Third Circuit Permits Recovery of Damages for Negative Tax

							Monday, March 16, 2009                                                                              VOLUME 1 ISSUE 3

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Topics
                           Third Circuit Permits Recovery of Damages for “Negative Tax
Red Carpet Moments
For The YLC
                           Consequences” in Discrimination Suit
                           by Robert J. Toy
School Limiting Student
Speech Held
Constitutionally
Permissible                           In a case of first impression, the United States Court of Appeals for the Third
Third Circuit Permits                 Circuit held on January 30, 2009 in a precedential opinion that a prevailing
Recovery of Damages                   plaintiff in an employment discrimination case under the Americans With
for “Negative Tax
Consequences” in                      Disabilities Act may recover damages for “negative tax consequences”
Discrimination Suit                   suffered as a result of receiving lost wages in a lump sum. The case is
MySpace Is LinkedIn to     Eshelman v. Agere Systems, Inc., 554 F.3d 426 (3d Cir. Jan. 30, 2009), and it may signal
My FaceBook’s              an emerging circuit split on the issue.
BlogSpot: Managing
Your Online Persona as
a Young Lawyer
                           An Outstanding Twenty-Year Employee Stricken By Breast Cancer.
Proposed Premises
Liability Legislation In   Joan Eshelman was hired in 1981 by Western Electric, the predecessor to Agere
Florida Seeks To           Systems, Inc. (formerly known as Lucent Technologies, Inc.). Over the next twenty
Recede From The            years, Eshelman advanced through the company, eventually ascending to the position of
Supreme Court’s
                           supervisor of the Chief Information Office at Agere’s facility in Reading, Pennsylvania.
Decision In Owens v.
Publix Supermarkets,
Inc.                       In 1998, she was diagnosed with breast cancer and took a medical leave of absence from
Attention Young            September 1998 until March 1999 while she underwent treatment, including
Commercial Litigators!     chemotherapy.
Young Lawyers
Committee Webcast          Following her leave of absence, Eshelman returned to work on a part-time basis. She
2009 DRI Drug &            advised Agere that she was suffering from a cognitive dysfunction as a result of her
Medical Device Seminar     chemotherapy treatment, colloquially known as “chemo brain.” Eshelman explained that
Spread the Word! DRI's     she was struggling with short-term memory loss and that the problem would continue for
2009 Law Student           an indefinite amount of time.
Diversity Scholarship
Annual Meeting             Her “chemo brain” condition notwithstanding, the parties were in agreement that
Subcommittee
                           Eshelman continued to excel in her job, and continued to receive excellent performance
                           reviews, promotions, raises and bonuses. In 1999 and 2000, Eshelman received Agere’s
                           highest possible performance rating, and in June 2001 she was promoted to a higher
                           managerial position, which was accompanied by a $7,000.00 annual raise. To overcome
                           her short-term memory problems, Eshelman simply carried a notebook and took more
                           notes than she had prior to undergoing chemotherapy. There appears to have been no
                           evidence that her “chemo brain” impacted in any way Eshelman’s ability to think, reason
                           or solve problems.

                           Agere’s Reduction in Force, Eshelman’s Layoff and the Predictable Subsequent
                           Litigation.

                           Very soon after her June 2001 promotion, in October 2001, Agere suffered a substantial
                           decline in profitability and immediately took steps to implement a company-wide reduction
                           in force (RIF), as a result of which 18,000 employees were laid off worldwide.
In determining which employees would be subject to the RIF, Agere undertook a process
designed to objectively rank employees based on an assessment of the skills each
possessed that Agere would need after the corporate restructuring. Eshelman’s
supervisor wanted to retain her and, consistent with her twenty years of excellent
performance, initially rated her very highly. She was initially ranked as one of the highest
scoring employees in the entire company.

When it became apparent during the restructuring process that Agere’s Reading facility
(at which Eshelman worked) could be closed altogether, her supervisor suggested to his
superior that Eshelman should then be transferred to a different Agere facility in the area.
Eshelman balked at the idea of transfer, citing a concern about traveling to a new location
given her memory troubles, increased commuting expense, the hardship of a daily
commute, potential relocation expenses, her husband’s inability to relocate, and her
potential for “some telecommuting.”

Following the discussions regarding a possible transfer, Agere changed Ehselman’s RIF
ranking from one of the highest scores in the company to one of the lowest. The
responsible manager testified at trial that the change was “based in part on Agere’s
perception that Eshelman would be unable to travel to” its other facility, and on “its belief
that Eshselman lacked ‘the ability to perform the job’” at the other facility. No one from
Agere ever discussed either concern with Eshelman or gave her any opportunity to
address Agere’s concerns after it dramatically decreased her RIF ranking.

Based on the revised RIF score, Eshelman was placed at risk for termination, and was
ultimately laid off effective December 30, 2001 – just six months after her June 2001
promotion.

Eshelman brought suit under the Americans With Disabilities Act, alleging among other
things that her termination was discriminatory (1) because Agere’s decision was based
on its regarding her as having a disability (as a result of her breast cancer), and (2)
because the decision was based on her “record” of having a disability.

Following a four-day jury trial, Eshelman obtained a verdict in her favor on her disability
discrimination claim, and the jury awarded her $170,000 in lost wages and $30,000 in
compensatory damages, for a total of $200,000. Of course, as the prevailing plaintiff,
Eshelman also is entitled to recover reasonable attorneys’ fees as well.

Eshelman Seeks – and is Awarded – Post-Trial Damages for “Negative Tax
Consequences.”

Following entry of the verdict in her favor, Eshelman filed a motion to mold the verdict to
include sums for prejudgment interest and for the negative tax consequences she would
suffer as a result of receiving her $170,000 in lost wages in a lump sum rather than over
time in normal paychecks. The argument was that she would not have suffered these
“negative tax consequences” in the absence of Agere’s disability discrimination because
she simply would have continued working and earning her normal annual salary of
approximately $47,000. The payment of $170,000 in a single year would place her into a
higher tax bracket than she normally would fall at a salary of $47,000 per year, she would
have a higher tax burden as a result, and she should be compensated for the harm Agere
caused.

Eshelman argued, based on an affidavit from an economic expert, that the lump sum
award would push her into a tax bracket in which she would pay federal income taxes of
approximately 24.1% of the lump sum. By contrast, she argued, if she had remained
employed at Agere, her annual effective federal tax rate would have been only 18.23% of
her income. Accordingly, Eshelman argued, she stood to suffer “negative tax
consequences” of 5.87% of the award. After some tax-related calculations, Eshelman’s
expert opined that her negative tax consequences were $11,740.00.

The trial court agreed in principle with Eshelman that she should be compensated for her
negative tax consequences, but awarded only $6,893.00 in additional damages. Though
Agere contested Eshelman’s motion, it did not rebut Eshelman’s expert’s affidavit and did
not contest the accuracy of the figure awarded by the trial court.

The Third Circuit Affirms.

On appeal to the Third Circuit, Agere contested substantively (and unsuccessfully) the
jury’s verdict on liability, but also contested the trial court’s decision to award damages for
negative tax consequences. The Third Circuit affirmed the trial court, finding that an
award for negative tax consequences is, like the well-entrenched right of a plaintiff to
recover prejudgment interest, consistent with the “make whole” remedial purpose of the
anti-discrimination statutes. The court noted that, “without this type of equitable relief in
appropriate cases, it would not be possible ‘to restore the employee to the economic
status quo that would exist but for the employer’s conduct.’”

The court’s conclusion was based on the premises that (1) back pay awards under the
federal discrimination statutes are taxable, and (2) they are taxable in the year paid. As a
result, employees would likely be subject to higher taxes upon receipt of a lump sum back
pay award in a given year. Accordingly, the court held that it was proper, “in an
appropriate case,” to award damaages for negative tax consequences.

The court tempered its holding, however, in the concluding paragraph of its opinion:

          We hasten to add that in so holding, we do not suggest that a
          prevailing plaintiff in discrimination cases is presumptively entitled to
          an additional award to offset tax consequences above the amount to
          which she would otherwise be entitled. Employees will continue to
          bear the burden to show the extent of the injury they have suffered.
          The nature and amount of relief needed to make an aggrieved party
          whole necessarily varies from case to case. Accordingly, district
          courts, in using their wide discretion to locate a just result, should
          grant relief in light of the circumstances peculiar to the case.

Eshelman, 554 F.3d at --- (internal quotations and citations omitted). The court did not
provide any guidance as to which cases, in its view, would justify an award for tax-related
damages.

A Circuit Split?

In announcing its decision in Eshelman, the Third Circuit took a position that appears to
add to a split among the federal circuits on whether damages for negative tax
consequences are recoverable in employment discrimination actions. The Tenth Circuit
held in a class action in Sears v. The Atchison, Topeka & Santa Fe Railway Company,
749 F.2d 1451 (10th Cir. 1984) that “the district court did not abuse its discretion when it
included a tax component in the back pay award to compensate class members for their
additional tax liability . . . .” 749 F.2d at 1456. It also noted, however, that “[a] tax
component may not be appropriate in a typical Title VII [discrimination] case. But this
case presents special circumstances in view of the protracted nature of the litigation.” Id.
The Tenth Circuit also held in an age discrimination case decided the same year that a
district court had “erred in awarding damages to plaintiffs for increased tax liability caused
by the receipt of damages in a lump sum.” Blim v. Western Elec. Co., 731 F.2d 1473,
          th
1480 (10 Cir. 1984). The court noted in Blim that, although the lump sum would be
taxable in the year it was received, the tax laws included averaging provisions that would
“eliminate nearly all of any penalty that would otherwise result from receipt of a lump-sum
payment.” Id. The Tenth Circuit’s view seems, therefore, to be similar to that of the Third
Circuit: damages for negative tax consequences may be recoverable, but only in an
“appropriate” case.

By contrast, the District of Columbia Circuit has unequivocally rejected the notion that a
plaintiff may recover damages for negative tax consequences in an employment
discrimination action. In Dashnaw v. Pena, 12 F.3d 1112 (D.C. Cir. 1994), cert. denied,
513 U.S. 959 (1994), the court held, “[a]bsent an arrangement by voluntary settlement of
the parties, the general rule that victims of discrimination should be made whole does not
support ‘gross-ups’ of backpay to cover tax liability. We know of no authority for such
                  relief, and appellee points to none. Given the complete lack of support in existing case
                  law for tax gross-ups, we decline to extend the law in this case.” Id. at 1116.

                  It remains to be seen whether the Third Circuit’s decision in Eshelman will usher in a new
                  era of decisions on the negative tax consequences issue and potentially provide the
                  impetus to place the question before the United States Supreme Court. Until then,
                  however, it is now abundantly clear that plaintiffs in the Third Circuit may recover
                  damages for negative tax consequences, if they bear their burden of proving that they
                  have in fact suffered such damages.


                  Robert J. Toy is an attorney in the Philadelphia, Pennsylvania office of Post & Schell,
                  P.C., where he advises employers and, when necessary, defends them in litigation
                  proceedings arising under federal or state employment laws. Mr. Toy is a member of the
                  DRI Employment Law and Young Lawyers Committees.


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