Making Plaintiffs Whole: A Tax Problem of Interest

William E. Foster, Washburn University School of Law

Abstract

This article illustrates the dramatic tax impact of interest awards in otherwise non-taxable litigation recoveries. While plaintiffs who recover personal injury awards typically receive favorable treatment, those receiving interest on such awards are taxed on the interest and are unable to utilize deductions for attorney’s fees paid to obtain the recovery. Further, the attorney’s portion of the recovery often will be included in the plaintiff’s gross income. The result is that the plaintiff recovers less of the interest than the Treasury or her attorney, preventing the plaintiff from being made whole. After reviewing the historical and theoretical framework that produces these results, I suggest previously-proposed judicial solutions are impracticable and a legislative solution is necessary. I conclude with a proposal for two alternative legislative solutions – an expanded deduction and an exclusion – to provide relief for plaintiffs recovering partially taxable awards and to achieve the policy of fully compensating injured plaintiffs.