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Tuesday, August 17, 2010

Tax Deductible Expenses: The BP Case

Molly F. Sherlock
Analyst in Economics

Following the release of BP's second quarter earning statement, which showed a $10 billion reduction in tax liability for oil spill related cleanup and expenses, media headlines have generated public concern, and in some cases outrage, over these tax savings. Further, the ability of BP to realize these tax savings has generated a number of inquiries as to how and why BP is entitled to this reduction in tax liability. 

BP's reduction in tax liability is the result of standard business expense deductions and the general ability of taxpayers to claim refunds for previously paid taxes when realizing a net operating loss (NOL) or carrying the loss forward to offset future tax liabilities. Business expense deductions and NOLs play a significant role in enhancing economic efficiency by reducing business-cycle induced fluctuations and spreading risk. BP has reportedly incurred, or expects to incur, $32 billion in cleanup related costs and settlements over a multiyear period. Under current law, these costs can be used to offset business income and reduce tax liability. To the extent that these costs generate a NOL, these costs can be used to collect a refund for taxes paid in previous years or carried forward to offset tax liability in future years. 

The $10 billion "credit" that appears on BP's second quarter earnings statement is a financial account of BP's anticipated tax savings associated with legitimate cleanup related expenses. The figure does not reflect a tax credit as typically defined in the tax code. The $10 billion reduction in tax liability relates to a multiyear period, over which the $32 billion will be spent. The $32 billion was reported in 2010 for financial reporting purposes, but reflects cleanup spending costs in the current year as well costs the company expects to incur in future years. The financial account and financial reports do not directly correspond to current year tax liabilities. Actual oil spill related expenditures will be made over multiple years. Consequently, the associated tax savings will not be realized until the year expenditures are made.

Date of Report: August 11, 2010
Number of Pages: 9
Order Number: R41365
Price: $29.95

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