BILL ANALYSIS Ó
AB 1276
Page A
ASSEMBLY THIRD READING
AB 1276 (Feuer)
As Amended March 31, 2011
2/3 vote. Tax levy
REVENUE & TAXATION 5-3 APPROPRIATIONS 12-5
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|Ayes:|Perea, Beall, Charles |Ayes:|Fuentes, Blumenfield, |
| |Calderon, Fuentes, Gordon | |Bradford, Charles |
| | | |Calderon, Campos, Davis, |
| | | |Gatto, Hall, Hill, Lara, |
| | | |Mitchell, Solorio |
| | | | |
|-----+--------------------------+-----+--------------------------|
|Nays:|Donnelly, Harkey, |Nays:|Harkey, Donnelly, |
| |Nestande | |Nielsen, Norby, Wagner |
| | | | |
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SUMMARY : Bars taxpayers from claiming a deduction for amounts
paid for punitive damages. Specifically, this bill :
1)Provides that no deduction shall be allowed for any amount
paid or incurred for punitive damages in connection with any
judgment in, or settlement of, any action.
2)Applies to taxable years beginning on or after January 1,
2012.
3)Takes immediate effect as a tax levy.
EXISTING LAW :
1)Allows plaintiffs, in non-contract cases, to recover
"punitive" or "exemplary" damages. These damages are limited
to cases where it is proven, by clear and convincing evidence,
that the defendant has been guilty of "oppression, fraud, or
malice," as defined.
2)Allows taxpayers to deduct ordinary and necessary business
expenses incurred in carrying on a trade or business.
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3)Allows for the deduction of punitive damages paid by
businesses as an ordinary and necessary business expense.
FISCAL EFFECT : The Franchise Tax Board estimates no revenue
impact in fiscal year (FY) 2011-12, and revenue gains of $1.8
million in FY 2012-13, and $1.3 million in FY 2013-14.
COMMENTS :
The author has provided the following statement in support of
this bill:
There has been much discussion recently about whether
California corporations pay their fair share of taxes.
This bill does not attempt to address that issue, but it
does take on one business tax deduction that I believe
ÝRepublicans] and Democrats can agree is logically
indefensible.
Punitive Ýdamages] should not be tax-deductible as ordinary
and necessary business expenses. Punitive damages are not
like salaries, equipment or operating expenses. They are
penalties for the most reprehensible violations of our laws
that are proven Ýby] the highest standard of evidence in
civil courts. (Reference omitted).
Tax deductions are intended to reward or incentivize good
behavior. A deduction for punitive damages works in
exactly the opposite direction - it rewards and subsidizes
the worst behavior by the most irresponsible corporate
citizens.
Committee Staff Comments:
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1)An overview of current law . As the name implies,
"compensatory" damages are awarded to compensate a plaintiff
for a loss or injury suffered as a result of another's breach
of duty. "Punitive" or "exemplary" damages, by contrast, are
generally not designed to compensate the plaintiff for actual
losses, but rather to deter the defendant (and other similarly
situated persons) from engaging in the underlying behavior
that caused harm. Thus, juries typically assess punitive
damages in an amount that they believe will be sufficient to
"punish" the defendant and deter future wrongdoing.
Defendants, however, are not always punished to the degree
sought. This is because punitive damages paid by business
defendants are tax deductible.<1> As a result, these
businesses often pay far less (in real dollars) than the jury
intended.
2)Proposals for reform . To address this problem of
"under-punishment," several scholars and policymakers,
including President Obama, have suggested eliminating the
deductibility of punitive damages payments.<2> President
Obama's proposal, in particular, would deny a deduction for
punitive damage payments, whether made pursuant to a judgment
or in settlement of a claim. Because it has become
increasingly common for companies to carry insurance covering
punitive damages, the administration proposal would also treat
damages paid by an insurer as gross income of the insured.
Moreover, to aid enforcement of this provision, insurers would
be required to report such payments to both the insured and
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<1> Internal Revenue Code Section 162(a) (allowing deductions
for ordinary and necessary business expenses incurred in
carrying on a trade or business); Rev. Rul. 80-211, 1980-2 C.B.
58 ("Amounts paid as punitive damages incurred by the taxpayer
in the ordinary conduct of its business operations are
deductible as an ordinary and necessary business expense under
section 162 of the Code.").
<2> This proposal has been made several times at the federal
level, notably during the Clinton administration. (See Joint
Committee on Taxation, "Summary of Tax Provisions Contained in
the President's Fiscal Year 2001 Budget Proposal," Feb. 7, 2000
(JCX-13-00), Doc 2000-3833, 2000 TNT 27-25).
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the Internal Revenue Service.
3)Arguments in favor of non-deductibility . Reform proponents
argue that, by providing a deduction, current law hinders both
the deterrent and punitive functions of exemplary damage
awards. Reform proponents also argue that the public fisc
should not subsidize acts of egregious corporate wrongdoing
and that punitive damages should be treated like civil and
criminal fines, for which no tax deduction is allowed.
Finally, proponents note that current law treats similarly
situated defendants inequitably, based solely on whether their
wrongdoing was business-related. Professors Gregg D. Polsky
and Dan Markel provide a useful example of this inequity in a
recent article published in the Virginia Law Review.<3>
Assume Defendant A, a self-employed courier, drives recklessly
to deliver a package on time, while Defendant B drives in a
similarly reckless manner to attend a concert. Assume also
that in both cases, the defendant causes the same harm to a
victim and each defendant is in the same financial position.
In both cases, a jury might award punitive damages of
$100,000. Under current law, however, Defendant A would be
able to deduct the $100,000 award, significantly reducing
his/her after-tax cost. Meanwhile, Defendant B would not
receive the benefit of a deduction.
4)The arguments in opposition : In an article published by The
Heritage Foundation, Hans A. von Spakovsky notes that punitive
damages are most often awarded in cases involving malpractice,
products liability, and business torts. As such, von
Spakovsky argues that eliminating deductibility would
"increase taxes on businesses, as well as the net costs of
litigation, burdening the economy and increasing the costs of
goods and services to the average consumer, including health
care."<4>
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<3> Gregg D. Polsky and Dan Markel, Taxing Punitive Damages, 96
Va. L. Rev. 1295 (2010).
<4> Hans A. von Spakovsky, "Punitive Damages and the Tax Code:
Punishing Business and the Economy." The Heritage Foundation,
No. 60, Nov. 15, 2010.
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5)An alternative approach ?: Professors Polsky and Markel argue
that a blanket non-deductibility rule would, despite its
theoretical elegance, be ineffective in solving the
"under-punishment" problem. Specifically, the authors argue
that businesses could circumvent this rule by disguising
punitive damages as deductible compensatory damages in
pre-trial settlements.<5> Instead, they argue that the
problem would be best addressed by state action to make juries
"tax-aware." Such tax-aware juries, in turn, would be in a
better position to adjust punitive damage awards to impose the
desired after-tax cost on defendants. <6>
Analysis Prepared by : M. David Ruff / REV. & TAX. / (916)
319-2098
FN: 0000965
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<5> Of course, existing law already provides many plaintiffs a
strong incentive to characterize pre-trial settlement awards as
compensatory. This is because, unlike compensatory damages for
physical injuries, punitive damage awards are generally treated
as income for the recipient. (See O'Gilvie v. United States ,
519 U.S. 79 (1996)).
<6> In determining an appropriate financial punishment for
misconduct, jurors are typically instructed to consider a number
of factors, including the defendant's financial condition.
Currently, however, it would not appear that jurors are informed
of the fact that businesses are able to deduct punitive damage
payments as a business-related expense.