Deducting the cost of disaster
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Note: On February 19, 2015, a federal judge ruled against BP in a motion to lower its maximum civil penalty for Deepwater Horizon. Here is the Friends of the Earth analysis from last September exploring the giant tax break BP may still be trying to wrangle from the disaster.
What sort of thoughts come to mind when you think about BP’s Deepwater Horizon? Do you think greed-fueled nightmare? Do you think out of work fisherman? Or do you think giant, undeserved tax deduction?
Now that a federal judge in Louisiana has declared that the company was “grossly negligent,” the way is clear for fines under the Clean Water Act to be nearly quadrupled, resulting in a potential fine of $18 billion.
This ruling has drawn cheers from environmentalists and raised interesting questions for tax experts. If the fine survives the parade of appeals that BP is already preparing to unleash, how is that money going to be taxed?
First, some terminology.
The U.S. has an income tax for both individuals and companies. The way this works is that companies are taxed on the income they generate; it also means that they can deduct the expenses they incur generating that income. This basically means that companies get to subtract the cost of “ordinary and necessary” business expenses like wages, rent and materials from their overall income, thereby lowering the amount of money they actually pay taxes on.
The problem is that if you’re an oil company, the cost of cleaning up after an oil spill is considered an ordinary business expense by the Internal Revue Service. Generally speaking, so are the costs you have to pay out in compensation when other damaged parties decide to sue you.
This is how BP treated the $37.7 billion fund it established for cleanup and settlement costs. By claiming it as a deduction, the company managed to capture a tax windfall of $10 billion.
As the U.S. Public Interest Research Group points out, this deduction doesn’t just mean that perhaps the worst environmental disaster in U.S. history was treated as an “ordinary and necessary” business event; it also means that the tax burden resulting from this deduction was shifted from one very guilty party onto American taxpayers.
This is not the first time a giant oil company has handed part of the bill for its negligence to taxpayers. In 1989, after 257,000 barrels of oil from the Exxon Valdez ended up in Alaska’s Price William Sound, Exxon was able to deduct more than half of the $900 million it paid in civil damages.
Exception to the rule?
If BP were forced to pay the maximum $18 billion in fines that emerged as a possibility last week in Louisiana, the tax status of that money is unclear. On the one hand, the U.S. expressly forbids fines and penalties paid to government agencies for violations of the law from ever counting as tax deductions. On the other hand, almost nothing about U.S. tax law is simple or transparent.
In fact, according to tax expert Robert Wood, there is some potential for BP to try and exploit legal gray areas. For example, if the fine was meant to be punitive — to punish the wrong-doer and deter others from doing the same — then it probably isn’t deductible. But if the fine was meant to be remedial — to repair the losses of damaged parties — then BP has a fighting chance to claim a deduction.
A lot of money is riding on how this fine is treated. If the full $18 billion were deducted, it could mean a tax windfall for BP of $6 billion that the rest of us would have to pay for.
If BP tries to settle out of court, it could seek a specific understanding from the government that its fines are deductible. Some of the financial sector giants that cratered the economy in 2008 have tried to use this strategy, albeit with mixed success. Admittedly, this didn’t work last time when BP settled for $4 billion as its share of the criminal liability for Deepwater Horizon. The Justice Department specifically said no. But considering the amount of money at stake under these new fines, BP may just want to try again.
Oil companies already enjoy some of the lowest tax rates in our entire economy. Considering the amount of oil money flowing into Congress — $35 million in the last cycle alone — it is no surprise that environmental disasters like Deepwater Horizon often result in tax breaks for the companies that perpetrate them.
This means that Congress needs to clarify the tax code so that egregious disasters resulting from criminal behavior are not treated as normal business expenses or opportunities for clever accounting. If we do anything less, even more of the Deepwater Horizon cleanup could show up on our tax bill — to say nothing of the next big spill.
Photo: Johm Amos, FSU, Flickr via Creative Commons