The Income Tax Gross-Up on a Cost of Care Award

by Derek Aldridge and John Tobin, C.A.

This article first appeared in the winter 1996 issue of the Expert Witness.

Consider a simple example where a plaintiff requires an award to pay for $11,000 in cost of care expenses one year from today. Assuming an annual (nominal, or observed) interest rate of 10 percent, this suggests that an award of $10,000 will be sufficient to cover the future cost of care expenses ($10,000 + 10% x $10,000 = $11,000). But suppose that the plaintiff’s interest income is taxed at a rate of 25 percent. Now $250 of the $1,000 in interest income is lost to tax, effectively reducing the interest rate from 10 percent to an after-tax rate of 7.5 percent (i.e., the plaintiff receives $750 after-tax interest on an investment of $10,000). One year from now the plaintiff will have only $10,750 to cover the $11,000 in expenses, a shortfall of $250.

To compensate for the tax impact, the plaintiff will require an additional award of $232.56 for a total of $10,232.56. Now the plaintiff will earn $1,023.26 in interest income (= $10,232.56 x 10%), of which 25 percent, or $255.82, will be lost to tax, for net after-tax interest income of $767.44. When the net interest income is added to the award, or capital, of $10,232.56, the plaintiff will have the required $11,000 to meet cost of care expenses one year in the future. The additional award of $232.56 is known as the cost of care tax gross-up.

Usually, the gross-up is reported as a percentage of the non-grossed-up award. In the example discussed above the tax gross-up would normally have been reported as 2.3256 percent of the “non-grossed-up” amount $10,000. Readers of The Expert Witness will know from experience that this percentage gross-up varies widely from case to case. The purpose of this article is to identify some of the factors which may affect the percentage gross-up.

Factors affecting the income tax rate (and the tax gross-up)

The gross-up is determined by calculating the plaintiff’s tax liability prior to considering the award for cost of care. This is compared to the liability including income generated from the award for cost of care. The gross-up is the additional capital required to fund the resulting tax liability.

The percentage gross-up is dependent on the plaintiff’s marginal tax rate and the plaintiff’s eligibility for various income tax credits. In the example above, if the individual’s investment income had been taxed at a marginal rate of 50 percent, instead of 25 percent, the effective after-tax interest rate would have fallen from 7.5 to 5 percent. A consequence of the increased marginal tax rate is that now the individual would have to invest $10,476.19 to provide $11,000 one year from today. That is, the percentage gross-up increased from 2.3256 to 4.7619.

A number of factors combine to affect the overall tax rate and the amount of tax paid on income invested to compensate for future costs of care. First, some of the future costs of care may be eligible for a medical tax credit (e.g., the cost of a wheelchair would typically be eligible for a tax credit). A tax credit reduces the plaintiff’s tax liability, at a certain percentage. The more expenses that the plaintiff has which are eligible for a medical tax credit, the lower his tax liability and the tax gross-up. To further complicate the tax calculation, it could be the case that once every five years the plaintiff will incur $50,000 in expenses, of which $40,000 are tax- creditable, while in the other years he faces costs of $20,000, of which only $5,000 are tax-creditable. Also, in certain circumstances the plaintiff’s injury may result in his qualifying for the disability tax credit. This will further reduce his tax burden (and the associated gross-up). In some cases, a severely disabled plaintiff may be entitled to a smaller gross-up, in percentage terms, than a moderately disabled person, as a result of his higher medical expenses and his eligibility for the disability tax credit (though the former’s total cost of care and gross-up will almost certainly be higher).

The plaintiff will usually have other sources of income which will affect the gross-up. Interest income on a loss of income award or a non-pecuniary award, as well as post-accident employment earnings or pension income will all attract tax, and will affect the marginal tax rate on the interest income earned from the cost of care award. (The percentage of tax applied to each dollar of additional income is the marginal tax rate.) The courts have ruled that the investment income from the cost of care award is to be added to all other sources of income and taxed at the rate associated with the highest tax bracket in which the individual’s income places him. To estimate the gross-up, details about the future cost of care requirements (and the associated tax credits) are required as well as information about all of the plaintiff’s expected income, including future employment income and any additional interest income that he will earn (especially from loss of income awards). The higher the plaintiff’s expected income, the greater the percentage gross-up resulting from income being taxed at a higher marginal tax rate.

A third issue to consider is the time path of award consumption. Just as the amount of any non-pecuniary and loss of income award will affect the tax gross-up, the time path of the consumption of these awards will affect the calculation. If the plaintiff spends his entire loss of income and non-pecuniary award immediately upon receipt, then the award will not generate any interest and will not attract any tax. Therefore, the plaintiff will be in a lower marginal tax bracket and he will pay a lower average tax rate over his lifetime on the award for cost of care. This would result in a lower tax gross-up. For the loss of income award, it may be argued that the plaintiff will consume enough of this award each year to compensate him for the income which he has lost due to his injury. For the non-pecuniary award, it may be assumed that the plaintiff will consume the award gradually over his lifetime, or alternatively that he consumes it quite quickly. Except for very large non-pecuniary awards, where the plaintiff does not have any other significant income, the variation of the consumption assumption on the award does not have a significant effect on the gross-up calculation.

We occasionally encounter cases where a plaintiff with a shortened life expectancy is expected to receive a “lost years” award (see “Shortened Life Expectancy: The ‘Lost Years’ Calculation” in the Spring 1996 Expert Witness) – this adds a further complication to the gross-up calculation. In such a “lost years” case, a plaintiff will receive a portion of the money that he would have earned in years in which he is now not expected to be alive. In these circumstances, if we assume that the plaintiff will consume enough of this award each year to compensate him for that year’s loss of income due to his injury, then he will not consume all of the loss of income award before his death. As an alternative in these situations, for the purposes of making the gross-up calculations, we assume that the plaintiff will consume the loss of income award at such a rate that by his expected death he will have consumed the entire award.

Given equal total awards, older plaintiffs will typically require lower gross-ups than their younger counterparts. This is because older plaintiffs will begin to draw on the capital amount earlier, so the interest income will decline more rapidly. A young plaintiff will usually consume only a portion of the interest income (which can be substantial) for several years before he begins to draw on the capital. Thus, we would expect that for several years a younger plaintiff will earn large amounts of (taxable) interest income, in excess of medical expenses which may be eligible for a tax credit. It should be noted, however, that if the plaintiff is a child then he may not be required to pay tax on any of the interest income earned on the cost of care award until the tax year of his 21st birthday. This would substantially reduce the tax gross-up. If a minor has a shortened life expectancy then it is conceivable that the gross-up would be nominal.

In the example described at the beginning of this article, it was assumed that the cost of care would be incurred one year hence. It can easily be shown that the tax gross-up will be larger, the further into the future is the cost of care to be incurred. For example, assume that $16,105.10 is to be replaced 5 years from now and that, again, the interest rate is 10 percent. In the absence of taxes on the investment income, this amount can be replaced with an investment today of $10,000. If the interest income is taxed at a marginal rate of 25 percent (resulting in an effective after-tax interest rate of 7.5 percent), the required award will increase to $11,218.15 – for a tax gross-up of 12.1815 percent (compared to 2.3256 percent in the earlier example). As the number of years over which the award is to be invested increases, the interest which will be earned on the award also increases. Hence, while the non-grossed-up award (here, $10,000) remains the same, the impact of income taxes increases, as does the percentage gross-up. In short, the longer is the period over which the costs of care are to be awarded, the higher is the percentage gross-up (everything else being equal).


To summarize, we have listed some of the factors which influence the value of the gross-up. Other things being equal, we can normally assume the following:

  • Cost of care award. A larger cost of care award will generate more interest and more tax. Thus it will lead to a higher gross-up.
  • Loss of income award. A larger loss of income award will translate to a larger cost of care tax gross-up.
  • Post accident employment income. Greater post accident employment earnings will lead to a larger gross-up.
  • Tax-creditable expenses. The greater the portion of tax-creditable expenses, the less tax will be paid. Thus the tax gross-up will be lower.
  • Time path of consumption. If a large portion of the cost of care award will be consumed early in the plaintiff’s life, then this will lead to a lower gross-up.
  • Age. Young plaintiffs will generally require larger gross-ups than will old plaintiffs, both because they will have more interest income and, therefore, be in higher tax brackets, and because their awards will continue much further into the future.


Derek Aldridge is a consultant with Economica and has a Master of Arts degree (in economics) from the University of Victoria.

John Tobin, CA, is a partner with Kenway Mack Slusarchuk Stewart LLP Chartered Accountants.