Court says taxes on awards in discrimination cases are recoverable as damages.

Even when plaintiffs in employment discrimination cases win, they sometimes lose. But not if they live in Washington state.

The federal tax consequences of a large settlement or award can mean plaintiffs end up paying more in taxes than they received as compensation for alleged workplace bias.

The Washington Court of Appeals ruled in October that a woman who sued her employer for violating the state's antidiscrimination law and won could recover an additional amount from the defendant to offset taxes on the award and on attorney fees. (Blaney v. Int'l Ass'n of Machinists & Aerospace Workers, 55 P.3d 1208 (Wash. Ct. App. 2002).)

Only a few other courts in the country have ruled similarly, but plaintiff lawyers say Blaney may help turn the tide. "The decision provides authority for courts elsewhere considering similar issues," said Stephen Connor, a Seattle lawyer who represented the plaintiff in the case. "It can certainly [indicate] that they're not venturing into uncharted territory."

Plaintiff lawyer Jeffrey Needle, also of Seattle, agreed. "Although this case was decided by a Washington state court interpreting Washington law, other courts may follow it if they have similar laws," he said.

In Blaney, the plaintiff alleged that her employer had violated the Washington Law Against Discrimination. After the jury agreed, she asked the court to award a supplemental amount covering the taxes she would have to pay on the award of damages and on attorney fees. The trial court declined, citing lack of precedent.

The appellate court, noting that this was a case of first impression, ruled: "The broad scope of the term `actual damages,' the analysis of that term in [other cases], the [state's] legislative statements of policy to `deter and eradicate discrimination' and to make that objective a matter of public policy of the `highest priority,' the policy of construing the [law] liberally to effectuate its purpose, and the grant of this type of relief in federal cases construing similar discrimination laws, all support the conclusion that adverse federal income tax consequences triggered by payment of a judgment for violation of the [law] are withing the scope of the term `actual damages.'"

Until 1996, the federal tax code excluded from taxation recoveries for plaintiffs claiming personal injury, including victims of civil rights violations. But Congress added language to [section] 104(a)(2) providing that jury awards or settlement recoveries for emotional distress damages unrelated to a physical injury or sickness are taxable. These nonphysical damages are often the only ones claimed in cases alleging job discrimination.

"It creates an unbelievably unfair tax burden for the plaintiff," Needle said. To illustrate, he described a recent Title VII sex discrimination case in which a jury awarded $3 million--later reduced to $300,000 because the judge deemed the verdict excessive--to an employee of Cook County, Illinois. The plaintiff also recovered attorney fees of $850,000 and litigation-related costs of $100,000. (Spina v. Forest Preserve Dist. of Cook County, 207 F. Supp. 2d (N.D. Ill. 2002).)

"All of it is taxable," Needle said. "In the end, the client ended up owing about $100,000 to the Internal Revenue Service. And her lawyer had to pay tax on the attorney fees, too--so they were taxed twice."

Cases like that have prompted an unusual consortium of business interests and consumer advocates to lobby for change to the tax laws governing recoveries in discrimination lawsuits. Throughout the 107th Congress, groups with often-competing legislative interests--including ATLA, the National Employment Lawyers Association (NELA), the U.S. Chamber of Commerce, AARP, and the Council for Insurance Agents and Brokers--urged lawmakers to pass the Civil Rights Tax Relief Act (H.R. 840; S. 917).

Plaintiff lawyer Connor noted that businesses and insurers would benefit from a change in the law because defendants would not have to pay as much to make a plaintiff whole. "Under current law, it costs a defendant $107,000 to settle a case that would net the person who brought the suit the same amount as a $50,000 settlement" under the proposed legislation, according to a NELA statement.

The proposed law would provide income averaging, allowing back pay awards to be taxed over a period of years rather than as a lump sum in the year they were awarded, and would eliminate taxation of emotional distress damages and attorney fee awards. The act covers various lawsuits based on civil rights violations, including discrimination in employment and housing.

Despite broad bipartisan support, the measure was not passed in the last congressional session. NELA staff lawyer Jenifer Bosco said supporters hope the legislation will come to a vote and pass in the next session.

Decisions like Blaney may help, Connor said. "It might prompt Congress to act in approving the legislation," he said. "The outcome of the case is completely reasonable if the purpose of antidiscrimination laws is to make the victim whole."