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Editorial

Keeping punitive damages punitive

Companies that pay punitive damages can deduct those payments from their state and federal income taxes. That's wrong and counterproductive. A bill in Sacramento would correct it.

June 02, 2011

In 2009, a Sacramento jury concluded that a nursing home company in Rocklin, Calif., had so abused an elderly patient, who eventually died as a result, that the company should pay $28 million in punitive damages. The judge in that case called the evidence of abuse "overwhelming." In a separate case a year earlier, an arbitration judge, after finding the practices of an insurance company that canceled the policies of sick customers "reprehensible," ordered the company to pay one of its patients $9 million. The company got the message and changed the policy.

Those awards and scores of others like them reflect the appropriate place of punitive damages in the legal system: As the name suggests, they are intended to punish egregious behavior and, under California law, can be awarded only in cases in which officers of a company committed or authorized the wrongful conduct. Nevertheless, through a controversial interpretation of federal tax law, companies that pay punitive damages are entitled to deduct those payments from their state and federal income taxes. That's wrong and counterproductive. A bill awaiting action this week in Sacramento would correct it.

AB 1276, introduced by Assemblyman Mike Feuer (D-Los Angeles), addresses a 30-year-old ruling by a federal tax commissioner who concluded that punitive damages were deductible as "ordinary and necessary business expenses." There are sound accounting reasons for that view, but they are far outweighed by the ridiculous public policy consequence of punishing companies for wrongful conduct while allowing them to write off a portion of the costs of that conduct. Criminal fines, by contrast, are not deductible, underscoring the aberrance of this policy.

There's not much that Republicans and Democrats in Sacramento agree on, but surely this is an area where legislators can find common ground. Punitive damages are appropriately rare — juries award them in only about 5% of cases — and California law prohibits insurance companies from covering them. The intent is to punish outrageous conduct and deter future misdeeds. Both of those goals are undermined by existing law. That fact has been recognized in Congress, where there is Republican support for changing the federal interpretation of the tax code on punitive damages.

This bill requires at least some measure of bipartisanship because it affects revenue, and thus requires a two-thirds vote in both houses of the Legislature. But it is really not about the budget — it would generate just a few million dollars, peanuts in the current environment. It would, however, correct an obvious wrong.

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