Page 74 - Life In Naples Magazine - November 2015

FINANCE
SETTLEMENTSLEGAL AWARDS AND
by Michael Wiener, E.A.
Y our contractor did shoddy work on your condo. You
were unfairly fired. If you are collecting a settlement or therapist. Many nontraditional treatments can count as well.
judgment, is it taxable income? Usually yes, but taxes
vary enormously depending on how you were damaged, how
the case was resolved, and even how checks and IRS Forms
1099 were issued. Here are some concepts you should know.
Settlements and judgments are taxed the same. The same
tax rules apply whether you settle or win a judgment. If you
are audited, you’ll need to show the
settlement agreement, complaint,
checks, IRS Forms 1099, W-2, etc.
Settlements and judgments are
taxed according to the “origin of your
claim.” For example, if you’re suing a
competing business for lost profits, a
settlement will be lost profits, taxed
as ordinary income. If you get laid off
at work and sue for discrimination
seeking wages, you’ll be taxed on
wages. Your former employer will
probably withhold income and employment taxes even if you
no longer work there.
Recoveries for personal physical injuries and physical
sickness are tax-free. If you sue for personal physical injuries,
your damages are tax-free. Most importantly, the Tax Code
states that in order to qualify for tax-free treatment your injury
must be “physical.”
Symptoms of emotional distress are not “physical.” Money
you receive for physical symptoms of emotional distress (like
headaches and stomachaches) is taxed, while physical injuries
or sickness is not. For example, if in settling an employment
dispute you receive $50,000 extra because your employer gave
you an ulcer. Is an ulcer physical, or merely a symptom of
emotional distress? Many plaintiffs take aggressive positions on
their tax returns, claiming that damages of this nature are tax-
free. But that can be a losing battle if the defendant issues an
IRS Form 1099 for the entire settlement. You may want to try
to agree with the defendant about the tax issues.
Medical expenses are tax-free, even if your injuries are
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purely emotional. The definition of “medical expenses” can be
surprisingly liberal. For example, payments to a psychiatrist or
counselor qualify, as do payments to a chiropractor or physical
Punitive damages and interest are always taxable. If you are
injured in a car crash and get $50,000 in compensatory damages
and $5 million in punitive damages, the former is tax-free. The
$5 Million is fully taxable, and you can have trouble deducting
your attorney fees.
Attorney fees can be a trap! Whether you pay your attorney
hourly or on a contingent fee basis, factor in the cost of your
attorney when you’re addressing taxes. Say you settle a suit
for intentional infliction of emotional distress against your
neighbor for $100,000, and your lawyer keeps $40,000. You
might think you’d have $60,000 of income. Instead, you’ll have
$100,000 of income, followed by a $40,000 miscellaneous
itemized deduction. You’ll be subject to numerous limitations-
and to the alternative minimum tax or AMT-that can whittle
your deduction down to nothing.
Bottom line: It can be tempting to end your dispute and
let the tax chips fall where they may. But before you resolve it,
consider the tax aspects. You’ll almost always have to consider
them at tax return time the next year. You’ll be better off
considering taxes earlier, and may save yourself serious money.
If you should have a topic that you would like me to
discuss or if you should have a question, please feel free
to call 239.403.4410 or e-mail me at
mike@cctaxandaccounting.com.
An enrolled agent, licensed by the US Department
of the Treasury to represent taxpayers before the IRS
for audits, collections and appeals. To attain the
enrolled agent designation, candidates must demon-
strate expertise in taxation, fulfill continuing education
credits and adhere to a stringent code of ethics.
Life in Naples | November 2015