Going to Court?

No Gravatar

I had two big arguments with clients this year.  OK.  One.  Because I fired the other client, who was clearly wrong, yet positive he would prevail.

About what was the fight?  Legal settlements.

Justice

Because, surprise- MOST are taxable.  (The IRS rules that taxes apply based upon the “origin of claim”.)

Oh, and it gets better.  If your attorney took its fees as contingency (say 35%), that $ 100K settlement which netted you $65K….is taxable at $ 100K.  Because personal legal fees are not deductible.  (I would make sure that the lawyer paid taxes on his share.  I’d issue him a 1099 on my client’s behalf- even though it’s not deductible to my client.  [The law does stipulate that folks in business (but not individuals) are supposed to issue 1099’s to lawyers for their fees. I just do it to ensure no one under-reports income.]

Let’s pick one of my clients.

He got axed at work and sued his employer for wages.  When he won, his back wages were reported on a W-2 (and NO income taxes were withheld, so he owed that money that normally would have been withdrawn before he received it)- and then a 1099 was also issued for the award given for his mental distress.  That’s taxable, too.   Only physical injuries and physical sickness recoveries can be received tax-free in a settlement.  The IRS considers mental and emotional issues to be non-physical.  (Yes, even migraines, stomach-aches, headaches that result from mental anguish are NOT physical maladies, according to the IRS.  The same applies to ulcers.  Unless you and your lawyer can gang up on the defendant and ensure that no 1099 is issued for those portions of your therapy and recovery.  But, if they issue a 1099, your goose is pretty much cooked.)

Which means keeping track of your expenses is a critical issue.  You need to allocate damage recovery to ensure the minimum of taxable events.  And, make sure your attorney includes those allocations in the settlement.  (The IRS does not feel bound by such allocations, but you can probably prevail when and if you are audited.)

$ 1 million legal settlement?

Oh, and don’t forget that interest and punitive damage recoveries are ABSOLUTELY taxable to you.  So, if you are awarded $ 1KK in punitive damages with your attorney clearing $ 400K, you are going to be taxed on the $ 1KK, not the $ 600K.

Yes, that means your punitive damages are going to be pretty puny, as you can see from the diagram above.Roy A. Ackerman, Ph.D., E.A.

Share this:
Share this page via Email Share this page via Stumble Upon Share this page via Digg this Share this page via Facebook Share this page via Twitter
Share

6 thoughts on “Going to Court?”

  1. I could make a crack that just thinking of our tax system gives people mental anguish, but something occurred to me. A loved one is seriously injured in an accident and needs care for the rest of his/her life. So you hire a lawyer who works on contingency and you have all these issues you are trying to work through as a caregiver- your life has permanently changed and so has your loved one’s- and you have to worry about your taxes, too. Physical injuries not taxable. Other stuff – maybe taxable or definitely taxable. It just seems like an anguish that should not be necessary.
    Alana recently posted..Scary Lucy

Comments are closed.