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Tax Gross-Up



Tax gross-up awards are calculated because the investment income from an award for damages is taxable, although the award itself is not taxable. The purpose of the tax gross-up calculation is to compensate the victim so that he or she will have sufficient funds to pay the additional income taxes arising from investment income derived from the award.


In effect, a tax gross-up calculation involves two distinct steps. The first step involves calculating the level of taxation based on what is commonly referred to as “first dollar” income. First dollar income (that is, income that would have been taxable in any event) includes investment income from the award for loss of future income, any residual employment income earned in future years, pension income, and income from interest, for example. In addition, so-called “collateral benefits” such as disability pension payments or survivors’ pension are usually included as first dollar income.


The second step of a tax gross-up calculation is to calculate the tax burden with inclusion of the investment income from an award for future costs of care. This is sometimes referred to as “second dollar” income. The value of the tax gross-up is then calculated as the net present value of the additional tax burden arising from the investment income from the award for future costs of care. Only second dollar income is grossed-up to offset the effects of income tax.


In wrongful death cases, tax gross-up calculations involve estimating the additional tax burden imposed by an award for loss of future household services and loss of future dependency.


The value of the tax gross-up is dependent on a number of factors, some of which are as follows:

1. The size of the award and the pattern of withdrawals over the lifetime of the award;
2. The assumed level of future price inflation;
3. The level of first dollar income;
4. The assumed level of expenditures from the award for future care costs that qualify as medical expense tax credits;
5. Whether or not the individual qualifies for the tax credit for the mentally or physically impaired; and
6. The age of the individual.


Without tax gross-up calculations, an award will not cover the future care costs for which it is intended. We suggest that the tax gross-up should be calculated after the trial or settlement discussions have settled key issues regarding the magnitude of losses and other factors that need to input to the gross-up calculations. This approach is recommended because the gross-up calculations are complex and can be costly if a number of possible assumptions need to be evaluated.