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This morning’s settlements between the Commodity Futures Trading Commission (CFTC) and the Office of the Comptroller of Currency (OCC) with multiple banks charged with manipulating foreign exchange markets will likely prevent the banks from deducting the payments from their taxes because the $1.4 billion in payments to the CFTC and $950 million to the OCC are explicitly deemed a “penalty.”
“The CFTC and the OCC protected taxpayers by specifically calling the payments a penalty. As other US regulators hammer out their own settlements, they should do the same,” said Michelle Surka, program associate with the United States Public Interest Research Group. “It’s an outrage that the Justice Department or other agencies so often dilute the value of settlements by failing to include similar language.”
The tax code Section 162(f) forbids deductions for fines or penalties paid to the government. Yet federal agencies such as the Justice Department often fail to specify if a payment is a penalty or designate only a fraction of the total settlement as a penalty. In a recent case, the Justice Department even took the additional step to spell out that no part of the final settlement constituted “an agreement by the United States concerning the Federal Settlement Amount for purposes of the Internal Revenue laws,” leaving the door open for the corporation to deduct the entirety of its payment.
By specifying that the $2.35 billion in payments are penalties, the CFTC and OCC together are preventing the banks from taking a likely $822,500,000 tax windfall, which would have largely shifted the burden back onto the Treasury and ultimately onto ordinary taxpayers. A GAO study in 2005 found that unless settlements include specific language to forbid it, companies treat the payments as ordinary business costs and write them off as tax deductions.
Some agencies do a better job than others at including language to protect the after-tax value of settlements. The EPA almost always specifies that payments are penalties. The Securities Exchange Commission (SEC) and the Consumer Financial Protection Bureau (CFPB) typically take the additional step of deeming that payments made in settlements are “penalties to the government for all purposes, including tax purposes”, or they add a section explicitly denying the right to apply for any tax deductions.
“The CFTC and the OCC have likely saved taxpayers a lot of money here. But they can better ensure that banks don’t claim tax deductions for their misdeeds by using the kind of ironclad language typically used by the CFPB,” said Surka.
The Department of Justice, the Federal Reserve, and New York’s Department of Financial Services have not announced their expected settlements yet regarding the investigations into foreign exchange benchmark manipulation.
“The remaining agencies should ensure their settlement payments are effective deterrents to future misbehavior and not ordinary costs of doing business,” said Surka. “By following this example and specifying any payments made as penalties, they can protect American taxpayers while protecting the integrity of the market.”
You can read U.S. PIRG’s research report on the tax implications of legal settlements, “Subsidizing Bad Behavior: How Corporate Legal Settlements for Harming the Public Become Lucrative Tax Write-Offs.
U.S. PIRG created a fact sheet on use of the settlement loophole by Wall Street financial firms.
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