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Abstract: 

The economic impact on clients, tax advisors, and tax collectors resulting from damage payments based on malpractice claims is significantly affected by the income tax treatment of such payments. Should damage recoveries be taxed and, if so, should clients be grossed-up? This article illustrates the economic effects under several scenarios. The more the law favors taxation of damage payments, the more tax collectors benefit from increased net tax revenue, at the expense of clients. However, the greater the tilt in favor of taxing recoveries, the stronger the case for gross-up payments. Gross-ups shift costs from clients to advisors--and could actually create a windfall to clients, the cost of which would be borne by advisors and tax collectors.

Keywords: Cosentino v. Comm’r, reimbursement for tax payments, tax advisor error, gain recognition

Affiliations:  1: Dechert LLP.