Kelly A. Knight is an attorney and mediator based in Los Angeles, CAlifornia. He handles matters throughout California.

In blockbuster case, Ninth Circuit holds that "tax adjustments" to back-pay awards are an equitable form of relief in Title VII cases.

The Ninth Circuit just issued a blockbuster opinion in Clemens v. Centurylink, Inc., 874 F.3d 1113 (9th Cir. Nov. 3, 2017), approving "tax consequence adjustment" awards for back-pay in Title VII cases.

The plaintiff in Clemens prevailed in a Title VII race-discrimination and retaliation jury trial.  After trial, the plaintiff moved for a "tax consequence adjustment" or tax "gross up" to compensate for the increased income-tax liability resulting from receipt of a lump-sum back-pay award (as opposed to what he would have paid out in taxes had the back pay been earned over time).  The district court denied the request on grounds that the Ninth Circuit had never authorized one before. 

Well, colleagues, it's the dawn of a new era, for now the Ninth Circuit has.

Because Title VII exists to make persons whole from injurious unlawful discrimination, courts have "considerable equitable discretion to ensure adequate compensation."  See slip op. at 4-5.  "[I]t is the historic purpose of equity to ensure complete justice," and district courts have "not merely the power but the duty to render a decree which will so far as possible eliminate the discriminatory effects of the past as well as bar like discrimination in the future."  Id. at 5, quoting Bayer v. Neiman Marcus Grp., Inc., 861 F.3d 853, 873 (9th Cir. 2017).  "Back pay is one manifestation of this principle . . . as is prejudgment interest on back-pay awards . . . ."  Id. at 6 (internal citations omitted).

But because back-pay awards are taxable, "a lump-sum award will sometimes push a plaintiff into a higher tax bracket than he would have occupied had he received his pay incrementally over several years."  Id. at 6.  The plaintiff-appellant claimed that the higher tax bracket effectively denies him the full relief that would make him whole because the lump-sum award after taxes does not put him where he would have been if the unlawful discrimination had never occurred (i.e., earned that money over time and subject to lower income-tax rates).  Id.  

Joining the Third, Seventh, and Tenth Circuits--all of which have held that district courts have the discretion to "gross up" an award to account for income-tax consequences (i.e., issue a "tax-consequence adjustment")--the Ninth Circuit held that district courts have the discretion (a) whether to award a tax-consequence adjustment and (b) the amount of it.  Id. at 6-7.  

A plaintiff is not presumptively entitled to such an award, and there may be cases where the amount is negligible or determining the proper gross-up amount would be too difficult; "the party seeking the relief [(this almost always means the employee-plaintiff)] will bear the burden of showing an income-tax disparity and justifying any adjustment."  Id. at 8.  

The Ninth Circuit vacated the district court's order denying an adjustment and remanded for further proceedings--i.e., to determine whether such an award is appropriate and the amount.  Id. at 9.


The takeaways from this opinion are clear and truly monumental. 

Let's look at a common scenario.  By the time an employment plaintiff gets to trial, often years of litigation have gone by.  The plaintiff may have a lengthy period of wage loss following a wrongful termination.  And if the plaintiff ultimately secured a new job making less money, then the wage differential between the two jobs results in yet more back pay that is required to compensate and make the plaintiff whole.  After years go by, payment on a judgment that includes a large lump-sum back-pay award may shoot the plaintiff into a much higher tax bracket. 

Typically, the tax effect of this scenario is easy to calculate.  Take what the plaintiff would have taken home net of taxes had the plaintiff never been wrongfully terminated, and compare that to what the plaintiff will take home net of taxes after the back-pay award.  (The immediately obvious next question is whether the entire amount of the judgment is considered for its effect in increasing the plaintiff's marginal tax rate and overall tax effect, since typically the entire judgment in employment cases (including emotional-distress damages) may be taxable).

Under this Clemens opinion, the tax effect of the increased lump-sum award should offset by a "gross up" or "tax-consequence award."  Otherwise, the plaintiff is not made whole and receives less than what would have been earned over time if his or her employment had not been wrongfully terminated.

And since this is now a recoverable item after trial, plaintiffs should analyze whether to include this calculation in settlement demands, settlement discussions, and mediations.  The value of a plaintiff's case may well have just gone up.  And depending on the amount of lost wages, significantly.

Employers, in the short term, many if not most plaintiffs' counsel may not be aware of this development. That means you may be able to obtain a significant discount on the potential value of the case if you resolve it quickly, before this major development in the law becomes widely known. But certainly you should factor this change in the law into your decision-making to ensure that you don't get caught by surprise and mis-evaluate the exposure.


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