Neutralizing the Adverse Effect of State and Federal Income Taxes on Lump Sum Awards in Employment Cases

By Nieswiadomy, Michael; Loudat, Thomas | Journal of Legal Economics, September 2019 | Go to article overview

Neutralizing the Adverse Effect of State and Federal Income Taxes on Lump Sum Awards in Employment Cases


Nieswiadomy, Michael, Loudat, Thomas, Journal of Legal Economics


I.Introduction

The adverse effect of federal income taxes in employment cases has received considerable attention in the forensic economics literature (Goodwill and Paul 1988; Benich, 1991, 1996; Markowski and Cross 1991a, 1991b; Bowles and Lewis 1996; Lewis and Bowles 1996; BenZion 2000; Rodgers 2003; Ireland (2010; 2012); Roney 2012, 2016; Macpherson and Stephenson 2016; Schap 2016). The ambiguity existing prior to 1996 in the treatment of taxes in litigation involving employment law was clarified by the Small Business Job Protection Act of 1996 (Public Law No. 104-88, Sec. 1605 (REPEAL OF EXCLUSION FOR PUNITIVE DAMAGES AND FOR DAMAGES NOT ATTRIBUTABLE TO PHYSICAL INJURIES OR SICKNESS); 26 U.S.C. ?104(a)(2)). This law codified that damages not resulting from a personal physical injury are subject to federal income taxes.1 This means taxes are levied on awards for back pay and front pay in employment cases. An award lacking an accounting for these tax consequences will undercompensate a plaintiff for the presumed tort. Rodgers (2003) addressed this issue in two respects. First, he noted that if the award is presented in after tax dollars, the taxation of the award causes the income to be taxed twice. Second, he noted that because federal tax rates are progressive, taxing the award of back pay and front pay when received as a lump sum in one tax year causes the plaintiff to pay higher taxes on the lost income than they would have paid if the plaintiff had received the income yearly. Ben-Zion (2000) termed this increase in federal tax liability an "adverse tax consequence."

Besides the usual loss estimation issues2 involved in personal injury cases, employment cases require the expert to address any adverse tax consequence. This means calculating an award amount such that after deducting federal and state income taxes and payroll taxes the resultant difference is the estimated loss amount. This calculation has been referred to as an award "gross-up" to account for, or neutralize, an adverse tax consequence of an award in employment cases or other non-physical injury cases (Ben-Zion 2000; Ireland 2010).

A "gross-up" calculation is not straightforward. The calculation must consider both federal and state (if applicable) income taxes and their progressive rate structure; the deductibility of state income taxes in some state jurisdictions; payroll taxes; and investment income. The "gross-up" calculation becomes more cumbersome when the forensic economist estimates alternative loss scenarios.

This paper provides an innovative method to perform "gross-up" calculations to determine an award amount when estimated losses are taxable income and extends the literature in two ways. First, it incorporates several real-world tax calculation issues (using the Tax Cuts & Jobs Act of 2017) when addressing adverse tax consequences of an award including investment income, Social Security and Medicare taxes and NIIT. Second, the paper presents a tax "gross-up" using readily available spreadsheet functions3 to iterate a user-friendly "gross-up" tax calculation.

Section II outlines the conceptual framework for the "gross-up" calculation. Section III uses an example to demonstrate the use of spreadsheet internal routines to solve for a tax-adjusted award amount for back pay. Section IV demonstrates the use of the model for grossup calculations for varying years of possible future lost earnings. Section V compares the accuracy of an approximation "gross-up" formula to the correct results for a range of annual earnings and years of losses. Section VI provides our conclusions.

II.Conceptual Framework

The following provides the conceptual framework for our grossup model.

GUA = ATL þ SITGU þ FITGU þ PTGU

Where:

GUA = the "grossed-up" award amount

ATL = the estimated after-tax loss amount

SITGU= the incremental state income tax on the "grossed-up" award amount (if applicable)

FITGU = the incremental federal income tax on the "grossed-up" award

PTGU= the incremental payroll (i. …

The rest of this article is only available to active members of Questia

Already a member? Log in now.

Notes for this article

Add a new note
If you are trying to select text to create highlights or citations, remember that you must now click or tap on the first word, and then click or tap on the last word.
One moment ...
Default project is now your active project.
Project items
Notes
Cite this article

Cited article

Style
Citations are available only to our active members.
Buy instant access to cite pages or passages in MLA 8, MLA 7, APA and Chicago citation styles.

(Einhorn, 1992, p. 25)

(Einhorn 25)

(Einhorn 25)

1. Lois J. Einhorn, Abraham Lincoln, the Orator: Penetrating the Lincoln Legend (Westport, CT: Greenwood Press, 1992), 25, http://www.questia.com/read/27419298.

Note: primary sources have slightly different requirements for citation. Please see these guidelines for more information.

Cited article

Neutralizing the Adverse Effect of State and Federal Income Taxes on Lump Sum Awards in Employment Cases
Settings

Settings

Typeface
Text size Smaller Larger Reset View mode
Search within

Search within this article

Look up

Look up a word

  • Dictionary
  • Thesaurus
Please submit a word or phrase above.
Print this page

Print this page

Why can't I print more than one page at a time?

Help
Full screen
Items saved from this article
  • Highlights & Notes
  • Citations
Some of your highlights are legacy items.

Highlights saved before July 30, 2012 will not be displayed on their respective source pages.

You can easily re-create the highlights by opening the book page or article, selecting the text, and clicking “Highlight.”

matching results for page

    Questia reader help

    How to highlight and cite specific passages

    1. Click or tap the first word you want to select.
    2. Click or tap the last word you want to select, and you’ll see everything in between get selected.
    3. You’ll then get a menu of options like creating a highlight or a citation from that passage of text.

    OK, got it!

    Cited passage

    Style
    Citations are available only to our active members.
    Buy instant access to cite pages or passages in MLA 8, MLA 7, APA and Chicago citation styles.

    "Portraying himself as an honest, ordinary person helped Lincoln identify with his audiences." (Einhorn, 1992, p. 25).

    "Portraying himself as an honest, ordinary person helped Lincoln identify with his audiences." (Einhorn 25)

    "Portraying himself as an honest, ordinary person helped Lincoln identify with his audiences." (Einhorn 25)

    "Portraying himself as an honest, ordinary person helped Lincoln identify with his audiences."1

    1. Lois J. Einhorn, Abraham Lincoln, the Orator: Penetrating the Lincoln Legend (Westport, CT: Greenwood Press, 1992), 25, http://www.questia.com/read/27419298.

    Cited passage

    Thanks for trying Questia!

    Please continue trying out our research tools, but please note, full functionality is available only to our active members.

    Your work will be lost once you leave this Web page.

    Buy instant access to save your work.

    Already a member? Log in now.

    Search by... Author
    Show... All Results Primary Sources Peer-reviewed

    Oops!

    An unknown error has occurred. Please click the button below to reload the page. If the problem persists, please try again in a little while.