This is Just Plain Wrong

Alva and Alberta Pilliod recently were awarded $2 billion in punitive damages from Monsanto, related to claims of cancer from using Roundup weed killer. Unfortunately, the big winners here are not the Pilliods, but the U.S., the State of California, and their attorneys, due to changes in the deductibility of legal fees in the 2017 Tax Act.

The big change was the elimination of miscellaneous itemized deductions through 2025, even for those taxpayers that itemize their deductions. Attorney’s fees generally are miscellaneous itemized deductions, so taxpayers that obtain a judgment and pay their attorneys from the judgment cannot deduct those fees.

So let’s review the math for the Pilliods (let’s assume the judgment remains the same after appeals and is paid). They have $2 billion of income from the judgment. With maximum federal tax rates of 37% and California income taxes of 13.3%, and with no deduction for the attorney’s fees and costs they pay, their combined income taxes should be around $1 billion. Their is speculation that their attorney’s fees and costs could total $1 billion. Net left for the Pilliods: $0.

Their attorneys will be taxed on the fee portion of what they receive. If we assume $200,000 in costs, the attorney’s fees will be $800,000. Since we don’t know where they live or what type of entities they practice in, we don’t know their tax bill. But let’s assume 50% - their after-tax receipts are $400,000.

Totals for the tax authorities under this scenario is $1.4 billion.

SOMETHING IS VERY WRONG WITH THIS RESULT, OBVIOUSLY.

When an income tax rises to 100% due to the disallowance of costs to obtain the income, does it cease to be an income tax? And what about the effective double taxation of the attorney’s fees - both the plaintiff and the attorneys are effectively taxed on the same payment?

As these results filter out in the world, it is going to impact the economics of litigation, and may work to the benefit of defendants where the financial incentives to plaintiffs are substantially diminished.

The Pilliods problems are exacerbated by living in a state with high income taxes, such as California, so residents of other states might be able to pocket more from such recoveries. The Pilliods were awarded an additional $55 million in compensatory damages. If qualifying as damages for physical injuries, the $55 million is not subject to income tax. After paying their lawyers, they would end up with $27.5 million. However, the physical injury exception will not be available to plaintiffs in lawsuits where the award is not for physical injury.

Note that there are some exceptions to nondeductibility. Costs involving discrimination suits and attorney’s fees relating to whistleblower awards are above-the-line deductions that were not chopped by the 2017 Tax Act. The same applies to recoveries relating to a taxpayer’s trade or business (other than sexual harassment and abuse cases where there is a nondisclosure agreement). Also, attorney’s fees that are court awarded or statutory are not included in income.

Taxes Slash $2 Billion Roundup Weedkiller Verdit to $27.5 Million, Forbes.com (May 14, 2019)