Double Check me please - Lawsuit settlement

[BulldogTom]

TP has been involved in a lawsuit against a former employer.  It is now moving to settlement.  The lawyer asked the TP to ask her Tax Professional how to word the settlement so as to reduce tax liability.

 

First of all, I am not going to bite on anything that has to do with the wording of a settlement.  I do taxes, I am not a lawyer.  I know this and will be careful.

 

I think I know all the rules.  The portion of the settlement that is attributable to lost wages must be paid as a payroll check, subject to all PR taxes and withholdings.  The portion that is attributable to punitive awards is other income reportable on line 21.

 

Many years ago, there was some ambiguity in the law about discrimination settlements and if they are taxable.  From my understanding, the Supreme Court settled this matter and all discrimination awards are subject to the rule I just wrote down above.  I think Congress also stepped in to make the laws match the SC rulings.

 

So my advice to the TP will be, if your attorney has the ability to move award amounts between lost wages and punitive damages, the higher the punitive award, the better.

 

Did I miss anything?

 

Thanks

 

Tom

Newark, CA

[Lion EA]

If it was discrimination, and a narrow definition (hostile job environment/sexual discrimination/something?) then the lawyers' fees can get netted on line 21 instead of being a 2% on Sch A.  As you say, I would not supply the wording but direct the lawyer to designate discrimination if appropriate to the settlement.

[rfassett]

Sounds good to me!

[kcjenkins]

You are correct, Tom.  And so is Lion, so I'd certainly mention that to the lawyer.  And there should be no problem discussing it WITH THE LAWYER, that is never going to get you accused of 'practice of law'.  Just don't do it with the client, unless the lawyer is also present.  And be glad the client has a lawyer smart enough to request your professional advice IN ADVANCE.  

[BulldogTom]

If it was discrimination, and a narrow definition (hostile job environment/sexual discrimination/something?) then the lawyers' fees can get netted on line 21 instead of being a 2% on Sch A.  As you say, I would not supply the wording but direct the lawyer to designate discrimination if appropriate to the settlement.

Lion or KC,

 

Where is that information in print for me to review?  If it is not too much to ask?

 

Thanks

 

Tom

Newark, CA

[Lion EA]

Sorry.  Just remembering something, probably an e-Newsletter from NAEA or similar, that noted a new rev proc or reg or....  It may come to me in the middle of the night, so I'll post more if/when I remember.

[Lion EA]

Gotta love IntelliConnect: U.S. Master Tax Guide (2015),1010A.Legal Fees and Costs

Related Information – Federal

 

An individual can deduct from gross income attorney’s fees and court costs incurred in connection with an action involving: (1) a claim of unlawful discrimination; (2) certain claims against the federal government; or (3) a private cause of action under the Medicare Secondary Payer statute ( Code Sec. 62(a)(20)). ¹² The deduction is limited to the amount includible in gross income on account of a judgment or settlement, whether as a lump sum or in periodic payments. The deduction is claimed by entering the amount and "UDC" on the dotted line next to line 36 of Form 1040 and including the amount in the total for that line.

An “above-the-line” deduction (formally referred to as an adjustment to gross income) is also allowed for court costs and attorney’s fees paid by or on behalf of the taxpayer in connection with any whistleblower award under Code Sec. 7623( for providing information regarding tax law violations. The deduction cannot exceed the amount includible in gross income as a result of the award ( Code Sec. 62(a)(21)). ¹³ The taxpayer claims this deduction by entering the amount and "WBF" on the dotted line next to line 36 of Form 1040 and including the amount in the total for that line.

For deductibility of legal fees associated with the production of income, see ¶1093.

  Footnotes   ¹²

FED ¶6002; FILEIND: 9,088; PTE §5,805

¹³

FED ¶6002; FILEIND: 9,088

[BulldogTom]

Thanks Lion.

 

Tom

Newark, CA

[kcjenkins]

Discrimination, Whistleblower, and Certain Other Suits - Above the Line Deduction for Attorney Fees
The American Jobs Creation Act of 2004 enacted IRC § 62(a)(20), thereby establishing an above-the-line deduction for attorney fees and court costs paid in connection with discrimination and certain other suits. In December 2006, the Tax Relief and Health Care Act of 2006 was enacted creating IRC § 62(a)(21), an above the line-deduction for attorney fees and court costs associated with suits involving whistleblower claims.
In order for IRC § 62(a)(20) to apply, attorney fees and court costs must have been paid after October 22, 2004, with respect to a judgment or settlement occurring after such date. Additionally, the suit must involve -
Unlawful discrimination,
Certain claims against the federal government, or
A private cause of action under Medicare Secondary Payer statute
In order for IRC § 62(a)(21) to apply, the attorney fees or court costs must have been paid in connection with a whistleblower award for providing information regarding violations of tax laws as outlined in IRC § 7623(b ), and the information must have been provided on or after December 20, 2006.
The deductions allowed under IRC §§ 62(a)(20) and 62(a)(21) are limited to the amount includible in the litigant’s gross income for the taxable year in which the deduction is being claimed.