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New estimates put the federal budget deficit at $331 billion this year, and one reason it’s so big is that companies will be claiming billions of dollars in tax breaks for settling shareholder lawsuits accusing them of corporate malfeasance. For some companies, federal and state tax deductions will amount to as much as 40 cents on every dollar they pay to settle investors’ claims. And given all the major settlements announced this year from the likes of Time Warner Inc., Citigroup Inc., JPMorgan Chase & Co. and many others, that quickly adds up. So next time a company announces a shareholder settlement, taxpayers should be crying foul instead of executives moaning about how it will hurt the bottom line. Take, for instance, the case of Time Warner, which announced earlier this month that it had agreed to set aside $3 billion to cover lawsuits from shareholders over its 2001 merger with America Online. The shareholders claim they were cheated in the merger by inflated revenue claims and improper accounting at AOL. The world’s largest media company said it will pay $2.4 billion to shareholders who bought shares of AOL or Time Warner between Jan. 27, 1999, and Aug. 27, 2002. The company also set aside another $600 million to settle other remaining shareholder litigation. But Time Warner won’t likely take a $3 billion hit from those settlements. As Merrill Lynch research analyst Jessica Reif Cohen explains in a note to clients, the majority of the financial liability will be tax deductible, and insurance could also cover part of those costs. What’s troubling is that this is business as usual in corporate America, and there is nothing illegal about it. According to Lehman Brothers accounting and tax analyst Robert Willens, the tax code allows companies to write off payments to cover private litigation by claiming that the activities that initially led to the lawsuits took place during the normal course of business. That means the costs to settle could be considered “ordinary and necessary” expenses. They also get to write off their legal fees. “It doesn’t really matter how heinous or reprehensible the conduct was,” Willens said. “They still get to take the deduction.” And those deductions can mean big savings for companies — and big losses in tax revenue for the government. Willens said the tax deduction could turn out to be as much as 40 percent, if federal income taxes are estimated at 35 percent and state and local taxes at 5 percent. This is particularly interesting this year because of the many major settlements that recently have been announced. It also comes as the Congressional Budget Office estimates that the federal budget could stay in the red for the next 10 years. Big promised payouts are coming from financial institutions to resolve investors’ claims that they helped hide losses at Enron Corp. before the energy trading giant collapsed as a result of a massive accounting fraud in 2001. Among those who have settled is Citigroup Inc., which agreed to pay $2 billion, and JPMorgan Chase & Co., which agreed to forfeit $2.2 billion. Others that have settled include Lehman Brothers Inc. and Bank of America Corp. There has also been the settlement of a class action lawsuit brought by former investors in WorldCom Inc., who claimed the financial institutions that underwrote or traded WorldCom securities should have been aware of ongoing fraud at the company. WorldCom collapsed in an $11 billion accounting fraud in 2002. About $6 billion in settlements have been reached in that case, including $2 billion from JPMorgan and $2.58 billion from Citigroup. What’s also interesting in the WorldCom case is that while the companies involved get to take a tax deduction on their settlements, the 12 former board members of the company who reached their own settlement for $24.75 million won’t get any tax breaks, according to attorney Leonard Barrack, who was lead co-counsel in the case against WorldCom brought by New York State Comptroller Alan Hevesi. It seems that corporate America, as usual, gets to live by a set of rules that often allow someone else to pay the price. Copyright 2005 Associated Press. All Rights Reserved. This material may not be published, broadcast, rewritten, or redistributed.

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