e. onerous civil fines and potential criminal penalties), there are also carrots that can often facilitate and expedite settlements with corporations. One such carrot has been the potential tax deductibility for certain portions of the settlement amount. Senators Grassley and Reed cite a 2015 study by the U.S. Public Interest Research Group (PIRG), which indicated that the largest corporate settlements over a three year period were nearly $80 billion, and these corporations were eligible to claim business deductions for at least $48 billion of that amount.

One example of such a result, according to the PIRG, can be found in a 2014 settlement with Bank of America that released the bank from alleged violations of law related to mortgage activities. There was a $16.65 billion settlement in which $5.02 billion was designated as a civil penalty. As a general principle of federal law, government fines or penalties are typically not deductible, which in this example may mean the $5.02 billion is non-deductible. Nevertheless, as PIRG notes, the bank could possibly deduct the remaining $11.63 billion of the settlement as an ordinary business expense.

The bipartisan bill introduced by Senators Grassley and Reed aims to amend the tax code to require the government and the settling party to agree on how settlements should be treated for tax purposes. The amendment also attempts to specify whether settlement payments are punitive, and therefore non-deductible. The drafters would require the government to file an information return at the time of settlement that states the tax treatment of amounts to be paid by the corporations.

On one hand, the Senators argue that “there shouldn’t be a tax write off for corporate wrong doing” and the proposed legislation intends to curb such write offs by increasing transparency and requiring the government to consider tax implications prior to settlement. However, allowing corporations a partial tax benefit to remedy alleged prior violations potentially encourages corporations to expedite or streamline settlement negotiations, rather than expend resources and time litigating the issue in court. Stated simply, will corporations still be inclined to enter into multi-billion dollar settlements if they are not allowed some partial tax benefit? While the proposed legislation on its face may raise government funds by potentially disallowing or reducing these types of deductions, it may have the unintended consequence of creating additional litigation for the government and reduce the number of lucrative settlements the government has reaped in recent years.

Additional information on S.803 can be found here.

For any questions on this or any other civil tax or criminal tax-related matter, please feel free to contact me at (214) 749-2405 or mvilla@meadowscollier.com.