Lawsuit Awards and Settlements: IRS Tax Law

With tax day fast approaching, Weitz & Luxenberg wants to ensure our clients have all the information they need to understand how to report their large settlements and lawsuit verdicts to the IRS. This information from the Internal Revenue Service does not consitute legal advice. We provide this document for informational purposes only. If you need help with your taxes, contact a tax attorney or an accountant. To file a personal injury lawsuit, click here.

Chapter 4, Sources of Information

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Note: The comments in this section concerning information sources must be used within the guidelines for compliance initiative projects. Additionally, the requirements for third party contacts and third party summonses outlined in RRA 98 must be followed.

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Identifying taxpayers who have received large taxable lawsuit settlements can be a difficult process because a Form 1099 is not usually issued to the plaintiff. Most of the returns to be examined would not normally be selected through regular classification. The following sources may be used to identify large taxable lawsuit settlements.

One readily available source of information is local newspaper articles. Large punitive damage verdicts generally make headlines. A coordinator can be responsible for reviewing and maintaining interesting newspaper articles.

This is an excellent source of identifying taxpayers that have gone to court and had a jury verdict. This does not identify individuals who settle prior to a jury verdict.

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Determine where civil lawsuits are originally filed in your jurisdiction. In many states cases are filed with the circuit clerk's civil division at the county courthouse where the lawsuit originates. There may be tens of thousands of civil cases filed in one year. Only a small portion of these cases will be punitive damage cases. Identifying punitive damage cases from this population can be a difficult process. Some of the techniques used to identify these cases include the following:

1. Scan the style of the case (plaintiff versus defendant) at each courthouse. Most of the circuit clerks' offices will be computerized, but some have hand-written records.
2. Identify insurance companies and finance companies who are defendants in the cases. These are typically the types of companies being sued for punitive damages.
3. Record the case file number.
4. Review the case file. Most of the cases are settled out of court and dismissed with prejudice. This means the case has received final settlement and cannot be further litigated. Typically the dollar amount of the settlement is not noted in the file if the case is settled out of court. Use a worksheet (see Appendix A for a sample) to gather pertinent information from the civil case file. Scanning the file is one of the most important techniques to become familiar with the type of lawsuit filed. Suits which seem to have non-physical damages (fraud, negligence, misrepresentation, etc.) are to be given priority.
5. Review cases which are large in size. This tends to indicate that the lawsuit was in process for an extended period of time, and this could be an indication of a large settlement.

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In some states it may not be necessary to manually research the courthouse as described above. Determine if your state has a centralized agency for recording all lawsuits filed. In some states information is sent to an Administrative Office of Courts (a state agency) on a monthly basis. This state agency should have a compiled list of the cases filed in counties having a computerized system. The list may provide information such as the case number, style (plaintiff versus defendant), type of case, date settled, and amount of damages awarded.

Once it has been determined that your state has a compiled listing of all civil cases, obtain the magnetic tape of the list for all open exam years. There may be a charge for this magnetic tape. The computer audit specialist (CAS) in your district can then manipulate the data on the tape to certain specifications. For example, the CAS could make a list of all civil cases that were settled by jury with specific dollar amounts designated as compensatory and punitive. In addition, the list could be sorted into geographic areas to fit post of duty locations. This POD data can then be reviewed for cases with exam potential. Specific courthouse files could be reviewed if deemed necessary.

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This same computerized data just discussed can be used to identify settlement payors. Review the database to select those companies that appear as defendants most often. Insurance companies are usually the defendants in these cases and are a prime source of information for lawsuits or payments made in lieu of a lawsuit. A contact with the insurance company's legal department should be made to establish communication with the company. At that time you may explain the possible tax consequences of the payments and what information you need. Request that they provide you with the information.

Third party letters can be issued to the settlement payors requesting records needed to begin examinations (see Appendix B for sample attachment to third party letters). However, because of legal reasons, many insurance companies will require that you issue a summons to them before they release any information to you. Whether you are issuing a third party letter or a summons, the following information should be requested:

1. Copies of the complaint,
2. Copies of settlement agreements and/or waivers,
3. Copies of front and back of checks,
4. Addresses of the plaintiffs, and
5. Social Security Numbers of the plaintiffs.

When issuing a summons, it is recommended that you request assistance from the company's legal department in structuring your request for information. This enables you to obtain the information needed while minimizing their efforts.

It should be noted that the payors generally will not have a disbursement schedule. It is standard practice for payors to disburse the gross amount of the settlement to the plaintiff's attorney, who then disburses the money to his or her client(s). Therefore, the disbursement schedule can best be obtained from the taxpayer (plaintiff). This information may also be available from the plaintiff's attorney. Generally, this information would not be protected by the attorney-client privilege, but consult with the appropriate Office of Chief Counsel if the facts and circumstances warrant pursuing this action. Use of settlement payors has advantages in that the correct person can be easily found. In addition, you know the amount of the payment and the date it was made.

See Chapter 5, Third Party Contacts and Summons Information, for further information.

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The State Supreme Court Library records all the cases that the State Supreme Court has heard. Many of the large awards by jury are appealed to the State Supreme Court. This reference can be used to make sure that no large cases are omitted from possible exam consideration.

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see also:

Ch.3: Related Topics IRS Tax Law: Lawsuit Awards and Settlements, how to report your compensation
IRS-FREE Tax help with your large settlements & verdicts - Chapter 3

App C: Letter IRS Tax Law: Lawsuit Awards and Settlements, how to report your compensation
IRS-FREE Tax day help with your large settlements and lawsuit verdicts

Tax Law IRS Tax Law: Lawsuit Awards and Settlements
IRS Information: Large settlements and lawsuit verdicts