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Third Circuit upholds gross-up of lump-sum employment discrimination award to reflect plaintiff's tax burden - Eshelman v. Agere Systems.


On January 30, 2009, tile U.S. Court of Appeals for the Third Circuit Court upheld the gross-up of a lump-sum award to reflect the increased tax burden of a winning plaintiff in an employee discrimination case. Eshelman v. Agere Systems, Inc. (1) involved the tax treatment of a lump-sum employment discrimination award. Specifically, the plaintiff in the case instituted a lawsuit claiming her employer had discriminated against her in violation of the Americans with Disabilities Act (ADA) and had unlawfully discharged her either because of cancer-related disability or because it regarded her as disabled. In the U.S. District Court for the Eastern District of Pennsylvania, the jury found in the plaintiff's favor and awarded her back pay and compensatory damages totaling $200,000.

Following the trial, the district court granted the plaintiff's post-trial motion to augment the jury's award to offset the negative tax consequences that she would incur from receiving the lump-sum back pay award. (2) The defendant-employer appealed the decision, claiming in part that the district court had improperly granted the plaintiff's post-trial motion to augment the jury's award. The Third Circuit upheld the district court's decision granting the gross-up amount under an abuse of discretion standard. (3) In doing so, the Third Circuit followed the Tenth Circuit, which considered the issue in Sears v. Atchison, Topeka & Santa Fe Railway Co. (4) In that case, the district court awarded the employees in a Title VII lawsuit compensation for the additional tax liability incurred as a result of receiving 17 years of back pay in a lump sum. In sustaining the award, the Tenth Circuit recognized that the trial court has wide discretion in fashioning remedies to make victims of discrimination whole and observed that, though perhaps not be appropriate in a typical case, it was appropriate under the facts in Sears.

In Eshelman, the Third Circuit likewise concluded that a district court may, pursuant to its broad equitable powers, award a prevailing employee additional money to compensate for the increased tax burden resulting from a lump-sum award of back pay. Citing the "make whole" remedial purpose of antidiscrimination statutes, the court stated that "[w]ithout this type of equitable relief in appropriate cases, it would not be possible to restore the employee to the economic status quo that would exist but for the employer's conduct."' (5) In addition, the court found support from the universal acceptance of prejudgment interest as a form of equitable relief on back pay awards. (6)

The Third Circuit acknowledged that the D.C. Circuit had considered and summarily rejected the argument that a court could issue an award to compensate an employee for additional tax liability. (7) In footnote 8 of its opinion, the Third Circuit quoted the discussion of the issue in Dashnaw as follows:

"[A]bsent an arrangement by voluntary settlement of the parties, the general rule that victims of discrimination should be made whole does not support 'gross-ups' of back pay to cover tax liability. We know of no authority for such relief, and appellee points to none. Given the complete lack of support in existing case law for tax gross-ups, we decline so to extend the law in this case."

Possibly recognizing the potential broad application of its holding, the court in Eshelman attempted to limit the holding:
   We hasten to add that in so holding, we do not suggest that
   a prevailing plaintiff in discrimination cases is presumptively
   entitled to an additional award to offset tax consequences
   above the amount to which she would otherwise be entitled.
   Employees will continue to bear the burden to show the extent
   of the injury they have suffered. The nature and amount of
   relief needed to make an aggrieved party whole necessarily
   varies from case to case. Accordingly, district courts, in using
   their wide discretion to "locate a 'just result,'" ... should grant
   relief "in light of the circumstances peculiar to the case." (8)

Relevance for the Tax Department

Before Eshelman, only two circuit--the Tenth Circuit holding for the employee and the D.C. Circuit holding for the employer--had addressed the issue of a tax gross-up in a back pay award context. After Eshelman, the majority of circuits (albeit only two) have approved a gross-up. The plaintiff bar likely will use this decision in negotiating settlements and in-house legal departments likely will involve their tax departments to help them understand the implications of the decision.

Eshelman May Effect Litigation Settlement Payments. If a plaintiff-employee's tax liability would be lower if payments were spread out over two or more years, a settlement with payments made to the plaintiff over more than one year would be attractive. A nonqualified structured settlement involving an unrelated assignment company could be used to avoid the acceleration of income tax recognition that occurred in Eshelman. Recently, the IRS has permitted the use of such settlement funds for this purpose. (9) Moreover, although it appears that Eshelman only involved a gross-up of federal income taxes, it seems plausible that additional taxes also may be taken into account in formulating a tax gross-up (e.g., FICA taxes, unemployment taxes, state income taxes, and local income taxes).

Eshelman Provides Interesting Points from the Employer's Perspective. The inclusion of the plaintiff's actual tax rates (and disclosure of her income tax returns) raises the issue whether the defendant-employer would be able to successfully petition the district court to reopen the computation of the tax gross-up amount if the amount of the employee's tax was reduced upon an IRS audit. Additionally, an interesting question is raised with respect to whether the court's rationale would be equally applicable if a lump sum-award resulted in less total taxes than would have occurred if the payments were spread out over several years. Query whether district courts have the discretion to reduce the back-pay award to reflect the income tax savings obtained by the plaintiff in this unusual situation. Furthermore, although Eshelman involved an employment discrimination suit under the Americans with Disability Act, employers should consider whether the court's rationale may apply to similar "make-whole" remedies found in other federal statutes, most notably, whistleblower statutes.

Potential Effect on Reinvigorating the Civil Rights Tax Relief Act of 2007. One final note on Eshelman is whether it and subsequent similar cases may help to unite employers and the plaintiff bar in reinvigorating the proposed Civil Rights Tax Relief Act of 2007. (10) The Act would amend the Internal Revenue Code to:

* Exclude from gross income non-economic damages in discrimination cases (back pay, front pay, and punitive damages would still be taxable); and

* Allow income averaging for back pay and front pay received from such claims, limiting an employee's tax liability for the year in which the money is received to the total amount received divided by the number of years it represents.

Thus, if this prior version of the Act were enacted, the averaging mechanism for the federal income taxation of back-pay awards would have avoided the issue presented in Eshelman. The Act was introduced in both the House and Senate in the summer of 2007.

(1.) 2008 WL 223858 (3d Cir. Jan. 30, 2009).

(2.) The amount of the gross-up was not equal to all taxes on the jury's award; rather, it was based upon the incremental amount of tax to the plaintiff as a result of receiving the judgment in a lump sum and not over time (i.e., in the normal course of her employment).

(3.) The amount of the gross-up was not at issue on appeal; the employer's argument was that the district court did not have the authority to grant the additional amount.

(4.) 749 F.2d 1451 (10th Cir. 1984). See also O'Neill v. Sears, Roebuck & Co., 108 F. Supp. 2d 443 (E.D. Pa. 2000) (holding plaintiff was entitled to award for negative tax consequences); E.E.O.C. v. Joe's Stone Crab, Inc., 15 F. Supp. 2d 1364 (S.D. Fla. 1998) (holding that district court, in exercising its discretion, may include tax component in lump sum back pay award).

(5.) Citing a prior Third Circuit decision, In re Continental Airlines, 125 F.3d 120 (CA-3, 1997).

(6.) See, e.g., Loeffler v. Frank, 486 U.S. 549 (1988) (finding that all U.S. Courts of Appeals that have considered the issue agree that Title VII authorizes prejudgment interest on back pay awards).

(7.) See Dashnaw v. Pena, 12 F.3d 1112 (D.C. Cir. 1994) (per curiam), superseded in part by 29 U.S.C. [section] 633a(d).

(8.) Citations omitted.

(9.) See IRS Letter Ruling No. 200836019 (holding that employee-plaintiff recognized no income upon employer-defendant funding settlement through third-party settlement fund; income is recognized only upon actual receipt of money by employee from fund disbursements).

(10.) H.R. 1540, 110th Congress; S. 1689, 110th Congress.

B. Benjamin Haas is a tax attorney and the Director of Federal Tax Research & Planning for Exelon Corporation, where he is responsible for strategic tax planning initiatives. A member of TEI's Philadelphia Chapter, Mr. Haas also serves as Exelon's in-house tax counsel. Before joining Exelon, Mr. Haas was a tax attorney with Morgan Lewis & Bockius, LLP and Pepper Hamilton, LLP, both in Philadelphia. He received his B.A. degree in Economics from Temple University, and his J.D. and LL.M. in Taxation degrees from Villanova University School of Law. Mr. Haas is an adjunct professor of law in the Graduate Tax Programs of both Villanova University School of Law and Temple University School of Law. He may be reached at Benjamin.Haas@ exelon corp. com.
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Author:Haas, B. Benjamin
Publication:Tax Executive
Date:Mar 1, 2009
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