Discussion:Personal Injury award and attorney fees

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Discussion Forum Index --> Advanced Tax Questions --> Personal Injury award and attorney fees


Discussion Forum Index --> Tax Questions --> Personal Injury award and attorney fees

Globalexpress (talk|edits) said:

7 April 2014
OK, so I'm getting answers that are ALL over the place in my office and among my tax preparer acquaintances.....hopefully you all can help!

I'm not going to post what I think or what my co-workers' opinions are as I don't want to taint your opinions.

Client pays $2,500 retainer to attorney and sues employer for personal injury Client wins personal injury lawsuit against former employer Client awarded $81,000, divided into thirds. $27,000 goes from employer to client in a W2 and is taxable to client $27,000 goes from employer to client tax free (not on a W2, 1099) $27,000 goes from employer to client's attorneys

What amount can my client deduct as a misc 2% deduction on his Schedule A?

Thanks for your time.

Frankly (talk|edits) said:

7 April 2014
My opinion, without research or cites to support it, is that part of the attorney fee is deductible. If the attorney provides an itemized bill that details what part of the fee was for the taxable income, deduct that amount. If not, I'd allocate the fee based on the ratio of the taxable W-2 income to the total award - 1/3 = $9,000.

Ckenefick (talk|edits) said:

7 April 2014
Was it a physical injury?

Nilodop (talk|edits) said:

7 April 2014
Or were his feelings hurt?

Globalexpress (talk|edits) said:

7 April 2014
It was a real physical injury.

Southparkcpa (talk|edits) said:

7 April 2014
I agree with frankly....

Ckenefick (talk|edits) said:

7 April 2014
If it was a real physical injury, then none of the award should be taxable, so none of the legal fees are deductible.

Ckenefick (talk|edits) said:

7 April 2014
Do you know who Aunt Esther is?

Globalexpress (talk|edits) said:

7 April 2014
Nope, don't know who she is. Google says she was the aunt on Sanford and Son. If you're going to reference her in your reply, I'd type really slowly as I'm probably not going to get it :)

Well, perhaps his/my definition of "real physical injury" is in error. The award was administered as my original post describes, a portion taxable to him per a W2.

Some in my office feel that that the only portion of his legal fees that should be deductible is the $2500 retainer he paid because that is the only "direct" out of pocket he paid for the attorney. They feel that since the employer paid the attorneys directly from the client's award that he shouldn't get to include that $27,000 at all. Others say to ratio the $27,000 + $2,500 into thirds and deduct only that portion. Then there are a few outliers. I can't seem to reach any consensus. I just want a position that is defensible as a very large 2% misc. deduction is likely to draw a lot of attention.

Ckenefick (talk|edits) said:

7 April 2014
The award was administered as my original post describes

Your original post doesn't describe anything regarding the nature of the award, and the nature of the claim, other than the nebulous "personal injury." Your original post only describes how someone else reported it to your client. In fact, your post begs many questions by the very nature of a portion of the award being tax-free.

So, I myself will be hard-pressed to give an opinion on the matter until you tell us what the claim was all about. And, if a physical injury was sustained, that involves contact of any sort, which perhaps resulted in bruising at a minimum, I'd like to know that.

And I really do hope you figure out who Aunt Esther is, maybe by checking the yellow box.

Southparkcpa (talk|edits) said:

7 April 2014
Aunt Esther.... Fred, you are stupid, stupid, stupid, where's Lamont?

Globalexpress (talk|edits) said:

7 April 2014
OK, so it wasn't a nebulous Sanford and Son reference/joke. Got it.

I think I'll be reading that Aunt Esther thread a few times for content. Lots of stuff there, especially if I have to count syllables to verify the existence of haiku and read tax court documents.

I think my use of "personal injury" was playing fast and loose with the legal definition of the word, so a mistake in nomenclature on my part.

I don't have the ruling available to me unfortunately right this second, but I believe the award was based upon a combination of physical injury and something related to wrongful termination, but I did not quiz my client too much about that aspect. He did, however, receive his award as described: a W2 for 1/3 of the award, with the other third not on a 1099 or W2. He just got a check. The lawyer got the "third" third directly from the company. I'm assuming (perhaps incorrectly) that the employer's insurance company is the entity that actually handled the claim, is in the business of handling these types of claims, so therefore distributed the amounts correctly on behalf of the company.

But for the sake of argument, if a taxpayer receives a settlement where 1/3 of the award is a physical injury award (excludible from income), 1/3 is in fact taxable to the taxpayer, and 1/3 goes to the taxpayer's lawyer, and the client pays a retainer on top of all of this, how can the retainer and lawyer's fees be deducted, if at all?

Ckenefick (talk|edits) said:

7 April 2014
How can any of it be taxable in such a case?

Terry Oraha (talk|edits) said:

7 April 2014
We need better facts.

Ckenefick (talk|edits) said:

7 April 2014
I know Aunt Esther would be mighty pissed off if you Heathens tried to tax her on her physical injury award...even though the injury didn't even occur to her...

Globalexpress (talk|edits) said:

7 April 2014
OK, when I see the client again I will get the full ruling and read it in its entirety so I can provide better facts. I guess I should have been more exact when asking the question, but I just wanted to have some background opinions before there was a follow-up.

Ckenefick, I don't know who gets to determine (the judge? the jury?) how a client and his/her attorney(s) receive their awarded money, via a W2, 1099, or as an excludable distribution. All I know is what was presented to me during the initial meeting: a portion of a transcript that shows how the award was divided and a nebulous explanation of an injury and loss of employment. The client showed up with a W2 with a Box 1 amount that matched what the transcript said he was supposed to receive. He verbally told me that he received a check for the second third with no taxes taken out, which matched the transcript. I assume the attorneys got their money on a 1099, but I have had no contact with them.

OK, so I'll get better information here shortly hopefully....

Ckenefick (talk|edits) said:

7 April 2014
All I'm saying is that you might be trying to answer the wrong question, based on a foregone conclusion.

Southparkcpa (talk|edits) said:

7 April 2014
In my view...once the award was partially put on a W2, the accountant has little to do. We must assume that 1/3 is taxable by law.

Are we saying now that the accountant would read the case and make a determination that may disagree with the w2?

Nilodop (talk|edits) said:

7 April 2014
Don't we interpret tax laws every day?

Ckenefick (talk|edits) said:

7 April 2014
Are we saying now that the accountant would read the case and make a determination that may disagree with the w2?

Yes.

Southpark, what if your employer took taxes out of your pay and then issued you a 1099-MISC at year-end. Would you just report it on Schedule C?

Michaelstar (talk|edits) said:

8 April 2014
I've been reading along and don't tend to agree with the conclusions reached but do agree we need more information.

Appears the injured actually received $27k maybe net of taxes but is taking the full $27k into income and an additional $27k of the injury settlement which is not taxable. What part of the other $27k is this individual taking into income which would then provide them with a schedule A deduction. That becomes the answer. If the injured recognizes $00 of that third $27k as income - they receive $00 of it as a tax deduction.

On the $2,500 retainer that was not returned - 1/3 of that.

Dennis (talk|edits) said:

8 April 2014
You have plenty of citations available relative to divorce. Really no technical difference. Attorney needs to segregate his bill. Thirds are just a meaningless distraction. 100% of what is allocable to income is deductible.

Ckenefick (talk|edits) said:

8 April 2014
Whose to say that if some of this is really taxable, the related legal isn't deductible above the line?

Globalexpress (talk|edits) said:

8 April 2014
Dennis-

OK, let's say I call the attorneys up and ask them what % of their awarded fees were allocable to the taxable award he received on his W2. For the sake of argument, let's say it's 50%. Can the taxpayer deduct 50% of the $27,000 that went directly from the taxpayer's former employer to the law firm? Is that $27,000 that the lawyers received considered paid by the taxpayer and therefore available for deduction? Or can the taxpayer only deduct the 50% of the $2500 retainer he directly paid the attorneys?

Michaelstar (talk|edits) said:

8 April 2014
No!

As Dennis points out "100% of what is allocable to income is deductible" Hello! did you not read my post as well?

PI Attorney's get 1/3 on PI cases - that is not new news.

"Thirds are just a meaningless distraction." I'd want a copy of the settlement agreement (the IRS would!) for the file but certainly agree with your conclusion.

Globalexpress (talk|edits) said:

8 April 2014
Yikes. OK thanks Michael. But I'm not sure you read my last question either?

Some of the feedback I have been getting at my office suggests that since my client didn't DIRECTLY pay these attorneys anything (the settlement money went from the employer directly to the attorneys), that perhaps the taxpayer can't deduct any of that $27,000- only the % allocation of the $2500 retainer which came directly out of the client's pocket could be deducted. Thoughts on that? I would ASSume that since the $27,000 came out of the client's settlement, the legal fees are considered paid for by the client. After having read that Aunt Esther case a couple of times, however, some of my assumptions about personal injury cases just got thrown out the window.

Also, is it common for tax preparers to ring law firms and ask them to allocate expenses for their work between taxable and nontaxable settlements their clients have received.......and perhaps provide written documentation to boot?

Ckenefick (talk|edits) said:

8 April 2014
Global - You are nowhere near understanding this matter, even the easy stuff. The Supreme Court has weighed in on this issue, and, pursuant to assignment of income principles, if we're dealing with a contingent fee case, the entire award (including the attorney fees) represents gross income to your client. Now, some of it might be taxable, some not. So, since the attorney fee is included in the client's gross income, the entire legal fee needs to be allocated - some might go against taxable income (deductible), some against tax-exempt income (non-deductible). So, for starters, start with the proposition that the award is $81k. As Dennis says, the 1/3rd, 1/3rd, 1/3rd is just a meaningless distraction.

Once you understand the basics, you need to address the point I made about physical injury.

But let's pretend we end up with something taxable here. The next question is allocating the deduction against taxable and tax-exempt income. 50/50? Based on attorney time records? There is more than one way to skin this cat.

Then another question is gonna be where to report the deduction allocable to taxable income - above the line under Sec 62 or on Schedule A (2%)?

So, you're missing some very basic stuff here, as are the people in your office who have never read Banks or any of the related cases.

Robert Wood writes extensively on these matters. Maybe pull up an article or two of his and get up to speed...quickly.

Globalexpress (talk|edits) said:

8 April 2014
OK, so if I'm understanding you correctly, I'm nowhere near understanding this problem. According to your previous posts, I might have to read the entire legal settlement documentation, interpret tax law and perhaps "second guess" the employer, the employer's insurance agent and the client's attorneys because perhaps a W2 shouldn't have been issued in the first place (per your comment to SouthparkCPA above), read Banks or any of the related cases, pull up a few Robert Wood articles, call the client's law firm and figure out what percentage of the firm's time was spent on the taxable portion of this settlement, and perhaps address a couple of other unknown unknowns that pop up along the way during this endeavor.

Yeah, I think I'm going to tell my client to try to find a tax attorney. I had no idea something this seemingly "simple" could go so deep into the weeds.

Ckenefick (talk|edits) said:

8 April 2014
Why does he need a tax attorney?

Just extend the return, get up to speed in the meantime, and we'll help you figure it out. Don't shy away from a learning opportunity.

The first step here is to understand the origin of the claim, including any physical injury aspect.

And, this stuff isn't totally easy. Even judge's get it wrong. Read the Dennis Rodman case (below), for example. He kicked a cameraman in the nuts. Camerman sues him. What does the judge do...the judge allocates the award between taxable and non-taxable (physical injury)...waaaay wrong. The language of Section 104 is clear: If the origin of the claim is in the nature of a physical injury, the entire award is tax free, despite what the settlement agreement says. The key language is "on account of." A lot of attorneys don't even know this stuff, so they divvy up an award between this and that, between taxable and tax-free, not realizing that such a move is improper. Look at the Aunt Esther case...104 extends so deep that you don't even have to be the one sustaining a physical injury to get a tax-free award under 104...and that is per Congress. But, the general consensus is that we need some evidence of physicality - some contact, something truly physical, maybe bruising. Emotional distress will not cut it.

So, if I were you, I would not bank on the reporting here (W2, non-W2) to be accurate until such time that you evaluate the exact nature and origin of the claim. However, seeing that you seem somewhat out of the loop on client's situation, it would not surprise me if we learn that there was no physical injury, whatsoever, in your client's case. But that's okay...it answers one piece of puzzle. Then we move on to the next piece...

http://www.ustaxcourt.gov/InOpHistoric/Amos.TCM.WPD.pdf

According to your previous posts, I might have to read the entire legal settlement documentation, interpret tax law and perhaps "second guess" the employer, the employer's insurance agent and the client's attorneys because perhaps a W2 shouldn't have been issued in the first place (per your comment to SouthparkCPA above), read Banks or any of the related cases, pull up a few Robert Wood articles, call the client's law firm and figure out what percentage of the firm's time was spent on the taxable portion of this settlement, and perhaps address a couple of other unknown unknowns that pop up along the way during this endeavor.

And yes, you have to do all of this...and this isn't so daunting if, as a tax professional, you actually immersed yourself in the cases and the law, on a regular basis, as this stuff comes out, before you were actually confronted with the issue. Then, when the issue presents itself, your thinking will already be lined up, you'll know what the issues are, and you'll know what to look for.

Nonetheless, the choice is yours: Learn nothing and pawn it off on someone else or actually make an effort to learn something. My experience is that clients like it when their accountant knows a lot of shit.

Frankly (talk|edits) said:

8 April 2014
Ckenefick's comments are worthy of comment. One good way to get better at this game is to stumble through new situations when they come up. I may work a particular tax return and get wind up getting paid about 3 cents an hour because of all the research involved and considering all the different approaches that could be used before settling in on the correct approach. But it is time well spent. Next case that comes up is easier because I now understand the issues.

Nilodop (talk|edits) said:

8 April 2014
He kicked a cameraman in the nuts. But, the general consensus is that we need some evidence of physicality - some contact, something truly physical, maybe bruising. Were selfies in vogue back then? I hope not.

Southparkcpa (talk|edits) said:

8 April 2014

Don't we interpret tax laws every day?Italic text Yes of course, but the facts here were not in dispute based on the OP , it was simply an allocation issue.

Southpark, what if your employer took taxes out of your pay and then issued you a 1099-MISC at year-end. Would you just report it on Schedule C?Italic text

Again... then the fact pattern changes. You are mentioning a clear error, that is not what the OP stated. I handle a LOT of law firms and for this or any amount to be put on a W2 did NOT come lightly. It was part of the negotiating process and was agreed by BOTH parties, client and employer in binding arbitration or mediation.

So I stand on my statement that any time spent to say the W2 portion is wrong (IN THIS CASE) is ill advised as you would put your client in a situation that disagrees from the signed agreement and the real issue is how to handle the legal fees.

Ckenefick (talk|edits) said:

8 April 2014
It was part of the negotiating process and was agreed by BOTH parties, client and employer in binding arbitration or mediation

I move to strike as irrelevant...at least in any case involving a physical injury...which we may or may not have here.

You are mentioning a clear error

Exactly. If your employer kicks you in the nuts and you sue him, and the "emotional distress" portion is put on your W2 (or a 1099), we should just slap it on the tax return as taxable because some settlement agreement calls it emotional distress?

Look at that Rodman case, every single thing the cameraman got stemmed from getting kicked in the nuts. No wonder the cameraman sued the IRS too.

Ckenefick (talk|edits) said:

8 April 2014
So I stand on my statement that any time spent to say the W2 portion is wrong (IN THIS CASE) is ill advised

How is it ill-advised? We're just trying to figure out if a physical injury is involved, that's all. If not, okay, we'll leave it alone.

Southparkcpa (talk|edits) said:

9 April 2014
My fact pattern is that this was a litigated case. As part of the negotiation the taxpayer agreed in writing that some of her claim was for back wages and taxable. For that taxpayer to claim to a preparer none of it is taxable is in my view not the proper procedure. have them amend the W2. I personally would not "back out" the W2 because the taxpayer tells me it was for personal injury when I know litigation/mediation was involved. There will be legal docs that dispute the taxpayers claim that it was all personal injury. The figuring out part should be done before a w2 is issued and if wrong, amend the W2.

Ckenefick (talk|edits) said:

9 April 2014
What do you mean by "my fact pattern?"

Aren't we dealing with the OP's fact pattern, where are the facts aren't out yet?

Southparkcpa (talk|edits) said:

9 April 2014
OP mentions the taxpayer had a lawyer.... and in my experience, the W2 was issued as part of the written settlement.

Ckenefick (talk|edits) said:

9 April 2014
and in my experience, the W2 was issued as part of the written settlement

So was the 1099 in Domeny:

An inference can be drawn, however, from the terms of the settlement agreement. The manner in which PACE agreed to pay out the settlement compensation reveals some recognition of petitioner's claim and condition. The $33,308 settlement was segregated into three separate and distinct payments. One amount ($8,187.50) was reflected as employee compensation due to petitioner which [pg. 70] PACE agreed to pay directly to petitioner's attorney. Petitioner reported that $8,187.50 on her 2005 Federal income tax return as wage compensation. Another $8,187.50 was sent directly to petitioner's attorney, and no Form 1099-MISC or Form W-2 was issued to petitioner by PACE for that amount. The remaining $16,933 was paid by PACE to petitioner, and the payment was not reduced by withholding. PACE issued a Form 1099-MISC reflecting that the $16,933 was “Nonemployee compensation”.

The differing tax and reporting treatments used for the three payments show that PACE was aware that at least part of petitioner's recovery may not have been subject to tax; i.e., was due to physical illness. Coupled with that inference is the fact that petitioner advised PACE of her illness before her employment was terminated and the likelihood that her attorney represented petitioner's circumstances to PACE in the course of the settlement negotiations. Petitioner made no other claim. We find that PACE intended to compensate petitioner for her acute physical illness caused by her hostile and stressful work environment.

In summary, petitioner has shown that her work environment exacerbated her existing physical illness. 7 Petitioner's condition and her MS flareup caused by her working conditions was intense and long lasting. Petitioner was physically unable to work until sometime in 2006, more than 1 year following her termination. She has shown that the only reason for the $16,933 payment was to compensate her for her physical injuries.

...now, I'm not saying the judge it right, but nevertheless...eerily similar facts to OP...existence of a settlement agreement, some taxable reporting...it's just that we don't know what that settlement agreement actually said. And all I'm suggesting is that before we slap the W2 on the guy's 1040, we review the settlement agreement like MichaelStar says and see if things are adding up here...

Southparkcpa (talk|edits) said:

9 April 2014
I can live with that.... now, back to Aunt Esther. ;)

Globalexpress (talk|edits) said:

10 April 2014
OK, I read the legal settlement, Aunt Esther again, and the Rodman case above. Then I had access to the legal settlement. It was about 20 pages long, but here's the meat of it:

The whole legal document refers to the agreement as a settlement.

Not paid exactly in thirds, but close enough. Also the numbers in the OP are not the "real" numbers- actual numbers are different for anonymity (and bigger).

Client told me verbally that he sustained some sort of injury that started this whole legal mess for him. But the term "physical injury" is not on the legal settlement document anywhere.

Client has a concurrent workman's comp claim. The settlement specifically says that this agreement is to have no affect on current workman's comp. claim.


Approximately 1/3 of the settlement was to be "paid as wages" on a W2 with withholding taken out. He gave that to me.

Approximately 1/3 of the settlement was paid for liquidated damages and emotional distress and non-economic losses, payable on a 1099 in Box 3 "as income to taxpayer" (was not given to me)

Approximately 1/3 of the settlement was paid on a 1099 to attorney, reported in box 14, "to be reported as income to both the taxpayer and the attorney." Client also paid attorneys a retainer as described in the OP.


Chatted with my boss about it. There's no way he's going to let me "ignore" this W2, whether it was issued correctly or not. He told me he wants it referred back to client's attorney if I think it was issued incorrectly.

Ckenefick (talk|edits) said:

10 April 2014
Fair enough. Your boss has an open mind and his position on it is reasonable in my view. And you've done a real good job here, Global. Kudos to you. By the time you're done, you'll know more about this stuff than we will...

The plot thickens. Client says, "I sustained some sort of injury," in more words or less. Seems very nebulous to me. Couple that with the fact that the agreement makes no use of the words, "physical injury." Makes we wonder if client is telling a tall tale, maybe, or maybe you misunderstood him, or maybe something else. If there really was a "physical injury" here, we'd think those two words would be all over the place in that agreement, so it makes you wonder...Was there a physical injury? Or, did attorneys do a real bad job?

Can we go back to the client, or the attorney, to obtain some more details?

Ckenefick (talk|edits) said:

10 April 2014
And note that MichaelStar's advice came in real handy here...about reading the agreement...had it not been read, we would have missed the one 1099. And, many, many of these cases get caught by the IRS when a 1099 is issued, but not reported at all on a return.

Globalexpress (talk|edits) said:

10 April 2014
It was nebulous, but I don't think I'm going to play 20 questions with this guy......he's young and quite frankly I don't think he's too bright. I talked about it with him for a few minutes when he came in, and it's going to sound like I don't believe him if I keep quizzing him. I think I'm done asking the guy questions about his injury.

When he did tell me about the injury, he raised his arms and said, "This is about as high as I can lift them now." He wasn't able to lift them more than shoulder high. He said he sustained some sort of injury at work. All I can do is go by what he told me and the (now) full length settlement I had access to today.

After reading the Rodman case and the Sanford & Son Aunt story, I see the direction you're trying to go. You want to say that all of this stemmed from the physical injury, and therefore it's all nontaxable- or a good chunk of it is nontaxable. But if in the settlement those "physical injury" words aren't used (and I looked hard), how can I "undo" what all the parties agreed to whether I think he had a bad attorney or not? Maybe everyone in the room knew he had some sort of physical injury, but the "language" was traded for a larger monetary award? Or for his right to be able to pursue his workman's comp claim? I'm not an attorney or even close. How does an EA with the ink still wet on his certificate second guess the agreed to settlement?

So....three days into this internet drama, based on the information I have given and have read......I think I am more confused. The "emotional distress" award, since it doesn't originate from a personal injury in the settlement documentation, is taxable, correct? The W2 portion is also taxable. The legal fees.......not sure how they can be "reported as taxable income to both the taxpayer and the attorney" as the settlement stated. And if he didn't pay them "directly" out of pocket (they came from the employer and were paid directly to the law firm), can he deduct them at all?

Ckenefick (talk|edits) said:

10 April 2014
You're confused because it's confusing.

The "emotional distress" award, since it doesn't originate from a personal injury in the settlement documentation, is taxable, correct?

As a general proposition, you would be correct. As a general proposition, the allocation will be respected if negotiated at arms length between adversarial parties and in "good faith." I do wonder about that "good faith" piece, because I think there is more to this story than you or I know. If the guy had a definite physical injury, that no one can dispute, and as evidenced by a doctor's examination, physical therapy visits, etc. we wonder why it wasn't referenced in the agreement. May have been bad lawyering. But maybe not. Might be that defendant refused to acknowledge any physical injury the taxpayer may have sustained (i.e. defendant believed the claim to be made up). Or, perhaps, defendant knew there was a physical injury, but refused to acknowledge it, in the settlement agreement, because of defendant's own negligence. Yet, we have clear language in the settlement agreement. In these situations, the agreement/allocation will generally be respected. So, now that we know what that settlement agreement says, and now that we know that the 1099's/W2 were properly issued in accordance with the agreement, I think you now have the deck stacked against you "somewhat" in making a Sec 104 claim.

I don't think you're going to get around the W2 issue, most likely. My guess is that that amount represents lost wages from being out of work. But at the same time, it appears that it is somewhat of an arbitrary amount, being 1/3rd of the three things, which might speak to "things we don't know" about this case. Now, you haven't told us what specifically the guy sued for and that is relevant. If one charge is lost wages, and he gets a W2 and the settlement agreement says to put it on a W2, then it's taxable as wages. End of story.

As to the other two items, the (1) "liquidated damages," "emotional distress," "non-economic losses" and (2) the attorney fees...to me, the language isn't all that clear. As you know by now, payments for emotional distress, if that distress stemmed from a physical injury, are excludible from taxation. Quite honestly, I am not sure that a lot of attorneys know that rule. (Nor am I sure that they know the Aunt Esther rule, hence the post for everyone to read). I do think the agreement lends itself to pro-IRS interpretation, given the wording surrounding the issuance of the 1099's, but I don't think it's necessarily a slam dunk for the IRS. The agreement doesn't really say the 1099 for Item (1) above is to compensate for non-physical injuries, yet it doesn't say it it is to compensate for physical injuries either. It just says "how" it is to be reported. Yes, the payer's intent can be inferred from the reporting language, but the taxpayer is free to argue for something different. In situations where things are unclear, the cases are across the board. Some say, "If we can't tell, it's all taxable." Yet in other cases, like Parkinson, the court will go to great lengths to interpret things in a pro-taxpayer fashion. In Parkinson, there was great focus on that phrase "non-economic damages," and the judge said that the physical injury sustained "figured prominently" in calculating the non-economic damages and as the reason why the related settlement payment was made.

A few more articles for you:

http://woodporter.com/Publications/Articles/pdf/Tax-Free_Physical_Sickness_Recoveries_in_2010.pdf

http://apps.calbar.ca.gov/mcleselfstudy/mcle_home.aspx?testID=15

In terms of the legal fees, they are income to the taxpayer under assignment of income principles...to be divided between taxable and non-taxable as the case may be. If it turns out that the entire award is taxable, all of the legal fees are taxable, then, they are also all deductible. And, it might be, that some are deductible under Sec 62, above the line, depending on the charges made in the suit. There are many, many things in this code section that call for an above the line deduction...so, if it turns out all is taxable, but that we also have a big Sec 62 deduction, that's equivalent to tax-free income...which would be a win.

Ckenefick (talk|edits) said:

10 April 2014
Also, if these numbers are really big, seems all the more likely a real physical injury was sustained...like big amounts to compensate the guy for not being able to work for a long, long time (or ever again).

If there were me, I might just place a call to the attorney and say, "Hey, how come all this stuff is taxable? I thought damages for physical injury were tax free? The guy says he can't move his arms above his head."...and then let the attorney do the talking.

Ckenefick (talk|edits) said:

10 April 2014
http://www.irs.gov/pub/irs-utl/lawsuitesawardssettlements.pdf

Also take note of the LeFleur case herein, where there was a settlement agreement and the court threw it out the window, holding that there was no physical injury.

Globalexpress (talk|edits) said:

10 April 2014
Yikes.......And two, 40 page reading assignments to boot......April 15th rapidly approaching with a stack of returns on my desk also demanding my attention....

So, let's say I want to complete this gentleman's return based upon the information given to me, as I have described above, without second guessing the settlement document.......yet. "Personal injury" is nowhere to be found on the settlement document.

$27,000 W2 is taxed to the taxpayer. $27,000 (not subject to SE tax) taxed to the taxpayer from the 1099 Box 3 income.

Now the lawyer fees. From the article, it appears to me that even though my client did not directly receive the $27,000 paid to the lawyer, he is able to potentially deduct the fees or take an adjustment for them. So then there's the link to your website, with numbers 4 & 8 of the article to consider. So my taxpayer has to claim the $27,000 paid to the lawyer as income? If the client's attorney received his/her own check, then I should be able to argue that the money is not taxable to my client, per point #8. But then the Banks case in point #4 states that the Supreme Court says my client "has gross income measured by the full amount of the revery." Huh? Clear as mud. What do I do with those pieces of conflicting information?

I'm thinking since the attorney got his/her own check, I can argue that the legal fees are not income to my client, and therefore I don't put it anywhere on the return. I then take the box 14 legal fees as a misc. 2% deduction. Or are there other 40+ page court documents that show that is the wrong path to take?

Ckenefick (talk|edits) said:

10 April 2014
You're missing a big point here, that has been mentioned numerous times: Your client is deemed to have received the entire (i.e. gross) award. Forget about labels. Forget about the legal fees going directly to the attorney. Your client is deemed to collect the ENTIRE/GROSS award and then is deemed to pay the attorney from there. A simple assignment of income situation. You cannot argue that the client and his attorney were in partnership together. You cannot argue that attorney had a lien equivalent to attorney's share of the proceeds.

And, if I was in your position, I'd extend the return and talk to the attorney after 4/15. Simply inform your client that you're trying to save him some tax dollars and you're following up on an angle that might or might not pan out. Your client will appreciate it. In the meantime, assume all is taxable and make extension payments based on that assumption. I would not file this return now and then possibly amend later.

Ckenefick (talk|edits) said:

10 April 2014
And, you need to find out about the specific complaints charged. Until then, when it comes time to deduct legal fees, you won't know if any can go above the line.

Globalexpress (talk|edits) said:

10 April 2014
You trying to make this a "learning experience." Great. That involves reading and making interpretations of the couple hundred of pages of text you have given me. You gave me a link to a website a few posts above with conflicting information. Point 8 on that website is "Beware of Duplicate Form 1099 reporting." Since the attorney took the time to wrote that point in his narrative, it implies that there is something that I need to be aware of-> the double taxation of this money. Since it's something I need to be aware of, that would imply that I need to make sure that this money is not "double taxed" somehow. Since the client's attorney is also receiving this 1099 with Box 14 AND attorneys don't get tax free income that I am aware of, it would lead me to believe that the law firm would pay tax on this money. Because I believe the attorneys will pay tax on this money, it would lead me to believe that my client shouldn't even put this money on his tax return at all. So I'm not trying to miss "big points" on purpose. I'm trying to wade through a complex, entirely new concept here that even you said is confusing. So now I get it. It's ALL flowing to the defendant as income. That makes no logical sense to me, but OK. Got it. He's reporting it all.

So now I'm confused. As the settlement is currently written, let's assume this is not a personal injury case. If I did his tax return today (which I am not going to do), He's got $81,000 in income he has to pay tax on. He takes his legal fee deduction below the line ($27,000 + retainer) because the case is not a personal injury case. Next step......

OK, so I call the attorney, and he says, "Globalexpress, you're a genius! It all stemmed from personal injury. The employer, the insurance company, and all the attorneys screwed up. We're going to fix all of this right now."

What does this fix look like? No more 1099? No more W2? No 1099 with box 14 income going to both the attorney and the client? What does a settlement (from a tax documentation standpoint) of a pure physical injury case look like?

Ckenefick (talk|edits) said:

10 April 2014
That makes no logical sense to me, but OK

There is some logic too it. I can't say I like the logic, but it is well settled, so we have to deal with it. The logic is Assignment of Income principles. The logic is that the claim stems from some wrong (or purported wrong) that happened to your client, not the attorney. So, your client cannot assign any part of that award away to someone else. No different than Global working at his accounting firm. Can Global say, "Don't pay me my wage, please pay my wages to my Uncle Freddy...and issue Freddy the W2,"...I don't think so. That W2 will come to Global no matter what.

What does a settlement (from a tax documentation standpoint) of a pure physical injury case look like?

Looks like no reporting at all, because nothing is taxable...and nothing is deductible.

"Globalexpress, you're a genius! It all stemmed from personal injury. The employer, the insurance company, and all the attorneys screwed up. We're going to fix all of this right now."

Do note that I'm not saying attorney's response will be that way. What I am saying is this: You've told us the guy sustained a physical injury. Yet, from what we can tell, the entire award is being taxed. Maybe there's a good reason for it, but at present, I do not understand it. And I myself don't like not understanding things I put down on a tax return. Might be that the agreed-upon award was $100k, but someone said, "We'll want to show it as taxable for this or that reason, so why don't we make it taxable, but gross it up to $140k for the tax consequence. Plaintiff will get his $100k at the end of the day." I just don't know...and neither do you. Pick up the Red Phone and call the attorney.

Nilodop (talk|edits) said:

10 April 2014
He's going to "fix" it. Great choice of words.

Globalexpress (talk|edits) said:

10 April 2014
The choice of word was on purpose. Who knows what kind of lawyer I'll be dealing with?

I will call the law firm later in the day when I have a gap in my schedule and reply back when/if I hear something. Back to the salt mines....

Ckenefick (talk|edits) said:

10 April 2014
Who knows what kind of lawyer I'll be dealing with?

That's the fun part, I've got my popcorn out.

As Aunt Esther used to say, "The root of all evil is the 1099 form."

Dennis (talk|edits) said:

10 April 2014
The IRS reserves the right to reallocate based on the underlying claim, regardless of settlement language.

LeFleur v. Commissioner, T.C. Memo. 1997-312

Nilodop (talk|edits) said:

10 April 2014
Right, so if the underlying claim is for physical injury, the settlement is not taxable and the legal fee is not deductible.

Ckenefick (talk|edits) said:

10 April 2014
Indeed...that case was mentioned above...so if IRS can do it, we should be able to as well. And maybe this is why the "general" rule is that the settlement language will be respected...

Ckenefick (talk|edits) said:

11 April 2014
Right, so if the underlying claim is for physical injury

I think it's gotta be more than that. I think there has to be more than just a claim, but a proveable "something" that was physical. And do note, the statute uses the word "sickness" too...if you want to throw this crazy topic into crazy crazy land.

In this case (Mumy), it's hard to say if the pinch on the arm wouldn't cut it...or if the problem was just that the settlement agreement made no allocation to it. My thought is that the judge thought the whole thing was laughable, so he found a way to stick it to the taxpayer.

http://www.ustaxcourt.gov/InOpHistoric/mumy.sum.WPD.pdf

For more, read this one too.

http://digitalcommons.pace.edu/cgi/viewcontent.cgi?article=1854&context=lawfaculty

Globalexpress (talk|edits) said:

11 April 2014
OK, called the law firm's office last night before I left work and asked if one of the attorneys on Joe Smith's case was available for a question concerning the written settlement. Got someone who identified herself as a paralegal instead. I identified myself as an Enrolled Agent preparing Joe Smith's tax return. I stated that Joe told me that he sustained a physical injury at work, and that it appeared that as a result of that injury, your law firm earned him a financial settlement. However, the way the settlement was written could have negative tax implications for Joe. Further, awards stemming from personal injury cases should not be taxable, but I was concerned that the way the settlement was written could lead to a possibly unnecessary, but potentially significant taxable event for Joe....or words to that effect. She said she would call me back.

He-he. I had just sat down and received a rather "snippy" phone call this morning from a different paralegal. He basically stated that the "matter concerning Joe Smith" had been adjudicated, the financial award and the terms of its distribution had been agreed upon by all concerned parties, and the time to make any changes to the award had already passed a long time ago (I was referred to the page number of the settlement that said Joe had 2 weeks after signing to change his mind- and that was many months ago). Then I was told that the information in the documentation given to Joe Smith should be adequate for the completion of his Federal tax return (or words to that effect). Thanks. Bye.

Yeah, I don't think I'll be talking to them again. Or using them if my Aunt or Uncle jump off a roof and are injured. Although then again, I wouldn't let my Aunt or Uncle on the roof to clean their gutters. As a good nephew, I would have done it for them. I guess Ckenefick isn't a good nephew, but that's for another thread.

So....here I sit, slightly confused but not as confused as I was in the original post. My thoughts are that I finally finish this guy's return. Everything is taxable to my client (W2, both 1099s). Even though he might have had a personal injury, it appears that the settlement was written the way it was purposely, so he can't take an "above the line" adjustment, but instead has to take the 2% misc. deduction for the legal fees. Or I am misinterpreting something again? Or there's another linked court case coming after this post that adds another wrinkle. Or I send the guy to the H&R Block office down the street and let them deal with it :)

Ckenefick (talk|edits) said:

11 April 2014
From Robinson, 102 TC 116:

When the settlement agreement allocates clearly the settlement proceeds between tortlike personal injury damages and other damages, the allocation is generally binding for tax purposes (and the tortlike personal injury damages are excludable under section 104(a)(2)) to the extent that the agreement is entered into by the parties in an adversarial context at arm's length and in good faith. Threlkeld v. Commissioner, 87 T.C. 1294, 1306-1307 (1986), affd. 848 F.2d 81 (6th Cir. 1988); Fono v. Commissioner, 79 T.C. 680, 694 (1982), affd. without published opinion 749 F.2d 37 (9th Cir. 1984); see also Mitchell v. Commissioner, T.C. Memo. 1990-617 (allocation of lump-sum payment in settlement document was not binding where taxpayer drafted the document without the participation or approval of his adversary), affd. 992 F.2d 1219 (9th Cir. 1993). An important factor in determining the validity of the agreement is the "intent of the payor" in making the payment. Knuckles v. Commissioner, supra at 613; Agar v. Commissioner, 290 F.2d 283, 284 (2d Cir. 1961), affg. per curiam T.C. Memo. 1960-21; Metzger v. Commissioner, supra at 847-848. If the payor's intent cannot be clearly discerned from the settlement agreement, his or her intent must be determined from all the facts and circumstances of the case in issue there.18 Factors to consider include the details surrounding the litigation in the underlying proceeding, the allegations contained in the payee's complaint and amended complaint in the underlying proceeding, and the arguments made in the underlying proceeding by each party there. See, e.g., Estate of Morgan v. Commissioner, 332 F.2d 144, 150-151 (5th Cir. 1964), affg. in part and revg. in part 37 T.C. 31 (1961); Threlkeld v. Commissioner, supra at 1306; Bent v. Commissioner, supra at 245. None of these factors is always outcome-determinative; in a given case, any of these factors may ultimately be persuasive or ignored. Threlkeld v. Commissioner, supra at 1306.

it appears that the settlement was written the way it was purposely, so he can't take an "above the line" adjustment,

Not sure what you're saying here, but I've mentioned Sec 62 several times. It might be that, to the extent we have something taxable here, which we do (at least the W2 for now, which is apparently back wages, but I don't know that for sure), some of the legal fees MIGHT be deductible above the line. This deduction has nothing to do with the way the settlement was written. It has to do with the nature of claims made: See Sec 62(a)(20) and 62(e). Not sure any of that will be at play, but it should be explored nonetheless. It is any easy analysis.

Part of the problem here is that we've had to get you up to speed from ground zero. Now that you know this stuff, next time, pick up the phone immediately and call the attorney. In addition, next time, you get a copy of the settlement agreement and hopefully are involved in it before it is drafted. Moreover, you'll need to know the nature of the guy's claims...you know, why did he sue - under what specific legal provisions. And, you'll need to get a grasp of any documented physical injuries that were sustained. Basically, get ALL of the facts together, which you didn't do here...but it's understandable the first time around.

I still don't have a totally clear picture about the guy's injury. You've been hesitant to call him. If you can't get all the facts, it's hard to say what we should do here, given the attorney's response. I think it matters what happened to him and when and what the timeline of events was. Was it an injury that happened all at once (similar to a car crash)? Or did it happen over a prolonged period of time? What was the guy's occupation? Etc. These are important questions. If injury was sustained all at once, that lends credibility to big-time 104 treatment. If we had prolonged issues, like emotional distress from the job, which ultimate led to a physical injury, a big-time 104 case is hard to make. In that case, IRS could argue that a big part of the settlement was to compensate for the distress that occurred prior to the injury, making such award not "on account of" a physical injury.

And, I'm not so sure you're familiar with the medical rule. Below is from the regs, although it's mentioned in the statute below 104(a)(5):

Section 104(a)(2) also excludes damages not in excess of the amount paid for medical care (described in section 213(d)(1)(A) or (B)) for emotional distress. For purposes of this paragraph (c), the term damages means an amount received (other than workers' compensation) through prosecution of a legal suit or action, or through a settlement agreement entered into in lieu of prosecution.

I'd also note that one speculation was that the law firm did a crappy job...and it seems that might be the case, although it's hard to say, because we don't know exactly what happened to the guy and when, in terms of his injury.

Southparkcpa (talk|edits) said:

11 April 2014
CK...its OK, you can say it, I was right.:) Like Haley's comet..once every 75 years or so.

Ckenefick (talk|edits) said:

11 April 2014
Actually, I think you're way wrong...if your comments stand for the proposition that we should blindly accept the tax reporting aspect of a settlement agreement, involving a purported physical injury case, that makes no reference to Section 104 or a physical injury.

Technically, one might argue that there was no Robinson-like allocation in OP's case. From Robinson:

When the settlement agreement allocates clearly the settlement proceeds between tortlike personal injury damages and other damages

There was no such allocation in OP's case. Not having an allocation in the agreement would make sense if there was no physical injury...but from what we know, although the record is incomplete, there was indeed a physical injury in OP's case. Moreover, even if we construe OP's settlement agreement as making an allocation, various cases stand for the proposition that it can be challenged...hence the word "generally" that precedes "will be respected." Global will actually have to call the client and get the details surrounding the injury, but for some reason, Global is reluctant to do so.

The case law seems to be pretty replete of situations where the attorneys did a pretty awful job for their clients. In some of these cases, the court got to the reality of the situation. In other cases, the courts simply said, "No allocation means its all taxable."

I bet we're dealing with a 6-figure settlement in OP's case. Big tax dollars are at stake, so I'd pretty much go to the ends of the earth, within ethical bounds, to make a pro-taxpayer case. And, if I had someone prepare my return, I would hope they would do the same for me.

Southparkcpa (talk|edits) said:

11 April 2014
Did you miss the ;) on my post. Its all good. I just thought I read where on investigation, the taxpayer in the OP's case did in factagree in writing that some of the claim properly belonged on a W2.

back to work for me............

Ckenefick (talk|edits) said:

11 April 2014
I'm guessing - but am not sure - that that might simply be lost wages.

Nilodop (talk|edits) said:

12 April 2014
In this case (Mumy), it's hard to say if the pinch on the arm wouldn't cut it... My thought is that the judge thought the whole thing was laughable, so he found a way to stick it to the taxpayer. From the Mumy case: "Petitioner did not seek medical care for her battery." Maybe she could have just replaced her battery.

Ckenefick (talk|edits) said:

12 April 2014
Don't know why a mummy would need medical care. But seriously, this is why I tend to think the judge thought Mumy's assertions were laughable.

Globalexpress (talk|edits) said:

12 April 2014

Part of the problem here is that we've had to get you up to speed from ground zero. Now that you know this stuff, next time, pick up the phone immediately and call the attorney.

I did pick up the phone and call the attorney.....almost immediately sort of. This guy just came into our office several days ago. I do appreciate you high speed guys getting me up to low speed, however. Have much reading to do after April 15th and I'm going to try to find some CE that covers this stuff in more detail.


In addition, next time, you get a copy of the settlement agreement and hopefully are involved in it before it is drafted. Moreover, you'll need to know the nature of the guy's claims...you know, why did he sue - under what specific legal provisions. And, you'll need to get a grasp of any documented physical injuries that were sustained. Basically, get ALL of the facts together, which you didn't do here...but it's understandable the first time around.

Yup, definitely need the WHOLE settlement agreement from day 1. That was a huge mistake. But how a Joe Blow tax preparer like myself is going to get involved with the drafting of a legal settlement of a complete stranger is beyond me. Not sure what you mean by that.


The drama unfolds....it's like a soap opera......

So....my client called me this evening asking about the return and how much of a "refund" he's going to get (I never told him he was getting a refund or going to owe, just that I needed to review the settlement and how to handle the legal fees.) I asked him if he minded if we talked about the events leading up to the lawsuit he had against his employer. Uuuuuhhhhhh......OK I guess. So what happened, Joe? What led up to the lawsuit? Well, Mr. tax preparer, (Mr. tax preparer is not my real name nor is his Joe), I worked for XXXX for many years doing general contractor work.(He was an assistant- this guy ain't contractor material). How long did you work for the guy? Uuhhhhhhhhhh........I don't know, a while. How long? 1 year? 5 years? 10 years? I guess around 7 or 8 years Mr. tax preparer. OK......so what happened? Well, over the years, I just could do less and less. What do you mean, less and less Joe? Well......uhhhhhh.....I couldn't lift as much, I couldn't carry stuff up ladders.......Uhhhhh. What exactly did you have to lift? (Industrial) pipe....sheet metal.....tools......all kinds of stuff. OK, but how does that lead to a lawsuit Joe? Well, after a while, I started not being able to show up for work. My back was bothering me. My shoulders were messed up. My boss started getting on me about missing so much work. OK Joe, were you missing work because you were too hurt to work or was something else going on? Well.......uhhhhh......basically because I woke up hurting and I couldn't do it anymore. OK, so how did this suit come about? Well, they fired me and I was still hurting. When they fired me I got really pissed and my parents said talk to a lawyer so I did. He sent me to a doctor. My back was better but my shoulders were still messed up. OK Joe, thanks. I'm not trying to pry, just trying to figure out how to best handle your settlement money. Uhhhhhh......OK Mr. Tax preparer. Do you think I'm going to get a refund.....?

That's what I got out of him. I've called the lawyer. I've talked to the client again. I need to get something filed or hand him off to a CPA or tax attorney outside of our office.

Dennis (talk|edits) said:

12 April 2014
Fact pattern indicates tort involved company responsibility for working conditions that could have caused client's injury, not the injury itself.

Note the employer has no incentive to classify any of the settlement as wages, so the attorney thought that would be in client's interest, possibly for Worker's Comp claim. Final note: If you get this wrong client will sue...♫

Ckenefick (talk|edits) said:

12 April 2014
Fact pattern indicates tort involved company responsibility for working conditions that could have caused client's injury, not the injury itself.

Yes indeed. This is one of those "prolonged" situations...then guy gets fired...then gets all pissed off and sues...for something - and we still don't know what he sued for. We still don't know the underlying cause of action. When we have a quick, singular identifiable event (like a fall from a ladder), and the guy cannot return to work because that one event, the suit is about that one event. It really can be about nothing else. The time frame is compressed and compacted into that one incident. But in these prolonged cases, a lot of time has gone by, so now we can sue for a bunch of different stuff and stuff that occurred over a period of time instead of just one incident: pain and suffering over those years, wrongful termination, etc.

If you want to see how complicated one of these "prolonged" situations can be, take a look at this PLR, primarily the "Holding" near the bottom. This is the "bruise" ruling that you probably came across in your research.

http://www.irs.gov/pub/irs-wd/0041022.pdf

OP's case is strikingly similar to Carranaza, which is below:

http://www.leagle.com/decision/In%20TCO%2020090226838

And note, the cause (or causes) of action is what's important. Sounds like maybe the employer didn't believe this guy...but that doesn't necessarily matter, because once a charge is made, it is that charge that gets settled.

Here's a blurb from Carranza:

Moreover, he did not allege in his complaint initiating the settled litigation that Spears employees or work conditions had caused him physical injury. There is some evidence in this record that could support a finding that his work conditions were a contributing factor to some of his physical problems, but that was not the focus of the litigation and, clearly not the purpose of the settlement.

Note the employer has no incentive to classify any of the settlement as wages

Yes. In fact, employer has less incentive to do so b/c employer will owe the employer's share of FICA on the settled wages.

So, given this new information, which would have been nice to have at the very beginning of this thread, I think classifying any of this settlement as tax-free is going to be very, very difficult. I also tend to think that it might be unlikely that the guy made a claim for his working conditions being the cause of his physical injury. But that's just a guess.

Nonetheless, we still need to know what his causes of action were to properly handle the legal fee deduction. If none of the charges fall within Sec 62, then 100% of the legal will be a 2% deduction, seeing that 100% of the damages are taxable.

But how a Joe Blow tax preparer like myself is going to get involved with the drafting of a legal settlement of a complete stranger is beyond me. Not sure what you mean by that.

I'm talking about a situation where you have the opportunity to do so...primarily, an existing client, where you get wind that there's gonna be a lawsuit. I'm not sure if this guy was an existing client of your firm, and you're just the one assigned to his return, or if he's just some guy that walked in off the street.

If you look at Carranza, and if you look at your case, it is clear that there could have been (at least) a claim for physical injury,. So, one of two things is going on in that case and maybe in yours: (1) attorney wasn't well-versed in the the tax consequence or (2) such a claim would be very difficult to prove in court, so attorney didn't pursue that angle. And this is where we'd have to get the attorney to talk to us.

Nilodop (talk|edits) said:

12 April 2014
I found this sentence from Carranza interesting and, perhaps, a slight overstatement as to the taxpayer's knowledge: "Petitioners, who have no expertise in or understanding of the tax laws, …" (Emphasis mine). No special relevance to the issue in the thread, but apparently was part of the Court's reasoning in getting rid of the 6662 penalty on the basis of reliance on the preparer.

Joanmcq (talk|edits) said:

13 April 2014
I've been reading this thread mostly because I've just got a client with a settlement, and this has been very illuminating, so thank you. My client was quite a bit more versed in her suit and I do have the papers, the lawyers statement, etc.

Fact pattern: client has three kids, third child has birth defects. Fearing another child with birth defects, client undergoes a tubal ligation. Doctor assures her it was successful. Less than 6 months later, client is pregnant and 4th child has same birth defect, but worse. Most of settlement is held in Trust for the 4th child, some is specifically for past medical expenses, and the rest to the client is for physical injury, emotional distress, future medical expenses for child. None of these is given a separate dollar amount. None is reported on any tax form. Lawyers fees are contingent, percentage of award. I say nontaxable, unless she deducted any of the medical in the past.

Thoughts? It's April 12, and I'm still looking at a pile of extensions to file.....

Globalexpress (talk|edits) said:

13 April 2014
Well, I handed my client off to a tax attorney today. I got three recommended names, called my first choice, and was happy with what he had to say after I explained the situation and my concerns. My client is going to get a free consult and the attorney said he will handle his tax return. My (ex)client seemed OK with the decision, and is going to see the attorney on Monday morning.

There's just too much money at stake, not enough hours in the days before April 15th, and the guy deserves someone more experienced than me who is more familiar and comfortable with the nuances of case law like you guys are.

I do appreciate the advice. I do appreciate the "learning experience." Thanks.

Ckenefick (talk|edits) said:

13 April 2014
@Global, let us know how it turns out.

@Joan, as far as I know, there are no cases that speak to birth related physical injuries such as yours. I suspect that you will find, if you talk to the attorney, that the position is being taken that the damages are excludible. The attorney that handled the case likely has handled many similar cases and might have some insight on the matter that you could share with us. In one of the links below (the one by Rob Wood), he raises the argument that even the parent might have suffered the physical injury. I am not quite sure what specifically he is thinking with that comment, but I've thought able that angle before (see my 2nd case below). He might be thinking about an unintended injury to the mother during birth. But one wonders if the tubal ligation itself, although voluntary, could be viewed as the physical injury (in addition to, or as opposed to, the "injury" to the child). After all, it was this surgery that led to everything else.

http://www.woodllp.com/Publications/Articles/pdf/Wrongful_Life.pdf

http://www.settlementlaw.com/blog/category/taxable-settlements

I've had two of these birth cases in the past. One was a clear error by the doctor during delivery. We had an umbilical cord wrap around the baby's neck. The nurses saw what was going on and told the doctor to unwrap it. He told them to shut up and that he knew what he was doing. Baby was born with massive brain damage and ended up dying at age 10 or 11. The settlement was big ($5m) and it was treated as tax-free. Medically speaking, I suppose the umbilical cord wrapped naturally, I guess...but the doctor's inaction to remove it led to the air supply to the brain being shut-off and the resultant brain damage. So, the doctor didn't directly cause the brain damage (the umbilical cord did), but his inaction and malpractice did. I don't think that matters, however, because the 104 language doesn't really say that the defendant had to be the one that directly caused the physical injury. Rather, all we have is "on account of" language...and all we need is some party we believe to be responsible that we can lawfully sue.

The other case was a bit similar to yours. I only gave my opinion on it, not sure how it turned out. If I recall correctly, the parents had a child with a certain genetic defect. The chances of this defect were like 98% if both parents carried the gene, but much less if only one parent carried the gene. The couple wanted to have a second biological child, but were worried because of what happened with the first born. They also had some fertility issues. So, they go to a fertility clinic, get all the testing done, etc. and wife gets pregnant. However, the fertility clinic failed to have the husband tested for the bad gene. Turns out, he was a carrier. Also turns out that wife was a carrier as well. The fertility clinic actually tested the mother, but not the father.

The husband and wife learn of this part way through the pregnancy, and with the 98% chance noted above, they decide to abort the fetus. Then, they sue, and get a big settlement. Where are the physical injuries in this case? I'm pretty sure the fertility clinic didn't perform the abortion. Yet, their gene testing failure caused, one could say, the abortion. So, here again, the defendant didn't directly instigate the physical injury. This brings up the next question: Where is the physical injury? Is it to the baby? Is it to the mother's womb? If it's to the baby, the baby's not a taxpayer. The baby didn't live for at least a second outside of birth. But then again, is the baby part of the mother, being tethered by the umbilical cord? If so, one could argue that the injury sustained to the baby, even though voluntary mind you, was an injury to the attached mother.

Nilodop (talk|edits) said:

13 April 2014
This case involved a child's injury during birth. The portion that was not interest was excludable under 104. http://www.legalbitstream.com/scripts/isyswebext.dll?op=get&uri=/isysquery/irl2b6d/13/doc (Woods; T.C. Memo. 1998-435)

This one http://www.legalbitstream.com/scripts/isyswebext.dll?op=get&uri=/isysquery/irl2b6d/9/doc (Medina; T.C. Summary Opinion 2003-148) questioned whether there was a physical injury to the mother resulting from a premature birth of twins. Taxpayer sued her employer for not re-hiring her and asserted "(1) Unlawful discrimination against petitioner because of her pregnancy; (2) breach of contract; (3) breach of implied covenant of good faith and fair dealing; (4) wrongful discharge; (5) intentional infliction of emotional distress; and (6) retaliatory discharge. " She lost on the 104 issue.

Ckenefick (talk|edits) said:

13 April 2014
I think the Woods case was a slam-dunk for the taxpayer on the 104 issue as a general proposition. But, do note, the Woods' sued the doctor and the hospital. Hospital settled before the hospital's trial - all excludible. The doctor didn't settle and lost in a jury trial. Then, doctor appealed...and while the appeal was pending, the case was settled. Part of what jury awarded, in the initial trial with the doctor, was pre-judgement interest. This type of stuff, you can't avoid being taxed on. Ditto for punitive damages. You really have to know ALL of the facts in these cases - why the client sued (i.e. the specif causes of action), did the case get to trial, what was the lower court's verdict and the award, etc. An absolute ton of fact gathering in these cases. A checklist would be nice...

Joanmcq (talk|edits) said:

13 April 2014
No interest in the settlement, so that's not an issue. I'll have to read the links after the 15th. The good news is that she is so low in one (not working much because she's taking care of two kids with health issues), so even in the worst case scenario, she's not in a bad situation. 3days to go, and people are coming out of the woodwork requesting extensions.....

Ckenefick (talk|edits) said:

13 April 2014
No interest in the settlement, so that's not an issue.

I think you saw in the case Lenny cited b/c the jury awarded it, in the first trial against the doc.

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