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Discussion:Age Discrimination, Form 1099

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Discussion Forum Index --> Advanced Tax Questions --> Age Discrimination, Form 1099


Discussion Forum Index --> Tax Questions --> Age Discrimination, Form 1099

EADave (talk|edits) said:

2 April 2014
Client wins Age Discrimination suit against his former employer. Client was also a shareholder in the company.

Former employer issues a 1099-MISC with NEC (Box 7) reporting $XXX,XXX for settlement of the age discrimination suit. The client's legal fees paid to his attorneys were included in the Box 7 total amount. The client also received $XXX,XXX for the sale of his shares back to the company.

Let's say the figures are as follows:
1. Age Discrimination settlement: $50,000
2. Sale of Stock: $150,000 This makes the total settlement $200,000.
3. Legal Fees: $80,000
BTW, these are the exact ratios of the terms (40% for legal fees, etc).

I have 3 questions:
1. Will the above the line deduction for legal fees be limited to 25% (50K / 200K)?
2. Can the taxpayer offset his gain on the shares of stock by the remaining 75% of legal fees paid? Add to the stock's basis?
3. Should the taxpayer pursue requesting a Corrected form 1099-MISC, and instead request a Form W-2 for the Age Discrimination lawsuit proceeds? See Chester Gerstenbluth v. Credit Suisse Securities where Age Discrimination payment was deemed "back wages" and subject to FICA. Also see Treas Reg 1.6041 for reference.

Thanks everyone, have a great day!

EADave (talk|edits) said:

2 April 2014
OR, I can just report the $50,000 on a form 8919 because relations between former employer and former employee....not too cordial at the moment. Probably will receive an inquiry from the IRS but I think we have enough to prove our case and at least the taxpayer is paying his portion of FICA/MED.

Terry Oraha (talk|edits) said:

2 April 2014
I would think the legal is above the line legal or exp of sale stock; either way no difference, so why hash out the various arguments for which is more appropriate and just do a whatever is a reasonable allocation.

Now I know it should be box 3 other income, but I don't think every age discrimination is automatically deemed back wages. If it said an amount was for back wages, then you should have received a w-2. But this goes back to the settlement, if it does not say back pay I would run with the 1099, as is, but treat as other income.

Terry Oraha (talk|edits) said:

2 April 2014
The answer to #2 is yes.

Terry Oraha (talk|edits) said:

2 April 2014
Wallace R. Noel, et ux. v. Commissioner, TC Memo 1997-113

Ckenefick (talk|edits) said:

2 April 2014
#1 - Why? Why is allocation methodology reasonable, correct, set in stone, etc? (And I'm assume we're talking Sec 62 here, right?)

Tax Writer (talk|edits) said:

2 April 2014
Had a very similar case a years ago, the former employee was given a settlement and the company admitted no wrongdoing, but the lawsuit was based on age discrimination and age-related harassment. Much smaller dollar amounts in my case, and no stock, but I reported the settlement as other income, even though the 1099 miscategorized the income as independent contractor income. I had a copy of the original case, so I knew what it was for.

We submitted the tax return, and I told the client to expect a notice, which we would contest. Sure enough, about 9 months after filing, we got a notice. I contested the notice, and said that the taxpayer "attempted to get the 1099 corrected by the company but received no response," the employee basically left a message on their payroll office and no one called her back, which I expected, but at least we can say that she tried.

The return was accepted as filed. And I went back to my files, and I found a copy of the letter!

Here you go, modify as needed, personal information has all be redacted:


TAXPAYER ID # 111-XX-XXXX RE: TAX YEAR 2005

To Internal Revenue Service:

Thank you for your notice regarding Ms. XXXX. Taxpayer disagrees with the proposed adjustments to her tax return. Ms XXXX received a $$$$ legal settlement in 2005. The settlement was pursuant to a lawsuit against, SOMECOMPANY International, INC. The original lawsuit was for harassment and emotional distress.

The 1099 that Ms. XXX received was incorrectly issued. Ms XXX tried unsuccessfully to have the 1099 corrected by SOMECOMPANY International, INC. Ms. XXX also contacted the IRS directly to seek their advice in this matter. Before filing her return, Ms. XXXXX spoke with IRS employee JOE IRS, (ID # 000000) who confirmed that the income should have been reported as “other income” in box 3 of the 1099-Misc, rather than nonemployee compensation. A copy of the attorney’s letter is enclosed for your review. This was not self-employment income, and therefore, not subject to self-employment tax.


Thank you so much for your timely consideration in this matter.

Sincerely,


XYZ Taxpayer

Nilodop (talk|edits) said:

2 April 2014
Good letter. Right to the point. Not too long. Gives the facts and says why taxpayer is right. Best of all, it worked.

EADave (talk|edits) said:

2 April 2014
Wow! Right on the money, thank you for the reference. I agree that the Settlement for the suit should be at least Box 3, I'll just report on Sch C and back it out.

I do think the allocation of the legal proceeds to ATL or Stock Basis is important; reduction of Ordinary Income vs. reduction of LTCG Income. This taxpayer is currently in the 39.6% realm. I'll just allocate the legal fees in proportion to the % of the settlement that represents suit/stock sale, blah, blah.

Thanks Terry, great work my friend. I've only had 2 of these in 12 years so I really appreciate the advice.

Nilodop (talk|edits) said:

2 April 2014
Ck suggests (I think) that you might be able to do a more favorable allocation.

EADave (talk|edits) said:

2 April 2014
Thanks Tax Writer. My client (about 8 years ago) had a similar case to yours and received an IRS letter too. This is good advice, thank you very much!

EADave (talk|edits) said:

2 April 2014
I'm open to all suggestions but....the settlement verbiage does mention the exact amount allocated to a) Sale of Stock and b) Settlement for "all other damages". It also makes mention of releasing all guilty parties of any future claims, etc, etc.

Ckenefick (talk|edits) said:

2 April 2014
the settlement verbiage does mention the exact amount allocated to a) Sale of Stock and b) Settlement for "all other damages".

Then how'd you get the numbers in the OP? Is it that the Age Discrimination award was shown on a 1099 and the stock award wasn't? Were there different law firms involved on the defendant's side?

http://www.philadelphiabar.org/WebObjects/PBAReadOnly.woa/Contents/WebServerResources/CMSResources/TaxAspectsofLitigation.pdf

There is plenty of case law on this. Go to Page 9 of the pdf. It involves looking at the complaint and the specific causes of action.

Ck suggests (I think) that you might be able to do a more favorable allocation.

Why should the legal fees be based on the relative sums of the awards? What if attorney spent 95% of his time on the Age Discrimination charge?

EADave (talk|edits) said:

3 April 2014
What do you suggest, ask the attorney what resources (time) was spent on each aspect of the case? Do you think they would provide such information?

No 1099 issued for the Stock Sale, but a 1099 was issued for the Age Discrimination portion of the suit. I am not sure how many law firms represented defendants, I'm not sure the plaintiff (my client) could find that out either.

Ckenefick (talk|edits) said:

3 April 2014
I'm just wondering why only 1 1099...which led me to believe maybe one law firm had it's act together and there was a 2nd law firm that didn't...just a guess. Law firm might have concluded that, since stock was not "sold/exchanged," that no 1099 reporting was required. A reasonable position, since defendant/corporation is not a broker with a 1099B reporting obligation.

This guy Rob Wood writes extensively on these matters:

http://woodporter.com/Publications/Articles/pdf/Attorney_Fee_Deduction_Problems_Remain.pdf

Put him in your Rolodex. See Page 708 of the attached, including the footnotes. Not sure if your client's case was a contingent fee arrangement or not, but it sounds like it was. If so, you'll want to make sure you've captured the entire fee. For example, is the entire fee included on the one 1099? I'm not sure what kind of paperwork you have.

EADave (talk|edits) said:

3 April 2014
So here are the real amounts:

1. Purchase of Stock: $440,000 2. Damages: $187,500

Attorneys list the Total Amount of the suit as $627,500, then they list their "Attorney's" fees as $251,000 plus $1,700 in incidental expenses (postage, couriers, etc). My client received a 1099 from the Company he sued, only because I asked the client to inquire about a source document. I told the client it was odd that he didn't receive some sort of source document (1099/W2) so he inquired and the Company responded with a 1099 MISC, $187,500 reported as NEC.

No other documents, other than the Settlement paperwork and a check was provided to the client. I have captured the entire fee, I allocated 30% of the legal fees to the ATL deduction and 70% of the fees to the Stock Basis. This allocation is based upon the portion of the specific award to the total award. Example: 187,500/627,500 = approx. 30%, .30 X 251,000 = $75,300 allocated to the ATL Deduction.

I understand your reasoning, Chris, when you ask how much time did the lawyers spend defending the Discrimination aspect of the Suit. This I don't know but it is worth looking into. There was a buy back option (I can't recall the exact verbiage) in the original shareholder agreement that stated the shares would be purchased at current FMV upon termination of employment. So, my point is, that piece of the puzzle wouldn't take much brain power/resources to calculate. You might be onto something. I have read the article you mentioned (Wood Porter) before, now it has more meaning to me.

Ckenefick (talk|edits) said:

3 April 2014
So, did the client get a check for $374,800?

EADave (talk|edits) said:

3 April 2014
Correct.

Ckenefick (talk|edits) said:

3 April 2014
Ok, and this was a contingent fee case, right?

If so, then this means someone has already allocated the legal fee to the awards, right?

In other words, if he got (cash) $374,800, yet gross settlement was $627,500, then there's been $252,700 added (already) to the net settlement to arrive at the gross settlement numbers ($440,000 and the $187,500), correct? Given this, wouldn't we need to how the $252,700 gross-up was allocated...(1) since the legal fee deduction we claim with respect to the Stock Award should be equivalent to the amount of legal fees imbedded in (grossed up in) the $440,000, correct and (2) since the legal deduction we claim with respect to the Age Claim should be equivalent to the amount of legal fees imbedded in (grossed up in) the $187,500, correct?

If that is the case, then I think our work has already been done for us. That is, it would be difficult to argue for one allocation on the deduction side if there's been a different allocation on the gross-up side.

EADave (talk|edits) said:

3 April 2014
Contingent case, not sure, I'll check but I doubt the client knows for sure. Wish I could speak to the Attorneys without receiving a bill :( The fact that legal fees were 40% of the gross may lean toward this case having a contingency fee.

I will tell you that the $440K was calculated using the FMV of the stock at the time of the stock surrender, if that helps.

Ckenefick (talk|edits) said:

3 April 2014
If they deducted their fee out of the award, then it was probably a contingent fee arrangement (also given the exact 40% figure). Otherwise, client would have been writing checks all along, most likely.

So, if fee was 40%...

$440,000 minus $176,000 [40% legal fee allocated] = $264,000...and

$187,500 minus $75,000 [40% legal fee allocated] = $112,500...

and $264,000 + $112,500 = $376,500...the difference between the $376,500 and the $374,800 is the $1,700 in expenses.

I think these fee allocations, as done by the attorneys, are coming pretty close to yours. And given that the settlement agreement does reference the specific claims and settlement awards allocated thereto, I think you are stuck. You see, if we were to change the allocation of the deduction on the deduction side, we'd also have to change it on the gross-up side, which means we'd end up with "grossed-up" award amounts that differ from the settlement agreement.

Doug M (talk|edits) said:

3 April 2014
Was there a buy-sell?

Was the payment for the stock via a "formula" as far as determination of value? As in a no brainer?

Trying to build a case for higher allocation of fees to discrimination award vs. stock proceeds.

Ckenefick (talk|edits) said:

3 April 2014
It could possibly be done even without lowering the $440k stock value. And, I don't think we have a lot of wiggle room with the $440k and the $187.5k if these gross numbers were stipulated in the settlement agreement.

Note that my figures in my last post were off the record, just trying to think through what the attorney might have been thinking...and I'm thinking that, if he even gave it a thought, he took 40% of the award from each claim and that resulting amount represented his fees to each claim.

But if we start with the gross numbers, $440k and $187.5k, it'd be great is attorney could tell us that the Stock Claim was easy and he spent 25.3% of his time on it and 74.7% of his time was spent on the Age Claim. This would give Legal numbers of $63,503 and $187,497, respectively. If we get an above the line deduction for the $187,497, this would essentially wipe out the Age Claim income, leaving nothing but LTCG.

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