Appellate court slashed award in Round up case; now for the tax bill

The California Court of Appeal has upheld a whopping verdict against Roundup. Johnson v. Monsanto Co., 2020 DJDAR 7575 (July 20, 2020). In 2018, jurors awarded $289 million to a man they say got cancer from Roundup weed killer. Plaintiff Dewayne Johnson was awarded $39 million in compensatory damages, and $250 million in punitive damages. Later, the judge reduced the $250 million punitive verdict to just under $40 million.

That left Johnson slated to collect $78.5 million, about half compensatory and half punitive damages. But Bayer, which now owns Roundup, appealed. The appellate court refused to reverse the decision, but it slashed the damages again. The court denied Monsanto/Bayer's motion for a new trial on condition that Johnson accept a settlement of $10.2 million in compensatory damages, plus the same amount in punitive damages.

However, Monsanto/Bayer has already filed a petition for rehearing asking the court to cut from $20.5 million to $16.5 million. But even if that were to happen, the appeal is still a win for plaintiffs, and it may influence even more suits. There are already vast numbers of cases. Most people don't think about these cases and taxes.

But the presence of punitive damages, and the strange new tax laws that took effect in 2018, should make everyone take notice. So how will this $20.4 million be taxed? Johnson will have to contend with new tax rules that make how legal settlements are taxed even trickier than in the past. Under the tax bill passed in late 2017, there is a new tax on litigation settlements: no deduction for legal fees. Amazingly, many legal fees simply can't be deducted.

That means Johnson must pay tax even on monies his attorney collects. That is so even though the attorney must also pay tax on the same money. Isn't that double taxation somehow? I don't think so, or at least I don't think it is an argument that anyone can win. The tax law is clear that if you are a plaintiff with a contingent fee lawyer, the IRS treats you as receiving 100% of the money, even if the defendant pays your lawyer directly. The U.S. Supreme Court said so in the Banks case in 2005.

If your case is fully nontaxable, say a physical injury case that settles before trial -- so there are no punitive damages and there is no interest -- that causes no tax problems. But if your recovery is taxable, all or in part, you could be taxed on more money that you actually collect. How the IRS prorates claims and prorates legal fees across claims can make the analysis complex.

Up until the end of 2017, you could claim a tax deduction for your legal fees in every case. In 2018 and thereafter, there is often no deduction for these legal fees. Of course, not all lawyers' fees face this terrible tax treatment. If the lawsuit concerns the plaintiffs' trade or business, the legal fees are a business expense, and those are still fully deductible.

Similarly, if your case involves claims against your employer, or certain whistleblower claims, those legal fees are also protected. They too can be deducted. Technically, the legal fee are still taxed to the plaintiff as gross income, but then they are immediately subtracted "above the line" so the plaintiff pays tax only on their net recovery, after fees and costs.

The net result -- if you can manage to claim the tricky above the line tax deduction properly on your tax return -- is that you have a wash. (Yes, claiming the above the line deduction for legal fees is surprisingly tricky, and even good accountants can find the mechanics challenging.) If you recover $1 million and your lawyer takes 40%, you net $600K. And you are taxed on $600K.

That seems fair, but that is only if you qualify for the above the line deduction. How about Johnson in the Roundup case? On the surface, I don't see how he qualifies, although he might be able to get creative and to try to work around the rules. Arguably, of course, the tax law should be easier and fairer to plaintiffs, so they do not have to hire sophisticated tax help just to be put in a position where they might be able to pay tax only on their net recovery!

Sometimes, tax advice before the case settles can make a huge difference. But you need to be creative, to document it, and the IRS may not agree. It isn't just punitive damages that cause problems. Awards of pre- or post-judgment interest can produce the same tax problems as punitive damages, with no deduction for legal fees.

Meanwhile, defendants like Monsanto and Bayer can deduct the whole verdict, even the punitive part. With the $20.4 million settlement, how much tax will Johnson pay? Let's assume that the combined contingent fees and costs Johnson pays might total 50%. If so, he gets to keep half of his $10.2 million compensatory award. His lawyer gets the other half. So, Johnson collects $5.1 million that should be tax free.

What about the punitive damages? He gets half of that too, another $5.1 million. But here's where taxes get strange. He is taxed on the whole $10.2 million of punitive damages. And even though he only gets to keep $5.1 million of the punitive damages (his lawyer gets the other half), Johnson pays tax on the entire $10.2 million, with no deduction for legal fees.

If you tally it, he gets cash of $10.2 million, and he pays tax on $10.2 million. That might seem fair, except that his compensatory damages for his physical sickness are supposed to be tax-free. Compensatory damages for physical injuries or physical sickness are tax free, one of the key rules governing how settlement awards are taxed.

But exactly what injuries are "physical" can sometimes seem like a chicken or egg issue. Here, the taxes are high as a result of the tax law that killed off tax deductions for many legal fees. Many plaintiffs have to get creative to deduct their legal fees under the new tax law just to get back to even. Go figure. 