Late last month, we commented on JP Morgan Chase’s $5.1 billion settlement with the Fair Housing Financing Agency (FHFA), as conservator of Fannie Mae and Freddie Mac. The Wall Street Journal has since reported that JP Morgan will be able to deduct that entire amount on its 2013 tax returns, allowing the company to reap a $1.5 billion tax windfall. Experts estimate that a large portion of the remaining final settlement, estimated at a total of $13 billion, may also be deductible. While JP Morgan has refused to comment about whether it will actually invoke the deductions, the revelation has greatly distressed observers, including Congress.
Newly Proposed Legislation Seeks to Close Tax Loophole
Outrage over the deductibility of the JP Morgan settlement has fueled the introduction of two bills in the U.S. House of Representatives: the Government Settlement Transparency and Reform Act, introduced by representatives Jack Reed (D., R.I.) and Charles E. Grassley (R., IA), and the Stop Deducting Damages Act, introduced by representatives Peter Welch (D., VT), a J.P. Morgan stockholder himself, and Luis Gutierrez (D., IL.).
Generally speaking, fines and penalties intended to punish and deter illegal conduct are not deductible, but compensatory payments are, as ‘ordinary and necessary’ costs of doing business. Settlements like those reached between the FHFA and JP Morgan last month, and between the FHFA and Wells Fargo this month, often fail to specify which portions of the total settlement amount are punitive in nature, creating a tax loophole for the defendants. The newly proposed legislation seeks to close that loophole.
Legal Framework Needed to Combat Big Banks’ “Play Now, Pay Later” Approach
Reed and Grassley’s Government Settlement Transparency and Reform Act more clearly delineates which penalties are punitive, and therefore non-deductible. It also requires the government party involved in settlement to file a return breaking down the total tax treatment of the settlement, as agreed upon by both parties. Though the IRS is not bound by the language in settlement agreements when assessing the validity of deductions claimed, such language is highly persuasive.
Welch and Gutierrez’s Stop Deducting Damages Act of 2013 is far more severe, completely disallowing corporate deductions for both punitive and compensatory damages in the context of settlements with the government.
While the viability of these bills, particularly the Stop Deducting Damages Act, is uncertain, having a clearer legal framework in place in this arena would help combat the reality that it is often more profitable for corporations to engage in questionable conduct now, and pay up later.