TAX NEWS - June 2010

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BP Payments Likely Deductible - Tax Expert

BP likely will be able to deduct payments it has agreed to make to compensate those damaged by the oil spill in the Gulf of Mexico, according to a tax expert.

BP last week agreed to establish a $20 billion escrow account to compensate victims of the spill. In determining whether the fund is tax deductible, BP first must establish that it is an "ordinary and necessary" expense BP incurs as part of conducting its business, a hurdle it clears fairly easily, according to a report Monday from Robert Willens, a longtime Lehman Brothers tax expert who now heads his own consulting firm.

Willens cites a past case in which the Internal Revenue Service allowed a taxpayer to deduct a payment made to settle a lawsuit since the act that gave rise to the lawsuit was part of the ordinary business activity of the taxpayer in question.

The fact that BP may not be legally obligated to pay the claims does not detract from their deductibility, Willens states, noting that a company making payments to protect its reputation has been established as a recognized business expense.

There is a question, though, about whether a BP deduction could be disallowed on public policy grounds. The IRS tried to disallow a tax deduction in one instance in which a taxpayer attempted to deduct legal fees he paid defending himself (unsuccessfully) against a criminal prosecution. In that instance, however, the Supreme Court ruled the deduction was allowable. Though the Court found that legislation could theoretically be crafted to disallow certain tax deductions on public policy grounds, absent such legislation, the Court stated it would admit such a disallowance in only "extremely limited circumstances" where the conduct was at odds with "sharply defined national or state policies," Willens states in his report.

In short, it would likely take an act of Congress to keep BP from deducting its payments, and while that can't be ruled out, given the mood of Congress toward BP, it would seem to be difficult from a legal point of view since it would likely be viewed as legislating ex post facto.

Further good news for BP is that if the payment causes BP to post a net operating loss, the oil giant would likely be able to use the loss to offset profits from the past two years.

Given BP's special eagerness to avoid further bad headlines, don't expect the oil company to start crowing about the tax benefits of its compensatory payments. It is even possible public pressure might force BP to forgo the deduction. For now, though, those doing the math on the cleanup costs to BP should pencil in a hefty tax deduction. Those outraged at BP, of course, have one more thing to ... um ...blow a gasket over.

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