When I was a little girl, rather than completely clean up my room, I used to decorate it. I’d make a tissue flower and put it in the corner or hang a lovely paper chain on the bed. I guess I figured that if I prettied it up a bit, it would distract my parents from the rest of the disaster area. It never worked.
Even though I learned this lesson by age 8 or so, Congress is still struggling with the concept. The American Jobs and Closing Tax Loopholes Act of 2010 hasn’t passed despite the fact that the bill has a few important and time sensitive provisions. And rather than clean up what’s in it, the plan has been to continue to tack on additional stuff. Apparently, that’s going to make it more appealing.
(Note to Congress: All of the tissue flowers in the world aren’t going to make that s corps provision any more palatable.)
Last week, Sen. Harry Reid (D-NV) introduced yet another amendment. Reid proposed the elimination of the federal tax deduction for companies who pay punitive damage awards. It was ostensibly offered to offset the cost of extending the homeowner’s credit through September 30, 2010. The amendment passed with a vote of 60 to 37 – exactly 60 votes were needed. The vote was largely along party lines with only one Democrat (Sen. Nelson from Nebraska) opposing and only four Republicans (Sen. Collins from Maine, Sen. Ensign from Nevada, Sen. Gregg from New Hampshire and Sen. LeMieux from Florida) crossing the aisle in favor.
Damages from court cases have long been controversial. In a court case, compensatory damages are those damages which a defendant pays in order to compensate the plaintiff for losses. The idea is that compensatory damages are supposed to put the plaintiff back in the position that he or she was in before the harm occurred – more or less, to make the plaintiff whole again. These are sometimes referred to as “actual damages.”
In some civil cases, punitive damages are also awarded to the plaintiff as a means of punishing the defendant. These are considered non-compensatory and are meant to send a message to the defendant that “outrageous” (insert Lionel Richie’s voice here if it helps you, I do) conduct isn’t tolerated. The hope is that it will deter similar bad behavior from the defendant and send a message to others.
From a tax perspective, punitive damage awards paid out by defendants are currently deductible to businesses as “ordinary and necessary” business expenses. They are also taxable to the plaintiff (you can read more about the tax consequences of settlements and damages here).
President Obama had initially proposed eliminating the deduction for punitive damages in his fiscal 2010 budget. The proposal was met with a host of opposition, mostly from the business community. Taking the deduction away is considered bad for business because the fear is that increasing the potential tax bill for defendants might encourage companies to settle not necessarily because they did something wrong but because they can’t afford the possibility that a jury might think that they did. Additionally, since costs related to settlements would still be deductible, there would be a tax incentive to settle bad cases.
On the flip side, those that support the elimination of the deduction argue that allowing the payment of a punishment to be deductible is simply bad tax policy. If the idea of punitive damages is to send a message, allowing a deduction for it, proponents argue, is sending a different kind of message – and it’s not a good one.
For now, the Senate has agreed that companies should not be allowed to take a deduction for punitive damage awards. I’m not sure that it will stick should it be signed into law – you can bet this one will be challenged. If that happens and if I were a betting girl (and I’m not, it would make my mom cry), I’d say that we’ll see it in the Supreme Court in a few years.
What do you think? Good sense or reactionary politics?
If eliminating the deduction for puntives becomes law, does it also mean that puntive damages would no longer be taxable income for the recipients? That seems to me to be a bigger incentive (payoff) for the trial attorneys and consumers. I doubt companies now shrug their shoulder at possible puntives and say, “Oh well, it’s deductible.” If puntives are no longer deductible AND taxable to plaintiffs, I guess the government will get a two-fer!
David, I don’t know. I’ve been poking around but I haven’t seen that it’s to be the case – I dunno if they’ve thought it out that much. But I agree with you. One of the first things that you learn about tax law is that the Tax Code is predicated on items of income matching deduction items. For example, you get a deduction for alimony payments and the recipient picks it up as income. That premise controls a lot of how our Tax Code works. So it would be odd, I think, to eliminate the deduction but not the tax on the other side. However, the talking points on the amendment are clearly that it’s meant to raise income to offset the homebuyer’s credit. That wouldn’t happen if you eliminated the tax on the other side.
I have no opinion on the legislation, but I want want WANT Lionel Ritchie’s tux.
Sparkly plaid is the new black.