Calculating economic damages in employment cases

1. Collect the documents you need to calculate damages

In employment cases, you should start by reviewing their historical earnings and benefits documents. Earnings are most often detailed in W-2s, 1099s, pay statements, and tax returns. The more earnings history you are able to review, the greater understanding you will have of the individual's earnings picture. Ideally that would include at least three to five years of documents before the incident through the present, including the post-termination time period. Use this information along with the individual's descriptions of their earnings to get a full understanding of their earnings, including salary, bonuses, commissions, etc.

To ensure you collect all relevant documents available from your client, review our list of earnings types.

For employer-provided benefits, review the employee handbooks, offer letters, and other benefit contribution descriptions that detail the benefits they received. These may include contributions to health insurance premiums, 401k and pension plans, Social Security and Medicare, etc. Often pay statements and W-2s detail the individual and employer's contributions to health insurance, 401k, and other benefits.

There are dozen of types of employer-provided benefits. Review our list of benefit types to ensure you ask for all relevant documents.

Each analysis, like each client, is different. If a client was a government worker, you may find that there were no contributions to Social Security if the agency offers a pension plan in lieu of Social Security.

2. Determine the earnings and benefits had the incident not occurred

The non-incident earnings and benefits are what the individual was capable of earning had the employment-matter not occurred. Employment cases include wrongful termination, failure to hire, failure to promote, and more.

In wrongful termination cases, their historical earnings may be the best guide to what they would have continued to earn for the remainder of their career. Depending on the historical earnings patterns, their earnings may be calculated as an inflation-adjusted average, a straight average, or their last full-year of earnings.

In other cases, such as failure to hire or failure to promote, the historical earnings may not represent the individual's earnings had the employment-matter not occurred. In examples like these, it is common to utilize the records of comparable employees at the company, or average earnings and benefits of similar individuals, such as by their occupation, industry, or education level.

3. Determine the earnings and benefits now that the incident occurred

Post-incident earnings and benefits are what the individual has actually received since the date of the employment-matter and what they are projected to receive in the future now that the employment-matter has occurred. Their actual earnings after the incident are documented in tax documents, pay statements, and personal accounts of earnings.

The earnings and benefits they have received since the incident should be reviewed in the same manner as the earnings and benefits they received prior to the incident. Review the W-2s, 1099s, pay statements, tax returns, and employee handbooks for the time from their incident through the present. If they have not been able to return to work since the incident, there may be no earnings to assess.

Projections of the individual's future post-incident earnings and benefits vary greatly from case to case. The individual may have already found comparable replacement employment. In other cases, they may not have yet found new employment, or have found new employment but with lower earnings or benefits. Each employment-matter and each case has a different impact on an individual's earnings and should be evaluated in the specific context of that individual.

4. The length of the damages

In cases involving an employment termination, the damages are generally projected through the individual's expected tenure with the company. This may be the same as their full worklife expectancy; or shorter, particularly for younger workers or those who had a short length of employment prior to the termination of their employment.

5. Project a growth rate for future earnings and benefits

Once the non-incident and post-incident earnings and benefits have been determined, the next step is to project them through the expected length of damages. In general, the longer someone works, the more they earn. Projecting future losses of earnings and benefits should account for these increases with the use of a growth rate.

In some cases, the individual's own historical earnings may indicate a growth rate. However, some caution is warranted as there may only be a small sample of years of earnings from which to determine a historical growth rate.

The most common method for determining future earnings and benefits is the application of a growth rate based on historical increases for all workers or within an occupation, industry, or education level. Bureau of Labor Statistics data is a commonly utilized source.

There may be circumstances where future growth is predetermined. If the individual was a government or union employee at the time of the employment-matter, there may be pay schedules that specifically detail the earnings they would have received over time. Pay schedules are commonly based on the individual's 'step', 'grade' and/or 'longevity' with the employer, and are generally set for a few years into the future. These pay schedules should be applied first into a projection of earnings had the employment matter not occurred. For years beyond the pay schedules, the projected future growth may then be based on average growth rates or by determining the historical growth rate of the pay schedules.

6. Adjust for income taxes, if relevant

Depending on the jurisdiction, income taxes may need to be incorporated into an analysis of economic damages. The application of income taxes to an analysis may be relevant to one or more factors in an economic damage analysis, depending on the jurisdiction rules. Jurisdiction rules should be reviewed before applying any income taxes to the analysis.

The primary and most obvious application of income taxes is from the earnings the individual would have received had the the employment matter not occurred and they are projected to receive now that the employment-matter occurred. By adjusting the projected earnings for the income taxes owed on those earnings, the resulting effect is a reduction to economic damages.

Income taxes may also need to be applied to the discount rate being used to adjust the economic damages to present value. Discount rates in analyses of economic damages account for the interest that will be earned from the potential award after it is received and invested. If income taxes should be applied to the interest earned, the result would be a reduction in interest received on the damage award, and therefore an increase to economic damages.

It is sometimes appropriate to apply income taxes to the award itself. This may be the case when the award is taxable. If income taxes are required to be paid on the award, the individual would be left with less money to invest towards their losses. The economic damages may need to be adjusted upwardly to account for income taxes on the potential award.

7. Determine the back and front pay losses

Economic damages may be relevant for two time periods: from date of the incident to the present, and from the present into the future. These are referred to as back and front pay losses.

To calculate the back pay losses, the earnings and benefits they have received since the employment matter are subtracted from the earnings and benefits they are projected to have received had the employment matter not occurred.

Similarly, front pay losses are calculated by subtracting the earnings and benefits they are projected to receive now that the the employment matter occurred from the earnings and benefits they are projected to have received had the employment matter not occurred.

8. Discount front pay losses to present value

Most settlements and awards are paid as a single lump sum. However, the economic damages may be calculated for future earnings and benefits that they would have received through their tenure with the company. Any future damages should be adjusted to present value, otherwise they would be over-compensated.

The present valuation of future damages accounts for the time-value of money. In short, money received today is more valuable than money received in the future, as money received today may be invested and earn interest over time.

To convert the future damages to present day value, a discount rate is applied. The discount rate accounts for the interest the individual could expect to receive from investing their lump sum in a risk-free investment. The use of a risk-free investment is necessary as it is assumed the investment will be secure and ensuring the annual funds needed to cover the projected future economic losses in each year they are expected to occur.

U.S. Treasury Securities are the most commonly used interest rates when adjusting economic losses to present value, as they are backed by the U.S. government.