Question

During the current year, Khalid was in an automobile accident and suffered physical injuries. The accident was caused by Rashad's negligence. Khalid threatened to file a lawsuit against Amber Trucking Company, Rashad's employer, claiming $50,000 for pain and suffering, $90,000 for loss of income, and $70,000 in punitive damages. Amber's insurance company will not pay punitive damages; therefore, Amber has offered to settle the case for $100,000 for pain and suffering, $90,000 for loss of income, and nothing for punitive damages. Khalid is in the 35% marginal tax bracket. What is the after-tax difference to Khalid between Khalid's original claim and Amber's offer

Answer 1

Answer:

Amber's offer actually represents $4,500 more after tax money than Khalid's original claim ($158,500 vs $154,000).

Explanation:

Khalid originally demanded:

• $50,000 for pain and suffering = no taxes charged*, net $50,000
• $90,000 for loss of income = $90,000 x (1 - 35%) = $58,500
• $70,000 for punitive damages = $70,000 x (1 - 35%) = $45,500

net income after taxes = $154,000

Amber's offer:

• $100,000 for pain and suffering = no taxes charged*, net $100,000
• $90,000 for loss of income = $90,000 x (1 - 35%) = $58,500

net income after taxes = $158,500

*Money settlements resulting from pain and suffering damages are not taxed.