What is Ex Gratia Payment?
An ex gratia payment is a type of payment made by an organization to an individual for damages or claims without recognizing any legal obligation. “Ex gratia” means “by favor” or “by virtue of grace” in Latin. Thus, an ex gratia payment is a voluntary payment that is not a part of an organization’s legal liability.
- An ex gratia payment is a voluntary payment made out of virtue of grace by an organization to an individual for damages or claims.
- Ex gratia payments are not as common as they are not enforced. Still, companies may make the payments as a strategy to maintain a good relationship with receivers and mitigate negative publicity.
- In the U.S., ex gratia payments are typically taxable by both the federal and the state authorities.
Understanding Ex Gratia Payments
An ex gratia payment refers to a voluntary payment made by virtue of grace literally. There is no legal liability for the organization to make such a payment. Different from legally enforced payments, ex gratia payments are made with an expression of goodwill. Typically, they are requested for damages or claims that are not covered under existing policies. When the first claim is denied, it brings up the concept of ex gratia payments.
Ex gratia payments are not common since companies or other organizations are usually only willing to cover the payments under legal enforcement. However, some organizations use ex gratia payments to express their goodwill to maintain good long-term relationships with the payments receivers.
For example, a company experienced a bad year and decided to lay off a large number of employees. In addition to compensating the employees according to legal terms, the company may also pay extra amounts to show its benevolence. It can help the company to lower the negative effect of the job cuts on its public image.
Ex Gratia Payments in Insurance
If a policyholder of insurance suffered from an injury caused by a reason covered under that insurance policy, the policyholder could make a claim to the insurance company. The company, subject to its legal obligation, must compensate the policyholder.
In contrast, if a policyholder is injured because the insurance terms do not cover it, the insurance issuer can deny the damage claim. There is no liability for the insurer to pay the policyholder. Yet, the insurer can still compensate for the losses of the policyholder voluntarily out of kindness or for other reasons. The compensation is thus an ex gratia payment.
Many large insurance brokerages or brokerage networks often promote their stronger capacities to lobby and influence insurers. When a customer claims for a debatable loss, whether it is covered under the insurance policy, the brokers will work collaboratively to handle the process. If the claim is denied, the brokers will persuade the insurer to make ex gratia payments to the policyholder.
Since the brokerage networks keep large customer bases and thus strong bargaining powers, it is more probable for insurers to make ex gratia payments to maintain good relationships with the brokers and create a positive public image to potential clients.
Here are some real-world examples of ex gratia payments. Following the disappearance and apparent crash of Flight MH370, in June 2014, Malaysia Airlines offered $50,000 to each passenger’s family before the final compensation decision was settled.
The airline was not legally required to make the payments since the claims were still unresolved. Therefore, they are ex gratia payments to support the impacted families and mitigate the negative publicity of the accident.
Not only companies but also governments can offer ex gratia payments. After the Black Hawk Incident took place in 1994, the U.S. Department of Defense announced a $100,000 ex gratia payment to the family of each non-US individual who got killed in the incident.
In the U.S., the receivers of ex gratia payments usually need to pay both federal and state income taxes for this part of income. The specific amount for state income tax is determined by the state’s tax regulations, which can differ in each state.
However, a certain amount of ex gratia payments is tax-deductible in some countries. For example, in the UK, as long as the ex gratia payment is below £30,000 and is not for work or service rendered, it is not taxable. The amount beyond £30,000 will be taxed.
CFI is the official provider of the Commercial Banking & Credit Analyst (CBCA)™ certification program, designed to transform anyone into a world-class financial analyst.
To keep learning and developing your knowledge of financial analysis, we highly recommend the additional resources below: