Lawsuit Settlement

[Russ S]

What to do regarding taxes?

Facts

Year 1 - 10K Legal expenses, Schedule A
Year 2 - 34K Legal expenses, Schedule A


Year 3 - 61K Legal expenses
Year 3 - Settlement for 69K (50K reimbursement of legal fees, 7K back wages, 12K mental distress

If the 69K is fully taxable (which I believe that it is), then I have to include it in income, however I get a deduction for legal expenses on schedule A.

1 - Is this deduction limited to the 50K reimbursed less the 44K already paid?
2 - What ever deduction that I do get will be nullified by the AMT, as legal expenses are not deductible for AMT.

So if you take the 105K that we spent and subtract the 50K reimbursement, we are out 55K for legal expenses.

We received net 19K and will have a tax liabiltiy of about 15K (69 x 21%), so we are out about 60K for our troubles......................and we won.

Someone please tell me I'm wrong.

[Nashville]

Mostly Fair if anything is...

Russ, I'm assuming that these legal expenses were incurred in pursuit of income or you would not have been able to deduct them on Schedule A to begin with.

The biggest goblins in the gook are the AMT that you already mentioned, plus the 2% threshhold which eats into the deductibility of the expenses.

Not sure about the taxability of the mental distress, or how that relates to punitive damages. Let's assume the taxpayer's AGI is $100K each year, and the mental distress is not taxable.

Taxable award is $57K income. Deductible expenses are $105K except for $6K lost to the 2% floor. Assume AMT results in another $5K.

This means over a 3-year period $69K in real income versus $105 in real expenses, net economic loss of $34K. Taxable stats: $57K taxable versus $94K in achievable deductions, net tax loss is $37K. Not a lot of difference, but we've made some assumptions which are not necessarily correct.

Looks like, as is so often the case, the only winners are the lawyers.

[vegasbill]

Lawsuit

Nashville, I believe that the mental distress (emotional distress) portion will be taxable, per Code 104(a).

[Kram BergGold]

You ar right I believe

To me the settlement is 100% taxable and all legal fees are deductible subject to 2% and AMT.

[Russ S]

So if someone could explain the following situation to me I would appreciate it, because I don't see the equity in it the way that you have described it above:



Say this year I spend 25K on a lawsuit. Settled it at the end of the year getting back 30K (back wages and reimbursement of legal fees).



The way that you guys have stated the tax law all 30K would be taxable, but I would get a deduction (subject to AMT) for 25K.



I understand why I would have a tax liability on the 5K, but I don't understand why there would be ANY liability (whether it be AMT or otherwise) for reimbursement of funds that I paid out.



Thanks in advance.

[Edsel]

None of us think it's fair

None of us maintain that the recording and recognition of taxable income is fair. We're just saying that is the proper way to report.

Firstly, the IRS uses the 2% as a revenue enhancement. This came into play in 1987. Before then, you could deduct the entire amount if the legal fees were used to pursue the production of income, but the top tax rate in those days was 50% instead of 39%.

Of course, all itemized deductions are a shell game. If the MFJ std deduction is $10700, and your legal fees are $25,000 and your AGI is $150,000, then FIRST your $25,000 is reduced by 2%, meaning your first $3000 in legal fees are not deductible. You can deduct the $22,000 but if you and your wife lived under a bridge with the street people, you could still have deducted $10,700. So from this perspective you receive the benefit of only $11,300 of the $25K you paid.

Then the $22K gets added back to AMT income.

Of all the posts above, no one indicated this is a fair arrangement, except possibly Nashville, who added "fair if anything is..." meaning he knew better, and also wasn't sure of the "mental anguish" taxability.

[Russ S]

???

But the corporatioin that paid out the settlement gets to deduct the settlement and the legal expenses associated with the suit from their revenues to lower their tax liability........

I understand that we have to pay taxes on the back wages and potentially on the "mental anguish" (however if we get a Dr's statement that depression resulted from the "act" and lawsuit, then it is not taxable), but please someone tell me how a provision got passed that makes us pay taxes on getting our money back.

[Edsel]

Corporations

Russ, if the aggrieved awarded party were a corporation, there would be no screwing around with the 2% or adding back for AMT or itemized deductions or restrictions on legal fees.

The awarded money would all be revenue, and the paid money would all be deductible expense subject to reasonableness. Corporate tax law differs. Much more generous in many ways than the laws which tax individuals.

In answer to your last question, no one actually passed a special law taxing you on recovered expenses. Simply put, most tax reporting is a full disclosure of proceeds and full disclosure of related expenses, and not much tax reporting allows you to simply offset these out and just report the "net."

This is the way things are -- none of us will defend the laws as being "fair." You may have more fodder for your congressman than for us.

[Russ S]

Found what I was looking for and why I may have confused everyone

Deductions for unlawful discrimination suits are above the line dedcutions from line 36 on 1040.....


...the suit that we brought was for retalition (which is a protected activity).