October 18,2005

Grassley, Baucus Question Civil Settlement Tax Deductions

Senators Will Introduce Legislation To Clarify Tax Deduction Requirements

(WASHINGTON, D.C.) Senator Chuck Grassley, chairman of the Senate Finance Committee,and Senator Max Baucus, ranking member, questioned companies using civil settlements as taxdeductions after the Government Accountability Office (GAO) released a study showing anumber of companies using the settlements as deductions on tax returns.

The two senators requested the study and will introduce legislation as early as today thatwould require settlement agreements to specify whether the payments are for non-deductiblepenalties and would limit deductions to the amounts paid for restitution or to come intocompliance with the law. In addition, the legislation would require agencies to send informationreports to the IRS so these deductions can be tracked and audited.

The Government Accountability Office (GAO) released a study today examining the taxtreatment of civil settlements between companies and government agencies that found many ofthese settlements are taken as a tax deduction. Civil settlements are enforcement tools used bygovernment agencies to resolve violations of the law and punish companies short of going tocourt. They may include penalties or compensatory damages. The annual value of thesesettlements can exceed billions of dollars. Amounts paid for fines and penalties are notallowable as tax deductions.

The GAO studied civil settlements from the Environmental Protection Agency (EPA),the Securities Exchange Commission (SEC), the Department of Justice (DOJ), and theDepartment of Health and Human Services (HHS) ranging from $870,000 to $1 billion. Inresponse to a survey conducted as part of the study several companies reported they deducted allor part of twenty out of thirty-four settlements, often because the agreements did not address taxtreatment of the payments or because they interpreted the tax law in their favor.

The Internal Revenue Service (IRS) and other government agencies have no routineprocess to share information about these settlements, leaving many deductions undetected andunaudited. As a result of the GAO study, two companies found mistakes in taking settlementdeductions for their settlements and indicated they would file amended tax returns. The GAOrecommended the IRS and the agencies develop a communication process to share settlementinformation so the IRS could follow-up on the tax treatment of the payments.

After the report was released, Senator Grassley and Senator Baucus the followingcomments:

Senator Grassley Quote:

“A civil settlement is supposed to sting like a bee, not annoy like a gnat. Letting companiesdeduct settlement payments from their income taxes takes away the sting. It minimizes the deterrenteffect, and it makes chumps out of the taxpayers who subsidize these deductions. And it all could beavoided if government agencies just work with the IRS and not at cross-purposes. The revised billthat Senator Baucus and I are introducing will make clearer what can and can't be deducted and givethe IRS the information it needs on the front end to make sure payments are treated properly for taxpurposes.”

Senator Baucus Quote:

“Companies being punished for violating the law should not be able to subsidize theirpenalties settlements through a tax deduction. It is galling that artfully crafted settlementagreements create loopholes that allow wrongdoers to escape the full impact of fines and waterdown any deterrent effect. It is unacceptable that government agencies routinely do not sharesettlement information with the IRS so payments and deductions can be monitored. The GAOreport confirms what many have suspected for some time -- that companies were shifting the costof their fines and penalties onto the backs to honest taxpayers.”

The full text of the report, “Tax Administration: Systematic Information Sharing Would HelpIRS”, GAO-05-747, can be found on the GAO website at http://www.gao.gov/.

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