ABSTRACT & TABLE OF CONTENTS
Tax Malpractice Damages: A Comprehensive Review Of The Elements And The Issues
Suits to redress instances of tax malpractice may be framed either in tort or in contract. While some ancillary aspects of the litigation may differ, a professional must exercise reasonable competence and diligence to avoid malpractice liability under either approach. The same basic standards apply to attorneys and accountants. Typically the tort of negligence will be the key to any recovery, though other causes of action are also encountered.
Damages are normally recoverable for all injuries proximately caused by the malpractice, consequential as well as direct. The measure of damages is expectancy damages. The injured party may recover the loss of any expected benefit that competent performance would have yielded.
The basic direct or “core damages” typically involve four types of injuries: additional taxes, interest paid the taxing authority, penalties and corrective costs. Three different views have developed concerning the recoverability of interest. The other core damages are normally recoverable, except for additional taxes in New York.
Non-core, or consequential damages, recoverable must not be speculative. Recovery for emotional distress is generally not permitted in such situations involving an economic wrong, though a number of exceptions exist for egregious situations. Suicide is not a foreseeable result of tax malpractice, and no recovery is available for it. Punitive or exemplary damages may be recovered, in accordance with the jurisdiction’s normal rules. Attorney fees incurred in bringing the malpractice action are not recoverable under the “American rule,” though the amount paid the professional for the engagement which was negligently performed may be recovered in some jurisdictions. Other consequential damages also may be recovered.
Other damage issues examined include the recoverability of audit damages (probably not recoverable), whether different criteria should be applied when the tax benefit involved is a timing benefit rather than a permanent benefit, whether damages may be reduced when a plaintiff realizes a tax benefit from the injury and whether damages awarded ought to be grossed-up if the receipt of the damages is or may be taxable.
Although the same framework of damages applies also in estate planning and estate and gift tax situations, the structure of these taxes differs from the income tax and determining the amount of extra taxes caused by the negligence may require special focus and consideration.
Table of Contents Page I. Introductory 1 II. Damages – General Background 7 III. Elements of Damages 10 A. Direct or Core Damages 10 1. Additional Taxes 11 a. Determining Additional Taxes 15 2. Interest 26 3. Penalties 38 4. Corrective Costs 41 B. Non-core (Consequential) Damages 46 1. Speculativeness 47 2. Emotional Distress 58 3. Suicide 63 4. Punitive/Exemplary Damages 65 5. Attorney Fees 68 6. Miscellaneous 72 IV. Other Damage Issues 78 A. Audit Damages 78 B. Timing Tax Benefits 81 C. Tax Benefits of the Injury 93 D. Tax Consequences of the Recovery: Gross-Up 95 V. Brief Observations: Estate Planning/Estate and Gift Tax Area 97 VI. Conclusion 99
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