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.
IRC section 6041(a) generally requires all persons engaged in a trade or business and making payment in the course of such trade or business to another person of fixed or determinable gains, profits, and income of $600 or more in a calendar year to file an information return with the Service. IRC section 6041(d) provides that each person required to make the return described in IRC section 6041(a) shall furnish to each person for whom a return is required a payee statement.
Treas. Reg. section 1.6041-1(c) states that income is fixed when it is paid in amounts definitely predetermined. Income is determinable whenever there is a basis of calculation by which the amount to be paid may be ascertained. The payor is required to determine whether payments are taxable and need to be reported. The Instructions for Forms 1099, 1098, 5498 and W-2G provides instructions on the items to be reported.
In lawsuit settlements, the person with the obligation to report payments to the plaintiff will generally be the defendant or its insurer rather the plaintiff's attorney. In addition, the defendant or its insurer will also generally be responsible for reporting payments to the plaintiff's attorney. Reporting of Damage Awards on Forms 1099-MISC
Box 3 of Form 1099-MISC is used to report other income that is not reportable in one of the other boxes on the form. Generally, all punitive damages (even if they relate to physical injury or physical sickness), any damages for non-physical injuries or sickness, liquidated damages received under the Age Discrimination in Employment Act of 1967, and any other taxable damages are required to be reported in box 3. Generally, all compensatory damages for non-physical injuries or sickness (for example, emotional distress) arising from employment discrimination or defamation are reportable in box 3. However, if a taxpayer receives an award of back pay that constitutes wages, it generally would be reportable on Form W-2, not Form 1099-MISC.
The following damages (other than punitive damages) are not reportable in box 3 of Form 1099-MISC:
Damages received on account of personal physical injuries or physical sickness.
Damages that do not exceed the amount paid for medical care for emotional distress; or
- Damages received on account of non-physical injuries (for example, emotional distress) under a written binding agreement, court decree, or mediation award in effect on or issued by September 13, 1995.
Damages received on account of emotional distress due to non-physical injury or sickness, including physical symptoms such as insomnia, headaches, and stomach disorders, are reportable unless described in 2 or 3 above. However, damages received on account of emotional distress due to physical injuries or physical sickness are not reportable.
The amount of damages reflected on the Form 1099-MISC is not reduced by attorney's fees. For example, a defendant settles a plaintiff's claim for emotional distress from non-physical injuries by writing a $100,000 check naming the plaintiff and her attorney as joint payees. The attorney retains $40,000 in fees for services rendered and remits the remaining $60,000 to the plaintiff. The amount of damages reportable with respect to the plaintiff on Form 1099-MISC is $100,000.
Fees paid to an attorney of $600 or more, paid in the course of the payor's trade or business, are reportable in box 7 of Form 1099-MISC. However, for 1998 and later years, if the payor pays an attorney in the course of its trade or business for legal services and the attorney's fee cannot be determined, the total amount paid to the attorney (gross proceeds) must be reported in box 13 with Code A.
For example, an insurance company pays a plaintiff's attorney $100,000 to settle a plaintiff's claims for damages that are excludable from income under IRC section104(a)(2). The attorney's fee cannot be determined by the insurance company. Therefore, the insurance company must report $100,000 in box 13 of Form 1099-MISC with Code A. If the insurance company knows that the attorney's fee is, for example, $34,000, the insurance company must report $34,000 in box 7 and nothing in box 13.
These rules apply whether or not the legal services are provided to the payor, and whether or not the attorney is the exclusive payee (for example, the attorney's and claimant's names on one check). However, these rules do not apply to profits distributed by a partnership to its partners that are reportable on Schedule K-1 (Form 1065), Partner's Share of Income, Credits, Deductions, etc., or to wages paid to attorneys that are reportable on Form W-2, Wage and Tax Statement. The term "attorney" includes a law firm or other provider of legal services.
In addition, the exemption from reporting payments made to corporations no longer applies to payments for legal services. Therefore, for 1998 and later years, attorney fees (in box 7) or gross proceeds (in box 13), as described above, paid to corporations providing legal services are reportable.