The McDonald's $5.5 million strip search verdict; taxable or tax free?

In another high profile case that the media has focused on, a jury in Shepardsville, KY today determined that McDonald's Corporation was in fact libel for failure to warn an employee about the dangers of a predatory hoaxer who had been calling fast food outlets and tricking management into humiliating and sexually abusing employees.

You can read the CNN link on the story by clicking here.  

There were a few local fast food establishments here in Arizona that were taken in by the same hoaxer, who would typically pose as a local police officer or sheriff investigating a crime that was reported and occurred in the fast food location. As incredible as it may be to believe, managers, assistant managers and employees would be taken in by this hoaxer who would have the offending employee stripped searched by the manager and in the more lurid cases such as this one in Kentucky, actually talk the manager into assaulting the employee and soliciting sodomy. Anyways, McDonald's knew this hoaxer was out there, had been warned by law enforcement, but then failed to send a notice to all of it's branches and managers informing them to be careful of those calls.

Apparently the jury agreed that McDonald's was at fault here, and with this award we now once again enter the strange never, never land of what is taxable damages and what would be tax free earnings under section 104.

I"m thinking, based on the reading of the trial reports and the fact that while the victim was clearly traumatize by the event and as she stated, "feared for her life" she is in pretty much the same boat as other sexual assault and abuse victims in that this will be considered a taxable damages case. There was no outward physical damages inflicted and the majority of her injuries were wrongful imprisonment, psychological distress and damage and mental anguish. These don't pass the test of outward demonstrable physical injury or sickness, and as such her award will be taxable.

As pointed in prior blog posts the impact of this is to dramatically reduce the net value of the award to this young woman, if McDonald's decides to pay it and not appeal. Lets do the typical math again:

                            $5,500,000    Verdict

                   Less  $1,850,000   Fee's and expenses.

                   Net    $3,650,000   Net to client.

However, once we factor in two important facts, those being the attorney's fee is NOT deductible and the entire award IS taxable you get a very different net amount to the client. Remember, the full marginal tax rate, state and federal is 41% so the new math looks like this:

                            $5,500,000 verdict amount

                 Less    $1,850,000 legal fees and expenses

                 Less    $2,255,000 taxes due by plaintiff.

                  Net     $1,395,000 Net recovery by plaintiff

So essentially the client in this case, while still obtaining a substantial verdict for a case of this nature, is sending $2,255,000 in taxes back to the federal government and state because she had the misfortune of being humiliated and assaulted by her employer instead of being "lucky enough" to slip and fall and break a shoulder, in which case her damages would be totally income tax free.

As I've stated before, this young woman and her attorney need to get with a structured settlement professional and look into their options of structuring this on a taxable basis so as to spread out the tax hit and help her conserve some of the money that might otherwise be eaten up by taxes this year.

Posted on October 5, 2007 .