Business Litigation I DECEMBER 14, 2017

Courts May 'Gross Up' Damages Awards for Increased Tax Liability

Arthur Clemens, Jr., sued his employer Qwest Corporation (“Qwest”) for race discrimination and retaliation contrary to Title VII of the 1964 Civil Rights Act. A jury awarded damages for back pay and emotional distress, as well as punitive damages.

The district court granted Clemens’s motions for attorney’s fees and (in part) an interest award. However, it denied his request for a “tax consequence adjustment” (or “gross up”) to compensate for increased income-tax liability resulting from his receipt of his back-pay award in one lump sum. Clemens appealed.

The appellate court observed that for successful Title VII plaintiffs, back-pay awards are taxable. Comm’r v. Schleier, 515 U.S. 323, 327 (1995) and 26 U.S.C. § 104(a)(2) (restricting income-tax exclusion for personal injury awards to those “received ... on account of personal physical injuries or physical sickness” (emphasis added by the court)). 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. Clemens claimed that very side effect. He argued that the taxman’s expanded cut effectively denied him what Title VII promises—full relief that put Clemens where he would be had the unlawful employment discrimination never occurred.

The court pointed out that the Third, Seventh, and Tenth Circuits have all held that district courts have the discretion to “gross up” an award to account for income-tax consequences. EEOC v. N. Star Hosp., Inc., 777 F.3d 898, 903-04 (7th Cir. 2015) (agreeing with Third and Tenth Circuits that without a tax-component award, the plaintiff will not be made whole, a result that offends Title VII’s remedial scheme).

The decision to award a gross up, and the appropriate amount, is left to the sound discretion of the district court. As the Third Circuit put it, “we do not suggest that a prevailing plaintiff in discrimination cases is presumptively entitled to an additional award to offset tax consequences .... The nature and amount of relief needed to make an aggrieved party whole necessarily varies from case to case.”

According to the appeals court, there may be cases where a gross up is not appropriate for a variety of reasons, such as the difficulty in determining the proper gross up or the negligibility of the amount at issue. In any case, the party seeking relief will bear the burden of showing an income-tax disparity and justifying any adjustment. The court expressed no opinion on whether a gross up was appropriate in this case. That issue was for the district court to decide on remand.

The case is Clemens v. Centurylink, Inc and Quest Corporation, 874 F. 3d 1113 (9th Cir. 2017).