Will punitive damages no longer be deductible in California?

Chris Micheli
Attorney and Lobbyist at the Sacramento government relations firm of Aprea & Micheli, Inc.

The California State Senate passed Senate Bill 66, which would disallow a deduction for the payment of punitive damages. SB 66 was introduced on January 5 of this year and passed the Senate last week along party lines, garnering the bare minimum 2/3 vote of 27 senators, with all Democrats voting aye and all Republicans voting no. Each of the 40 senators voted on this bill. The super-majority vote threshold is required because the bill is a tax increase pursuant to Article XIIIA, Section 3 of the California Constitution.

SB 66 would add Section 17226 (in the personal income tax law) and Section 24343.4 (in the corporation tax law) to the California Revenue & Taxation Code. These new code sections, if enacted, would disallow under both laws a deduction for amounts paid or incurred for punitive damages. This change in California law would be effective prospectively. In both proposed new code sections, the language would provide: “For taxable years beginning on or after January 1, 2018, a deduction shall not be allowed for any amount paid or incurred for punitive damages in connection with any judgment in, or settlement of, any action.”

Under both the Personal Income tax Law and the Corporation Tax Law in California, various deductions are permitted as ordinary and necessary business expenses (similar to provisions of the Internal Revenue Code) when an individual or a business computes income that is subject to tax. Under current federal and state tax laws, a deduction is allowed for amounts paid or incurred for specified types of punitive damages.

According to the legislative bill analysis of SB 66, “The objective of punitive damages is to deter the specific defendant from repeating their offensive behavior and to warn other potential individuals and corporations from committing similar offenses. Further, punitive damages are not meant to compensate the plaintiff; compensatory damages achieve that purpose. California law favors imposing punitive damages against defendants, but the courts have also maintained that punitive damages must not be overly excessive.”

According to the bill’s author, “California taxpayers should not be subsidizing the worst offenders in our state. I think most people would be shocked to learn that punitive damages can simply be deducted by these bad actors. The purpose of punitive damages is to make an example out of the defendant both to punish his reprehensible behavior and to deter future bad behavior by others.  Allowing the deduction defeats the purpose of the punitive action and is poor public policy.”

On the other hand, opponents argued “California conforms to the federal rule that allows deductions for ordinary and necessary business expenses, including the payment of monetary damages in legal cases. Deductions prohibited by this bill will continue under federal law, so SB 66 creates a federal and state difference. Removing deductibility also increases the burdens associated with the unpredictability of punitive damages, placing additional pressure on business to settle suits instead of seeing them through a long legal process.  Additionally, if the pressure to settle lawsuits increases, California companies can expect to see more frivolous suits.”

Among the listed supporters of SB 66 are: American Civil Liberties Union, California Employment Lawyers Association, California Professional Firefighters, California Tax Reform Association, Consumer Federation of California, and Disability Rights California.

The listed opposition to this bill includes: Air Logistics Corporation, Association of California Insurance Companies, California Chamber of Commerce, California Life Sciences Association, California Retailers Association, California Taxpayers Association, National Federation of Independent Business, Property Casualty Insurers Association of America, and West Coast Lumber & Building Material Association.

The bill next will be considered by the State Assembly later this summer. Sb 66 must passed the Legislature by its mid-September adjournment date. The Governor will have until mid-October to consider all bills sent him by the Legislature.

Chris Micheli is an attorney and legislative advocate at the Sacramento governmental relations firm of Aprea & Micheli, Inc.

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