Malpractice Settlement is it taxable

[ATSMAN]

A new client just informed me that in 2016 he received $50,000 as settlement for a malpractice lawsuit against a former divorce attorney. Not sure if the attorney or liability insurance paid it. He lost his 1099 but I can assume it was marked box 3. His new lawyer (who sued the old lawyer) gave him a letter that it was net payment for compensatory damages. His new attorney told him it is not his job to tell if it is taxable or not, ask the accountant.

I think this is 100% taxable (including the portion attorney kept for fees) and attorney fees, court costs are subject to 2% limitation on Sch A.

Taxpayer thinks he can net out 100% of attorney fees.

Anyone have a different opinion?

[Roland Slugg]

The taxability of the damages depends on factors not disclosed in your post. What was recovered? Fees paid to the first attorney? Since it was a divorce attorney, if the plaintiff recovered fees paid, the recovery would not be taxable unless the fees originally paid were deductible. Was some or all of the award for punitive damages? Punitive damages are taxable in most cases.

He lost his 1099? Good one! Did he lose the $50,000 check, too?

[ATSMAN]

Good points. I am going to tell the client that this return needs to go on an extension with some payment until I get a chance to either speak to his new attorney or he gets me the information. From what little I know, his divorce was botched because the original attorney "dropped the ball" and he ended up losing a lot of his assets, including some business assets and retirement to his ex-wife. Supposedly the ex wife hired a forensic accountant that dug up stuff that should not have been in contention because those assets were prior to his 2nd marriage and supposedly there was a pre-nuptial agreement but was deemed invalid etc.

His new attorney figured out that the prior attorney screwed up big time and they sued and prevailed. I am not sure if it was a out of court settlement or a judgement.

Because of the complexity, and the fact that client can not accurately remember all the facts, I believe it would be prudent to put his return on extension.