Trial lawyer earmarks: ending deductions for punitive damage payments

by Ted Frank on May 19, 2009

One can certainly see why ending tax deductions for punitive damages is a superficially appealing idea.

But the main effect will be to increase settlement pressure in cases where there are unjust punitive damages awards. Because settlements can be characterized as “compensatory” and tax-deductible while court-ordered judgments cannot, trial lawyers will be able to use the tax differential to discourage defendants from seeking appellate review. So one cannot expect very much tax revenue from this: “punitive damages” will drop precipitously, but money going to trial lawyers will go up. Moreover, appellate courts will have fewer opportunities to correct bad decisions by trial courts, creating more uncertainty in litigation, which raises litigation expenses because it will be harder to predict outcomes.

Note that taxpayers are not subsidizing punitive damages award deductions by businesses: the income “lost” because a defendant deducted the punitive damages award will be income realized by the plaintiff and his or her attorney. If the deduction is forbidden, the government will be, in effect, double-taxing the same money.

The Obama administration makes much of its claim of being pragmatic, rather than ideological, but this looks like an indirect giveaway to the trial bar rather than a source of government revenue. More: Walter at Point of Law; and my shining mug quoted at the Southeast Texas Record.

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PointOfLaw Forum
05.19.09 at 8:41 am

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1 Roy in Nipomo 05.19.09 at 8:36 am

Why not cut out the middleman and have punitive damages go directly to the government?

If “punitive” damages are supposed to be to discourage persons/companies from continuing improper actions, losing the money to the gov’t is just as effective as giving it to a single “victim”.

Of course juries might be less likely to award huge amounts of money to the gov’t than a neighbor, but…

2 Dirk D 05.19.09 at 8:52 am

“If “punitive” damages are supposed to be to discourage persons/companies from continuing improper actions, losing the money to the gov’t is just as effective as giving it to a single “victim”.”

I believe a couple states have tried this (Oregon?) but it was found to be unconstitutional, IIRC from torts. Someone correct me if I’m wrong.

3 Ted Frank 05.19.09 at 8:52 am

Same problem, Roy, in the opposite direction: parties will settle to avoid the 100% tax — and why would a trial lawyer spend time and effort and briefing to generate a punitive damages award for which neither he nor his client gets paid? California briefly had a 75% recovery of punitive damages and didn’t collect a single dollar.

4 Max Kennerly 05.19.09 at 10:09 am

As far as I can tell, this measure would affect two companies: Exxon Mobile & Philip Morris. I don’t know of too many others with actual “punitive” judgments against them sustained all the way through appeal, since everyone else either settles or gets the punitives thrown out on appeal.

So, to the extent this is an issue, we’re talking about extremely outrageous conduct by very large companies. No other defendants really even consider punitive damages, much less the tax consequences. I am sure you folks at the Manhattan Institute have heard many corporations fret about punitive damages, but the vast majority of defendants do not believe the plaintiff will win punitive damages or that such damages will hold up on appeal. Indeed, the judge I clerked for explicitly kept punitive damages off of the table at settlement discussions, because they were so rare and so unlikely to produce fruitful engagement in the settlement process.

To be honest, given the context, I do not have a strong position on this issue one way or another. I personally do not think it would really change much about my own practice, since, even in cases where I believe punitive damages are likely, the defendants rarely do. The question is how much we want to punish these handful of very large corporations that do something terrible like spill oil everywhere or give people cancer. And that’s purely a political, not legal or tax, question.

5 Roy in Nipomo 05.19.09 at 10:43 am

“Why would a trial lawyer spend time and effort and briefing to generate a punitive damages award for which neither he nor his client gets paid?”

Okay, compensate the attorney for his/her time (out of the fine/punitive damages) an amount equal to, say, the hourly equivalent of the case’s judge’s salary.

I’m cynical (but ignorant on this point), but do many trial lawyers really care how much much money their client is paid in punitives other than how it affects their own percentage?

6 CarLitGuy 05.19.09 at 2:41 pm

I guess this post will tend to reinforce the opinion that I have odd reading habits.

Max,
in answer to your question, you might want to look at auto “Lemon Law” litigation in states such as Wisconsin (double damages *MUST* be awarded) and California. WI has numerous appelate cases where the manufacturer tried to raise a “duty of good faith” appeal to the court as defense of perceived gamesmanship by plaintiff counsel, yet for most of a decade, the appellate courts wouldn’t consider it. Check out Estate of Riley v Ford Motor (635 N .W.2d 635) where a customer sought double damages on that portion of a vehicle lease they were never obligated under the lease to pay (the residual value at lease turn in), or Tammi v Porsche Cars North America (this is so outrageous you wouldn’t believe it if I summarized it here) – 536 F.3d 702 (7th Cir 2008). Or Marquez v Mercedes Benz USA (also WI, don’t have a cite handy).

In Illinois, you have Belfour v Schaumberg, et al [2-98-0849, 2nd District 1999). CA has Dominguez v American Suzuki (Superior Court #05CC10415) or Johnson v Ford (Ct. App 5 F040188/F040529).

Only in Belfour and Dominguez did the manufacturer “win”, in both cases incurring expenses far in excess of the cost to simply repurchase the vehicle (which in both cases they had tried to do). In Johnson, punitives were ultimately reduced, again at huge expense.

Note further that “Lemon Law” cases have fee shifting provisions, so that the manufacturer (in almost every state) has to pay plaintiff counsel their fees so long as the customer gets any award, yet the manufacturer does not recover fees if their defense is successful. In spite of that unbalanced playing field, plaintiff counsel still seek fee multipliers under a “lodestar” calculation AND often take a percentage of the punitive damages in addition. See for instance (these are all CA cases:) Graciano v Robinson, Nightingale v Hyundai, Robertson v Fleetwood Travel Trailor, Levy v Toyota, or Serrano v Unruh. (again, no cites handy – my apologies).

Roy, I think this addresses some of your questions as well.

7 CarLitGuy 05.19.09 at 3:35 pm

(Clarification/Disclosure) – I work closely with a major car manufacturer.

Nor should my comments be intended to cast focus on CA specifically, it simply has an easily searchable index of cases, and more litigation (owing to population, at least) than most states.

8 SWB in Texas 05.19.09 at 6:00 pm

I’m with Roy – take punitive awards and use them to pay for Obamacare. Just set it up so that the plaintiff attorneys can still get a fee on the punitive award and don’t allow anyone in the courtroom to state who gets the punitive award.

9 Max Kennerly 05.19.09 at 7:49 pm

CarLitGuy,

I hadn’t considered lemon law; indeed, there are lots of “damage doubling” and “damage tripling” statutes, and a number of states have the same for insurance bad faith claims.

Two issues, though:

(1) I’m not sure those automatic damage fees would necessarily qualify them for the ‘punitive’ tax. The fee-shifting provisions likely wouldn’t. (I don’t know either way, I haven’t seen the specifics on this bill.)

(2) How big, really, do the damages get here? And, again, how many large punitive verdicts survived everything up to final, enforced judgment? Even a total “loser” of a punitive damages case is likely settled post-appeal, but while technically on writ of cert, and thus ends up avoiding the tax anyway.

It comes back to California collecting $0 after it implemented its punitive damage sharing statute. A tax on punitive damages would very rarely enter the equation; the only time I can think of that actually happening would be the huge, never-settle cases like Exxon Valdez.

10 Steve 05.19.09 at 10:27 pm

Am I the only one to wonder what the purpose of a law would be if it is so narrow as to only be applied in a “couple” of cases?

Me thinks that there really is much more use than we are gathering from the discussions here.

11 CarLitGuy 05.19.09 at 10:55 pm

Max,
in answer to 1.) I don’t know, I’m not a tax lawyer. What I have read of the tax code related to auto warranty litigation awards is terribly confusing – to the point that major manufacturers, the IRS, and plaintiff counsel can’t agree. One significant Supreme Court case close to on point does not seem to address awards on claims with fee shifting statutes. Most members of P/C claim that an award of “restitution” or an amount for “diminished value” is compensatory, and thus non taxable. They also claim that their client shouldn’t be taxed for amounts manufacturers pay for customer’s attorney’s fees – though the IRS seems to differ on that point.

2.) “Big” is a relative term. In some states, if you have a $40,000 car, and you pay $12,000 in finance charges, plus another $3,000 in taxes, registration, license and title charges, your recovery is $55,000 less some nominal amount of “usage”. The civil penalty component adds another $55,000, bringing the total award up to $110,000 (excluding attorney fees for both sides – in some venues, plaintiff fee requests will double that figure again) on a car the mfg likely sold to the dealer for $36,000 and built for $32,000. The numbers seem small till you multiply it by hundreds to a few thousand cars (some already five years old or older when the claim is first brought) each month. (Admittedly, most claims settle w/o penalty or all car manufacturers would be out of business). In the porsche case I referenced, the courts awarded over $200,000 to the owner, and let him keep the car! Not only that, but the porsche in that case was so “awful” that when his lease ended, the lessee bought it so he could continue to drive and enjoy it… The nation’s other new car purchasers help subsidize awards like that through inflated purchase prices to cover the anticipated future costs of litigation regarding the vehicle.

My experience is that some members of plaintiff counsel will use the threat of a civil penalty award to their client in order to assert a higher fee demand for their own pockets. The unspoken threat is, essentially “pay me far more than I’ve actually billed to file or I’ll inflict years of expensive and unneeded litigation upon your company.” Several of the attorney fee cases I referrenced above evidence what appears to be just that tactic. There are literally hundreds more unpublished cases just like it, around the nation – but that is unrelated to the issue that started this thread.

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