Despite opposition from the business community, the Senate appears ready to eliminate the federal tax deduction for companies who pay punitive damages awards.
The Senate on Wednesday, voting 60-37, approved an amendment to the American Jobs and Closing Tax Loopholes Act of 2010 that ends the deduction in order to pay for an extension of the First Time Home Buyer Credit program. The jobs bill is still pending final approval in the Senate; it was passed by the House of Representatives last month.
President Barack Obama proposed eliminating the deduction in his fiscal 2010 budget. The administration explained at the time that "the deductibility of punitive damage payments undermines the role of such damages in discouraging and penalizing certain undesirable actions or activities."
Under current law, companies are permitted to deduct almost all ordinary and necessary business expenses, including compensation, operating expenses, and compensatory and punitive damages.
In a June 16 letter to senators, R. Bruce Josten, executive vice president of the U.S. Chamber of Commerce, warned that "plaintiffs' lawyers would use this provision to force the hand of business to settle frivolous or speculative cases, so that companies might deduct the amounts of those settlements rather than risking incurring non-deductible punitive damage awards."
The deduction for punitive damages awards has been controversial over the years and still divides tax scholars and practitioners.
Some, such as Dan Markel and Gregg Polsky of Florida State University College of Law, have argued that, lacking a punitive damages deduction, defendants will simply disguise those damages as compensatory damages in lawsuit settlements. Others say it is disingenuous to "punish" a company with a punitive award and then allow it to deduct the amount to lower its tax bill.
The Senate amendment, sponsored by Majority Leader Harry Reid, D-Nev., would apply to damages paid or incurred after Dec. 31, 2011. The provision is estimated to raise $315 million over 10 years.
This article first appeared on The BLT: The Blog of Legal Times.