How BP's $18.7 Billion Gulf Spill Fine Could Be One Giant Tax Deduction

Gulf Oil Spill 2010 Fire
Fire boat response crews in 2010 battle the blazing remnants of the oil rig Deepwater Horizon, off Louisiana. Last week's spill is the biggest since the 2010 disaster. U.S. Coast Guard/Reuters

On Thursday, the oil company BP reached an agreement to pay $18.7 billion to settle all the remaining federal and state claims from the years of litigation following the catastrophic 2010 Gulf oil spill. But thanks to provisions in the tax code, they might be able to deduct a large chunk of that sum from their taxes.

According to tax code, when a company pays a fine, the company is free to write it off their corporate income taxes, unless the fine is expressly for violation of the law. Typically that's indicated by the fine being called a "penalty," meant to punish the company for wrongdoing. If the language of the settlement describes the fine differently—as "money to resolve claims," or money used for restoration, for example—the fine can be treated for tax purposes as a business expense. Or, put another way, the fines can be treated as though they were "just compensating for damages that happened, the same way as you were a company that cleaned someone's rugs and you spilled something on their rugs, you pay them to replace their rug," explained Phineas Baxandall, the senior tax and budget policy analyst at the U.S. Public Interest Research Group (U.S. PIRG), a consumer-oriented nonprofit that advocates against such write-offs.

So far, prior to Thursday's announcement, BP has paid $42 billion in cleanup and claims in relation to the spill. Of that, only $4 billion was explicitly marked as not tax deductible; That $4 billion was for 14 criminal counts, including manslaughter for the deaths of the 11 people killed in the drilling rig explosion. In that case, the DOJ explicitly stated that none of the $4 billion could be written off.

In the case of Thursday's BP settlement, the Department of Justice has yet to release the final language of the agreement, as it is yet to be finalized by the court. But in a statement released Thursday, U.S. Attorney General Loretta Lynch hinted to what might and might not be eligible for a tax write off. She applauded the settlement as just and comprehensive, and referred to the fines as covering "Clean Water Act civil penalties and natural resource damages." Her use of "penalties" indicates that the $5.5 billion of the total $18.7 billion that are in response to Clean Water Act violations probably won't be tax deductible, Baxandall says.

But in a fact sheet published Thursday, the DOJ does not refer to the remaining $13.2 billion of the settlement using "penalty" language. Over the next 18 years, BP will pay $8.1 billion for "natural resource damages," the fact sheet states. $5.9 billion will be split between five states and several local governments to "settle claims" for spill-related "economic damages," and the remaining $600 million will go to an array of other unresolved damage claims, including the cost of doing the natural resource damage assessments. This fact sheet is not the final agreement, but it could indicate that the remaining $13.2 billion could be written off by BP.

In BP does write off the remaining $13.2 billion as losses of corporate income, which is taxed at 35 percent, the fine could amount to $8.58 billion in tax deductions for the company. The actual tax value of the whole settlement, then, would be $14.08 billion, not $18.7 billion.

Even the $5.5 billion in Clean Water Act violations Lynch referred to as a "penalty" might not be immune to tax deduction, Baxandall says, because 80 percent of it is set to go to natural resource restoration—something that BP could use to argue that most of the fine is not solely punitive and therefore should not be treated as a penalty for tax purposes.

But Baxandall says that a lack of disclosure requirements mean that we'll never know for sure what happens, because tax deduction claims on settlements are treated as confidential business information. "We wouldn't know unless the IRS challenged it in court and that court case came to light."

Earlier this year, Senators Elizabeth Warren (D-Mass.) and James Lankford (R-Okla.) introduced a bill to bring more transparency to the process. The Truth in Settlements Act would require public disclosure of settlement agreements that federal agencies enter into, if the agreement exceeds $1 million.

"When government agencies reach settlements with companies that break the law, they should disclose the terms of those deals to the public," Senator Warren said in a statement when the bill was introduced.

Tax deductions from settlements are a far-reaching phenomenon. The information sheet for Warren's bill cites a recent case where JPMorgan Chase settled with the DOJ to pay a fine of $13 billion. But approximately $11 billion of that will be tax deductible, according to a Reuters report.

In another case, a healthcare company in Massachusetts named Fresenius was found to be defrauding Medicare for years. The company settled with the DOJ for $385 million, but then attempted to deduct nearly the whole sum from its taxes. The IRS intervened, but a court ultimately sided with the health care company, because in the settlement, the DOJ had not described the fines explicitly enough as punitive.