Liability costs for businesses could increase if an overlooked provision slipped into a tax bill currently pending in the Senate is approved, two attorneys say.[@@]

The provision would abolish the tax deduction in current law for punitive damages payments, the attorneys said. In addition, if a punitive damage liability is covered by insurance, the amount paid by the insurer would be included in the gross income of the policyholder.

Mark A. Behrens and Kimberly D. Sandner, attorneys in the Washington office of Shook, Hardy & Bacon, said in a Legal Opinion Letter published by the Washington Legal Foundation that the provision is contained in S. 1637.

"The main point," Mr. Behrens told National Underwriter, "is that the government is looking at punitive damages as a potential revenue raiser."

This, he said, has significant implications in that it could force defendants to settle lawsuits on terms that are more unfavorable than would otherwise be the case.

If a lawsuit is settled, Mr. Behrens said, the settlement could be termed compensatory and thus would be tax deductible.

However, he said, if a case goes to trial, the punitive damage portion of any verdict would not be tax deductible.

This, Mr. Behrens said, would give plaintiffs' attorneys more leverage to try and force large settlements.

S. 1637 was approved recently by the Senate Finance Committee. In the report accompanying the legislation, the Committee explains the proposed new treatment of punitive damages as advancing public policy goals.

"The Committee believes that allowing a tax deduction for punitive damages undermines the societal role of punitive damages in discouraging and penalizing the activities or actions for which punitive damages are imposed," the report says.

In their letter, Mr. Behrens and Ms. Sandner argue, however, that punitive damages are awarded under vague and unpredictable standards that have been substantially weakened over the past 30 years.

For example, they say, very few states now require proof of actual malice before punitive damages can be awarded.

"As long as unpredictable punitive damages can be awarded without proof beyond a reasonable doubt of intentional misconduct and without any statutory protections against excessive or repetitive punishment, the tax deduction for punitive damages is justified," Mr. Behrens and Ms. Sandner said.

Mr. Behrens noted that the punitive damage was included in S. 1637 without any hearings. He said it is unclear whether S. 1637 will be enacted into law. It still has not passed the full Senate, Mr. Behrens noted, and there is no companion bill in the House.

But he noted that the punitive damage issue arose once before about four years ago when President Clinton included it in one of his budgets.

The Joint Committee on Taxation estimates that the punitive damage provision would raise $333 million in revenue over 10 years.