Calculating Loss of Earning Capacity

by Charles Amodio, CPA,CFF, MAFF, MBA
Partner at FAZ Forensics

Loss of earning capacity damages are typical damages in a personal injury claim involving severe injury. If an injury affects the Plaintiff’s future career advancement, they may seek loss of earning capacity damages. Due to the speculative nature of a lost earning capacity claim, the Plaintiff must prove the value of the damages with reasonable certainty in litigation. This burden of proof makes the services of forensic accounting experts vital. FAZ Forensics works with attorneys and litigation firms nationwide to provide calculations and expert witness testimony for damages such as loss of earning capacity.

What is Loss of Future Earning Capacity?

Lost earning capacity is a general damage category that compensates for the Plaintiff’s ability to earn money in the future. Lost earning capacity considers what a Plaintiff could have earned had their injury never occurred. A severe injury can drastically impact a Plaintiff’s lifetime earning potential. Severe injuries can alter a career, cause lost opportunities for pay raises, promotions, and new job offers.

The Difference Between Lost Earning Capacity and Lost Earnings

It’s important to clarify the distinction between “lost earning capacity” and “lost earnings” in the context of an economic damages assessment. Lost earning capacity is the reduction in a person’s ability to receive future earnings over their lifetime due to an injury or wrongful act. The concept is forward-looking and speculative, considering the potential future earnings that the individual could have made if not for the incident. The assessment involves analyzing the individual’s skills, education, experience, and the impact of the injury on their future work life. Factors such as potential promotions, career advancements, and inflation are also considered.

Lost earnings pertain to the actual lost income due to an injury or wrongful act. This is a historical calculation, focusing on the income the individual would have earned had the incident not occurred. Lost earnings are calculated from the time of the incident to the present and include wages, salaries, bonuses, and other forms of compensation that the individual would have received. This calculation is more concrete and is based on the individual’s past earnings history, without speculation about future potential income.

Formula for Calculating Loss of Earning Capacity

The speculative nature of lost earning capacity damages means they are not measurable in exact dollar figures. The court requires a plaintiff to provide evidence proving the reasonable value of their lost earning capacity.

A forensic accounting expert calculates this reasonable value using the claimant’s work-life expectancy, projected future earnings, cost of living, and other data. A vocational expert can then support these assumptions. They will offer professional opinions about the person’s ability to continue their career and other work they may or may not be able to perform.

Lost Earning Capacity Claim

Consider Nick, a 40-year-old human resources director earning $100,000 annually with a work-life expectancy of 25 more years. As a result of a severe injury, his earning capacity is diminished, and he is now expected to earn $60,000 annually. Inserting the lost annual income of $40,000 into the formula above, the expert forensic accountant hired by Nick’s personal injury attorney determines that his lost earning capacity due to the injury should permit him to recover past and future lost earnings worth $1,000,000.

Factors Involved in Calculating Earning Capacity

A forensic accounting expert must consider several influencing factors that affect earning capacity. These considerations include:

• Profession & Career
• Current wages
• Market value
• Historical career performance
• Skills, Talents, & Abilities
• Education, Licenses, Certifications
• Work history
• Location

Profession & Career

Understanding the claimant’s profession and career is essential as each profession has a unique growth curve with specific compensation levels. Additionally, the forensic accountant must consider the projected industry performance over the claimant’s work-life.  For Nick, his profession as a human resource director has a moderate growth curve with potential for increased earnings. 

Current Wages

Current wages include any actual earnings the claimant was receiving before the accident. These are the same figures used to calculate lost wages, including the plaintiff’s salary and benefits.  Nick’s current wages of $100,000 are the baseline for calculating his lost earnings and factor significantly into the lost earning capacity. The $40,000 annual difference in earnings post-injury directly impacts the loss of earning capacity calculation.

Market Value

Forensic accountants must also consider the market value of the profession which includes future income and benefits throughout the plaintiff’s work life. The forensic accountant will determine the market value of the claimant’s career using The Department of Labor’s Bureau of Labor Statistics. The market value of a human resource director like Nick is expected to increase over time. 

Historic Career Performance

Evaluating historic career performance is crucial. The expert forensic can use past raises, bonuses, and promotions data to accurately predict future lost earnings. If Nick had a history of receiving a 5% annual raise or annual bonuses, this would be factored into the calculation.    

Skills, Talents, Abilities

The claimant’s skills, talents, and abilities significantly influence their future earning capacity. The more skills, talent, and abilities a claimant has, the more likely they will have a successful career. That success correlates to a higher potential future earning capacity. Nick’s skills and talents in human resource management increase his potential for higher future earnings. 

Education, Licenses, Certifications

A claimant’s education and professional qualifications also play an essential role. Education, professional training, and opportunities for career growth all share a strong correlation. Therefore, the expert forensic must consider these when calculating lost earning capacity damages.  Nick’s advanced degree and certifications in human resources further enhance his earning capacity. 

Work History

The consistency of the claimant’s work history is vital for understanding their future earning potential. Higher levels of consistency correlate to higher earning potential. The number of past jobs, the time gaps between them, and the amount of time in their current position are critical indicators of consistency.  Nick’s stable work history, with long tenures at each job, supports a higher future earning capacity.

Location

The claimant’s geographical location also plays a significant role in the calculations. If the claimant lives in an urban location with a booming economy, they have a high opportunity cost. Conversely, their exposure to opportunities is much lower if they live in a rural area or an area with less economic opportunities. On top of that, specific industries perform better in one location compared to another. 

Loss of Earning Capacity for a Self-Employed Person

Proving lost earning capacity for a self-employed claimant can be difficult. The primary determining factor is the age and earnings of the claimant’s business. Suppose they provide financial records to prove a history of steady revenues. In that case, a vocational expert can evaluate the claimant’s reduced earning capacity after the injury. With that information, the forensic accountant can calculate lost earning capacity. If the company is new or revenues are inconsistent, proving lost income and loss of earning capacity becomes more complex. However, that does not mean lost earning capacity cannot be proven.

Loss of Earning Capacity for a Person with No Work History

The fact that a plaintiff has no work history doesn’t stop them from claiming lost earning capacity damages. This scenario is common in children and people under the age of 20. Working with a vocational expert, economic experts can survey the labor market to determine the employment opportunities available to the injured claimant. They can compare this data to the claimant’s pre-injury education and career aspirations. This allows them to determine a reasonable figure for loss of earning capacity damages.

Hire a Forensic Accountant to Calculate Loss of Earnings Capacity

When determining a reasonable value for loss of earning capacity damages, the services provided by forensic accountants are crucial. FAZ Forensics has provided forensic accounting, valuation and litigation support services to attorneys for more than 25 years. In addition, we have provided expert witness testimony in multiple state and federal courtrooms.