Untangling Taxes from Personal Injury Damages
Lawyers who represent plaintiffs or defendants in personal injury cases are well acquainted with a number of legal doctrines that affect the amount of the plaintiff’s recovery, such as the PIP threshold defense, apportionment of fault, collateral source setoffs, caps on damages, or the statutory abrogation of joint and several liability. There is one legal issue, however, that is often overlooked by attorneys, although its resolution can affect the amount of the plaintiff’s recovery just as much as the others mentioned.
This commonly neglected issue is whether damages awarded for lost future earning capacity should be calculated on the basis of gross earnings or net, after-tax earnings. Stated differently, the question is whether the jury, in calculating how much to award the plaintiff for loss of future earning capacity, should deduct the income taxes that the plaintiff would have had to pay on the income that he or she would have been able to earn had he or she not been injured.
The answer to this question can have a substantial impact on the amount of the award. Damages for loss of earning capacity in the future are determined by taking the sum of earnings that the plaintiff would have been able to earn in the future if he or she had not been injured, reduced to present value; and subtracting the amount that the plaintiff is still able to earn after his or her injury, projected into the future and also reduced to present value. The question is whether the figures for the plaintiff’s projected future earnings (both pre-morbid earnings and post-morbid earnings) should be gross earnings or after-tax earnings. If gross earnings are used, then the jury’s award for lost earning capacity will be higher than if after-tax earnings are used. The difference can be quite substantial when the amounts involved are very high or when the plaintiff’s disability is severe.
This pre-tax/post-tax controversy arises because compensatory damages awarded in personal injury actions are not subject to the federal income tax. Since 1918, the Internal Revenue Code has excluded from gross income any damages recovered because of personal injury or sickness.1 In effect, these damages are exempt from the federal income tax.2 Because the plaintiff’s recovery is not taxed, but the income that the plaintiff would have been able to earn if not injured would have been taxed, some jurisdictions have adopted a rule that the jury should only consider after-tax income when calculating how much to award for lost future earnings or loss of future earning capacity. This approach has been mandated by the U.S. Supreme Court for actions arising under federal law.3
In Florida, the issue is rarely discussed in the published case law. This sparsity of case law may indicate that attorneys rarely raise the issue at the trial level. Perhaps most attorneys do not recognize the issue as a legal question, and, therefore, leave it up to economic experts to decide which method to use when they perform their calculations and form their opinions. It would be a mistake, however, to defer this question to the economists, because there is legal authority in Florida holding that the computation of an award of damages for lost future earning capacity shall be based on gross income. Attorneys and courts should be aware of this legal authority.
• Case Law. In Florida, the rule that personal injury awards are to be based on gross earnings grew out of a line of decisions addressing a different, but related issue — specifically, whether the jury should be instructed that the amount it awards to the plaintiff will not be subject to income tax. The rationale for giving such an instruction is to prevent the jury from adding an extra amount to the award to cover income taxes in the mistaken belief that the plaintiff’s recovery will be taxed.
In the first decision to address the propriety of such an instruction, Poirier v. Shireman, 129 So. 2d 439 (Fla. 2d DCA 1961), the court held that it was not error for the trial court to instruct the jury that its award would not be taxable. It approved the following instruction: “You are instructed that any award made to plaintiff as damages in this case, if any award is made, is not subject to federal or state income taxes, and you should not consider such taxes in fixing the amount of any award made plaintiff, if any you make.”4
Poirier does not directly address whether gross income or after-tax income should be used to calculate damages. It indirectly favors using gross income, however, because the instruction approved by Poirier tells the jury not to consider income taxes at all when making its award. It would be impossible for a jury to use after-tax income figures in its calculations without considering income taxes.
After Poirier, two more decisions considered the propriety of instructing the jury that its award would not be taxable. In Stager v. Florida East Coast Railway, 163 So. 2d 15 (Fla. 3d DCA 1964), the Third District Court of Appeal followed Poirier with little discussion and held that it was not error to give the instruction. Next, in Atlantic Coast Line Railroad v. Braz, 182 So. 2d 491, 495 (Fla. 3d DCA 1966), quashed without prejudice on other grounds, 196 So. 2d 109 (Fla. 1967),the Third District held that although it might have been proper to give the instruction, the trial court did not abuse its discretion or commit reversible error in refusing to do so. Neither decision addressed whether the jury’s award should be based on gross or net pay.
The first appellate court to state directly that an award of damages for loss of future earning capacity shall be based on gross income was the First District Court of Appeal in St. John’s River Terminal Co. v. Vaden 190 So. 2d 40 (Fla. 1st DCA 1966). The issue before the court was whether the trial court should have instructed the jury that its award to the plaintiff would not be subject to income tax. In explaining why the trial court did not abuse its discretion in refusing to give that instruction, the appellate court held that gross income, rather than after-tax income, is the proper basis for determining how much to award for lost earning capacity. It wrote:
It appears that the decided majority of courts in America support the view that in fixing damages for accrued loss of earnings or for impairment of future earning capacity because of personal injury, the income tax consequences of the injury and the award should not be taken into consideration; on the contrary, the award of damages should be based upon the plaintiff’s gross earnings or earning capacity and should not be reduced because of any income tax saving which may result to the plaintiff because of the fact that the damages will be exempt from income tax. Courts so ruling premise their conclusion on the theory that income tax liability of the plaintiff is not pertinent to the damage issue, being a matter strictly between the plaintiff and the taxing authority and of no legal concern to the defendant; that the amount of income tax which might become due on a person’s prospective future earnings is too conjectural to be considered in fixing the damages to which he may be otherwise entitled; that to introduce the income tax feature into a lawsuit seeking damages would be unduly complicating and confusing.5
Twenty years later, in Good Samaritan Hospital Association, Inc. v. Saylor, 495 So. 2d 782, 783 (Fla. 4th DCA 1986), the Fourth District followed St. John’s River Terminal Co., quoting the above excerpt with approval.
The four decisions discussed thus far all reviewed a trial court’s decision to grant or deny a request to instruct the jury that its award would not be subject to income tax. At first glance, these decisions may appear to be in conflict, but in fact they are not. Because rulings on jury instructions are reviewed only for an abuse of discretion,6 together these decisions establish that it is within the trial court’s discretion to either grant or deny a request for an instruction that the award is not taxable.7 None of the cases holds that a trial court is required to grant or deny the instruction. Also, nothing said in Poirier or Stager conflicts with the proposition that the jury’s calculation of damages should be based on gross income, as was later held in St. Johns River Terminal Co. and Saylor.
Thus, whether a trial court should instruct the jury that its award is not taxable is a separate issue from whether the jury’s calculation of damages should be based on gross income or after-tax income. In that light, some might question whether St. Johns River Terminal Co. really established a binding legal rule that the calculation of damages shall be based on gross income, given that the actual issue before the court was whether the trial court erred in refusing to give the requested jury instruction.
For that reason, it is significant that the Fourth District’s decision in Leaseco, Inc. v. Bartlett, 257 So. 2d 629 (Fla. 4th DCA 1971), applies St. Johns River Terminal Co.’s gross income rule in the context of reviewing a trial court’s evidentiary ruling. In Bartlett, a husband recovered a judgment for the wrongful death of his wife, who was killed in an automobile accident. On appeal, the defendants argued that the trial court should have limited the evidence concerning the wife’s earnings to her net earnings after deducting federal income taxes, instead of permitting the husband to offer testimony regarding her gross earnings. The Fourth District disagreed, holding that the issue had already been answered adversely to the defendants by St. Johns River Terminal Co.8 Bartlett, thus, recognized that the significance of the holding in St. Johns River Terminal Co.’s holding is not limited to the jury instruction context, and that St. Johns River Terminal Co. established a principle of law that damages awarded for lost earning capacity shall be calculated on the basis of gross income rather than after-tax income.
One appellate decision in Florida may appear at first glance to conflict with the proposition that gross income is the proper basis for calculating damages for loss of future earning capacity. In Basel v. McFarland & Sons, Inc., 815 So. 2d 687 (Fla. 5th DCA 2002), Mark Basel suffered severe brain damage as a result of a vehicular accident, and his guardians brought a negligence action on his behalf. The jury returned a verdict awarding $224,108 for past lost wages and $484,000 for future loss of earning capacity, among other items of damages. The plaintiffs filed a motion for additur or, in the alternative, for a new trial on damages, arguing that the undisputed evidence established that Basel’s past lost wages were $317,450 and his future lost earning capacity was $933,067. The trial court denied their motion.
On appeal, the Fifth District affirmed the denial of the motion for additur or new trial, holding that the trial court did not commit an abuse of discretion and the amount awarded by the jury was not so wholly inadequate as to shock the judicial conscience of the court. The plaintiffs’ proof of damages rested principally on testimony of expert witnesses. Both the trial court and the appellate court, therefore, relied on the legal principle that a jury is not bound to accept opinion testimony given by an expert, even if uncontroverted.9 Accordingly, the appellate court’s opinion discusses several possible reasons why the jury might have rejected the plaintiffs’ evidence supporting their claim for damages. Among those potential reasons, the court observed that the jury may have concluded that the growth rate used by the plaintiffs’ expert in calculating the loss of future earning capacity was incorrect, and that he did not consider the effect of income tax.10 This remark, however, is dictum that does not establish any controlling precedent on the question of the proper measure of damages for loss of future earning capacity. It is offered only as one of several possible reasons why the jury was not fully persuaded by the testimony of the plaintiffs’ expert. The court’s opinion contains no discussion of what constitutes the appropriate measure of future loss of earning capacity, or whether the jury’s award should be based on gross earnings or after-tax earnings. Therefore, Basel does not establish any legal rule on that issue, and does not conflict with the holdings of St. John’s River Co. and Saylor that gross income is the proper measure.
• Statutes. The Florida Statutes also provide support for the principle that damages for lost earning capacity shall be calculated on the basis of gross income. Two different statutory schemes — one dealing with arbitration of medical malpractice claims, the other concerning personal injury protection (PIP) insurance — require an automatic reduction of any award for lost earnings or lost earning capacity as a rough way to account for the fact that the awards will not be taxable. This approach implicitly confirms the rule that such damages shall be computed on the basis of gross income.
The relevant medical malpractice statutes were created by a medical malpractice reform bill enacted in 1988 which, among other measures, implemented a process for voluntary binding arbitration of medical malpractice claims.11 In this arbitration scheme, the economic damages that may be awarded when a claim is arbitrated include only 80 percent of the claimant’s damages for wage loss and loss of earning capacity. No such reduction is required for other economic damages, such as past and future medical expenses.12 If a plaintiff rejects a defendant’s offer to submit to voluntary binding arbitration, then there are adverse consequences for the plaintiff, such as a $350,000 cap on the noneconomic damages that may be recovered at trial.13 Economic damages are not capped, but the economic damages that the plaintiff may recover include only 80 percent of lost wages and lost earning capacity, just as if the claim had been arbitrated. Again, there is no such reduction for other types of economic damages.14
But does this mandatory reduction of lost wages and lost earning capacity really have anything to do with income taxes, or is it only a discount intended to reward medical malpractice defendants for choosing arbitration? The answer is found in F.S. §766.201 (2007), which sets out a number of legislative findings and statements of legislative intent in support of the 1988 malpractice reform bill. One of the legislative findings is, “The recovery of 100 percent of economic losses constitutes overcompensation because such recovery fails to recognize that such awards are not subject to taxes on economic damages.”15 This explains why the legislature decided to require, in certain instances, a 20 percent reduction of the amount recoverable for lost wages or lost earning capacity. The 20 percent represents the income taxes that the plaintiff would have paid on the lost wages or future earnings if he or she had not been injured.
A similar approach is seen at work in the PIP statute, F.S. §627.736 (2007), which is the centerpiece of the Florida Motor Vehicle No-fault Law. The no-fault law requires most motor vehicles in Florida to carry PIP coverage, which pays benefits up to $10,000 as compensation for certain types of losses resulting from bodily injuries caused by an automobile accident.16 The benefits payable under a PIP policy include disability benefits, which cover “[s]ixty percent of any loss of gross income and loss of earning capacity per individual from inability to work proximately caused by injury sustained by the injured person. . . . ”17 How do we know this reduction has anything to do with income taxes? The connection was explicit in earlier versions of the statute, which linked the reduction to the tax-free status of the benefits. The original PIP statute, enacted in 1971, defined the amount payable in disability benefits as, “[o]ne hundred percent of any loss of gross income and loss of earning capacity per individual, unless such benefits are deemed not includable in gross income for federal income tax purposes, in which event such benefits shall be limited to 85 percent, from inability to work proximately caused by the injury sustained by the injured person. . . . ”18
In 1977, an amendment to F.S. §627.736 reduced these amounts to 80 percent if the benefits were taxable, and 60 percent if they were not.19 Yet another amendment, passed in 1982, eliminated the distinction between taxable and nontaxable benefits and provided that the amount payable would always be 60 percent — the same percentage that applied to nontaxable benefits under the previous version of the statute.20 The legislature may have determined that disability benefits are never subject to federal income tax and, therefore, amended the statute to treat all disability benefits as nontaxable.
Thus, the reason that PIP’s disability benefits only pay 60 percent of lost wages and lost earning capacity, while the medical benefits portion of PIP pays 80 percent of medical expenses,21 is to account for the tax savings resulting from the fact that disability benefits are not taxable. The difference of 20 percentage points roughly represents the income tax that the claimant would have paid on the income he or she would have earned had he or she not been injured.
These statutory provisions confirm that the general rule in Florida is that damages for lost earnings and lost earning capacity are calculated on the basis of gross income. Although the legislature may have deemed it a windfall for the plaintiff to recover a tax-free award of 100 percent of his or her lost earnings or lost earning capacity, the fact that the legislature saw fit to address this perceived windfall only in these limited areas (medical malpractice arbitration and PIP) shows that the use of gross income for calculating damages remains the general rule in other personal injury contexts. Furthermore, the remedy that the legislature chose to implement in those limited areas — a fixed-percentage reduction of the recovery — will work as intended only if the initial calculation of damages by the jury is based on gross income. Therefore, when one of these statutory reductions applies, the plaintiff should object to the admission of any expert testimony regarding the plaintiff’s future lost earning capacity that is based on net income figures. Otherwise, the plaintiff’s recovery would be reduced twice to account for income taxes — first when the expert subtracts taxes from the plaintiff’s projected lost income, and again when the court applies the 20 percent reduction of the award required by statute.
• Wrongful Death Distinguished. Wrongful death cases are an exception to the rule discussed above. statute, two of the elements of damages that may be recovered in a wrongful death action — the estate’s loss of prospective net accumulations, and a survivor’s loss of support and services — are based in part on the decedent’s net, after-tax income.22
Interestingly, Saylor was a wrongful death case, and yet the Saylor opinion quotes Vaden for the principle that “damages should be based upon the plaintiff’s gross earnings or earning capacity. . . . ”23 This does not necessarily mean that Saylor’s holding was erroneous, however. First, it cannot be determined from the Saylor opinion exactly which elements of damages were awarded in that case. Second, the actual holding of Saylor was that the trial court did not abuse its discretion by refusing to instruct the jury that its award of damages would not be subject to income tax, which is a separate issue from whether damages should be calculated on the basis of gross income or net income.
Two other decisions discussed previously, Braz and Leaseco, were also wrongful death cases, but were issued before the Florida Wrongful Death Act had been enacted in 1972.24 The statutes that governed wrongful death actions at the time of Braz and Leaseco did not require any of the recoverable damages to be based on net income.25
Under Florida law, damages for lost earnings or lost future earning capacity shall be based on gross income, rather than after-tax income, and income taxes shall not be considered by the jury in determining the amount to award as damages. This principle of law should inform the trial court’s rulings on affected matters such as jury instructions, the admissibility of evidence regarding income taxes, the admissibility of expert opinion testimony regarding the computation of damages, and whether to allow comments regarding income taxes in argument to the jury. Wrongful death actions are an exception to this rule, because the Florida Wrongful Death Act requires certain elements of damages to be based on net income.
1 26 U.S.C. §104(a)(2).
2 Punitive damages, however, are not excluded from taxable income. 26 U.S.C.§104(2)(a).
3 See Jones & Laughlin Steel Corp. v. Pfeifer, 462 U.S. 523, 534, 536 (1983); Norfolk & W. Ry. Co. v. Liepelt, 444 U.S. 490, 493 (1980).
4 Poirier, 129 So. 2d at 440 (Fla. 2d D.C.A. 1961).
5 St. John’s River, 190 So. 2d at 41-42 (Fla. 1st D.C.A. 1966).
6 See Goldschmidt v. Holman, 571 So. 2d 422, 425 (Fla. 1990); H & H Elec., Inc. v. Lopez, 967 So. 2d 345, 347 (Fla. 3d D.C.A. 2007).
7 See Ageloff v. Delta Airlines, Inc., 860 F.2d 379, 390 (11th Cir. 1988) (concluding that Florida law permits the instruction to be given, but does not require it; rather, it is left to the discretion of the trial court).
8 St. Johns River Terminal Co., 257 So. 2d at 633 (Fla. 4th D.C.A. 1971).
9 Basel, 815 So. 2d at 697-98 (Fla. 5th D.C.A. 2002).
10 Id. at 698.
11 See Ch. 88-1, Laws of Fla.; Fla. Stat. §§766.201-766.212 (2007).
12 Fla. Stat. §766.207(7)(a) (2007).
13 Fla. Stat. §766.209(4)(a) 2007).
14 Fla. Stat. §766.209(4)(b) (2007).
15 Fla. Stat. §766.201(1)(e) (2007).
16 Fla. Stat. §627.736(1) (2007).
17 Fla. Stat. §627.736(1)(b) (2007).
18 Fla. Stat. §627.736(1)(b) (1971) (effective January 1, 1972).
19 Ch. 77-468, §33, Laws of Fla.
20 Ch. 82-243, §554, Laws of Fla.
21 See Fla. Stat. §627.736(1)(a) (2007).
22 Fla. Stat. §768.18(5) (2007); Fla. Stat. §768.21(1) (2007)
23 Saylor, 495 So. 2d at 783 (quoting, Vaden, 190 So. 2d at 41-42).
24 See Ch. 72-35, §1, Laws of Fla.
25 See Fla. Stat. §§768.01-768.04 (1971).
Shea Moxon received his J.D. in 1994 from Harvard University. Mr. Moxon is a member of The Florida Bar, the Hillsborough County Bar Association, and the Florida Justice Association. He practices with Swope, Rodante, P.A., in Tampa.
This column is submitted on behalf of the Trial Lawyers Section, Bradley E. Powers, chair, and D. Matthew Allen, editor.