[CLC-Discussion] Damages, Death, and Taxes

Tue Sep 10 17:49:26 PDT 2019

Bruce:  For everyone’s benefit, can you cite the tax provision you are referring to?  None of us are tax lawyers (at least, I’m not), but the citation would be helpful nonetheless.

From: clc-discussion-bounces at lists.flabarrpptl.org <clc-discussion-bounces at lists.flabarrpptl.org> On Behalf Of Bruce Partington
Sent: Tuesday, September 10, 2019 8:36 PM
To: clc-discussion at lists.flabarrpptl.org
Subject: [CLC-Discussion] Damages, Death, and Taxes

This message originated outside of GrayRobinson.
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Folks –

Floating an idea here about a damages issue for your comments and thoughts. Not really anything in here about death, I just thought the subject line had a nice ring to it.

As I’m sure many of us do, I represent both plaintiffs and defendants, and often both in the same case, so my question cuts both ways, I know.

The 2017 tax law has effectively made recoveries from property damage claims “income” of some sort without a corresponding deduction (I think this is only an issue in individual claims—mostly residential obviously). I understand there is some uncertainty about exactly how it is treated (ordinary income/capital gain, factoring in the owner’s basis), but in sum, the things that our clients could use before 2017 to reduce or eliminate taxes on property damage awards (or even breach of contract) are gone. So, for an individual client whose marginal rate is 39%, the IRS will go a long way to keeping owners from being put in the position they would have been in but for the breach. (For purposes of this discussion, I’m excluding consequential damages like loss of revenue since that would have been taxable anyway, and would have corresponding expense deductions that would go with it).

In some other areas of law, damages called “tax neutralization” or “tax gross-up” damages are allowable. They seem most common in employment cases where the employee receives a lump sum that results in paying taxes on parts of the award at marginal rates higher than what the rate would have been had the employee received the money over some period of years as wages. The idea is so that the employee wouldn’t pay more in taxes than he or she would have otherwise paid, so additional damages are awarded to neutralize the tax impact. There are some cases on both sides of the issue – but exactly none that deal with this issue post-2017 tax law for property damage claims in either direction. But, if the general damages rule is to put the injured owner in the same position…..then it would make sense to include these types of damages (at least until 2026 when the law phases out, or Congress changes it before).

It’s a somewhat complex calculation because you can’t just add the taxes that would be due, because then that total is the amount on which the taxes would be calculated, so you have to add more. This results in substantial additions, particularly at higher marginal rates. For example, to “net” $1.5 Million at a 39% marginal tax rate, you have to “gross up” the amount by $959,016.40 – or about 63.9% of what your “net” damages are supposed to do. So instead of a $1.5 Million claim, your claim becomes $2,459,016.40. Of course there’s a whole other layer here about whether that would be covered under a CGL policy that I’m not even thinking about yet.

Anyway, has anyone tried this yet (or defended it)? Or have you tried anything else to mitigate the impact of the changes in the tax law?

Bruce Partington | Shareholder
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