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|11-19-2008, 05:30 PM||#1 (permalink)|
Join Date: Nov 2008
Loss of income part of personal injury settlement
I was hit by a car some years ago. It has been a very long and tedious legal battle. Finally its over and there is a judgement.
The accident has left me partly disabled and I can never go back to my career. The court found the other driver 100% liable. The award includes some loss of income amount too. This is what the award says:
(i) Non-pecuniary damages $ xxxx
(ii) Loss of income/capacity:
Past: $ xxxx
(iii) Cost of future care $ xxxx
(iv) Loss of housekeeping capacity $ xxxx
(v) Special damages $ xxxx
I have asked several tax professionals and I keep getting different answers. Hope someone here can help based on your own experience.
Is any part of this award taxable?
The legal fees is 33% of the award plus tax. Is the legal fee tax deductible?
Thanks for your help.
|11-19-2008, 06:21 PM||#2 (permalink)|
Join Date: Nov 2006
For a verdict or settlement to be tax-free, it must be structured to meet two new code requirements:
Lawyers in personal-injury cases usually work on a contingency basis. So, your lawyer gets paid only if you win, and his fee is a percentage of your award or settlement.
The courts used to be mixed on how to handle the fees. Some courts hold that the fees create a right of ownership -- or attorney's lien -- for the lawyers. Since the lawyer owns that portion of the award, it's not your asset and therefore shouldn't considered taxable income.
However, most courts, including the U.S. Tax Court, held contingency fees to be a creditor's right, a right to be paid by you, as the attorney's client. In such cases, the entire award is included in your gross income, and is taxable.
[COLOR=black]To [COLOR=blue]ERR [/COLOR]is human.[/COLOR]
To [COLOR=darkorchid]FORGIVE [/COLOR]is divine.
[FONT=Comic Sans MS][FONT=Times New Roman][COLOR=red]NEITHER[/COLOR] is my policy.[/FONT] [/FONT]
|01-28-2009, 09:56 AM||#3 (permalink)|
Join Date: Nov 2008
THE FOUR CATEGORIES OF LITIGATION CLAIMS
Litigation proceeds and the related legal fees generally fall into four categories:
1) Personal injury claims where the proceeds are excluded from gross income under IRC section 104(a)(2).
2) Discrimination claims that qualify for the new deduction for AGI under section 62(a)(20). [COLOR="Red"]N/A for you.[/COLOR]
3) Claims where only the net proceeds are awarded. [COLOR="Red"]N/A for you.[/COLOR]
The amount received after all costs are deducted from the sale of a piece of property or security.
In the case of an investor selling a security, net proceeds represent the proceeds from the sale minus any trading costs (i.e. commissions).
4) Claims that remain fully includible in gross income, but where the related legal fees and court costs are not eligible for the above-the-line deduction outlined in section 62(a)(20).
Personal injury exclusion. Proceeds from personal injury or sickness-only claims are excluded from income under section 104(a)(2). The legal fees litigants pay for claims that fall fully under this exclusion are not at issue, since the exclusion of any income renders the legal fee deduction question irrelevant.
Personal injury awards can include both compensatory (non-taxable) and punitive (taxable) portions. An example would be when an individual sues a pharmaceutical company for drug-related injuries and is awarded both compensatory and punitive damages. Monetary compensation awarded to an injured party that goes beyond that which is necessary to compensate the individual for losses and that is intended to punish the wrongdoer.
Only the compensatory portion is excludable from income; punitive damages are included in gross income.
When a damage award or settlement has both components, the taxpayer must allocate the proceeds and legal fees paid. The punitive component is included in gross income and any allocated legal fees and court costs are deductible as miscellaneous itemized deductions under IRC section 212 as expenses incurred in the production of income. This classification puts punitive proceeds into the fourth category.
Taxpayers are unable to get advance rulings from the IRS An abbreviation for the Internal Revenue Service, a federal agency charged with the responsibility of administering and enforcing internal revenue laws. on the excludability and allocations of damage awards (revenue procedure 2005-3). As a result many have attempted to exclude large portions or the entire damage award when they should have made a different allocation. CPAs should be aware the IRS does pursue the allocation issue and has been reasonably aggressive when the issue arises on audit, so clients should follow established law and case precedent or risk the consequences.
Last edited by donallie; 01-28-2009 at 10:19 AM.
|01-28-2009, 10:12 AM||#4 (permalink)|
Join Date: Nov 2008
Also, for your perusal and assistance in talking to the defendant's insurer....
IRS Tax Law: Lawsuit Awards and Settlements, how to report your compensation
In lawsuit settlements, the person with the [COLOR="red"]obligation to report payments to the plaintiff will generally be the defendant or its insurer rather the plaintiff's attorney.[/COLOR] In addition, the defendant or its insurer will also generally be responsible for reporting payments to the plaintiff's attorney. Reporting of Damage Awards on Forms 1099-MISC
Box 3 of Form 1099-MISC is used to report other income that is not reportable in one of the other boxes on the form. Generally, all punitive damages (even if they relate to physical injury or physical sickness), any damages for non-physical injuries or sickness, liquidated damages received under the Age Discrimination in Employment Act of 1967, and any other taxable damages are required to be reported in box 3. Generally, all compensatory damages for non-physical injuries or sickness (for example, emotional distress) arising from employment discrimination or defamation are reportable in box 3. However, if a taxpayer receives an award of back pay that constitutes wages, it generally would be reportable on Form W-2, not Form 1099-MISC.
The following damages (other than punitive damages) are not reportable in box 3 of Form 1099-MISC:
Damages received on account of personal physical injuries or physical sickness.
Damages that do not exceed the amount paid for medical care for emotional distress; or
Damages received on account of non-physical injuries (for example, emotional distress) under a written binding agreement, court decree, or mediation award in effect on or issued by September 13, 1995.
Damages received on account of emotional distress due to non-physical injury or sickness, including physical symptoms such as insomnia, headaches, and stomach disorders, are reportable unless described in 2 or 3 above. However, damages received on account of emotional distress due to physical injuries or physical sickness are not reportable.
The amount of damages reflected on the Form 1099-MISC is not reduced by attorney's fees. For example, a defendant settles a plaintiff's claim for emotional distress from non-physical injuries by writing a $100,000 check naming the plaintiff and her attorney as joint payees. The attorney retains $40,000 in fees for services rendered and remits the remaining $60,000 to the plaintiff. The amount of damages reportable with respect to the plaintiff on Form 1099-MISC is $100,000.
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Reporting Payments to Attorneys on Form 1099-MISC
Fees paid to an attorney of $600 or more, paid in the course of the payor's trade or business, are reportable in box 7 of Form 1099-MISC. However, for 1998 and later years, if the payor pays an attorney in the course of its trade or business for legal services and the attorney's fee cannot be determined, the total amount paid to the attorney (gross proceeds) must be reported in box 13 with Code A.
For example, an insurance company pays a plaintiff's attorney $100,000 to settle a plaintiff's claims for damages that are excludable from income under IRC section104(a)(2). The attorney's fee cannot be determined by the insurance company. Therefore, the insurance company must report $100,000 in box 13 of Form 1099-MISC with Code A. If the insurance company knows that the attorney's fee is, for example, $34,000, the insurance company must report $34,000 in box 7 and nothing in box 13.
These rules apply whether or not the legal services are provided to the payor, and whether or not the attorney is the exclusive payee (for example, the attorney's and claimant's names on one check). However, these rules do not apply to profits distributed by a partnership to its partners that are reportable on Schedule K-1 (Form 1065), Partner's Share of Income, Credits, Deductions, etc., or to wages paid to attorneys that are reportable on Form W-2, Wage and Tax Statement. The term "attorney" includes a law firm or other provider of legal services.
In addition, the exemption from reporting payments made to corporations no longer applies to payments for legal services. Therefore, for 1998 and later years, attorney fees (in box 7) or gross proceeds (in box 13), as described above, paid to corporations providing legal services are reportable.
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|01-28-2009, 12:45 PM||#5 (permalink)|
Join Date: Nov 2008
Succinctly, from the IRS.GOV website:
Legal expenses. You may be able to deduct attorney fees and court costs paid in connection with the civil action. Depending on the facts and circumstances, these expenses are either claimed on Schedule A (Form 1040) or Form 1040NR (Schedule A), or deducted in figuring the income you report on Form 1040, line 21, or Form 1040NR, line 21. If the qualified settlement income was received in connection with your trade or business (other than as an employee), you can reduce the taxable amount of qualified settlement income by these expenses. In all other situations, you can only claim these expenses as a miscellaneous itemized deduction subject to the 2%-of-adjusted-
gross-income limit on Schedule A (Form 1040), line 23, or Form 1040NR (Schedule A), line 11. For example, an employee or the surviving spouse or beneficiary of a deceased plaintiff would claim the expenses as a miscellaneous itemized deduction subject to the 2% limit. See Statement, next.
Statement. If you report on Form 1040, line 21, or Form 1040NR, line 21, qualified settlement income that is less than the gross amount shown on the Form 1099-MISC, you must attach a statement to your tax return. The statement must identify and show the gross amount of the qualified settlement income, the reductions for the amount contributed to an eligible retirement plan or allowable as legal expenses not reported as a miscellaneous itemized deduction, and the net amount.