BILL ANALYSIS �
SENATE GOVERNANCE & FINANCE COMMITTEE
Senator Lois Wolk, Chair
BILL NO: AB 458 HEARING: 8/14/13
AUTHOR: Wieckowski FISCAL: Yes
VERSION: 2/19/13 TAX LEVY: Yes
CONSULTANT: Austin
INCOME TAXES: DEDUCTIONS: PUNITIVE DAMAGES
Repeals authority to deduct punitive damages on personal
and corporate tax filings.
Background and Existing Law
Current law authorizes individuals and corporations to file
tax deductions for the payment of monetary damages in legal
cases. Under existing law plaintiffs can seek "punitive"
or "exemplary" damages in legal cases where the defendant
is guilty of "oppression, fraud, or malice." "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.
California courts hold that punitive damages punish the
defendant and deter similar conduct. The goal of
deterrence of similar conduct is both for the specific
defendant who may repeat or continue offensive behavior and
to other potential parties who may commit similar offenses.
Punitive damages are not intended to compensate a
plaintiff unlike compensatory damages, which are intended
for compensation.
The Book of Approved Jury Instructions (BAJI) provides that
a jury should consider two factors to determine the amount
of punitive damages to award:
The reprehensibility of the defendant's conduct.
The amount of punitive damages, which will have a
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deterrent effect on the defendant in the light of
defendant's financial condition.
In addition, a defendant may ask that a jury be instructed
to consider that the punitive damages bear a reasonable
relation to the injury, harm, or damage actually suffered
by the plaintiff.
Tax deductions are generally used to encourage certain
behaviors. State law allows taxpayers to deduct ordinary
and necessary business expenses incurred in trade or
business. Firms that pay punitive damages can deduct those
damages as an ordinary and necessary business expense.
California has never affirmatively adopted the policy of
allowing punitive damages to be tax deductible as a normal
and necessary cost of doing business. Instead, California
conforms to the federal rule allowing deductions for
ordinary and necessary business expenses (26 U.S.C.
�162(f)). The federal deduction is also not found in the
U.S. Internal Revenue Code. Instead, it is the result of a
1980 IRS administrative ruling (Rev. Rul. 80-211, 1980-2
C.B. 570).
Proposed Law
Assembly Bill 458 prohibits, on or after January 1, 2014,
taxpayers from claiming a deduction for amounts paid for
punitive damages.
AB 458 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.
AB 458 applies to taxable years beginning on or after
January 1, 2014 and takes effect immediately as a tax levy.
State Revenue Impact
The Franchise Tax Board estimates revenue gains of $400,000
in 2013-14, $1 million in 2014-15, and $1.1 million in
2015-16.
AB 458 -- 2/19/13 -- Page 3
Comments
1. Purpose of the bill . The purpose of punitive damage
penalties is to punish and deter egregious misconduct
committed with malice, oppression and fraud. This is a
higher standard than normal civil liability. According to
the author, "Punitive damages should not be tax-deductible
as ordinary nor necessary business expenses; they are not
like salaries, equipment or operating expenses. They are
financial penalties that are intended to serve the same
purpose as criminal fines and statutory penalties, which
are not deductible." By removing the tax deduction
currently allowed for punitive damages paid, AB 458 treats
punitive damages differently from ordinary and necessary
business expenses and aligns them with the intent of the
penalty.
2. Cost of doing business . Punitive damage awards can
vary significantly. Expensive judgments can be difficult
for businesses to plan for, and a tax deduction provides
financial relief. One example of a costly California
punitive damage award in 2012 includes UPS. In Michael
Marlo v. United Parcel Service, Inc., UPS paid
approximately $16 million dollars in punitive damages for a
wrongful termination/retaliation judgment. There are
other costs to a business that do not get priced into a
punitive damage award. An additional expense is the costs
associated with disclosure. Companies usually have to
disclose punitive damage judgments which can negatively
affect their share price and/or overall enterprise value.
Opponents of AB 458 argue that requiring a business to pay
an unbudgeted judgment amount could drive up the cost of
business, negatively affecting the economy and increasing
the cost of goods and services to consumers.
3. Tax Aware Jurors . When juries and judges award
punitive damages there is no evidence that they do so with
knowledge that punitive damages incurred can be tax
deductible. Thus, some defendants are not punished to the
degree that the jury intends. In the University of
Virginia Law Journal article Taxing Punitive Damages
authors Gregg D. Polsky and Dan Markel argue that there are
two ways to solve that problem. First, the law may be
changed to match juror expectations by making punitive
damages nondeductible, which is what AB 458 would do in
California. Second, you can change the understanding of a
AB 458 -- 2/19/13 -- Page 4
juror to include tax awareness. Polsky and Markel argue:
"Tax-aware juries would adjust the amount of punitive
damages to impose the desired after-tax cost on the
defendant? tax awareness would
best solve the under punishment problem even though it
does come at the cost of enlarging plaintiff
windfalls. However, given the defendant-focused
features of current punitive damages doctrine, this
cost is not particularly troubling."
Tax aware jurors may provide an alternative to AB 458.
Should the committee wish to explore this further, and
consider requiring that jurors are provided with
instructions including the tax deductibility of punitive
damages in addition or as an alternative to AB 458, AB 458
should be referred back to Rules Committee for
consideration by the appropriate Committee.
4. Try Again . Assembly Bill 458 replicates AB 1276 (Feuer,
2011), which prohibited a deduction for amounts paid or
incurred for punitive damages for taxable years beginning
on or after January 1, 2012. AB 1276 failed passage on the
Assembly Floor (50-26).
5. Tax increase . Legislative Counsel has assigned a 2/3
vote key to SB 458, as the measure may lead to a tax
increase on any taxpayer under Section Three of Article
XIIIA of the California Constitution.
Assembly Actions
Assembly Revenue and Taxation Committee 6-3
Assembly Appropriations Committee 12-5
Assembly Floor 54-25
Support and Opposition (8/8/13)
Support : American Federation of State, County and
Municipal Employees, AFL-CIO; California Church Impact;
California Employment Lawyers Association; California Labor
Federation; California Nurses Association; California
Professional Firefighters; California School Employees
Association, AFL-CIO; California Tax Reform Association;
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Consumer Federation of California; Disability Rights
California; Mexican American Legal Defense and Educational
fund; Public Advocates; SEIU; Western Center on Law and
Poverty.
Opposition : California Association for Health Services at
Home; California Taxpayers Association; Construction
Employers' Association.