Tax on a Settlement Agreement

With respect to these facts, the Treasury Court agreed with the IRS that the settlement agreement does not expressly assign or characterize the settlement payment, except to state in summary that it was done “as non-economic damage and not as wages or other income.” However, in order to determine whether the transaction payment was taxable, the Finanzgericht examined the legislative history of Article 104(a)(2). While the plaintiff is typically taxed on the entire settlement – including amounts paid directly to the lawyer – the plaintiff will likely be entitled to deduct the attorneys` fees. Section 62(a)(20) of the Internal Revenue Code provides above the line for deductions for attorneys` fees incurred in the event of claims of unlawful discrimination, as well as many other employment-related claims. The first step in determining whether the proceeds of the settlement are subject to tax is to determine what exactly will be paid. Typically, almost all settlement payments in a labour dispute are included in the claimant`s taxable income. This includes payments for additional payment, advance payment, damages for emotional burden, punitive and lump sum damages as well as interest awarded. The only exception to this rule applies to payments to compensate the claimant for damages “due to physical injury or illness” that would not be covered by an employee`s right to compensation. I.R.C. § 104(a)(2).

For both the payer and the payee, the terms of a settlement or judgment may affect whether it is deductible or non-deductible, taxable or non-taxable, and its nature (i.e., capital or ordinary). In general, the taxpayer bears the burden of proof of the tax treatment and characterization of a dispute payment, which is usually determined by the language contained in the underlying procedural documents such as pleadings or a judgment or settlement agreement. Taxpayers should consider these issues in litigation or arbitration. It may be easy to assume that only $60,000 should be recorded as income, but that may not be the case. For taxable settlements, including attorneys` fees, the amount is likely to be treated as if you had received the total income of $100,000. The taxpayer and the medical centre reached an amicable settlement. Under the terms of the settlement agreement, the medical centre agreed to pay the taxpayer $350,000 “as non-economic harm and not as wages or other income.” In 2005, the taxpayer received a payment of $34,000 from the medical centre and treated it as non-taxable under paragraph 104(a)(2). The IRS reviewed the statement and did not agree that the payment of $34,000 fell within the section 104(a)(2) exclusion. Ask the taxpayer if they have made a settlement payment to one of their employees (past or present).

Plaintiffs are generally much more concerned about tax planning than defendants. However, also consider the defendant`s point of view. A defendant who pays for a settlement or judgment will always want to deduct it. If the defendant carries out a commercial activity, this is rarely questioned, as a dispute entails costs to do business. Punitive damages are also tax deductible by companies. Only certain state fines cannot be deducted, and even then, defendants can sometimes find a way if the fine is compensatory in some way. In addition to tax rate preference, your tax base may also be relevant. This is usually your initial purchase price, plus any improvements you`ve made and reduced by depreciation, if any. In some cases, your settlement may be treated as a restoration of the base rather than as income. 3. The award of damages may save taxes. Most disputes involve several issues.

You could claim that the defendant kept your laptop, wasted your trust fund, underpaid you, did not compensate you for business travel or other items. Even if your dispute is about behavior, there`s a good chance that the overall solution involves several types of consideration. It is preferable for the plaintiff and the defendant to agree on the tax treatment. Such agreements do not bind the IRS or the courts in subsequent tax disputes, but are generally not ignored by the IRS. I handle tax matters in the United States and abroad (www.WoodLLP.com), deal with tax matters, tax disputes, draft tax notices, provide tax advice on legal regulations, The general tax rule for amounts received from dispute resolution and other remedies is the Internal Revenue Code (IRC) Section 61, which states that all income from any source is taxable. unless this is excluded by another section of the code. Article 104 of the IRC provides for an exclusion from taxable income in respect of shares, settlements and arbitral awards. However, the facts and circumstances of each settlement payment must be taken into account in determining the purpose for which the money was received, as not all amounts received from a settlement are exempt from tax.

The key question is, “What should comparison (and corresponding payments) replace?” Section 104(a)(2) of the IRC allows a taxpayer to exclude from gross income “the amount of all damages (other than punitive damages) received (whether by prosecution or agreement and whether in the form of lump sums or periodic payments) as a result of bodily injury or physical illness. In some cases, a tax provision in the settlement agreement characterizing the payment may result in its exclusion from taxable income […].