| |
You are here: Experts > Business > Corporate Law > Tax Law (Questions About Taxes) > taxes on a class action lawsuit settlement
Expert: Glenn D Schnabel - 10/22/2009
Question
We recently settled a class action lawsuit against the city in which I live. It was due to the city's neglegence with their sewer system, as a result many basements flooded with sewege. It was taken to all the courts and we won and were awarded judgements from a jury. Of course the city appealed the verdict and has been paying interrest for the last 2.5 years. The city recently got a new mayor and it was decided to settle for a little less, just to get it over with. The awards were broke into three catagories, real property, personal property and pain and suffering. My question to you is, are there taxes on all of the monies or just certain parts of the awards? Thank you for your time, it is greatly appreciated!
Answer
Lori,
Compensatory
Generally speaking, most people view the term "compensatory" to mean "nontaxable." However,
as the above examples reflect, determinations of the taxability of lawsuit awards cannot always
be made simply by referring to the terminology used, that is, compensatory or contractual.
The term “compensatory” merely means that the payment compensated the taxpayer for a loss.
This loss may be purely economic, for example, arising out of a contract, or personal, for
example, sustained by virtue of a physical injury. Furthermore, not all torts constitute personal
injuries. Some torts may involve invasion of property rights, for example, conversion, or
interference with economic interests, for example, tortious interference with contractual relations,
or purely personal interests, for example, defamation. Further, even in tort cases, where the
damages compensate for the aggravated manner in which the defendant committed the tortious
act, such damages are not received on account of any personal injury.
The facts and circumstances of each lawsuit settlement must be considered to determine the
purpose for which the money was received. Then, it can be determined whether these amounts
are excludable.
Punitive
• To Punish
• Taxable. (Caution: Alabama wrongful death proceeds)
Types of Settlements
Determining the correct allocations among taxable payments and non-taxable payments is usually
the most difficult part of these examinations. There are two ways in which settlement proceeds
are originally categorized:
Jury/Court Verdicts
If damages have been clearly allocated to an identifiable claim in an adversarial proceeding by
judge or jury, the Service will usually not challenge their character because of the impartial and
objective nature of the determinations. But see Robinson v. Commissioner, 102 T.C. 116, 122
(1994) and Kightlinger v. Commissioner, T.C. Memo. 1998-357.
Settlements Out of Court
Many lawsuits are settled prior to a jury verdict. These settlements should be closely reviewed,
and facts and circumstances should be carefully determined. The allocation among the various
claims of the settlement can be challenged where the facts and circumstances indicate that the
allocation does not reflect the economic substance of the settlement. See Phoenix Coal
Reference: http://www.irs.gov/pub/irs-mssp/a9lawsut.pdf
I hope this explanation is helpful. I was asked a question a while back in which I provided more information. Search for taxability on settlements of lawsuits.
Add to this Answer Ask a Question
|
|
