July 5, 2010

NYT Op-Ed on Taxing Punitive Damages

We previously blogged about the Senate's recent approval of a measure to prevent corporations from taking tax deductions for punitive damages awards.

Law Professors Gregg Polsky and Dan Markel criticize that proposal in a New York Times op-ed entitled "Damages Control." Profs. Polsky and Markel argue that the proposal won't work because parties will still be able to settle punitive damages cases, and the defendants can characterize the settlements as payments of compensatory damages, which will remain deductible.

Polsky and Markel contend that, instead of eliminating the tax deduction, we should allow plaintiffs' lawyers to explain to juries that punitive damages awards are tax deductible, which would then encourage juries to award higher amounts to offset the fact that the award will be deductible. Polsky and Markel concede, however, that "tax-aware" juries would have to know the defendant's marginal tax rate in order to figure out the appropriate amount to offset the deduction.

It seems to me that the jury would have to know more than that; the jury would have to understand the defendant's overall tax situation to calculate any such offset. If the defendant were not expected to report any income for the year in question, would any offset be appropriate? Would the jury be asked to consider the effect of carry-overs from one tax year to the next? Would the jury be asked to determine the defendant's expected tax liability, based on speculation about what was likely to occur during the remainder of the tax year?

California courts decided long ago that juries should not be asked to consider the tax consequences of any damages awards, because juries would have to engage in "intense speculation about the future" in order to accurately adjust their awards. (See Rodriguez v. McDonnell Douglas Corp. (1978) 87 Cal.App.3d 626, 667-668.) Any proposal that increases speculation by the jury is probably not a good idea.