Page 41 - Economic Damage Calculations

Figure 6-2

An After-Tax Discount Rate

In general, damages are taxable as ordinary income (whether as a result of judgment or settlement). fn 12
As such, damage calculations are typically prepared on a pre-tax basis. Nevertheless, to make the plain-
tiff whole, the damage computations often use an after-tax discount rate. This is because a damages
award may be invested and income taxes will be incurred on related earnings. Thus, by applying an af-
ter-tax discount rate, the plaintiff’s accumulated value net of taxes is reflected.

This can be demonstrated using the following example. Assume that a plaintiff is awarded $1,000 in pre-
tax cash flow due in one year and has an income tax rate of 35 percent, with an after-tax discount rate of
12 percent.

Computation
Pre-Tax Cash Flow A $1,000

After-Tax Cash Flow B = A × (1 − 35%) $650
Discounted Cash Flow C = B ÷ (1 + 12%) $580

Taxable Damage Award D = C ÷ (1 − 35%) $893

One way to calculate the present value award to make a plaintiff whole is by using a three-step process:

fn 12 This issue was presented in paragraphs 130–133 of AICPA FVS Section Practice Aid No. 06-4. The discussion set forth subse-
quently in the text is consistent with that guidance, but it is also presented here for convenience.

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