1099-Misc Lawsuit settlement - Taxable?

[Jack from Ohio]

Client received 1099-Misc with $25,000 in box 3.  She states it is settlement of a lawsuit against a previous employer.  1099-Misc issued by an insurance company. 

 

Client's "attorney" INSISTS that it is all non taxable.  Part is punitive, part is for missed wages. 

 

I think it is all taxable, although I also believe the 1099 was issued incorrectly.  Lost wage recovery should have been in box 7 subject to SE and the remainder in box 3.  However, the insurance company will not even talk about reissuing the 1099.  Therefore, I believe it is all taxable on line 21.

 

Here is my question:

 

The "attorney" (not sure if it really fits) says there is a place to make an entry on the tax form to make it non-taxable.  Client refuses to believe anything else.  We have no documentation of how the settlement was allocated.  "Attorney" says such documentation is not needed.

 

Before we send this client packing to the attorney for him to prepare her return, does anyone know of a method like the "attorney" had described?  He swears it will work and no CP2000 will be issued next year.  I do not think so but wanted input from all the experienced people here.

Edited April 20, 2015 by Jack from Ohio

[Richcpaman]

Jack:

 

Ask the "attorney" for a copy of the settlement document.  You can be hired by the "attorney" to prepare the return and would be covered by attorney client privledge and or confidentiality of the agreement to read it.

 

No, the insurance company isn't going to correct.

 

You can also have the "attorney" give you a letter stating that the amounts received by client "a" were for "xx"  and "YY"  and therefore not subject to any taxation and why not.  Then you can file the return list the income to Line 21, and then back it out.  And if the CP2000 letter comes, send them a copy of the attorneys letter. 

 

Rich

[rfassett]

Agree with Rich.  I have done it that way for a number of years - well, not the same fact pattern.  And it always resulted in a CP2000. And was easily remedied after the first year (our was a multi-year installment sale that the purchaser insisted upon putting the number in box 7).  After we got the IRS to listen the first year, it was just a matter of changing the dates on the letter year after year.  Client thought I walked on water because the CP 2000 reflected high five figure liability every year and when I was done it was zero.  That guy never will go anywhere else.  Use your skills as a marketing mechanism.

[Pacun]

Attorney is correct. None of the events listed are taxable events.

 

"Client's "attorney" INSISTS that it is all non taxable.  Part is punitive, part is for missed wages"

 

The only time that this could be taxable is that if part of the payments were for emotional damages that didn't result on a medical illness.

[BulldogTom]

Jack,

 

You need to see the settlement docs.  My first blush is it is all taxable, but the costs of the litigation may be handled differently depending on what the settlement docs say.

 

1.  Lost wages should be paid on a w2 to the recipient.    These are fully taxable and subject to employment taxes.  The defendant is also subject to their portion of the payroll taxes.

2.  Punitive damages are fully taxable on line 21 unless they related to injury or illness.

3.  If the award is for discrimination, the taxpayer can take the legal fees as an above the line deduction on line 34 of the 1040.

 

You need to see the settlement docs.

 

Did I say that already?

 

Tom

Newark, CA

[jklcpa]

I'm going to agree with Jack for the moment until he gets a copy of the settlement to see exactly what it was for, or until he gets something formally in writing that states exactly why this settlement isn't taxable.  If a settlement is related to an employment-related lawsuit and is for lost wages, that is compensatory damages treated like wages and is taxable.  Jack states that the other portion of the settlement is for punitive damages, and that would also be taxable and reported on line 21.

 

Jack, get the documents and speak with the attorney, get something in writing.   Over the years I've worked with attorneys that have been wrong about the taxation of settlements.

[Jack from Ohio]

I'm going to agree with Jack for the moment until he gets a copy of the settlement to see exactly what it was for, or until he gets something formally in writing that states exactly why this settlement isn't taxable.  If a settlement is related to an employment-related lawsuit and is for lost wages, that is compensatory damages treated like wages and is taxable.  Jack states that the other portion of the settlement is for punitive damages, and that would also be taxable and reported on line 21.

 

Jack, get the documents and speak with the attorney, get something in writing.   Over the years I've worked with attorneys that have been wrong about the taxation of settlements.

Surely you jest...

[Jack from Ohio]

Attorney is correct. None of the events listed are taxable events.

 

"Client's "attorney" INSISTS that it is all non taxable.  Part is punitive, part is for missed wages"

 

The only time that this could be taxable is that if part of the payments were for emotional damages that didn't result on a medical illness.

Court awards and damages.   To determine if settlement amounts you receive by compromise or judgment must be included in your income, you must consider the item that the settlement replaces. The character of the income as ordinary income or capital gain depends on the nature of the underlying claim. Include the following as ordinary income.

1. Interest on any award.

2. Compensation for lost wages or lost profits in most cases.

3. Punitive damages, in most cases. It does not matter if they relate to a physical injury or physical sickness.

4. Amounts received in settlement of pension rights (if you did not contribute to the plan).

5. Damages for:

   1. Patent or copyright infringement,

   2. Breach of contract, or

   3. Interference with business operations.

6. Back pay and damages for emotional distress received to satisfy a claim under Title VII of the Civil Rights Act of 1964.

7. Attorney fees and costs (including contingent fees) where the underlying recovery is included in gross income.

 

   Do not include in your income compensatory damages for personal physical injury or physical sickness (whether received in a lump sum or installments).

[jklcpa]

Haha, Jack. At first I thought it was because I was agreeing with you,         and then I saw your bolded item.

 

 

Yeah, some attorneys are pretty bad with the taxation issues, especially those that are the litigators.  Worse one was an attorney handling a divorce that had never heard of a QDRO, I kid you not, and was about to cause a huge tax bill until I stopped her. She was so bad that I had to tell her that if she didn't know how to structure that portion of the settlement properly, then she needed to let the opposing side's attorney draw up that portion of the settlement because the amount had already been agreed on. 

 

Most of the attorneys I work with now are for the business clients that specialize in estate and financial planning and business taxation, a couple of them also CPAs that worked in the industry, so they're very good.

[Pacun]

Question: Tina was injured in a car accident in 2013 and in 2014 received a settlement from the insurance company in the amount of $350,000. The settlement itemized the proceeds as follows:

Lost wages $50,000

Physical injury $250,000

Emotional Distress $50,000

The emotional distress did not cause a medical condition. Can Tina exclude the entire $350,000 from income under §104(a)(2)?

Answer: No, the court settlement indicated that Tina did not suffer any medical conditions due to the emotional distress. The amount received for emotional distress is not excludable under §104(a)(2) unless the taxpayer can prove that the emotional distress caused medical conditions. The allocation of the proceeds to lost wages and physical injury are excluded from income under §104(a)(2). Amounts received for lost wages are excluded from income even though had she earned these wages they would have been taxable.

[jklcpa]

http://www.irs.gov/pub/irs-pdf/p4345.pdf

[jklcpa]

Jack's post stated that his client's settlement is a result of litigation with a previous employer.  At this point we (on here) don't know what caused the lost wages, but if it is an employment-related lawsuit, then the compensatory damages are going to be taxable.  If it's related to an injury sustained on the job, then it wouldn't be taxable. That's why I said I'd agree with him for the moment, but that he needs to read the documents and talk with the attorney.

[Jack from Ohio]

Client received 1099-Misc with $25,000 in box 3.  She states it is settlement of a lawsuit against a previous employer.  1099-Misc issued by an insurance company. 

Client's "attorney" INSISTS that it is all non taxable.  Part is punitive, part is for missed wages. 

I think it is all taxable, although I also believe the 1099 was issued incorrectly.  Lost wage recovery should have been in box 7 subject to SE and the remainder in box 3.  However, the insurance company will not even talk about reissuing the 1099.  Therefore, I believe it is all taxable on line 21.

Here is my question:

The "attorney" (not sure if it really fits) says there is a place to make an entry on the tax form to make it non-taxable.  Client refuses to believe anything else.  We have no documentation of how the settlement was allocated.  "Attorney" says such documentation is not needed.

Before we send this client packing to the attorney for him to prepare her return, does anyone know of a method like the "attorney" had described?  He swears it will work and no CP2000 will be issued next year.  I do not think so but wanted input from all the experienced people here.

No ambiguity about the reason for the settlement.  I am hearing that my instincts are correct.  Lawsuit was for sexual harassment and illegal termination.  No physical injury involved.  I will contact the attorney for documentation about the settlement.

Edited April 20, 2015 by Jack from Ohio

[jklcpa]

Taxable.

 

There's no need to shout at anyone here that is trying to help you or answer your question. Your original post did not state the entire basis for the lawsuit. If you were *that* sure, why did you even ask?!?!?!?!   Do you shout at your clients too?   Sheesh!

[Jack from Ohio]

Taxable.

 

There's no need to shout at anyone here that is trying to help you or answer your question. Your original post did not state the entire basis for the lawsuit. If you were *that* sure, why did you even ask?!?!?!?!   Do you shout at your clients too?   Sheesh!

 

I will no longer ask any questions on this board.  If you read my original question, you would know the reason I posted.

 

Ban me if you like.  Fed up.

Edited April 20, 2015 by Jack from Ohio

[BulldogTom]

Judy,

 

I don't see any shouting.  I think he was pointing out (just like you did with the bold in your earlier post).  We all post to confirm our thought process, and Jack just pointed out that he was getting his thought process confirmed.

 

I think you read too much into his post.

 

Just my 2 cents.

 

Tom

Newark, CA

[RitaB]

OK, I was so aggravated today at the two who called and one who came by to see how their very special tax returns were "coming along," my daughter said I needed a Snicker Bar. I want to just offer everybody a Snicker Bar and report that I AM going to write it off:

[Catherine]

GREAT commercial, Rita!

[kcjenkins]

Judy, I think you owe Jack an apology.  

[Pacun]

AND we thought that on April 16th we all were going to be relaxed. lol.

[kcjenkins]

On point 

 

Sanford v. Commissioner, T.C. Memo. 2008-158.
The plaintiff experienced emotional distress due to sexual harassment which she suffered through her employment. The emotional distress manifested itself in physical symptoms. However, because these physical symptoms were not the basis of the award that the taxpayer received, the award was not excludible from the plaintiff’s income.

[RitaB]

AND we thought that on April 16th we all were going to be relaxed. lol.

Shut up no you shut up.

[rfassett]

Shut up Rita - and go get a snickers bar!

[RitaB]

Shut up Rita - and go get a snickers bar!

Don't tell me what to do. Oh, wait - ok.

[jklcpa]

I apologize to everyone including Jack for my rude post.