Tax rate changes in malpractice cases.

• Author: Barton, Peter C.

In Oddi v. Ayco Corp., 947 F2d 257 (7th Cir. 1991), aff'g DC Ill., 1990, the Seventh Circuit held that the burden of proof on whether future tax rates will change fell on a tax adviser who made that assertion.

Oddi was a corporate executive with profit-sharing funds. He retired early and had to choose one of two alternatives for these funds: a lump-sum distribution or a rollover of the funds into an individual retirement account (IRA). Oddi initially favored the IRA, but his tax adviser (Ayco) advised selection of the lump-sum option that allowed 10-year averaging and a 20% capital gains rate during a limited window ending Mar. 15, 1987. (See Tax Reform Act of 1986 Section 1142(a).)

Oddi resisted this advice for several months, but in February 1987, Ayco presented Oddi with a calculation showing that the lump-sum strategy had a $3 million life-time advantage over the IRA. Stated assumptions included returns of 9% for taxable and 6% for nontaxable investments, as well as a maximum 28% tax rate and mandatory IRA withdrawals starting in 1998. Based on this advice, Oddi selected the lump-sum alternative.

Unfortunately, when making the decisive calculation, Ayco mistakenly reversed the taxable and nontaxable rates of return, resulting in nontaxable investments earning 9%. Three months later, Oddi discovered this error. Since corrected calculations now indicated a $2 million advantage for the IRA option, Oddi sued for the difference. The district court awarded Oddi $483,088 in damages and Ayco appealed.

The central issue was the effect of future tax rates on the amount of damages. Since the damages awarded by the district court were based on future tax rates remaining at 28% (a historically low rate), Ayco argued that a significant increase in rates by 1998 would eliminate the difference between the lump-sum and IRA strategies.

The question was whether Oddi had to prove that the tax rates would remain unchanged at 28% or Ayco had to prove that the rates would increase. The court ruled that the burden of proof was on the...