I am suing a professional for actual damages. When I win, will the proceeds be taxable, since they are just to reimburse me for what I lost? Are my legal fees tax deductable?
If it is more complicated than this, what are the issues involved?
It is taxable. Only specific personal injury damages are potentially tax-free. The legal fees are deductible on Schedule A subject to the
2% limit -- only the amount over 2% of your AGI is deductible, and the furthermore deduction is not allowed under the AMT.
It is more complicated. What is the nature of the damage you suffered?
Compensation for property is also tax-free, isn't it? (It's considered a sale at a price equal to the amount received, so there might be some tax involved.)
Seth
My accountant gave me advice which turned out to be seriously wrong, resulting in much higher taxes. He had all the information needed to answer correctly, but (apparently) chose to make incorrect assumptions rather than looking at the information.
Sorry but that's wrong. It's only taxable to the extent it's income. If someone steals your money and you sue to get it back, it's not income. It's just getting back what you lost. Even though it's not for personal injuries.
Stu
True. The original post says " to reimburse me for what I lost". If this is lost wages, then I imagine it is taxable. If it is a recovery of capital as in your stealing example, then it should not be taxable.
I found a good overview and discussion of some of the issues involved at
(I have no connection to the publisher of this web site.)
All income from whatever source is taxable, unless specifically excluded. Physical injury settlements are specifically excluded, punitive damages normally are taxable.
Are you saying that your taxable income would have been the same, regardless of whether you had received "correct" or incorrect advice? In other words, the bad advice resulted only in higher taxes on the same amount of income?
Taxation of lawsuit settlements has itself been taken to court on numerous occasions. On top of that, they are often not reported, or mis-reported, on Form 1099-MISC.
Good luck with trying to come out ahead on this!
-Mark Bole
As an additional factor, if you had previously taken a deduction for theft loss, then you would have a taxable recovery. Also, the OP states elsewhere that his "damage" was paying too much tax. If any of it was deductible state taxes, then, again, the legal settlement would be partly a taxable recovery.
-Mark Bole
Right (and that paraphrases IRC 104). However, the key word is INCOME. Not all transfers of money represent income to any/all of the parties involved.
Suits of equity are about making one whole for some damage. Income should be recognized in them only when the payment is to represent income lost via the act of damage (back pay, lost wages, earning potential, etc....) or when it is reimbursement for an amount permitted as a deduction (tax benefit rule). Otherwise, it's not income and therefore doesn't fall under the general rule of inclusion in IRC 61.
Punitive damages are a matter of law, not of equity, and that's why they're taxable.
It's too bad that the Supremes chose not to hear Murphy (493 F.3d 170) - SupCt Docket 07-802. If you agree with the first impression of the appeal, maybe you can cause conflict between circuits and get this settled for once and all. I believe that the first impression was the correct result.
Yes, my income would have been the same in any event; it more or less comes down to improper deduction timing.
Since it is not income, but a damage of avoidable taxes paid, it presumably would not be taxable? Would the legal fees still be deductable even if the award is not taxable?
text -
The legal funds could be deductible only to the extent they were charged for the recovery of "TAXABLE" income.
Exactly. The original post did not specify what the damages might consiste of, so you're right from the standpoint that it could have gone either way depending.
The rules concerning paying too much in taxes, as I recall, can not always be easily figured out based on general rules. Courts sometimes treat them differently based on public policy grounds. So to answer the question authoritatively I suspect that more research will be necessary.
Stu
Just curious what the specifics are. Normally you have to take a deduction in the year that you pay it. That's if you're a cash basis taxpayer. If you're an accrual basis taxpayer, then the rules are a little different.
Or are you saying that the person advised you to, for example, make a charitable contribution in December 2006 whereas January 2007 would have been better because you took the standard deduction in 2006 (so lost the benefit of the tax deduction) but itemized in 2007 (so you could have got the benefit of the tax deduction)? In this case, I'm not sure the damages would be tax free.
This may be right, but we'd have to see all the facts to know for sure. There's also the issue of if you took a state tax deduction for excess tax paid as pointed out elsewhere in this thread.
Have you considered filing an amended return? This way you avoid lawyers fees and the hassle of proving to a judge that your damages are not taxable. Plus it might be better for the original tax preparer's reputation and they may do the ameded return for free.
No. Legal fees for non-taxable income are not deductble.
Stussy's response is correct. I checked, and legal fees are not deductible if they give tax free income.
Is there a distinction between non-taxable income and income that was previously taxed but is merely being recovered?
Stu
I don't follow. If it were previously taxed, then how can it be be subject to recovery?
Now, if you are saying it was previously taxed due to accrual accounting but never received, then fees to collect it are deductible.
Neither. You have money in your bank account that you received in past years and have paid tax on it. Someone (in a consumer transaction) sells you something that turns out to be worthless, so you pay for it with money in that same bank account. When you sue for it later you receive a judgment for your money, but after paying your lawyer you only get two-thirds back.
There is no tax on recovery of the money, but after paying attorneys fees you are still in the hole. Can you deduct those fees in that case?
Stu
Stuart Bronstein wrote in news:Xns9A9A796235CA5avocatstuyahoofr@130.133.1.4:
Why would you get only 2/3 back? That sounds like a lousy result for a suit to recover money. It means a certain amount of money gets taxed twice: Once for having been earned by the person who later had to sue for recovery of a 3 times greater amount, then by the lawyer who received it as a fee. Something isn't kosher here, but then I am neither lawyer nor accountant .
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