Toxic Deductible Sludge


Back in 2010, British Petroleum 's Deepwater Horizon drilling rig exploded and spilled millions of barrels of oil off the Louisiana coast. Countless small business owners - including fishermen, hotel operators, restaurants, rental companies, and seafood processors - suffered and went bankrupt. State and local governments lost billions more in tax revenue. Lawyers, who may be some of the few people to actually profit from the disaster, are still fighting over compensation and claims, and will probably still be fighting long after anyone reading these words is still alive.  

Since the spill, BP has been gushing cash to clean up its mess with the intent of restoring both its reputation, as well as the damaged environment. The total includes $20 billion for a trust fund to settle financial claims, $4.5 billion in criminal fines, and $18.7 billion to settle federal and state claims. But there's good news for the company, too: they 'll be getting billions in help from their friends at the IRS!  

Here 's how that little plot twist works: Section 162(f) of the Internal Revenue Code states that "no deduction shall be allowed…for any fine or similar penalty paid to a government for the violation of any law. " But defining exactly what makes up a "fine" or “penalty" isn't as obvious as you might think (which gives those lawyers we previously mentioned the opportunity to bill a lot of hours just talking about it). And payments that aren't considered fines or penalties are deductible just like any other business expense. So let's take a look at exactly how BP will be structuring this final settlement:

  • $5.5 billion goes toward a Clean Water Act penalty. This amount should be nondeductible. However, the press release announcing the settlement states that 80% of the penalty "will go to restoration efforts in the affected states pursuant to a Deepwater-specific statute, the RESTORE Act. " That should give a clever lawyer more than enough rope to argue for deductibility!
  • $8.8 billion goes towards natural resource damage and funding Gulf restoration projects. Since it's not explicitly designated a "fine" or "penalty, " BP will probably deduct it.
  • $5.9 billion goes towards state and local governments to settle their claims. Again, since it's being paid to "settle" claims, BP will likely deduct it.

Ultimately, we may never know exactly how much BP writes off because deductions on settlements are confidential business information. What we do know is the company's federal tax rate is 35%. So that means, if BP writes off, say, $20 billion of the payments, they'll save $7 billion in taxes. That money, of course, comes out of all of our pockets. So pat yourself on the back for playing your part in cleaning up the Gulf!