Thursday, March 17, 2022
Jeffrey Kahn (Florida State) presents Taxing Tort Damages: Do Juries Care? (with John Lopatka (Penn State-University Park)) at Duke today as part of its Tax Policy Seminar hosted by Lawrence Zelenak:
A taxpayer may exclude from her income any compensatory damages received on account of a physical injury. While the exclusion has narrowed in scope since its inception, the general rule of nontaxation for compensatory damages has existed in the United States tax system since 1919. Despite this rule already celebrating its 100th birthday, there is still no consensus on the tax policy justification for the exclusion of compensatory damages. Whether there is a policy justification or not, the current rule of exclusion raises another issue: should juries be informed about this tax treatment when determining the appropriate amount of damages. Again, despite this related issue being as old as the exclusion itself, there is no uniform resolution in state courts. A majority of states prohibit any tax jury instruction, but several states allow courts to inform juries that awards are not subject to taxation. The Supreme Court also sanctioned the use of a tax exclusion instruction in Federal Employee Liability Act cases.
Proponents of informing the jury of the tax exclusion treatment stress that such information leads to more appropriate compensation for the plaintiff. Without such information, juries may mistakenly believe that they need to gross up the award to ensure that plaintiffs are fully compensated, thereby in fact providing the plaintiff a windfall. Opponents of providing the information note that it adds unnecessary complications to the trial and benefits the tortfeasor since it likely leads to lower damage awards. What then should a court do when the defendant requests an instruction informing the jury that some damages are excluded from federal income tax?
In this piece, we revisit the issue of the taxation of damages and review the policy justifications that have been set forth to justify the current exclusion. We then review the policy elements of tort law to question whether the current tax exclusion furthers those goals. With those tort policies in mind, we turn to the question of whether a tax jury instruction is appropriate and helpful.
To support our conclusions, we report the results of an empirical experiment designed to determine the effects of a tax jury instruction. We believe this is the first empirical study that tested the effect of jury instructions that inform the jury of the tax treatment of compensatory damage awards. Using the results of this survey to bolster our case, we conclude with both a proposal for altering the income tax treatment of damages and, assuming that such change is unlikely in the near future, a resolution of the issue of whether tax jury instructions should be provided in tort cases.