The Development and Solution of a Tax-Adjusted Model for Personal Injury Awards

Abstract

In Norfolk & Western Railway vs. Liepelt, 444 U.S. 490 (1980), the United States Supreme Court rejected the plaintiff's contention that a victim's lost earnings should be determined without reference to income taxes. As a result, there is now a need for reexamination of economic loss calculations in personal injury cases. In this paper a general model is developed for computing the sum of future wages, where both the sum interest earnings and the wages may be subject to taxes. A detailed mathematical explanation of the procedure is provided, describing the relationships that involve tax rates and their effects on the award. Recent judicial decisions encourage the inclusion of an income tax analysis in the calculation of the present value of loss of earning capacity in personal injury or wrongful death cases [5]. Although several authors have addressed the issue, none has presented a detailed model that is capable of dealing with the variable tax rates involved [1,2,3,6]. The purpose of this article is to present such a model. Typical no-tax procedures select a loss period which accounts for work-life expectancy, and then estimate the progression of wages over that work-life expectancy. Such considerations as fringe benefits and personal consumption of a decedent may be used to adjust estimates either upward or downward. Each annual wage is then reduced to present value using a discount factor based upon projected interest rates. The total of all these annual present value figures is the lump sum equivalent of the loss of wages. This sum award provides the actual income stream necessary to pay out wages in each future year, and it does so in such a way that the sum will be exhausted after the last wage payout is made. The sum of a stream of wage income is found using the following formulas: W. w