BILL ANALYSIS Ó
AB 458
Page A
ASSEMBLY THIRD READING
AB 458 (Wieckowski)
As Introduced February 19, 2013
2/3 vote. Urgency
REVENUE & TAXATION 6-3APPROPRIATIONS 12-5
-----------------------------------------------------------------
|Ayes:|Bocanegra, Gordon, |Ayes:|Gatto, Bocanegra, |
| |Mullin, Pan, | |Bradford, |
| |V. Manuel Pérez, Ting | |Ian Calderon, Campos, |
| | | |Eggman, Gomez, Hall, |
| | | |Ammiano, Pan, Quirk, |
| | | |Weber |
| | | | |
|-----+--------------------------+-----+--------------------------|
|Nays:|Dahle, Harkey, Nestande |Nays:|Harkey, Bigelow, |
| | | |Donnelly, Linder, Wagner |
| | | | |
-----------------------------------------------------------------
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,
2014.
3)Takes effect immediately as a tax levy.
FISCAL EFFECT : The Franchise Tax Board estimates revenue gains
of $400,000 in fiscal year (FY) 2013-14, $1 million in FY
2014-15, and $1.1 million in FY 2015-16.
COMMENTS :
1)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
AB 458
Page B
it does take on one business tax deduction that I
believe [Republicans] and Democrats can agree is
logically indefensible.
Punitive [damages] 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
[by] 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.
The purpose of punitive damages penalties is to
penalize and deter egregious misconduct - malice,
oppression and fraud. "Malice" means conduct which is
intended by the defendant to cause injury or
despicable conduct that is carried on with a willful
and conscious disregard of the rights or safety of
others. "Oppression" means despicable conduct that
subjects a person to cruel and unjust hardship in
conscious disregard of that person's rights. "Fraud"
means an intentional misrepresentation, deceit, or
concealment of a material fact known to the defendant
with the intention on the part of the defendant of
thereby depriving a person of property or legal rights
or otherwise causing injury.
Allowing wrongdoers to deduct punitive damages
payments on their taxes undermines the very purpose of
punitive damages by making them significantly less
punitive, as [former] New Hampshire Republican Sen.
Judd Gregg has noted. Sen. Gregg is one of many
Republicans in recent years who have given bipartisan
support in Congress for proposals to eliminate the
federal tax deduction for punitive damages, calling it
the most outrageous section of American tax law.
(Reference omitted.) [?]
AB 458
Page C
Although federal efforts have not been successful,
California does not need to wait for federal action to
correct this irrational and self-defeating tax policy
that rewards the worst wrongdoers with a significant
tax break. California has never affirmatively adopted
this policy - we simply follow the general federal
rule allowing deductions for ordinary and necessary
business expenses. But punitive damages are neither
ordinary nor necessary. They are financial penalties
that are intended to serve the same purpose as
criminal fines and statutory penalties, which
appropriately are not deductible. (See 26 U.S.C.
§162(f).) In fact, like California the federal
deduction is not found in the U.S. Internal Revenue
Code; it is simply the absurd result of a 1980 IRS
administrative ruling. We need not continue to follow
this unintended and irresponsible IRS decision, and we
should not. Eliminating this deduction will certainly
not balance California's budget, or even make a
significant dent in the problem. But that is not the
purpose of this bill. What it is designed to do is to
prevent the worst kind of wrongdoing, and to take away
the rewards we now provide to those bad actors.
2)Proponents state:
Deductibility is always permitted for the cost of
doing business, but punitive damages do not represent
such costs - they are court judgments that make clear
that the business has avoided the law in some
important way which endangers the public. Ordinary
taxpayers cannot deduct fines and penalties, and the
exception for punitive damages for businesses is not
only unnecessary but inappropriate, since these
damages are not part of the ordinary cost of doing
business. California has not always conformed to
administrative rulings at the IRS level, and it should
not conform to this ruling either.
3)Opponents state:
This bill would eliminate the current deduction
allowed for punitive damages in connection with any
judgments, settlements or actions. Punitive damages
AB 458
Page D
are often times not associated with any culpability on
the part of [the] company or association, but little
more than a deep pocket to pursue. We are concerned
that by disadvantaging California businesses from the
current business deduction will [sic] ultimately hurt
employers, employees and our construction economy
overall. We cannot afford to negatively impact the
companies that are still here, providing critical jobs
to Californians.
4)Assembly Revenue and Taxation Committee staff comments:
a) Current law . "Compensatory" damages are intended to
redress the concrete loss that a plaintiff has suffered by
reason of the defendant's conduct. In order to be awarded
compensatory damages, a plaintiff must prove that he/she
has suffered legally recognized harm that is compensable by
a certain amount of money that can be objectively
determined by a judge or jury. "Punitive" or "exemplary"
damages, however, are damages intended to punish or deter
the defendant and others from engaging in similar conduct
that served as the basis of the lawsuit. Thus, juries
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 extent sought by the jury. This is because punitive
damages paid by business defendants are tax deductible. In
the end, these businesses often pay far less than the
juries intended.
b) Why have punitive damages ? The United States (U.S.)
Supreme Court has continually reaffirmed the goals of
punishment and deterrence, stating that punitive damages
are "private fines levied by civil juries to punish
reprehensible conduct and to deter its future
occurrence.<1>" Absent the threat of punitive damages, a
business, with ample means, might choose to engage in
egregious acts that result in only a small amount of purely
economic damage. In such cases, rectifying the behavior
may be more expensive than paying compensatory damages to
individual plaintiffs. For example, assume ABC Company
operates a grocery store and overcharges $1 to every
--------------------------
<1> Cooper Indus., Inc. v. Leatherman Tool Group, Inc., 532 U.S.
424, 432 (2001).
AB 458
Page E
customer at the register. Because the economic damages are
nominal and because not everyone who is injured will demand
their dollar back, these egregious acts will likely
continue. Punitive damages in this scenario would be
appropriate to punish and deter ABC Company from engaging
in egregious acts of this kind.
c) Frequency of punitive damages . Proponents for reform
have argued that punitive damages increase the costs of
doing businesses and, therefore, increase the cost of goods
and services to consumers. However, according to Professor
Patrick A. Gaughan, punitive damages are imposed relatively
infrequently<2>. Specifically, the American Bar Foundation
found that punitive damages were awarded in only 4.9% of
cases<3>. Additionally, the Department of Justice released
a study that showed an aware rate of only 6%<4>. The
numbers vary depending on the study, but it is clear that
punitive damages are not awarded very frequently.
d) Business vs. non-business . According to Professors
Gregg D. Polsky and Dan Markel, current law treats
defendants differently based on whether their wrongdoing
was business-related<5>. As an example, assume that
Defendant A, a self-employed courier, drives recklessly to
deliver a package on time, while Defendant B drives
recklessly to get to a movie on time. Assume also that
each defendant injures and causes the same harm to a
victim, and that each defendant is in the same financial
position. In both cases, a jury might award $100,000 in
punitive damages, believing that both defendants will be
equally punished. However, because Defendant A's driving
was in the course of her courier business, Defendant A gets
to deduct the $100,000, significantly reducing after-tax
cost.<6> In addition to treating business and non-business
defendants differently, current law also treats business
--------------------------
<2> Patrick A. Gaughan. "The Economics of Punitive Damages."
Econometrix Research Associates, Inc. (2005)
<3> Id.
<4> Id.
<5> Greg D. Polsky and Dan Markel, Taxing Punitive Damages, 96
VA. L. REV. 1295, 1309 (2010).
<6> Id.
AB 458
Page F
defendants differently based on the marginal tax rate<7>.
If two defendants, both in the same financial position,
similarly injure a plaintiff, the defendant with the higher
marginal tax rate will have a lower after-tax punishment.
e) Hiding punitive damages in pre-trial settlement
agreements . Professors Polsky and Markel argue that a
blanket non-deductibility rule would be ineffective in
solving the "under-punishment" problem described above.
Specifically, the authors argue that businesses could
circumvent this rule by disguising punitive damages as
deductible compensatory damages in pre-trial
settlements.<8> 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. <9> However,
making juries tax-aware may be expensive and difficult to
accomplish. Expert testimony would likely be required to
explain the issues of deductibility, gross-up calculations,
and marginal tax rates. Assuming expert testimony can
properly inform the jury, jury instructions may later serve
as a basis for challenging the amount of punitive damages.
Additionally, the U.S. Supreme Court has imposed due
process limitations on punitive damages. In State Farm v.
Campbell, the Court announced that "few awards exceeding a
single-digit ratio between punitive and compensatory
damages, to a significant degree, will satisfy due
--------------------------
<7> Id. at 1310.
<8> 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)).
<9> 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.
AB 458
Page G
process."<10> This raises concerns with respect to
tax-aware juries that have increased the amount of punitive
damages based on after-tax punishment. It is unclear if
courts will address issues of due process based on the pre
or after-tax figures. As of now, it appears that courts
only look at pre-tax punitive damages.
Analysis Prepared by : Carlos Anguiano / REV. & TAX. / (916)
319-2098
FN:
0000737
---------------------------
<10> State Farm Mut. Auto. Ins. Co. v. Campbell, 538 U.S. 408,
425 (2003).