By using this site, you agree to our Privacy Policy and our Terms of Use.

Liars, Damn Liars, Defamation, and Double Taxation

A large book with the title Defamation law printed on it sitting on top of a desk with other books

In the current digital and highly charged political age, the power of words has never been more salient. It has become an all-too-common place for words to be used as weapons for making untrue statements about a person or entity. A single untrue utterance can ripple through society, casting shadows of controversy and, sometimes, engendering significant legal implications. Untrue words (lies) have become an ugly weapon against adversaries in the public domain. This article ventures into defamation law, exploring the legal and ethical ramifications and the tax implications of an associated legal settlement.

Defamation: A Primer

Defamation is a tort comprised of the following elements: (i) a false statement of fact, (ii) that was published, and (iii) which publication causes harm to the reputation of the subject of the statement. The requisite standard of proof associated with the above-listed elements varies depending on the plaintiff’s status in society, as public figures are required to prove that the statements were made with actual malice. In ruling on a defamation suit, courts seek to balance the freedom of speech with protecting individual reputations.

Victims of defamation can pursue various civil causes of action aside from defamation claims, such as intentional infliction of emotional distress and loss of income. Some states have civil laws allowing defamation victims to seek compensatory and punitive damages.

Plaintiff Double Tax Imposed by Banks v. Commissioner

Unfortunately, because of the “plaintiff double tax,” defamation victims suffer twice – first by the defamation itself and second by how their litigation recovery is taxed. The defamation offense is obviously worse, but double taxation remains an unfair outcome.

What is the Plaintiff Double Tax?

Commissioner v. Banks, 543 U.S. 426 (2005), is a Supreme Court case that addressed the question of whether, for federal income tax purposes, the taxable components of a judgment or settlement paid to a taxpayer’s attorney under a contingent fee agreement is taxable income to the taxpayer. The Supreme Court ruled that one hundred percent (100%) of the gross taxable portion of the litigation/settlement recovery constitutes the taxpayer’s income and explicitly includes the portion paid to the attorney as a contingent fee. The Court viewed the attorney as merely the plaintiff’s “agent,” thus, the proceeds were wholly those of the plaintiff.

The plaintiff double tax applies to many litigation claims, including those involving no physical injuries – such as defamation and punitive damages. Thus, as has been noted, the entire award is taxable income in those cases, but the related attorney fees are not deductible on the victim’s Form 1040 tax return. Having to pay taxes on the total value of the award where the related attorney fee is not deductible is the plaintiff’s double tax.

For example, assume a defamation victim lives in NYC and recovers $1,500,000 in non-physical injury and emotional distress damages and an additional $1,500,000 in punitive damages. The entire $3,000,000 gross settlement proceeds are taxable to the plaintiff, but none of the attorney fees are deductible.

In NYC, the combined Federal/State/Local income tax rate on this award is likely 50% (or more), and the attorney has a forty-percent (40%) contingency rate, so the plaintiff ends up with a net of only $300,000. (netting $300,000 after tax is only 10 cents on the dollar!) Now, add the litigation costs associated with the action that the plaintiff also bears, and the net recovery could be zero ($0) or even produce a negative after-tax net settlement. We can all agree that 10 cents on the dollar (or less) is not fair compensation for a ruined reputation.  

A defamation victim seeking to avoid this unfortunate scenario created by Banks might consider a Plaintiff Recovery Trust (PRT), a specially designed trust that exists to hold the litigation claim. If there is a successful recovery, the PRT will significantly increase the net after-tax recovery, perhaps by 100% or more, depending on the recovery amount and where the defamation victim is domiciled.

To learn about PRTs, go to https://www.easternpointtrust.com/plaintiff-recovery-trust.

Disclosure: This content is an overview. It is not a detailed analysis and offers no legal or tax opinion on which you should solely rely. Always seek the advice of competent legal and tax advisors to review your specific facts and circumstances before making any decisions or relying on the content herein.
Any opinions, views, findings, conclusions, or recommendations expressed in the content contained herein are those of the author(s) and do not necessarily reflect the view of the Eastern Point Trust Company, its Affiliates, or their clients. The mere appearance of content does not constitute an endorsement by Eastern Point Trust Company (“EPTC”) or its Affiliates. The author’s opinions are based upon information they consider reliable, but neither EPTC nor its Affiliates, nor the company with which such author(s) are affiliated, warrant completeness, accuracy or disclosure of opposing interpretations.

EPTC and its Affiliates disclaim all liability to any party for any direct, indirect, implied, special, incidental, or other consequential damages arising directly or indirectly from any use of the content herein, which is expressly provided as is, without warranties.
Article Archive

Get More Information

Your submission has been received.
A member of our team will be in touch with you soon.
Something went wrong while submitting the form.
Please see our Contact Us page for more options to connect with us.