WASHINGTON -- Two senators introduced legislation Wednesday to outlaw tax deductions by companies for penalties paid as part of government settlements, responding to concerns that JPMorgan Chase & Co. could end up with a huge write-off if it settles civil investigations with the Justice Department over mortgage bonds.
Sens. Jack Reed (D-R.I.) and Charles E. Grassley (R-Iowa) said they wanted to close a loophole that allows companies to "reap tax benefits" for payments made to settle allegations of "illegal corporate behavior."
"A penalty is supposed to deter others because it causes pain to a company's bottom line," Reed said. "If a company is paying thousands, millions, or even billions in fines, it shouldn't save money for those same misdeeds. It should be held accountable."
Their bipartisan Government Settlement Transparency and Reform Act is similar to the Stop Deducting Damages Act introduced in the House last week by Democrats Peter Welch of Vermont and Luis Gutierrez of Illinois.
Federal law prohibits companies from deducting fines and other penalties paid to the government. But the law allows write-offs for settlement payments "to non federal entities," Reed and Grassley said.
A report in January by the U.S. Public Interest Research Group found that even though the law is clear that punitive fines and penalties issued by government agencies are not tax deductible, settlements often are not clear on how much of the payment amount is punitive.
The ambiguity allows companies to deduct the cost of some of the penalties.
The Wall Street Journal reported last week that JPMorgan's $5.1-billion settlement with the federal regulator for Fannie Mae and Freddie Mac would be entirely tax deductible, giving the bank as much as a $1.5-billion write-off.
JPMorgan could get more deductions if other parts of a potential $13-billion settlement with the Justice Department are deemed tax deductible.
That has sparked anger among some lawmakers and consumer advocates.
U.S. PIRG and Americans for Tax Fairness delivered a petition with 160,000 signatures to the Justice Department on Monday calling for language in any JPMorgan settlement prohibiting a tax write-off for the penalties.
U.S. PIRG's report said agencies have specifically indicated in some settlements, including a $4-billion agreement between the Justice Department and BP over the gulf oil spill, that the penalties were not tax deductible.
"Allowing major corporations to write off penalties for breaking the law and harming the public is impossible to justify to taxpayers," said a letter last week to Atty. Gen. Eric Holder from Democratic Sens. Mazie Hirono of Hawaii, Bill Nelson of Florida, Elizabeth Warren of Massachusetts, Martin Heinrich of New Mexico and Sheldon Whitehouse of Rhode Island.
They called for Holder to ensure that any settlement "explicitly prohibits JP Morgan Chase from claiming a tax deduction for any part of the settlement amount."
The bill by Reed and Grassley would require pre-filing agreements as part of government settlements that would specify the tax treatment of payments. The legislation also would clarify rules about what types of penalties are punitive.
"A penalty should be meaningful or it won't have the deterrent effect it's supposed to have," Grassley said. "This issue comes up regularly, and this bill would make deductibility clear going forward."