[CLC-Discussion] Damages, Death, and Taxes

Wed Sep 11 17:44:37 PDT 2019

So I found out a good bit more on this today, and the tax situation is not as dire as I originally understood. I think I may have had too much spicy food for lunch when it was explained to me the first time. My one tax class in law school in 1989 I think obviously didn’t “take.”

The impact of the elimination of the “miscellaneous deduction” in the 2017 tax law prevents individuals from deducting attorneys fees paid (either hourly or contingency) in the collection of a damages award. The fee award would have been considered “income” but would have formerly been deductible as a “miscellaneous deduction” up to a cap. But that deduction is now gone, so say, for example, that a homeowner recovers a $100K fee, after already having paid that to her attorney. She now has to pay taxes at her marginal rate on that attorney’s fee award.

On the property damage side, the recovery is taxable as a capital gain to the extent it exceeds the taxpayer’s basis in the property, or, more accurately, it reduces the basis, but when the basis gets to zero, that’s what you’re dealing with when you sell the property (i.e., if you haven’t increased your basis somehow, the entire sales price is a capital gain). But, to the extent the basis is exceeded, the award is taxable at the capital gains rate which can vary. So, for example, let’s say the owner has a damages recovery of $1,500,000, and has a basis in the property of $1,000,000. There is a taxable gain of $500K, or, after taxes, assuming a 20% rate, a net of $400K, or a total net of $1,400,000. To get back to $1.5MM, the homeowner needs more than the $100K in taxes – probably around $160K (without my having done the math), to be put back in the same place she would have been in before the breach.

So it’s less severe, but it’s still “a thing.” I think perhaps I’ll work on something a bit more scholarly to share with the group to perhaps consider asserting “tax neutralization” damages.

Bruce Partington | Shareholder
bpartington at clarkpartington.com | (850) 432-1399<callto:(850)%20432-1399>

CLARK PARTINGTON
Office: (850) 434-9200 | Fax: (850) 432-7340
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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 7:58 PM
To: Reese J. Henderson, Jr. <Reese.Henderson at gray-robinson.com>; clc-discussion at lists.flabarrpptl.org
Subject: Re: [CLC-Discussion] Damages, Death, and Taxes

It has to do with the elimination of the “miscellaneous deduction” as I understand it. I’m not a tax lawyer either, but I know some….

Bruce Partington | Shareholder
bpartington at clarkpartington.com | (850) 432-1399<callto:(850)%20432-1399>

CLARK PARTINGTON
Office: (850) 434-9200 | Fax: (850) 432-7340
125 East Intendencia Street, 4th Floor
Pensacola, Florida 32502
clarkpartington.com<http://clarkpartington.com/>

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From: Reese J. Henderson, Jr. <Reese.Henderson at gray-robinson.com>
Sent: Tuesday, September 10, 2019 7:49 PM
To: Bruce Partington <bpartington at clarkpartington.com>; clc-discussion at lists.flabarrpptl.org
Subject: RE: Damages, Death, and Taxes

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<mailto:clc-discussion-bounces at lists.flabarrpptl.org> <clc-discussion-bounces at lists.flabarrpptl.org<mailto: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<mailto:clc-discussion at lists.flabarrpptl.org>
Subject: [CLC-Discussion] Damages, Death, and Taxes

This message originated outside of GrayRobinson.
________________________________
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
bpartington at clarkpartington.com<mailto:bpartington at clarkpartington.com> | (850) 432-1399<callto:(850)%20432-1399>

CLARK PARTINGTON
Office: (850) 434-9200 | Fax: (850) 432-7340
125 East Intendencia Street, 4th Floor
Pensacola, Florida 32502
clarkpartington.com<http://clarkpartington.com/>

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Reese J. Henderson, Jr. | Shareholder
Florida Bar Board Certified in Construction Law
Florida Supreme Court Certified Circuit Civil Mediator
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