The civil  settlements we examined ranged in size from about $870 thousand to over  $1 billion. In preparing for negotiations, two agencies— EPA and DOJ—consider certain tax issues in calculating the amounts they  propose to seek in negotiating environmental settlements. This calculation  estimates a company’s financial gain from not complying with the law, that  is, their economic benefit. The  officials emphasized that the law is generally clear that civil penalties paid  to a government are not deductible and stating so in the agreement is  essentially restating the law and is not necessary. The officials said they  do not negotiate with the settling companies about whether the amounts  are deductible. A Majority of the Surveyed Companies Deducted Civil Settlement Payments, Generally When Settlement Agreements Did Not Label Payments as Civil Penalties

In responding to our survey, companies that paid some of the largest civil  settlement payments at the four agencies we reviewed generally reported  that they deducted civil settlement payments when the settlement  agreements did not label the payments as penalties. Overall, for 20 of  the 34 settlements for which we received survey responses, companies  stated that they deducted some or all of their civil settlement payments. No Permanent System Is in Place for Agencies to Routinely Inform IRS of Civil Settlements or Provide Other Settlement Information That IRS Would Find Useful

The four federal agencies do not systematically provide IRS with civil  settlement information that would be useful to IRS for compliance  purposes, although the agencies do provide such information on a case-by- case basis at IRS’s request, such as for audits of companies with  settlement agreements. IRS usually  contacts the agencies on a case-by-case basis to obtain information to use  during audits in assessing whether companies properly treated their  settlement payments on their income tax returns. Because Schedule M-3 collects information on fines,  penalties, and punitive damages, it may help IRS identify settlements that  should be considered if a company is audited. Appendix I: Scope and Methodology

The objectives of this report were to (1) identify federal agencies that  negotiated some of the largest dollar civil settlements in recent years,   (2) determine whether the selected federal agencies having some of the  largest civil settlements take the tax consequences of the companies into  account when negotiating civil settlements and officials’ views on whether  they should address the deductibility of payments in the agreements,   (3) determine whether the companies that paid some of the largest civil  settlement payments deducted any of the payments on their federal  income tax returns, and (4) determine what information the Internal  Revenue Service (IRS) collects on companies with civil settlements  reached by federal agencies. Also, during these 2 fiscal years, we  determined that the Department of Health and Human Services (HHS) was  involved in negotiating some of the largest dollar False Claims Act health- care-related civil settlements that DOJ has primary responsibility for  negotiating.
Why GAO Did This Study

Although some civil settlement payments are deductible, their deterrence factor could be lessened if companies can deduct certain settlement payments from their income taxes. GAO was asked to (1) identify federal agencies that negotiated some of the largest dollar civil settlements, (2) determine whether selected federal agencies take tax consequences into account when negotiating settlements and officials' views on whether they should address payment deductibility in settlement agreements, (3) determine whether companies with some of the largest civil settlement payments deducted any of the payments on their federal income taxes, and (4) determine what information the Internal Revenue Service (IRS) collects on civil settlements reached by federal agencies.

What GAO Found

The Environmental Protection Agency (EPA), Securities and Exchange Commission (SEC), and Department of Justice (DOJ) negotiated civil settlements that were among the largest in the federal government in fiscal years 2001 and 2002. Also, the Department of Health and Human Services (HHS) was involved in negotiating some of the largest dollar False Claims Act (FCA) health-care civil settlements for which DOJ has primary responsibility. The largest civil settlements at these agencies ranged from about $870 thousand to over $1 billion. Officials in the four agencies we surveyed said that they do not negotiate with settling companies about whether settlement amounts are tax deductible. They said it was IRS's role to determine deductibility. In preparing to negotiate environmental settlements, EPA and DOJ may consider certain tax issues in calculating the amounts they propose to seek. This calculation estimates a company's economic benefit, that is, the financial gain from not complying with the law. Some DOJ environmental settlements with civil penalties have language stating that penalties are not deductible. DOJ officials said since the law is generally clear that civil penalties paid to a government are not deductible, stating so in the agreement was merely restating the law and is not necessary. The majority of companies responding to GAO's survey on how they treated civil settlement payments for federal income tax purposes deducted civil settlement payments when their settlement agreements did not label the payments as penalties. GAO received responses on 34 settlements totaling over $1 billion. For 20 settlements, companies reported deducting some portion or all of their settlement payments. IRS does not systematically receive civil settlement information from all four agencies. IRS officials said that a permanent system for agencies to provide information would be useful. IRS obtains information on a case-by-case basis from public sources and agencies. IRS also has two temporary compliance projects focusing on tax issues that affect settlement payment deductibility. In 2004, IRS introduced a tax schedule to provide information on a company's fines, penalties, and punitive damages.