TaxProf Blog

Editor: Paul L. Caron, Dean
Pepperdine University School of Law

Thursday, April 7, 2011

Zelenak & Mogin on Taxing Punitive Damages

Following up on Gregg Polsky (North Carolina) & Dan Markel (Florida State), Taxing Punitive Damages, 96 Va. L. Rev. 1295 (2010):

In Taxing Punitive Damages, Gregg D. Polsky and Dan Markel argue that defendants paying punitive damages are under-punished relative to juries' intentions, because tax-unaware juries do not take into account the fact that the deductibility of punitive damages significantly reduces defendants' after-tax costs. They note that the Obama administration has proposed addressing the under-punishment problem by amending the Internal Revenue Code to disallow deductions for punitive damages (and for settlements paid on account of punitive damage claims). They conclude, however, that the proposal would be ineffective because defendants could avoid its impact by disguising nondeductible punitive damage settlements as deductible compensatory damage settlements. They argue that a superior approach would be to leave federal tax law unchanged and to change jury instructions in punitive damage cases instead. If juries were explicitly told that punitive damages were deductible, they could "gross up" the awards to impose the desired level of after-tax punishment on defendants. In contrast with the Obama administration's proposal, this non-tax, non-federal solution to the under-punishment problem would not be undermined by pre-trial settlements: "Gross ups, in addition to increasing jury verdicts, would increase settlement values because litigants determine these values in the shadow of what a jury would be expected to award."

Their argument is powerful and original. It may have dramatic real-world effects, if it inspires plaintiffs' lawyers across the nation to request the jury instructions required to produce tax-aware juries, and if courts grant those requests. In this brief Response, however, I raise two possible objections to their analysis. The first objection is that they do not consider the alternative of a nondeductibility rule applicable to punitive damages but not to settlements of punitive damage claims. This narrower nondeductibility rule is arguably superior to both broader nondeductibility and tax-aware juries. The second objection is that they do not consider how their analysis would change if deterrence, rather than punishment, were viewed as the primary function of punitive damages. Although these are considerably more than quibbles, they do not detract from my view of their article as a major contribution to the scholarly literature on the intersection of torts and taxes, with the potential for significant real-world impact. The Response closes with a brief observation on the relationship between the article, plaintiffs' attorneys, and ten dollar bills on sidewalks.

Considered in isolation, the proposal advanced by Professors Polsky and Markel has a certain logic. But it is in tension with how courts treat collateral sources of reimbursement and the exclusion from taxable income of compensatory damages awarded on account of personal injury or sickness, it disregards the distorting impact of evidence of corporate wealth, and it attributes undue importance to jury intent. It should not be adopted.

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Instead of spending so much time matching ties and shirts, checking for stains, polishing his wingtips and combing his hair, perhaps Professor Weissberg should dedicate that extra time to studying the judicial doctrine of substance over form. I would argue that much of what plagues today’s academy can be traced to outdated professors clinging on to antiquated traditions that either have no effect or hinder the true purpose for which the professors are in the classroom. Those professors who connect with and engage the minds of their students are much more valuable than those who merely dress and act the part as tradition dictates.

Posted by: JudicialDoctrines | Apr 7, 2011 6:31:21 AM