JPMorgan Chase's preliminary $13 billion mortgage settlement with the U.S. government could end up costing the bank as little as $9 billion after taxes, because the majority of the deal is expected to be tax deductible, two sources said.
The deduction also means the government is getting less than it appears in this deal. Banks can often deduct legal settlements from their taxes, but cannot get tax benefits for penalties for violating laws.
JPMorgan and the U.S. government have been negotiating the tax treatment of the settlement. The outcome could have a dramatic impact on exactly what the deal ends up costing the bank, how it is perceived by the public, and whether it becomes a model for resolving government investigations of mortgage deals at other banks.
JPMorgan is negotiating the settlement with a group of government agencies led by the Justice Department, and the deal is expected to include a $2 billion penalty, one source said.
But another $4 billion of the deal, which will go toward aid for struggling mortgage borrowers, is tax deductible, another person familiar with the negotiations said.
How the remaining $7 billion will be addressed remains unclear, but most, if not all, is likely to be deductible. Much of it is intended to compensate investors for shoddy mortgage securities they purchased from JPMorgan, as well as Bear Stearns and Washington Mutual, failing banks JPMorgan acquired during the financial crisis.
Those payments would usually be deductible as a normal business expense, just as would payments by an appliance manufacturer to make good on defective washing machines, said tax expert Robert Willens.
If $11 billion is tax deductible, and assuming a 38 percent tax rate, the tax deduction could save JPMorgan as much as $4.18 billion, Willens said.
The government, however, could negotiate an exception and require that JPMorgan agree not to deduct some of those expenses from its taxable income, he said.
There is some precedent for such an exception. When Goldman Sachs agreed to pay $550 million in 2010 to resolve charges from the Securities and Exchange Commission, for example, the deal specifically forbade the bank from claiming a tax deduction on the portion of the settlement designed to compensate harmed investors.