Tax Treatment of Settlement

I don't have a citation or case but I believe they are independent of each other. One part deals with physical injury and a workers comp claim. The other part deals with an employment related claim. That would make the employment related payment taxable. If there were legal fees and other costs involved, the t/p would have to allocate those costs against the two revenue streams to obtain the amount deductible (misc. itemized) for the employment related claim.

None of it is excludible. The settlement does NOT say that the amount is for compensation for personal injuries nor does it allocate an amount to such. In the absence of such, the courts have generally ruled that the entire payment is taxable. Although the origin of ONE OF the claims is a personal injury, the other was not (termination of employment), and therefore without an allocation, the taxpayer is screwed. He should sue any attorney who represented him for malpractice for not considering this.

and he should kick himself real hard for agreeing to a settlement without he himself considering this angle.

Harsh criticism of a blue collar worker who may deal with a tax issue of this nature maybe once in his lifetime? I'm sure he was confident that his lawyer, who took 40% of the settlement, was looking out for the client's best interests.

And why shouldn't the critizism be? Where you see confidence, I see malpractice.

I have no quarrel with your malpractice assertion. I was responding to Gil Faver's post which I felt was an unwarranted criticism of the taxpayer ("he himself") for agreeing to a settlement without considering the tax consequences. I contend that a taxpayer with no education or training in law or accounting should be able to have confidence in and rely on the advice and counsel of his attorney. I would hope that any licensed professional would agree, else why retain same?

I am of the opinion that NOBODY is wise if they think they can "have confidence in and rely on the advice and counsel of his attorney". If this guy had no reason to consider the tax implications, why is he doing so now? Why didn't he just make an assumption, and file his taxes?

And, FWIW, my comments are made "by a licensed professional".

and, also, I see no reason why the attorney should not be held to a malpractice claim on this matter, but I bet he cannot be, if that was not his area of expertise.

Isn't the workman's comp payment, by definition, for compensation for the personal injury?

Seth

Workman's comp is excludible by statute.

**BEGIN QUOTE** 104(a) IN GENERAL. --

Except in the case of amounts attributable to (and not in excess of) deductions allowed under section 213 (relating to medical, etc., expenses) for any prior taxable year, gross income does not include --

104(a)(1) amounts received under workmen's compensation acts as compensation for personal injuries or sickness; **END QUOTE**

None of the amount paid is marked as workman's comp. Therefore, none of it is.

How do you reconcile that statement with the first quoted paragraph above? Settlement of a workman's comp benefit claim is surely workman's comp, is it not?

Seth

I reconcile it easily. From the OP's post:

'... [T]he payment was made, "...solely in order to compromise and purchase peace, to avoid the vexation and expense of litigation, and does not and is not to constitute an admission of any liability, but on the contrary is being paid with the express understanding of the denial of any liability."'

I don't see any mention that the payment is to satisfy any workman's compensation claim. The payor is also specifically stating that they DENY any such claim.

"Taxpayer reached a settlement of his workman's comp benefit claim and received payment of that claim directly from the municipality's "Taxpayer and the municipality agreed on a cash payment amount to settle the retaliatory termination claim. Per the settlement, the payment was made, "...solely in order to compromise and purchase peace, to avoid the vexation and expense of litigation, and does not and is not to constitute an admission of any liability, but on the contrary is being paid with the express understanding of the denial of any liability."

The settlement itself allocates ZERO to worker's comp (by omission). The claim never matured but was agreed to be aborted WITHOUT regard to its nature or origin. Note also the word "solely." That specifically excludes all other reasons, even those in the originating claim.

You've been told how the courts (Tax Court and Court of Federal Claims) rule on settlements that don't have any allocation of payments to any type of excludible income. It's not my personal opinion. It's case law repeated ad nauseum.

I believe that if the complaint had only one cause of action, and recovery under that cause of action would not be taxable, no allocation is required. But if there are causes of action some of which would result in taxable income and some of which would result in non-taxable income, failure to allocation would definitely be a problem.

Stu

I think I am still going to disagree with your conclusion. Tax court decisions in Stocks (98 TC 1) and Metzger (88 TC 834) deal with settlement agreements and allocations. In both instances there was a single payment made to settle the plaintiffs claims. These cases form the basis that one looks to the intent of the payor in settling the claim. In both those cases, the court divided the amount between the taxable and nontaxable pieces. In this instance, we also have more than one claim. I.e., workers compensation and retaliation. However, we do not have one payment that has to be allocated. We have two payments. One payment made by the employers insurance company for workers compensation and one payment by the company for the retaliation claim. The settlement agreements in both referenced cases made no mention of or allocated any amount to the nontaxable part of the claim.

I have to conclude, that when one files a claim for workers comp and receives payment from the WC insurance company to settle that claim, you have excludable income. There is no need to make any allocation in this instance and there is no requirement that any settlement agreement state that the payment was or was not for personal injury.

I see nothing in any tax court cases or appeals court cases that require

The full last sentence should have been: I see nothing in any tax court cases or appeals court cases that require a settlement agreement to specifically identify the personal injury amount in order for the taxpayer to exclude the amount paid.

I have to agree with your conclusion. There was a reasonable allocation, though not in the settlement agreement, and it should be honored.

Stu

The OP stated that there were TWO causes of action:

- the injury (a workman's comp claim)

- wrongful termination.

Amounts paid for the wrongful termination are in lieu of [lost future] income and are fully taxable.

An allocation needs to be made, and without an allocation, it is all taxable.