An aspect of U.S. tax law is being criticized by some lawmakers and consumer groups concerned that it may be worth billions of dollars for JPMorgan Chase in negotiations with the Department of Justice.
An agreement between the government and the bank over mortgage-bond sales that's silent on taxes would let the company take a deduction and shave 35 percent off any settlement cost publicized in headlines. That would, for example, turn an announced settlement of $10 billion into one for $6.5 billion.
"It shouldn't have hidden subsidies or sweeteners in the settlement," said Francisco Enriquez, a tax and budget associate at the U.S. Public Interest Research Group, which says it operates as a counter to big banks. "If the DOJ is in the end going to look for a $6.5 billion price tag, then that's what they should say."
Tax implications are a complicated part of settlement talks between companies and the U.S. government. Companies focused on after-tax costs negotiate with government agencies that may be more concerned about how big a payment they can claim to have extracted than about how much money ends up in the Treasury.
"At dinner parties, a billion sounds better than $700 million, even if a billion is tax deductible and $700 million is not," said Gregg Polsky, a law professor at the University of North Carolina at Chapel Hill who has studied the taxation of penalties and damage payments.
Brian Fallon, a DOJ spokesman, declined to comment because the talks are continuing on resolving multiple legal issues surrounding the mortgage-bond sales. Also declining to comment was Brian Marchiony, a spokesman for the New York-based bank.
U.S. tax law places payments to government agencies into two categories: fines and penalties, which are not deductible, and compensatory damages and restitution, which can be deducted as business expenses.
If a settlement agreement is silent on taxes, a company is free to claim a deduction against the 35 percent federal corporate income tax and state income taxes.
The Internal Revenue Service may challenge the deduction, a path that can lead to litigation over whether payments were deductible restitution or non-deductible penalties.
Some government settlement accords include clauses where companies agree not to take deductions. For example, the agreement this month between the Justice Department and SAC Capital Advisors LP prevented the hedge fund from deducting any of the $1.8 billion payment in that settlement and a related case with the Securities and Exchange Commission.
JPMorgan's $5.1 billion settlement on Oct. 25 with the Federal Housing Finance Agency included no clause limiting tax deductions.
"Absent such an agreement, I think it's pretty clear that virtually all of the payment will be deductible," said Robert Willens, a New York-based tax and accounting consultant.
U.S. lawmakers including Representative Peter Welch, a Vermont Democrat, want the bank to forgo a tax deduction.
"It was the taxpayer who initially funded the bailout of Wall Street," Welch wrote on Oct. 30 to Jamie Dimon, the bank's chairman and chief executive officer. "It was the taxpayer who continues to endure the consequences of the worst recession since the Great Depression. The taxpayer should not, therefore, be required to contribute a nickel towards the fines imposed for conduct that got America into this mess in the first place."
Senator Charles Grassley, an Iowa Republican, and Senator Jack Reed, a Rhode Island Democrat, introduced legislation this month that would require the government and companies to reach advance agreements on how settlements will be taxed.
A 2007 version of the measure was estimated to generate $263 million in government revenue over 10 years, according to Jill Gerber, a spokeswoman for Grassley.
Cases with punitive and compensatory components are complicated by the differing goals of those involved in the negotiations, Polsky said.
"The defendant cares about the after-tax dollars," he said. "The IRS cares about the after-tax dollars. The regulatory agency that's settling the case, they don't seem to care about the after-tax" amount.
Enriquez said settlement deductibility is a systemic issue that amounts to a loophole, letting companies deduct payments that are really being made to avoid formal fines.
"Wrongdoing should not constitute a tax writeoff and wrongdoing shouldn't be subsidized by the American people," he said. "People are just generally quite angry and rightfully so that JPMorgan could get a massive $3.5 billion tax deduction for their suffering."
Willens said lawmakers have become more aware of the deductibility of settlements, making it possible that the JPMorgan agreement could include clauses on taxes to make the real cost more closely match the announced amount.
"Given the outrage that has been expressed by some about the ability to deduct this, including some pretty influential politicians, I would think there probably would be something in the agreement," he said.
The Reed-Grassley bill is S. 1654.