Why calculating lost earnings according to the pre-accident average may over-compensate some personal injury claimants.

The conventional method when calculating a claimant’s loss of earnings is to take average net earnings for a representative period prior to the accident occurring (usually 13 weeks) and use this figure to calculate past and future loss of earnings. However, there is an alternative method of calculating loss of earnings, using tax bands and taking into account tax rebates, that can lead to more favourable results for defendants but which is often overlooked by claims handlers.

Claimants in personal injury claims who sustain a temporary loss of earnings and resume work in the same tax year frequently receive a tax rebate. This has to do with the way the PAYE tax system works.

When collecting income tax, HM Revenue & Customs (HMRC) does not wait until you earn £8,105 to start taxing you at 20 per cent. Rather, it deducts income tax every month/week at an average tax rate based on an earnings projection for the year. It also assumes you will be working full-time from this April to next April. If a claimant has a few months off work because of an accident, there is a good chance he will be entitled to a partial rebate of the tax he has already paid.

The actual rebate that a claimant will likely receive will vary but can easily be assessed if he has a letter from the HMRC confirming the amount, or alternatively by calculating the correct tax bill according to published tax bands, or even by instructing a forensic accountant in the most complex cases, if proportionate to the sums involved.

Take the following basic example: a male claimant who earns £30,000 gross per year, is injured in an accident at the beginning of October and is off work for six months. Had the accident not happened, his average net earnings would have been £22,933.60 per year, or £441.03 per week. Using the conventional method, an absence of six months from work equates to £11,466.80 in lost earnings.

However, the claimant’s actual gross earnings for the tax year since April were only £15,000 (i.e. half his full annual salary). Using the 2012/13 tax rates, his net earnings for the year are calculated as follows:

  • Tax <£8,105 @ 0% + £8,106-15,000 @ 20% = £1,379 NI £146-£817 @ 12% + £818-£15,000 @ 2% = £364
  • Gross earnings: £15,000 - £1,379 tax - £364 NI = £13,257 net
  • Loss: £22,933 - £13,257 = £9,676

Compared to expected earnings of £22,933.60 for the full year, his actual net earnings of £13,257 for the half-year results in a loss of £9,676. This is £1,790 less than the loss of earnings calculated using the "usual" 13-week average earnings route.

This opportunity to reduce a claimant’s claim for past loss of earnings is seldom used and is something worth bearing in mind when you next have to negotiate a settlement or make a Part 36 offer in a personal injury case.