Punitive Damages

As a dedicated plaintiff’s attorney, it's crucial to secure the best possible outcome for your clients when it comes to their award. Unfortunately, in cases involving taxable damages, clients often find themselves facing the burden of taxes on both their received award amount and the attorney's fee. However, there are innovative tax planning strategies available that can effectively double or even triple the post-tax amount for your clients.

While settlements for personal physical injuries without punitive damages or post-judgment interest are typically tax-exempt, the majority of other legal recoveries are subject to taxation. These encompass a wide range of cases, including employment law, defamation, libel, emotional distress claims without physical injury, fraud, breach of contract, and professional malpractice suits.

In a significant twist of tax law that occurred in 2017, plaintiffs now face the obligation to pay taxes on both the money they receive and the attorney's fee portion of a punitive damages awarded. For example, in a $10 million punitive verdict with a $4 million attorney's fee, the plaintiff is liable for taxes on the entire $10 million, even though their actual share is only $6 million. This creates a substantial financial burden for plaintiffs, and minimizes their reward.

The most famous personal injury verdict in America is Liebeck v. McDonald’s. This lawsuit was so famous that it was the subject of a documentary, mentioned by Toby Keith in a country song, and spoofed on an episode of Seinfeld. Most people remember that a jury awarded Stella Liebeck $3 Million dollars for burns caused from hot coffee. The jury actually awarded $160,000 for her compensatory damages (medical bills and pain and suffering) and $2.7 Million in punitive damages (decided by the jury because it amounted to about two days of revenue for McDonald’s coffee sales.) 

In this case, Stella was awarded $2,860,000 in total by the jury. Her attorney would receive $1,144,000 in fees. As far as her tax liability, Stella Liebeck would not owe taxes on the compensatory damages of $160,000, but she would owe approximately $1,350,000 in taxes on the $2.7 Million dollars of punitive damages. In this scenario, Liebeck would have only netted $366,000 of the $2.86 Million dollar verdict.

The encouraging news is that innovative tax planning strategies exist to drastically reduce the tax obligations of plaintiffs. By collaborating with an experienced settlement planner like Brian Adair, plaintiffs can explore these tailored strategies, significantly reducing the tax burden on their verdicts. In Liebeck v. McDonald’s, AFG could have possibly saved Liebeck the taxes on the attorney fee portion of the punitive damages, which in this case could have been as much as $510,000, thus taking her settlement from $366,000 to $876,000.