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Fines and Penalties: Deductible or Not?

Many of you may remember one of the largest environmental disasters in our nation’s history. Back in April of 2010, BP’s Deepwater Horizon drilling rig exploded, killing 11 men and spilling more than three million barrels of oil into the Gulf of Mexico. The Gulf economy took a huge hit as fisheries were closed and wildlife decreased in the area. Five years later, the Department of Justice finally proposed a settlement agreement that would give around $20.8 billion in restitution to the U.S. and each of the Gulf States.

What makes this case interesting is the fact that a majority of the settlement is looking to be tax deductible to BP. You may be scratching your chin and asking yourself how such a serious fine can actually be a tax write-off. The answer to that lies within the tax code.

Reg. §1.162-21 states that while fines and penalties paid in settlement of a taxpayer’s actual or potential liability are non-deductible, it does note that compensatory damages paid to a government would be deductible. Under the proposed settlement, $5.5 billion goes toward the federal Clean Water Act penalty which would be non-deductible. The rest of the costs would go to natural resource damages, restoration, and claims for reimbursement of federal and state damages. That leaves BP with a whopping $15.3 billion write-off, along with their previous clean-up efforts that cost them $32 billion.

This is not the first case to raise questions about deductible settlements. As society demands more and more transparency in large public cases such as BP’s, there will be a shift in what all the Department of Justice starts to disclose. Already, bills have been proposed to help clarify these after-tax settlement values, so it is only a matter of time before we get some additional clarification on the fines and penalties ruling.

If you have any questions regarding the deductibility of your fines and penalties or any other tax related question, feel free to contact our office at 614.221.1120.

Author: Paige Stacy, CPA
Tax Senior