Tuesday, January 18, 2005
Gregg D. Polsky (Minnesota) & Stephen F. Befort (Minnesota) have published Employment Discrimination Remedies and Tax Gross Ups, 90 Iowa L. Rev. 67 (2004). Here is the abstract:
This article considers whether a successful employment discrimination plaintiff may be entitled, under current law, to receive an augmented award (a gross up) to neutralize certain adverse federal income tax consequences. The question of whether such a gross up is allowed, the resolution of which can have drastic effects on litigants, has received almost no attention from practitioners, judges, and academics. Because of the potentially enormous impact of the alternative minimum tax (AMT) on discrimination lawsuit recoveries, however, the gross up issue is now beginning to appear in reported cases.
The three principal federal anti-discrimination statutes - Title VII, the Age Discrimination in Employment Act (ADEA), and the Americans with Disabilities Act (ADA) - generally confer broad equitable powers on the courts to devise remedies that will make the victims of discrimination whole in economic terms. The Internal Revenue Code (Code), however, sometimes operates to frustrate this make-whole objective by taxing a discrimination award more heavily than the components of the award would have been taxed had the components been earned in due course by the plaintiff. This excess taxation gives rise to what this article calls adverse tax consequences.
A discrimination plaintiff may suffer adverse tax consequences in two distinct ways. First, amounts recovered to compensate for back pay and front pay losses may be subjected to higher income tax rates than if such amounts had been earned as wages in due course. This increase in tax rates is typically due to the fact that the plaintiff's recovery is in a lump sum; as a result, a portion of the recovery may be subject to marginal rates higher than the plaintiff's typical marginal rate.
Second, an employment discrimination recovery could implicate the AMT. If so, the AMT may cause the recovery to be effectively taxed at rates significantly higher than the top marginal rate of 35 percent. In fact, in certain cases, the AMT may cause the tax on the recovery to exceed 100 percent - meaning that a victorious plaintiff would owe more in taxes than her recovery. This AMT trap is notoriously absurd as a matter of tax policy and undermines the national policy of encouraging the pursuit of meritorious civil rights claims. Yet, the trap persists, at least in most areas of the country.
The resolution of the gross up issue depends ultimately on whether the federal anti-discrimination remedial provisions permit judges to shift the liability for these adverse tax consequences from the plaintiff - on whom the Internal Revenue Code specifically imposes the liability - to the defendant - whose unlawful conduct necessitated the lawsuit that caused the adverse tax consequences. The potential vehicle for this shift is the broad equitable powers conferred upon courts to fashion relief in order to make victims of discrimination whole.
The issue of whether these broad equitable powers allow judges to shift a portion of the plaintiff's federal income tax liability to defendants is particularly interesting since both the plaintiff's tax liability and the defendant's discrimination liability arise from federal statutes passed by Congress. Thus, the resolution of the issue depends on which body of statutes, the Internal Revenue Code or the pertinent federal anti-discrimination statute, prevails over the other.
More generally, though, the issue concerns the courts' willingness to delve into federal income tax matters and focus on after-tax dollars, which are meaningful, rather than pre-tax dollars, which are meaningless. Courts typically have been reluctant to get their hands dirty with tax law if they can avoid it. Determining after-tax income can be a painstaking process and predicting future after-tax income even more so. Nevertheless, we conclude that courts have the authority to provide gross ups to discrimination plaintiffs and should exercise this authority whenever adverse tax consequences are substantial.