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FINANCE

LEGAL AWARDS

AND SETTLEMENTS

by Michael Wiener, E.A.
Y our contractor did shoddy work on your condo. You were as do payments to a chiropractor or physical therapist. Many

unfairly fired. If you are collecting a settlement or judgment, nontraditional treatments can count as well.
Punitive damages and interest are always taxable. If you are
is it taxable income? Usually yes, but taxes vary enormously
depending on how you were damaged, how the case was resolved, injured in a car crash and get $50,000 in compensatory damages and
and even how checks and IRS Forms 1099 $5 million in punitive damages, the former is tax-free. The $5 million
were issued. Here are some concepts you is fully taxable, and you can have trouble deducting your attorney fees.
should know. Attorney fees can be a trap! Whether you pay your attorney
Settlements and judgments are taxed hourly or on a contingent fee basis, factor in the cost of your attorney
the same. The same tax rules apply whether when you’re addressing taxes. Say you settle a suit for intentional
you settle or win a judgment. If you are infliction of emotional distress against your neighbor for $100,000,
audited, you’ll need to show the settlement and your lawyer keeps $40,000. You might think you’d have $60,000
agreement, complaint, checks, IRS Forms of income. Instead, you’ll have $100,000 of income, followed by a
1099, W-2, etc. $40,000 miscellaneous itemized deduction. You’ll be subject to
Settlements and judgments are taxed numerous limitations-and to the alternative minimum tax or AMT-
according to the “origin of your claim.” that can whittle your deduction down to nothing.
For example, if you’re suing a competing Bottom line: It can be tempting to end your dispute and let the tax
business for lost profits, a settlement will chips fall where they may. But before you resolve it, consider the tax
be lost profits, taxed as ordinary income. If you get laid off at work and aspects. You’ll almost always have to consider them at tax return time
sue for discrimination seeking wages, you’ll be taxed on wages. Your the next year. You’ll be better off considering taxes earlier, and may
former employer will probably withhold income and employment save yourself serious money.
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 If you should have a topic that you would like me to
are tax-free. Most importantly, the Tax Code states that in order to discuss or if you should have a question, please feel free to
qualify for tax-free treatment your injury must be “physical.” call 239.403.4410 or e-mail me at
Symptoms of emotional distress are not “physical.” Money you
michael@mwtaxandaccounting.com.
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 4280 East Tamiami Trail
extra because your employer gave you an ulcer. Is an ulcer physical, Executive Suite 302-M | Naples, FL 34112
or merely a symptom of emotional distress? Many plaintiffs take
aggressive positions on their tax returns, claiming that damages of An enrolled agent, licensed by the US Department
this nature are tax-free. But that can be a losing battle if the defendant of the Treasury to represent taxpayers before the IRS for
issues an IRS Form 1099 for the entire settlement. You may want to audits, collections and appeals. To attain the enrolled agent
try to agree with the defendant about the tax issues. designation, candidates must demonstrate expertise in
Medical expenses are tax-free, even if your injuries are purely taxation, fulfill continuing education credits and adhere to
emotional. The definition of “medical expenses” can be surprisingly a stringent code of ethics.
liberal. For example, payments to a psychiatrist or counselor qualify,

74 Life in Naples | May • June • July 2017