Purdue settlements and others as tax deductions

In America, litigation and lawyers are costs of doing business. Businesses can and do deduct their legal costs. And in most cases, when they have to pay out settlements, those are deductible business expenses too. That seems obvious, but aren't their exceptions?

Yes, there are a few. Starting in 2018, under the so-called Weinstein provision, defendants cannot deduct legal fees or settlement payments that dispose of confidential sexual harassment claims. The deduction is allowed, but only if the settlement agreement does not require confidentiality. See IRC Section 162(q). There are likely to be some tax disputes about the bounds of this rule, and whether companies can ever draft their way around it.

Another exception relates to fines and penalties. The tax code says you generally cannot deduct them. What about the big pharma companies such as Purdue and others, who are settling up with governments and private parties over their alleged role in causing or enabling the opioid crisis? The settlements are notable in size, totaling hundreds of millions of dollars. But they seem to have one thing in common: taxes.

It turns out that Purdue Pharma and other companies may have structured their settlements so they can still deduct their opioid settlements. Plainly, tax deductions make any legal settlement less painful, and deductions are standard fare for business. That's hardly a new concept, nor is uneasiness about some of the rules.

In 1961, President John F. Kennedy told Congress, ''The slogan -- 'It's deductible' -- should pass from our scene.'' JFK made the comment about expense accounts and business entertainment, but it has broader application, and still seems timely over half a century later. When the ''It's deductible'' mantra comes up in cases that suggest corporate wrongdoing, emotions on this issue can run especially high.

You might think the tax law would prevent deductions for all fines, but that is not so clear. For decades, Section 162(f) of the tax code has prohibited deducting any fine or similar penalty paid to a government for the violation of any law. That includes criminal and civil penalties, as well as sums paid to settle potential liability for a fine. This sounds absolute, but the law is riddled with exceptions.

To begin with, the rules cover only government payments, and creative companies can often find ways to write off even the biggest payments. After all, many fines are not made to punish, but to fund some kind of remediation, and that can make a difference. For example, BP probably wrote off a majority of its $20.8 billion out-of-court settlement for the Deepwater Horizon oil spill. The deal designated only about one quarter, $5.5 billion, as a non-tax-deductible Clean Water Act penalty.

Congress has pushed back on such practices. In 2017, the tax rules were tightened by the Trump tax reform law. Even under the new rules, however, it is still permissible to write off certain payments of restitution or amounts paid to come into compliance with law. Some settlement agreements contain an explicit no-deduction provision.

For example, the Department of Justice expressly blocked Credit Suisse from deducting its $2.6 billion settlement for helping Americans evade taxes. The same was true of the BNPP terror settlement, which states that BNPP will not claim a tax deduction. But various government agencies have seemed reluctant to develop or enforce policies, so it seems to be a hit or miss affair.

One big critic of deductible settlements is U.S. Public Interest Research Group, which often rails against tax deductions by corporate wrongdoers. U.S. PIRG has a research report, "Settling for a Lack of Accountability," that details the tax deductions corporations can claim for legal settlements. The group has asked the Justice Department to deny tax deductions for many corporate defendants.

Some opioid settlements appear to be structured in tax-efficient ways. For example, Teva Pharmaceuticals agreed to an $85 million settlement that is expressly labeled as restitution. Notably, that is one of the exceptions allowed in the 2017 tax law that tried to clamp down on deductions. McKesson, too, might have been thinking about taxes in its $37 million settlement with West Virginia. It also says the settlement is compensatory and not punitive, and makes clear it is not a fine or penalty.

The granddaddy settlement is Purdue Pharma's $270 million settlement with the Oklahoma attorney general. This one has strange mechanics, with an irrevocable line of credit that is a type of installment plan, coupled with donations to charity. Even here, though, tax deductions seem likely to be available despite the fine-like context and the arguably forced nature of the charitable donations.

Predictably, many companies may argue that they have an obligation to shareholders to minimize the company's taxes, and to claim tax deductions whenever they are entitled to them. Sometimes the deductions are not so clear, as the tax law is frequently made up of shades of gray. However, some groups are pushing for reform.

U.S PIRG has suggested that express prohibitions on deducting payments can sometimes be put in settlement agreements. Although proponents of such prohibitions, including Sen. Charles Grassley (R-Iowa), have talked about it for more than a decade, it seems hard to get it done. Some companies expressly agree not to deduct payments.

For example, when Tesla and Elon Musk settled with the SEC for $20 million each, a court filing said Tesla expressly agreed not to claim a tax deduction for its $20 million. Had it not been for that agreement, the tax write-offs don't seem to have been prohibited. After all, the SEC said the $40 million in penalties will be distributed to harmed investors under a court-approved process. That sounds like restitution, which often means a tax deduction. 