Third Circuit Approves Additional Award to Compensate Plaintiff for Adverse Tax Consequences

On January 30, 2009, the U.S. Court of Appeals for the Third Circuit affirmed a US Magistrate Judge’s ruling awarding a Plaintiff who was terminated in a reduction-in-force after experiencing memory loss issues following chemotherapy, an additional $6,893 to offset the negative tax consequences of her taxable award of $206,893.  Eshelman v. Agere Systems Inc., 3d Cir., No. 05-4895, 1/30/09.

In Eshelman, the plaintiff worked as a supervisor for the defendant. She took a leave of absence to undergo chemotherapy for breast cancer.  When the plaintiff returned to work, she suffered from a malady commonly known as "chemo brain," which is a cognitive dysfunction that involves short-term memory loss. She compensated for her memory deficiency by diligently maintaining a notebook.  Despite receiving high performance ratings, the plaintiff was terminated as part of a company-wide reduction in force.

The plaintiff sued under the Americans with Disabilities Act, alleging that the defendant selected her for termination because it regarded her as being disabled.  The defendant argued that the plaintiff could not show that the company viewed her memory impairment as substantially limiting a major life activity.

While the Court of Appeals spent most of its decision analyzing the parties’ legal arguments under the ADA, the Court made new law by holding for the first time that trial judges have the power to increase a winning plaintiff's award to account for the increased tax burden of receiving a backpay award as a lump sum. “Our conclusion is driven by the ‘make whole’ remedial purpose of the anti-discrimination statutes." U.S. Circuit Judge Michael A. Chagares wrote.  “Without 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.”  Chagares wrote in an opinion joined by Judges D. Michael Fisher and Morton I. Greenberg.

The Third Circuit’s decision deepens a split in the federal circuits, with the 3rd Circuit opting to follow a 1984 decision from the 10th Circuit and rejecting a 1994 decision from the D.C. Circuit.  The D.C. Circuit's decision in Dashnaw v. Pena flatly rejected the notion that winning plaintiffs are ever entitled to supplemental awards to make up for increased taxes.  “The general rule that victims of discrimination should be made whole does not support ‘gross-ups’ of backpay 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 to so extend the law in this case." the Dashnaw court wrote.

In rejecting the DC Circuit’s analysis, the Third Circuit stated, “[w]e disagree with Dashnaw,” and trial judges have “broad equitable powers” under discrimination laws to fashion a remedy that truly makes the plaintiff whole.  “This type of an award, as with prejudgment interest, represents a recognition that the harm to a prevailing employee's pecuniary interest may be broader in scope than just a loss of back pay.”

Practice Pointer:  Many types of awards and settlements are taxable, not just those that are employment related. Claims or awards for punitive damages, discrimination, non-physical injuries, emotional distress, defamation and interest are generally taxable. Employers should be cognizant of the potential for additional damages because of a lump sum award and consider the impact of an additional tax award in evaluating any potential settlement.