INFORMATION DEPARTMENT VOLUME 13, NUMBER 4
TAX SETTLEMENTS Tax Basics for Personal Injury Cases Personal injury lawyers aren’t tax specialists, but a little tax knowledge comes in handy when working with clients and trying to settle cases. Wording in settlement agreements influences taxes to a surprising degree. Plaintiffs want to know whether their settlement is taxable and may ask their lawyer about this. Even if your engagement letter says you don’t advise about taxes, what do you say when a client asks, “Is this taxable or not?” Answering can be harder than you might think – tax law is full of shades of gray. The tax treatment of settlements and judgments depends on the type of claims, whether the case is settled or goes to judgment, how checks and IRS 1099 forms are issues, and more. The same tax rules apply to settlements and judgments, but you have more predictability and more flexibility to reduce taxes when a case is settled. Here are some tax tips for trial lawyers in this surprisingly thorny area. Physical Injury Damages If your client is suing for personal physical injuries, the compensatory damages should be tax free. Section 104 of the Tax Code shields damages for compensatory personal physical injuries and physical sickness. This is true whether the case involves a car crash, medical negligence, a defective medical device, sexual assault or most any kind of personal (and physical) injury). Before 1996, “personal” injury damages were tax free. That meant emotional distress, defamation, and many other kinds of legal injuries also produced tax-free recoveries. But that changes in a fundamental way when Section 104 of the Tax Code was amended in 1996. Since then, your injury must be “physical” to give rise to tax-free damages. Unfortunately, neither Congress nor the IRS has clarified exactly what is physical and what is not. The IRS has generally said that you must have visible harm (cuts or bruises) for your injuries to be physical. This observable bodily harm standard generally means that if your clients bring claims for intentional infliction of emotional distress, their recovery is taxes. To view the full text of the article, please click here.	Top Stories of April 2023 TAXING CONFIDENTIALITY Hush Money And Taxes, Five Things To Know Hush money sounds dirty or illegal, but many businesses pay it on occasion. There are important tax rules at play, and everyone in business should know the key rules. Let’s start with the fact that just about every kind of payment has tax consequences, to both the recipient and to the one who paid the money. If you get paid hush money, is it income you have to report on your taxes? Yes, the IRS says almost everything is income, and that certainly applies to hush money, whatever the circumstances. In fact, almost all legal settlements are income. TAX ON LEGAL FEES Gwyneth Paltrow’s $1 Ski Trial Win Has A Strange Tax Twist Gwyneth Paltrow’s ski accident trial was not as alluring as the Johnny Depp and Amber Heard case, but it still attracted people who couldn’t look away. At a minimum, it was worth losing half a day of skiing to check it out. In the end, a Park City, Utah, jury deliberated for less than three hours after being handed the case and they came down in favor of the Oscar-winning star. TAX REFUNDS If You Have to Repay Compensation, Will IRS Refund The Taxes? With all the failed companies and pay disputes, orders to repay compensation are more common than you might think. Sometimes, it is simply a signing bonus that you did not earn because it was conditioned on you staying with your employer for a minimum period. But there may be other reasons for returning pay too, such as legal violations. How pay clawbacks are treated by the IRS varies with timing and other details. EXTENSIONS TO FILE IRS Gives New York Storm Victims Extension To May 15, Tax Relief The IRS has given New York winter storm and snowstorm victims until May 15, 2023, to file various federal individual and business tax returns and make tax payments. The relief applies to any area designated by FEMA as a result of storms that occurred between Dec. 23 and Dec. 28, 2022. STRUCTURED SETTLEMENTS How Lawsuit Structured Settlements Work and Are Taxed Unless you've been involved in a lawsuit, you may not know about structured settlements. You may have heard of them on late night TV. "It's your money," some TV ads will exclaim. "Cash in your structured settlement and use your money now!" These TV ads are from factoring companies that buy up lawsuit structured settlements, but how do you get one in the first place? CALIFORNIA TAXES Wildfire Victims Wait Years For Settlements, Then Face IRS Taxes Many PG&E and Edison wildfire victims are finally starting to get legal settlements. For many of them, the road has been long and difficult, so frustration levels can be high. And on top of all the heartache, financial, physical and emotional losses, thinking through the tax consequences can be a bitter pill to swallow. For unfortunately, most legal settlements are taxable, even for a devastating fire loss. STRUCTURED LEGAL FEES Update on IRS Attack I recently wrote for the ABA’s Business Law Today about structured legal fees for lawyers in “Plaintiff Lawyer Tax Benefits Other Lawyers Don’t Get.” For nearly 30 years, plaintiff lawyers have been structuring their contingent legal fees based on the seminal tax case of Childs v. Commissioner. Only contingent fees can be structured, and their basic idea is to convert an anticipated lump sum contingent fee into a stream of payments. Payments over time can flatten the peaks and valleys of a lawyer’s income and reduce the need to borrow to finance cases. An annuity company or third party doles out the payments, so a legal fee structure is a little like a tax-deferred installment plan. It doesn’t rely on the credit-worthiness of the defendant or the client, and it can grow pre- rather than post-tax.
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