2017 Tax Reform Has Decimated Plaintiff Recoveries: Should We Tell the Jury?

This week, a Cook County jury awarded almost $5.1 million to the family of an African American man who was killed by a white Chicago police officer in 2014. Within the last month, an Omaha jury awarded a firefighter almost $1.2 million for retaliation he experienced for reporting sexual harassment of a female recruit in 2015. What both these plaintiffs have in common is that they will be hit with substantially higher tax bills from their jury awards because their lawsuits finalized in 2018, after 2017 tax reform took effect. Had the jury known, it is very likely they would have wanted to increase the award.

How do Plaintiff’s Incur Attorney’s Fees?

Attorney fees are a practical necessity in today’s world when going to court. Attorneys are often paid hourly, usually hundreds of dollars an hour, which adds up over the course of a trial. Since plaintiffs often do not have a lot of cash on hand, a popular form of payment for difficult cases is contingent fees, where an attorney takes a percentage of the total damage award. Contingent attorney fees for personal injury are known to be high, usually between 33% to 40%. This is in addition to costs and expenses incurred in going to trial, such as expert witness fees, investigator fees, or filing fees. The attorneys fees plus the costs and expenses may total from 45% to 60% of the final settlement or damage award. While the costs of trial are high, the plaintiff is left with at least 40% to 55% of the award, right? Wrong.

How Have Plaintiff’s Taxes Increased?

Starting in 2018, the Tax Cuts and Jobs Act tax reform will require almost all plaintiffs to pay tax on the total damage award without any offset for expenses for attorney’s fees. For example, if the plaintiff is awarded a $5M award, the income will be taxed primarily at the 37% marginal tax bracket. A plaintiff with a 40% attorney fee, will take home only $3M of a $5M damage award, but will still pay tax on the full $5M. In this case, the plaintiff is left with approximately $1.15M (3M - 1.85M tax), leaving the plaintiff with only 23% of the original jury award.

In cases where the plaintiff does not have a contingent attorney fee, the taxpayer may even pay more in tax plus attorney’s fees than the overall settlement. For example, if a plaintiff is charged 400k in fees by the attorney and the award is only 450k, then the tax on 450k will certainly be larger than the 50k difference.

If This is Such a Big Change, Why Haven’t Jurors Already Heard of it?

Since the April 15 deadline for 2018 tax returns is coming up, many plaintiffs will only now find out the devastating tax consequences of their award settlement. This is especially the case because very often attorney’s fees go straight to the attorney and do not even go into the plaintiff’s bank account. In fact, my personal experience is that the attorneys have no idea of this change. As a practicing CPA, I have communicated with attorneys who are completely surprised that their clients have to pay tax on income received directly by their law firm. The attorney of course also pays tax on the income received, so the IRS is receiving tax twice on the same income.

It has also largely gone unnoticed because the eliminated deduction was buried among the denial of many other deductions. Attorney fees are one of many miscellaneous deductions on Schedule A Itemized Deductions. Therefore, rather than tax reform specifically creating a statute denying attorney fees, they passed IRC 67(g), which denied all miscellaneous deductions from 2018 to 2025 for the purpose of raising revenue. Essentially, they were able to more quietly eliminate the deduction.

Should we Tell the Jury?

I strongly believe we should tell juries. It is far too large of a tax consequence to ignore. Juries already are given a lot of information and instruction in assessing damage awards. If we leave out the tax consequence of attorney’s fees, we are perhaps omitting one of the most substantial factors for them to consider in deliberation.

What Do Scholars Think?

Surprisingly, there has been very little written on the topic. It is likely that many scholars are not aware of its far-reaching effects just like jurors or plaintiffs are unaware. An attorney in San Francisco and contributor at Forbes, Robert Wood, has been the most outspoken on the negative tax impact. In fact, he even went through the tax impact of the $289 million Monsanto jury verdict, explaining how the plaintiff would actually end up with only $52 million after tax. While the verdict was later reduced to $80 million by the judge, a similar reduction in the award will occur.

With studies indicating that juries actively process information and can successfully deal with complex information, I feel strongly that once scholars become aware of the impact on plaintiffs, they will agree that juries must immediately be instructed on the tax impact of attorney’s fees.