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Birmingham Bar Association Bulletin | Spring 2015

Tax Law Mike Baker, Managing Partner, Dent, Baker & Company YOU NAILED THE SETTLEMENT. BUT WHAT ABOUT REPORTING DAMAGES? Make sure you’re understanding and reporting what you should In part one of this article I introduced a common area of confusion among attorneys and their clients—the reporting requirements and potential tax consequences of settlement damages and attorneys fees. In part two the rubber meets the road in the form of actual examples straight from the U.S. Treasury playbook. Th e Internal Revenue Code represents the rules and the Treasury Regulations represent the codifi ed interpretation— the practical application of the Code. I’ve selected some examples from the Regulations to help clarify the reporting requirements in various situations. In these examples a “Payor” is defi ned as an individual who pays a settlement to the attorney of a client, or the person’s insurer if they make the payment. TAXABLE TO THE CLAIMANT In this example one check is written to more than one payee. Employee C, who sues employer P for back wages, is represented by Attorney A. Employer P settles the suit for $300,000, which represents taxable wages to C under existing legal principles. Employer P writes a settlement check payable jointly to C and A in the amount of $200,000, net of income and FICA tax withholding with respect to Employee C. Employer P delivers the check to A who keeps $100,000 as compensation for legal services and disburses the remaining $100,000 to C. Employer P must fi le an information return (1099- MISC) with respect to Attorney A for $200,000 and must fi le an information return with respect to C for $300,000. Th e following case involves separate checks and separate payees. Plaintiff C, in a suit for lost profi ts against Corporation P, is represented by Attorney A. Corporation P settles the suit for $300,000, all of which will be taxable in C’s gross income. Attorney A asks Corporation P to write two checks, one payable to A in the amount of $100,000 as compensation for legal services, and the second payable to Plaintiff C in the amount of $200,000. P writes the checks and delivers both checks to A. Now © Wisconsinart | Dreamstime.com - US Federal 1040 Tax Form, Plain Forms Concept Photo P must fi le an information return (1099- MISC) with respect to A for $100,000 and one with respect to C for $300,000. In cases where the defendant issues a Form 1099-MISC for the full amount to the plaintiff , the law fi rm representing the client does not have to issue a 1099- MISC for funds disbursed to the client from the escrow account. EXCLUDABLE TO CLAIMANT Th is example addresses the issue of one check and joint payees. Plaintiff C, who sues Corporation P for damages for personal physical injuries, is represented by Attorney A. Corporation P settles the suit for a $300,000 damage payment that is excludable from C’s gross income. P writes a $300,000 settlement check payable jointly to C and A and delivers the check to A. Attorney A retains $120,000 of the payment as compensation for legal services and remits the remaining $180,000 to C. In this case P must fi le an information return (1099-MISC) with 12 Birmingham Bar Association


Birmingham Bar Association Bulletin | Spring 2015
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