How Does Recent Tax Reform Impact Legal Settlements?
In December 2017, the United States Congress passed the Tax Cuts and Jobs Act; a tax reform law that resulted in changes to allowable deductions for certain types of taxable settlements. Previously, claimants receiving taxable settlements could typically deduct attorney fees/case costs as a miscellaneous itemized deduction. Current tax law eliminates miscellaneous itemized deductions for many types of non-employment related settlement recoveries. As a result, impacted claimants are taxed on their entire gross recovery including attorney fees/costs.
Which types of settlements are impacted?
The law impacts many types of taxable settlement recoveries including, but not limited to: invasion of privacy or defamation, construction defect, wrongful arrest or imprisonment, and emotional distress. There are provisions that allow for a deduction in certain types of cases (e.g. employment); however, it is important to seek advice from your tax professional to determine whether a carve-out applies.
Payments on account of qualified personal physical injury are excludable from gross income under IRC § 104 and are therefore not affected. However, if the recovery includes punitive damages, that portion will be impacted.
Who receives the tax documents?
Structured settlements are often used as a planning tool for taxable settlements. In the case of a structured settlement, the payor (defendant or insurance company) generally issues IRS Form 1099-MISC to the claimant for the cash portion of the settlement, including the portion or the cash attributable to attorney fees, and a separate 1099 to the assignment company for the structured portion.
With confusion regarding the change in tax laws, some defendants/insurance companies are erroneously issuing 1099 income tax forms to claimants and/or their attorneys for funds placed in a structured settlement. In those circumstances, it may be appropriate to request that the defendant/insurance company reissue the 1099 to the appropriate structured settlement assignment company.
Contact an expert today
Tax law is constantly evolving, so make sure you consult a tax advisor before filing. For information regarding comprehensive settlement planning, contact Sage Settlement Consulting today.