Damages: Deductible?

It’s a fact of life that businesses get sued. Even if they win, there are legal and related fees. What if they lose and have to pay compensatory and perhaps also punitive damages? Perhaps also some fines to the government? What is deductible for tax purposes? A recent case from the First Circuit Court dealt with an action involving the False Claims Act with total damages of just over $486 million!

I had a blog post (9/02/14) about this case a few weeks ago, noting the challenging vocabulary used by the judge and a few quotes from Shakespeare he included.

This topic also raises an important consideration for tax reform purposes. Should any of these damages be tax deductible? Arguably, compensatory damages (for making the injured party whole), seem to be a part of business – accidents will happen, mistakes will be made. But should all mistakes be deductible or would it be greater punishment to deny a tax reduction for the damages? I note two legislative proposals at the end of the article. On a related topic, President Obama proposes to deny a deduction for punitive damages (FY2015 Greenbook, page 101).

What do you think a business should be allowed to deduct and not deduct regarding various damages?

Original Post By:  Annette Nellen

Annette Nellen, CPA, Esq., is a professor in and director of San Jose State University’s graduate tax program (MST), teaching courses in tax research, accounting methods, property transactions, state taxation, employment tax, ethics, tax policy, tax reform, and high technology tax issues.

Annette is the immediate past chair of the AICPA Individual Taxation Technical Resource Panel and a current member of the Executive Committee of the Tax Section of the California Bar. Annette is a regular contributor to the AICPA Tax Insider and Corporate Taxation Insider e-newsletters. She is the author of BNA Portfolio #533, Amortization of Intangibles.

Annette has testified before the House Ways & Means Committee, Senate Finance Committee, California Assembly Revenue & Taxation Committee, and tax reform commissions and committees on various aspects of federal and state tax reform.

Prior to joining SJSU, Annette was with Ernst & Young and the IRS.

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