Untangling taxes from personal injury damages.

• Author: Moxon, Shea

Lawyers who represent plaintiffs or defendants in personal injury cases are well acquainted with a number of legal doctrines that affect the amount of the plaintiff's recovery, such as the PIP threshold defense, apportionment of fault, collateral source setoffs, caps on damages, or the statutory abrogation of joint and several liability. There is one legal issue, however, that is often overlooked by attorneys, although its resolution can affect the amount of the plaintiff's recovery just as much as the others mentioned.

This commonly neglected issue is whether damages awarded for lost future earning capacity should be calculated on the basis of gross earnings or net, after-tax earnings. Stated differently, the question is whether the jury, in calculating how much to award the plaintiff for loss of future earning capacity, should deduct the income taxes that the plaintiff would have had to pay on the income that he or she would have been able to earn had he or she not been injured.

The answer to this question can have a substantial impact on the amount of the award. Damages for loss of earning capacity in the future are determined by taking the sum of earnings that the plaintiff would have been able to earn in the future if he or she had not been injured, reduced to present value; and subtracting the amount that the plaintiff is still able to earn after his or her injury, projected into the future and also reduced to present value. The question is whether the figures for the plaintiff's projected future earnings (both pre-morbid earnings and post-morbid earnings) should be gross earnings or after-tax earnings. If gross earnings are used, then the jury's award for lost earning capacity will be higher than if after-tax earnings are used. The difference can be quite substantial when the amounts involved are very high or when the plaintiff's disability is severe.

This pre-tax/post-tax controversy arises because compensatory damages awarded in personal injury actions are not subject to the federal income tax. Since 1918, the Internal Revenue Code has excluded from gross income any damages recovered because of personal injury or sickness. (1) In effect, these damages are exempt from the federal income tax. (2) Because the plaintiff's recovery is not taxed, but the income that the plaintiff would have been able to earn if not injured would have been taxed, some jurisdictions have adopted a rule that the jury should only consider after-tax income when calculating how much to award for lost future earnings or loss of future earning capacity. This approach has been mandated by the U.S. Supreme Court for actions arising under federal law. (3)

In Florida, the issue is rarely discussed in the published case law. This sparsity of case law may indicate that attorneys rarely raise the issue at the trial level. Perhaps most attorneys do not recognize the issue as a legal question, and, therefore, leave it up to economic experts to decide which method to use when they perform their calculations and form their opinions. It would be a mistake, however, to defer this question to the economists, because there is legal authority in Florida holding that the computation of an award of damages for lost future earning capacity shall be based on gross income. Attorneys and courts should be aware of this legal authority.

Florida Law

* Case Law. In Florida, the rule that personal injury awards are to be based on gross earnings grew out of a line of decisions addressing a different, but related issue--specifically, whether the jury should be instructed that the amount it awards to the plaintiff will not be subject to income tax. The rationale for giving such an instruction is to prevent the jury from adding an extra amount to the award to cover income taxes in the mistaken belief that the plaintiff 's recovery will be taxed.

In the first decision to address the propriety of such an instruction, Poirier v. Shireman, 129 So. 2d 439 (Fla. 2d DCA 1961), the court held that it was not error for the trial court to instruct the jury that its award would not be taxable. It approved the following instruction: "You are instructed that any award made to plaintiff as damages in this case, if any award is made, is not subject to federal or state income taxes, and you should not consider such taxes in fixing the amount of any award made plaintiff, if any you make." (4)

Poirier does not directly address whether gross income or after-tax income should be used to calculate damages. It indirectly favors using gross income, however, because the instruction approved by Poirier tells the jury not to consider income taxes at all when making its award. It would be impossible for a jury to use after-tax income figures in its calculations without considering income taxes.

After Poirier, two more decisions considered the propriety of instructing the jury that its award would not be taxable. In Stager v. Florida East Coast Railway, 163 So. 2d 15...