Ordinary business expense

From today’s NYT:

But even if Hyundai is eventually forced to pay the full amount of the damages, the punishment could be substantially reduced through a tax loophole that permits the company to save millions of dollars by deducting any court-ordered punitive damages as an ordinary business expense. The result, critics say, is that taxpayers are in effect subsidizing corporate misconduct.

What’s terrible about this isn’t that companies are allowed to claim the fines they pay for malfeasance are an ordinary business expense.  What’s terrible is that it’s true.

Update:  I misspoke, as a commenter points out.  A “fine” — that is, a penalty you pay to the government — is not deductible.  What may be deductible are punitive damages, paid to people you injured or whose river you despoiled.  Prepare your return accordingly!

5 thoughts on “Ordinary business expense

  1. Mark Badros says:

    Contrary to your statement after the excerpt from the Times, fines (i.e., penalties paid to a government) are never deductible. Punitive damages arising out of action in the ordinary ordinary course of a defendant’s business are deductible; however, they are income to the recipient, who presumably pays taxes on them.

  2. JSE says:

    Thanks, changed!

    But what relevance does it have that the injured party pays taxes on the damages?

    (Note: I looked this up, and it seems that you don’t pay taxes on compensation for injuries, loss of property value, etc., but you do if the received damages are purely punitive: see http://www.irs.gov/pub/irs-pdf/p4345.pdf)

  3. Mark Badros says:

    Since the injured party pays taxes on the damages, the U.S. Treasury (and the federal taxpayers) are essentially “made whole” (subject to the discrepancy between the federal corporate rate and the marginal individual rate, which is negligible). So I don’t believe it’s the case (broadly speaking) that taxpayers are subsidizing punitive damages, as I thought the original posting said/implied (prior to the recent edits). The fact that you don’t pay taxes on compensation for injuries is analogous to the principle that you are merely being made whole for what has been taken from you — and that it’s doesn’t represent income (i.e., the accretion of wealth).

  4. JSE says:

    Aha, now I get it! So I think this is a problem both for what I said and for the New York Times’s account (or at least the view they ascribe to unnamed “critics.”) In the situation where there’s no deduction, the money transfer is treated like any other transfer and is revenue-generating for the government. With the deduction, the transfer is (apart from difference in rates, as you say) revenue-neutral for the government, and the issue is just that the nominal damages have to be (1 + tax rate)*N in order to achieve actual transfer of N. Have I got it right now?

  5. Mark Badros says:

    Yes, I think that’s right … p.s. I think we have friends in common – Brian and Keith Conrad – and I’m originally from Maryland too – and remember the cover story article about you in the Wash Post magazine from ages ago

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