Kids for cash

[lovesledz]

I have a client who is the parent of one of the juveniles locked up by one of the scumbag judges in the Luzerne County, PA, "kids for cash" scandal. In 2013 this kid (now a troubled 27 year old) receives a $25,000 payment in a civil rights violation settlement, and in 2014 receives another payment of $4,000. He is then issued a 1099-MISC for tax year 2013 for the total amount, $29,000.
While this kid was locked up, his parents were forced to pay child support to the facility in which the kid was incarcerated, and also paid some fines. As part of the settlement that awarded the kid 29k, the parents received a refund of the amount they paid for child support and fines. In 2013 they also receive a 1099-MISC for the refunded child support & fines.
My questions are:
Should the kid have received a 1099 for his settlement? (He is a really screwed up adult now, quite possibly because of this situation)
Do the parents really have to pay income tax on their own money that was refunded to them?
This all seems too bizarre to me and I'm not sure how to proceed with this. I advised them that they might want to consult with an attorney, but they are concerned about the additional costs and aggravation.
Thoughts anyone?

[Koss]

Settlement Proceeds

Fascinating case...

The issuance of Form 1099-MISC, by itself, does not automatically mean that the payments are taxable. 1099 forms are routinely issued for many different types of lawsuit settlements. In some cases, the party receiving the payment can deduct attorney's fees. In other cases, part or all of the payment may not be taxable, regardless of the amount stated on Form 1099-MISC.

Your client probably didn't have any attorney fees, since this was a class action case. The attorneys were compensated from the overall settlement fund.

The general principle is that money received for non-physical injuries or harm is taxable. There is one important exception. If the person needed treatment for psychological harm, then the money they received is nontaxable to the extent of the expenses of the treatment, and only if the cost of the treatment was not previously taken as a tax deduction on Schedule A.

These are the same rules that apply to awards and settlements for discrimination--regardless of the type of discrimination (age, race, religion, etc). These are awards for civil rights violations, and that is what happened in Luzerne County.

In contrast, money received for physical pain and suffering is not taxable.

In the case you have described, the award paid to the child--who is now an adult--will be taxable unless he (or the parents) can document medical expenses for a condition that was caused by the unlawful confinement.

The payment to the parents, in my view, is not taxable, to the extent that it is a reimbursement of money that they paid to the county. This has nothing to do with physical or psychological harm, or with the cost of treatment. Rather, it is the basic principle that a lawsuit settlement is not taxable when it is compensatory in nature. If someone damages your car, and you pay to get it fixed (without any insurance reimbursement), and then the party who damaged it reimburses you for the cost of the repair, that payment is not taxable, because it is simply making you whole. (But it would be a taxable recovery if you had taken the repairs as a tax deductible business expense, or as a casualty loss.)

But you should not assume that the entire payment to the parents is nontaxable. You should attempt to verify how much they actually paid the county. The payment they received may have been more. Under the terms of the settlement in this case, some parents may have received an award that was based, in part, on the fact that while the child was locked up, the parents suffered a "loss of companionship and/or familial integrity."

That kind of payment would be treated as a payment for nonphysical injuries. It would be taxable, unless the parents paid for treatment for their psychological distress while the child was locked up.

You can read the settlement agreement here:

http://kidswinsettlement.com/MSA-filed.pdf

Bottom line: The tax treatment of these awards depends on the individual facts and circumstances of the person who received the money. There is no one-size-fits-all answer. Even within the same settlement, the treatment may vary from one person to another.

BMK

[lovesledz]

Fascinating case...

The issuance of Form 1099-MISC, by itself, does not automatically mean that the payments are taxable. 1099 forms are routinely issued for many different types of lawsuit settlements. In some cases, the party receiving the payment can deduct attorney's fees. In other cases, part or all of the payment may not be taxable, regardless of the amount stated on Form 1099-MISC.

Your client probably didn't have any attorney fees, since this was a class action case. The attorneys were compensated from the overall settlement fund.

The general principle is that money received for non-physical injuries or harm is taxable. There is one important exception. If the person needed treatment for psychological harm, then the money they received is nontaxable to the extent of the expenses of the treatment, and only if the cost of the treatment was not previously taken as a tax deduction on Schedule A.

These are the same rules that apply to awards and settlements for discrimination--regardless of the type of discrimination (age, race, religion, etc). These are awards for civil rights violations, and that is was happened in Luzerne County.

In contrast, money received for physical pain and suffering is not taxable.

In the case you have described, the award paid to the child--who is now an adult--will be taxable unless he (or the parents) can document medical expenses for a condition that was caused by the unlawful confinement.

The payment to the parents, in my view, is not taxable, to the extent that it is a reimbursement of money that they paid to the county. This has nothing to do with physical or psychological harm, or with the cost of treatment. Rather, it is the basic principle that a lawsuit settlement is not taxable when it compensatory in nature. If someone damages your car, and you pay to get it fixed (without any insurance reimbursement), and then the party who damaged it reimburses you for the cost of the repair, that payment is not taxable, because it is simply making you whole. (But it would be a taxable recovery if you had taken the repairs as a tax deductible business expense, or as a casualty loss.)

But you should not assume that the entire payment to the parents is nontaxable. You should attempt to verify how much they actually paid the county. The payment they received may have been more. Under the terms of the settlement in this case, some parents may have received an award that was based, in part, on the fact that while the child was locked up, the parents suffered a "loss of companionship and/or familial integrity."

That kind of payment would be treated as a payment for nonphysical injuries. It would be taxable, unless the parents paid for treatment for their psychological distress while the child was locked up.

You can read the settlement agreement here:

http://kidswinsettlement.com/MSA-filed.pdf

Bottom line: The tax treatment of these awards depends on the individual facts and circumstances of the person who received the money. There is no one-size-fits-all answer. Even within the same settlement, the treatment may vary from one person to another.

BMK

Thank you for your insightful reply. As this income was reported to both the parents & their son in box 3 of a 1099-MISC, how would I reconcile any exclusion of this on their tax returns?

[Koss]

Reporting

You need to make multiple entries on line 21.

One entry for each Form 1099-MISC. And then a negative entry for the amount that is not taxable. Your software should attach a worksheet containing the description of each line item.

This question has come up before. Think of it this way: Suppose your client has gambling winnings, and also has a net operating loss carryforward. You need a positive and a negative entry on line 21, and you'll get a net result.

BMK

[lovesledz]

You need to make multiple entries on line 21.

One entry for each Form 1099-MISC. And then a negative entry for the amount that is not taxable. Your software should attach a worksheet containing the description of each line item.

This question has come up before. Think of it this way: Suppose your client has gambling winnings, and also has a net operating loss carryforward. You need a positive and a negative entry on line 21, and you'll get a net result.

BMK

Okay; once again, thank you very much.