Individuals can experience a temporary or permanent reduction in their ability to perform certain functions due to the actions or negligence of others. Forensic accountants are regularly retained in matters involving the injury or death of an individual for the purpose of quantifying the economic value of this diminished capacity, including, but not limited to, the reduction in the individual’s past and future earnings. This article discusses some of the issues that may arise in a personal injury case involving the temporary or permanent reduction in an individual’s earning potential.
An assessment of an individual’s lost earnings considers the following:
- The projected or potential earnings stream of the injured party;
- Actual earnings achieved following the incident;
- Mitigation potential;
- Offset for saved expenses; and
- Costs to mitigate damages
Forensic accountants compute the future earnings that would have been achieved “but for” the incident that limits or terminates an individual’s income stream. For individuals deriving compensation in the form of employee wages and employer-paid benefits, the following information specific to the individual may be useful in determining “but for” earnings:
- Educational attainment;
- Employment history;
- Anticipated date of retirement;
- Individual Federal and State Income Tax returns;
- Form W-2 Wage and Tax Statements;
- Personnel file;
- Employee benefit plan documents; and
- Retirement and pension plan documents
Business owners and self-employed individuals may also experience a reduction in earnings due to a temporary or permanent diminished capacity. However, unlike an employee, business owners or self-employed individuals may derive their income from multiple sources, such as the profits (or losses) of the business(es) that they either wholly or partially own, a salary paid by the business(es) to the owner, or a combination thereof. Forensic accountants are particularly adept at deciphering business records and determining the actual earnings/compensation realized by business owners and self-employed individuals, especially given the varying compensation methods that these individuals may utilize. The documents requested from a business owner or self-employed individual will vary from the documents requested of an employee. The forensic accountant will tailor the document and information request, dependent on the specific situation.
In cases where individuals return to work following an injury, his or her actual earnings may be obtained from the same types of documents that were originally utilized to forecast wages and benefits “but for” the incident. For business owners and self-employed individuals, however, there are additional considerations. First, the business’ financial records after the occurrence should be thoroughly examined to ensure that any reduction in compensation and profits are causally related to the owner’s injuries and not attributable to other factors, such as changes in economic conditions, increased competition, modifications to cost structure, and product mix. In addition, while the self-employed individual or business owner may no longer receive the same level of compensation for their own physical efforts due to the injuries, the business may still continue to provide the owner a return on their investment. For these reasons, it is again imperative to obtain a thorough understanding of the individual’s compensation package prior and subsequent to the incident.
If an individual is not able to resume working in the same capacity due to his or her injury, their employability should be considered. Generally, injured individuals must undertake a reasonable effort to mitigate their losses, and the following questions can help establish the extent of the impairment, if any, along with his or her efforts:
- Do your injuries preclude you from working on a part-time or full-time basis?
- With treatment for your injuries, are you be able to continue working in the same or a similar job either on a part-time or full-time basis?
- Do you possess any education, knowledge and/or skills that may transfer to another vocation?
- Have you undertaken any efforts to find substitute employment?
- Will your injuries force you to retire earlier than originally planned?
- Is it anticipated that your injuries will have a negative impact on your life expectancy?
Since forensic accountants typically do not possess the education, experience, and training to answer these types of questions, attorneys on both sides may engage a medical and/or vocational rehabilitation expert to address these issues. These other experts review medical records, meet with the injured individual, perform testing, and complete research to opine on the impact of the injuries to the individual’s ability to work, while also providing a recommendation of other types of occupations that may be suitable given the individual’s limitations. Forensic accountants then incorporate the findings of the medical and/or vocational rehabilitation experts to compute the individual’s residual earnings capacity, which is an offset to the individual’s “but for” earnings.
The reduction in earnings for an injured individual should be adjusted for costs related to his or her employment that are no longer being incurred. Examples of avoided (saved), expenses for an employee may include the following:
- Commuting costs;
- Membership Dues;
- Professional licenses and memberships; and
- Income taxes
Increased Expenses to Mitigate Damages:
The vocational rehabilitation expert may also identify opportunities for an injured party to obtain further education and/or re-training in order to allow for his or her return to the workforce in a different capacity or occupation. If an individual incurs education and/or retraining expenses and these costs mitigate the loss of earnings, the computation of an individual’s lost earnings should consider these increased costs.
For self-employed individuals and business owners, the forensic accountant’s examination of the business’ financial records is necessary not only to understand the profits (or losses), but also to confirm that all costs related to his or her self-employment are properly considered. For instance, assume an individual reported $50,000 per year of gross revenues for income tax purposes. The valuation of lost earnings needs to consider not only the gross income, but certain saved expenses, as he or she would only be entitled to the lost gross income less certain variable costs that are no longer being incurred, such as travel, fuel, tolls, and repairs.
A self-employed individual or business owner may also be able to mitigate their earnings loss by hiring a replacement worker or substitute employee to complete certain tasks and responsibilities that he or she is unable to perform following an injury. The cost to hire a replacement worker would more than likely result in an increased payroll cost. However, since the business owner presumably mitigates a loss of earnings by hiring the replacement worker, the additional payroll expenses would be included in any computation of lost earnings.
Forensic accountants should be engaged at the onset of the case to provide guidance in identifying relevant compensation issues, along with the types of financial records that should be obtained to accurately quantify an individual’s earnings. The calculation of lost earnings can have a major impact on the amount of damages awarded in a lawsuit. There are several factors that affect a plaintiff’s right to future loss of earnings. Understanding these factors and applying them to the lost earnings evaluation is an essential piece of any economic damage analysis.