Legal landscape note: This article was originally published in 2015 and describes the law as it stood at that time. New Jersey law changes frequently.
Punitive Damages
Imagine being punished for wrongdoing -- and then writing the punishment off on your taxes. In 2015, that was largely how the system worked: a jury's punitive damages award, designed to sting, could be treated as an ordinary business expense at tax time. Punitive damages are intended to punish, not to create an opportunity to take an additional tax deduction, and two New Jersey legislators set out to close that gap.
That debate was about more than tax accounting. It asked whether the financial consequences imposed for exceptional misconduct remain meaningful after insurance and tax treatment are considered. The historical account below follows the competing policy arguments rather than treating the proposed deduction ban as a routine budget measure.
In New Jersey, punitive damages are uninsurable, so if defendant Pecora Corp. appeals the verdict out of Middlesex County and is unsuccessful, that money will have to come out of the company's coffers.
Ultimately, however, the company would be able to deduct the punitive damages from its corporate business and gross income taxes because New Jersey, like nearly every other state and the federal government, considers punitives to be a cost of doing business.
But if two Democratic legislators have their way, that may change, at least in New Jersey. A state Senate committee has recommended passage of legislation that would bar businesses from deducting punitive damage awards from their state taxes.
The Senate Budget and Appropriations Committee on June 23 recommended approval of the bill, S3034, in an 8-4 vote split along party lines, with Republicans voting against it.
The bill, sponsored by Senate President Stephen Sweeney, D-Gloucester, is scheduled to be voted on by the full Senate on June 25. An identical bill, A4583, sponsored by Assembly Judiciary Committee chairman John McKeon, D-Essex, is pending before the Assembly Budget Committee.
"It's head-scratching to me," said McKeon, who is an attorney with Hardin, Kundla, McKeon & Poletto in Springfield. "Since punitive damages are not insurable, they are supposed to be punishment for bad acts.
"It seems contrary to basic public policy that bad actors are able to escape punishment by deducting punitive damages from their taxes," he said. "Our tax should not award bad acts." The bills are facing stiff blow-back from the business community, and their lobbyists all registered their opposition with the Senate committee before its vote.
"There's a reason no other states have a tax like this -- it's a terrible idea," said Marcus Rayner, president of the New Jersey Civil Justice Institute, a tort reform organization, in written testimony. "It is bad for business from the get-go because it is a tax increase. But it is also bad for our state's business climate in the long term since it puts the state in the position of benefiting financially from excessive litigation.
"It is hard to imagine the state working to curb lawsuit abuse when the taxes on litigation are being used to fill budget gaps," he said.
The CJI's legal director, Alida Kass, warned the committee that disallowing tax deductions for punitive damages could drive businesses out of the state.
McKeon said that should not matter.
"If denying benefits to bad actors drives them out of the state, so be it," he said. "New Jersey's public policy should not be to award corporations who have been punished for their actions.
"If punitive damages are just the cost of doing business, how can there be any deterrent?" McKeon said.
The U.S. Public Interest Research Group has been trying for years to persuade Congress to change the federal tax code so that companies that are hit with punitive damages verdicts or agree to pay civil penalties cannot claim them as tax deductions. Presidents Bill Clinton, George W. Bush and Barack Obama have tried, without success, to have that benefit eliminated.
The New York Times reported earlier this year that Sens. Charles Grassley, R-Iowa, and Jack Reed, D-Rhode Island, plan to reintroduce legislation that would prohibit corporate violators from deducting settlements from their taxes.
"New Jersey would definitely be a leader if it did this," said Phineas Baxandall, the U.S. PIRG's senior analyst for tax and budget policy, who is the co-author of a 2013 report titled, "Subsidizing Bad Behavior." Baxandall said he does not completely subscribe to the notion that the ability to deduct punitive damages from taxes means that defendants don't care about having to pay them.
"I'm sure that altogether they'd rather not pay punitive damages," he said.
But allowing companies to deduct punitive damages from their taxes "definitely softens the blow," he added.
One legislator from California in 2013 and 2014 tried, also without success, to change that state's tax code to disallow the deduction of punitive damages.
Sen. Robert Wieckowski, a Democrat from Fremont, California, was able to get his bill, AB458, through the California Assembly in 2013 when he was a member of that chamber. However, he was unable to move the bill after he was elected to the Senate last year.
Wieckowski said he did not know if there were any states that prohibited the deduction, but noted that once the Internal Revenue Service adopts a policy regarding tax deductions, states generally follow suit.
He said, however, that he continues to hope that California will change its tax policy regarding punitive damages.
"Punitive damages are not part of the ordinary cost of doing business," he said. "Allowing corporations to deduct them from their taxes should be an outrage to public policy."
Why This Historical Debate Matters
The 2015 proposal illustrates the separate roles of compensatory damages, punitive damages, insurance, and tax treatment in a civil case. Someone evaluating present-day exposure should not assume that the proposal described here became current law. A current civil litigation analysis must begin with the claim, the available remedies, and the law in force now.