Bloomberg, Goldman Waives Tax Deduction on SEC Settlement, by Ryan J. Donmoyer:

Goldman Sachs Group Inc. agreed to waive tax deductions it could have claimed after paying a $550 million penalty in a settlement with U.S. regulators, giving up as much as $187.5 million in savings.

In yesterday’s settlement with the SEC, the firm agreed “it shall not claim, assert or apply for a tax deduction” for any penalty amounts. Goldman Sachs will pay a $535 million civil penalty, which normally would be deductible, and give up $15 million in profits, which the firm likely can still deduct.

“It’s unusual, but not unheard of” for companies to forgo tax deductions when negotiating settlements, said Robert Willens, founder of Robert Willens LLC, a consulting firm that advises investors on tax and accounting rules. “It’s actually become a little more popular in recent years for the government to insist that no deduction be taken for any portion of the payment.”

In order to deduct the payments, Goldman Sachs would have had to argue that a portion were compensatory and would be paid to third parties rather than the government. Other companies have argued that position, said Ron Pearlman, a tax law professor at Georgetown University. …

Giving up the tax deduction makes the penalty appear smaller than paying a larger penalty and retaining the deductions. Had Goldman Sachs agreed to a $1 billion fine and kept its federal and state deductions, the net outlay would have been about $600 million.

Here is the tax language in the 11-page settlement agreement:

4.  Defendant acknowledges that the civil penalty paid pursuant to the Final Judgment may be distributed pursuant to the Fair Fund provisions of Section 308(a) of the Sarbanes-Oxley Act of 2002. Regardless of whether any such Fair Fund distribution is made, the civil penalty shall be treated as a penalty paid to the government for all purposes, including all tax purposes. …

5.  Defendant agrees that it shall not seek or accept, directly or indirectly, reimbursement or indemnification from any source, including but not limited to payment made pursuant to any insurance policy, with regard to any civil penalty amounts that Defendant pays pursuant to the Final Judgment, regardless of whether such penalty amounts or any part thereof are added to a distribution fund or otherwise used for the benefit of investors. Defendant further agrees that it shall not claim, assert, or apply for a tax deduction or tax credit with regard to any federal, state, or local tax for any penalty amounts that Defendant pays pursuant to the Final Judgment, regardless of whether such penalty amounts or any part thereof are added to a distribution fund or otherwise used for the benefit of investors.

Update: Wall Street Journal, Goldman Sachs Will Forgo Tax Deductions On SEC Penalties, by Martin Vaughan:

SEC Enforcement Director Robert Khuzami said at a Thursday press conference that the prohibition on tax deductions for penalties is consistent with "the standard terms of an SEC settlement."

Even so, federal prosecutors may have wanted to avoid the kind of backlash that has occurred in the past when large companies have sought to reduce the after-tax cost of penalties through deductions.

The SEC drew ire from several senators including Charles Grassley (R., Iowa) in 2003 when it allowed tax deductions in a $1.4 billion settlement with 10 financial firms.

"Tax deductions for most government fines or penalties are disallowed. Still, there is often a way for companies to deduct many such payments," said Robert W. Wood, a tax lawyer with Wood and Porter. "Yet in a high-profile case of alleged wrongdoing like this, a tax deduction would probably have rubbed many people the wrong way," he added.