On Monday, a federal judge for the Eastern District Court of Louisiana approved a settlement between BP and the United States for $20 billion to settle claims related to the 2010 oil spill in the Gulf of Mexico. Of that amount, $5.5 billion represented a Clean Water Act penalty, which is nondeductible under Internal Revenue Code sec. 162(f) (barring deductions for “any fine or similar penalty paid to a government for the violation of any law”). However, $15.3 billion of this settlement qualifies for a business tax deduction.

The fact that BP will be legally able to write off such a significant portion of this settlement amount, effectively reducing the amount of money owed, has raised concerns and generated discussion in the media this week. The Department of Justice had the opportunity to limit or fully prohibit this option when drafting the settlement agreement, but barring write-offs is not yet standard in these cases or current tax law. On April 28, 2015, Senator Elizabeth Warren (D) proposed Bill S. 1109: Truth in Settlements Act of 2015, which would require language addressing the tax treatment of payments under settlement agreements entered into by Federal agencies. This bill passed the Senate in September 2015, and is currently under consideration with the House of Representatives.

This case may pave the way for a significant change to American tax law.