When an employee wins a wrongful termination lawsuit, the judge or jury is supposed to award economic and emotional distress damages that compensate the employee for his or her losses. In particular, damages for past and future lost wages and benefits are supposed to compensate the employee for the economic losses caused by the illegal discrimination or retaliation. Courts often refer to this as making the employee whole.
However, because higher incomes are taxed at higher rates, an employee who receives an award for lost wages can end up paying much more in taxes than she would have paid if she had not experienced the discrimination or retaliation. In those cases, employees are not made whole for their economic losses. Rather, they end up with less money in their pockets after taxes than if the unlawful employment practice had not occurred.
For example, if an employee making $100,000 per year is illegally fired, a jury might award her $400,000 for past and future lost income. That individual would receive the $400,000 in one lump sum, rather than the $100,000 per year she would have received if she had remained employed. But because the income tax rate increases as your total annual income increases, that individual would pay significantly more in taxes than if she had remained employed and received $100,000 each year. The higher the total lost wages award, the greater the impact of this problem.
On January 30, 2009, the United States Court of Appeals for the Third Circuit (the federal appellate court that covers New Jersey) addressed this problem. Specifically, the Court recognized that under the appropriate circumstances a judge should increase lost wages damages awards in employment law cases to offset this adverse tax consequence. The Third Circuit ruled that federal district courts can, in their discretion, award an employee “an additional sum of money to compensate for the increased tax burden a back pay award may create.” However, the court made it clear it was not suggesting that there should be a presumption that an employee is entitled to additional money to offset this negative tax consequences. Rather, courts have the option to increase a judgment if the employee proves she suffered a negative tax consequence as a result of a lump sum judgment for lost wages and doing so is fair under the circumstances.
The case, Eshelman v. Agere Systems, Inc., involves a disability discrimination lawsuit under the American’s with Disabilities Act (ADA). However, the decision appears to apply to claims of discrimination due to race, color, sex (gender), national origin and religion in violation of Title VII of the Civil Rights Act of 1964 (Title VII), and its reasoning would apply equally to other discrimination and retaliation claims under federal law.
It is unclear why the Court resisted creating a presumption of a tax offset, even though this adverse tax treatment occurs in the vast majority of employment law cases in which the plaintiff is awarded lost wages stemming from more than one year. However, the case is an important step in the right direction, since it allows federal judges to increase judgments to offset this tax penalty, and help make more victims of discrimination and retaliation economically whole.