‘The cost of doing business’ is a phrase we have used a number of times on this blog to describe the prevailing attitude that corporations appear to take when they pay millions (or even billions) to settle allegations of wrongdoing. At first glance, that phrase may seem overly cynical in relation to settling fraud charges—companies don’t literally view these settlements as the cost of doing business…right?
According to a new study conducted by the United States Public Interest Research Group Education Fund, that phrase is actually more applicable under these circumstances than many of us realize.
When corporations commit fraud, engage in financial scams, spill chemicals, manufacture dangerous products, or commit other misdeeds, they very rarely go to jail the way ordinary people would under the same set of circumstances. Instead, corporations are permitted to negotiate out-of-court settlements resolving the allegations of wrongdoing in return for agreed-to payments or promised remedies.
Even though these settlements are made on behalf of the American people, they are not subject to any transparency standards, according to the U.S. PIRG study. Worse yet, companies are often allowed to write the settlements off as tax deductions. Put simply, corporations literally get to chalk up these settlements as ‘the cost of doing business.’
U.S. tax code allows businesses to deduct from their taxable income “all ordinary and necessary business expenses,” but they are prohibited from deducting penalties or fines paid to the government. This means that out-of-court settlements fall in a legal gray area as far as our tax code is concerned—settlement payments aren’t penalties or fines, but they are required payments made to address allegations of wrongdoing.
When the government agency that signs off on a settlement doesn’t have a standard for addressing tax liability, corporations are free to write the settlement off as a normal business expense.
You’re probably thinking, “But government agencies all have a strict policy for these circumstances, right?”
You’d think so, but according to the U.S. PIRG study, five of the largest government agencies that sign off on settlement agreements with corporations rarely specify the tax status of the subsequent payments, which means that the billions paid to resolve allegations of wrongdoing are considered no different than a business dinner.
We all suffer as a result of this for two reasons:
- The write off status undermines the deterrent value those settlement payments are supposed to represent. Rather than sending a message of atonement for wrongdoing, the message is that the wrongdoing is literally accepted as the cost of doing business.
- When corporations are permitted to write off settlement payments, the taxpaying public ultimately has to make up for the lost revenue in the form of higher taxes, cuts to vital public programs, or more national
Of course, the public really isn’t aware of just how much money is being lost in these settlements, because they are confidential. We get numbers from the Justice Department every year, saying just how much was returned to the government, but we have no idea what the real value is when settlement agreements are signed and tax implications are not considered.
If you want to see a clear example of this in action, look at the 2013 JPMorgan Chase and Co. case in which the bank was accused of illegally packaging, marketing, selling and issuing residential mortgage-backed securities. The settlement from the case received a lot of attention (and outrage) because it was the largest amount in Justice Department history, and reports revealed that the government allowed JPMorgan to classify the $11 billion as a “legitimate business expense.”
Similarly, the Justice Department announced a blockbuster settlement with British Petroleum in October of this year over the 2010 Deepwater Horizon oil spill. BP will pay a $20.8 billion settlement, of which the company will be able to write off approximately $15.3 billion as a deductible business expense.
Key Findings From the U.S. PIRG Study
The U.S. PIRG study looked at all out-of-court settlements reached between 2012 and 2014 for which press releases were posted by the Justice Department, the Environmental Protection
Agency, the Securities and Exchange Commission, the Department of Health and Human Service, and the Consumer Financial Protection Bureau.
- Of the five agencies studied, not one has a publicly announced policy concerning how the agencies address the tax status of the settlements they sign.
- In the ten largest settlements announced during the study period, companies were required to pay nearly $80 billion to resolve federal charges of wrongdoing. However, the same companies can write off at least $48 billion as tax deductions.
- Some agencies do take action to limit tax deductibility for the settlements they negotiate, while others do little to address the issue. Likewise, some agencies have stronger practices in place than others to prevent settlements from being written off as tax deductions. The EPA and the CFPB, for example, are the most consistent in ensuring that at least portions of the settlements they sign are explicitly not tax-deductible.
- The Justice Department signed most of the largest settlement agreements of all the federal agencies that were studied. Only 18.4 percent of settlement dollars during the period of study was explicitly not tax-deductible. Worse, only 15 percent of settlement dollars negotiated by the SEC included language to ensure that the settlement amounts were not tax-deductible (at least for those with publicly available settlement language).
- The most transparent agencies in terms of making settlement terms publicly available were the EPA and the CFPB. The least transparent were the Justice Department and the SEC.
What Needs to Happen?
It’s pretty obvious, isn’t it? The tax code should prohibit corporations from writing off payments made in connection with allegations of wrongdoing unless reasons are specified in settlement agreements themselves. Furthermore, in the interest of transparency, all agencies should be required to publicly post the details of all settlement agreements.
After all, these agreements are ostensibly made on our behalf, so we deserve to know the stakes. In the event that an agreement needs to be kept confidential, the appropriate agency as well as the corporation involved should have to explain why the terms should be kept confidential.