Taxing Punitive Damages

66 Pages Posted: 19 Jun 2009 Last revised: 27 Sep 2010

See all articles by Gregg D. Polsky

Gregg D. Polsky

University of Georgia School of Law

Dan Markel

Florida State University College of Law (Deceased)

Date Written: September 20, 2010

Abstract

There is a curious anomaly in the law of punitive damages. Jurors assess punitive damages in the amount that they believe will best “punish” the defendant. But, in fact, defendants are not always punished to the degree that the jury intends. Under the Internal Revenue Code, punitive damages paid by business defendants are tax deductible and, as a result, these defendants often pay (in real dollars) far less than the jury believes they deserve to pay.

To solve this problem of under-punishment, many scholars and policymakers, including President Obama, have proposed making punitive damages nondeductible in all cases. In our view, however, such a blanket nondeductibility rule would, notwithstanding its theoretical elegance, be ineffective in solving the under-punishment problem. In particular, defendants could easily circumvent the nondeductibility rule by disguising punitive damages as compensatory damages in pre-trial settlements.

Instead, the under-punishment problem is best addressed at the state level by making juries “tax-aware.” Tax-aware juries would adjust the amount of punitive damages to impose the desired after-tax cost on the defendant. As we explain, the effect of tax awareness cannot be circumvented by defendants through pre-trial settlements. For this and a number of other reasons, tax awareness would best solve the underpunishment problem even though it does come at the cost of enlarging plaintiff windfalls. However, given the defendant-focused features of current punitive damages doctrine, this cost is not particularly troubling.

Keywords: punitive damages, tax, torts, dispute resolution

Suggested Citation

Polsky, Gregg D. and Markel, Dan, Taxing Punitive Damages (September 20, 2010). Virginia Law Review, Vol. 96, No. 6, 2010, Available at SSRN: https://ssrn.com/abstract=1421879

Gregg D. Polsky

University of Georgia School of Law ( email )

225 Herty Drive
Athens, GA 30602
United States

Dan Markel (Contact Author)

Florida State University College of Law (Deceased)

Do you have negative results from your research you’d like to share?

Paper statistics

Downloads
509
Abstract Views
9,663
Rank
101,224
PlumX Metrics