Death of Taxes: Bill Allowing Plaintiffs in Fee-shifting Discrimination and Qui Tam Cases to Claim Income Tax Exclusion Gets Final Legislative Approval

On Monday, the New Jersey State Assembly approved a bill that would provide a substantial tax benefit to victims of unlawful workplace discrimination, retaliation, or other violations of laws that regulate any aspect of the employment relationship.  This bill was first introduced in the New Jersey State Senate in January 2018, and has enjoyed widespread, bi-partisan support as it has worked its way through the legislative process.  Monday’s approval by the Assembly, by a unanimous vote of 79 to 0, was the final legislative hurdle.  If Governor Phil Murphy signs the bill into law, it will be a great victory for victims of workplace discrimination and retaliation across New Jersey.

In 2004, the United States Congress passed the Civil Rights Tax Relief Act. The Civil Rights Tax Relief Act was intended to, among other things, eliminate a flaw in the tax treatment of awards won by plaintiffs who successfully prosecuted claims of discrimination or retaliation.  Prior to 2004, a plaintiff who received an award in a discrimination or retaliation case were required to include in their gross income the entire amount of that award.

This was the case, despite the fact that a portion of that award constituted attorney’s fees and costs that were awarded along with the amount awarded for the plaintiff’s damages. Not only did this tax treatment negatively impact those plaintiffs, it also subjected that portion of the award to double taxation, as the attorneys who ultimately collected those fees and costs were also required to include that amount in their gross income. Congress cured this flaw by exempting that portion of such a plaintiff’s award from their gross income.  In approving the legislation on Monday, New Jersey is finally following suit.

This exemption will not apply in most cases.  In the United States, the default rule is that each party is responsible for paying their own attorney’s fees and the prevailing party is not able to recover attorney’s fees or costs.  This is known as the “American Rule,” a term that has been used to describe this paradigm since at least the 1920’s.  See, Toward a History of the American Rule on Attorney Fee Recovery, John Leubsdorf, Law and Contemporary Problems, Vol. 47, No.1,1984. As Professor Leubsdorf traces in his article, the precise origins and justifications for the American Rule are subject to dispute, but it is clear that over the course of the late-19thand early-20thcenturies, it became a fundamental aspect of the American legal system.

The American Rule is the default rule; however, it is not absolute.  In certain circumstances, the legislature will specifically allow for the recovery of attorneys fees.  This is known as a fee-shifting statute.  Many civil rights laws are fee-shifting, such as laws against discrimination, harassment, and retaliation in the workplace.  This departure from the American Rule is typically justified on two grounds: (1) it provides greater access to the courts to plaintiffs who otherwise could not finance a lawsuit; and (2) it furthers social policy objectives.

For example, in furthering the goal of eradicating the cancer of discrimination, the New Jersey Law Against Discrimination (“NJLAD”) is a fee-shifting statute.  This goal is advanced by increasing the likelihood that an individual will file a complaint, and further by increasing the penalty that individuals and corporations face when they commit unlawful acts of discrimination or retaliation.  By making the NJLAD and other similar statutes fee-shifting, the legislature determined that successful plaintiffs should not bear their legal costs, but that they should be borne by the bad actor.

With this is mind, the negative tax consequences that plaintiffs have long faced under these fee-shifting statutes make even less sense.  Where the fee-shifting nature of the statutes is intended to encourage individuals to file complaints, these negative tax consequences could have the opposite effect.  Under the current rule, in a case with relatively low damages, an individual might face a greater tax liability than the award they ultimately collect.  This underscores just how crucial this legislation is.

Providing this tax exemption will not be without some downside.  The fiscal ramifications of making this change were analyzed by the Office of Legislative Services which concluded “that the enactment of this bill would result in an indeterminate annual decrease in gross income tax revenue.” Despite this finding, the bill faced no opposition in either house of the State Legislature, demonstrating just how important this correction is.

According to the bill’s text, “the act will take effect immediately and will apply to taxable years ending after its date of enactment.”  For victims of discrimination and retaliation, that date cannot come soon enough.