Legal Commentary

It's about four days until my wife is "due." During this pre-baby period, one of my projects has been an effort with my friend and co-author, Gregg Polsky, to finish our "shitty first draft" of Taxing Punitive Damages. I'm happy to say we're almost there. This paper is actually the fourth paper on punitive damages I've been involved with the last few years. The first two came out this past spring (here and here) and I was initially planning on turning to work further on and submit the third one, Punitive Damages and Complex Litigation, later this summer.  But for a cluster of reasons, that piece is now on the back burner and has swapped places with the fourth piece -- the one with Gregg on the intersection of taxation and punitive damages. 

Taxing Punitive Damages

In this article, we address the important but astonishingly under-examined issues associated with the taxation law and policy of punitive damages. For the most part, the tax consequences of punitive damages are not on anyone?s minds, and as a result of this blind spot, plaintiffs and their lawyers are likely leaving enormous amounts of money on the table in every case involving punitive damages against defendants whose torts occurred in the context of business operations. Of course, even if we assumed that decision-makers regarding punitive damages were aware of the relevant tax effects, there are still a number of other important issues affecting whether a jurisdiction should make punitive damages a) deductible from defendants? gross income or non-deductible, and b) taxable gains to the plaintiff.  

This Article examines those issues, and by doing so, spotlights the policy difficulties associated with trying to use tax law to help achieve the goals of current punitive damages law.  Contrary to a number of scholars who have flatly endorsed the move to a non-deductibility rule to simply increase the putative ?sting? of punitive damages, we explain what that change in taxation would augur for a broad array of policy concerns including federalism, settlement incentives, collusion against third parties, and administrative oversight. Although it is not without its own problems, we suggest that a tax-aware decision-maker might better gross-up the damages to take account of one?s marginal tax rate rather than simply make the punitive damages non-deductible. Moreover, because we think a lot of the difficulties associated with the taxation of punitive damages cannot be readily fixed simply by tweaking tax law, we sketch out in the last two parts of the Article a vision for what a more attractive punitive damages regime would look like, and how the tax rules would correspond appropriately.