This is the tenth in a series of articles on issues surrounding the Taxation of Settlements and Verdicts. The chart below summarizes the reporting obligations of the payor.

Damage Award	Payments to Current or Former Employee	Payments Not Segregated from Wage Award to Employee	Payments to Non-Employee *
IRS Section 104	None	None	None
Back Pay	W-2	W-2	N/A
Front Pay	W-2	W-2	N/A
Emotional Distress	1099 MISC	W-2	1099 MISC
Medical Reimbursement	None	W-2	1099 MISC
Medical Insurance Reimbursement	None	W-2	1099 MISC
Pre Judgment Interest	1099-INT	W-2	1099-INT
Post Judgment Interest	1099-INT	W-2	1099-INT
Wrongful Refusal to Hire	W-2	W-2	W-2
Wrongful Dismissal	W-2	W-2	N/A
Balance of Contract	1099 MISC	W-2	1099 MISC
Liquidated Damages	1099 MISC	W-2	1099 MISC
Deductible Losses	None	None	None
Punitive	1099 MISC or W-2	W-2	1099 MISC

* Payments of Attorney’s Fees – In the context of settlements and verdicts from employment litigation, 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. If the payment to the attorney includes both an award to the attorney’s client and attorney’s fees, and the potion attributable to attorney’s fee cannot be determined, the total amount paid to the attorney (gross proceeds) must be reported in box 14. These rules apply even when the legal services are not provided to the payor or when the attorney is not the exclusive payee. The term “attorney” includes a law firm or other provider of legal services.

This is the ninth in a series of articles on issues surrounding the Taxation of Settlements and Verdicts. The chart below summarizes the withholding and payment obligations of the defendant/ payor.

	Employee *		Non Employee **
Damage Award	Payments Combined with Wages but Segregated	Payments Combined with Wages But Not Segregated
Section 104	None	None	None
Emotional Distress	None	Withholding/FICA/ FUTA/SUTA	None
Back Pay	Withholding/FICA/FUTA/SUTA	Withholding/FICA/ FUTA/SUTA	N/A
Front Pay	Withholding/FICA/FUTA/SUTA	Withholding/FICA/ FUTA/SUTA	N/A
Medical Reimbursement	None	Withholding/FICA/ FUTA/SUTA	None
Medical Insurance Reimbursement	None	Withholding/FICA/ FUTA/SUTA	None
Pre Judgment Interest	None	Withholding/FICA/ FUTA/SUTA	None
Post Judgment Interest	None	Withholding/FICA/ FUTA/SUTA	None
Wrongful Refusal to Hire	Withholding/FICA/FUTA/SUTA	Withholding/FICA/ FUTA/SUTA	Withholding/FICA/FUTA/SUTA
Balance of Contract	None	None	None
Liquidated Damages	None	None	None
Self Employment (Payment otherwise deductible under IRC Section 165)	None	None	None
Wrongful Dismissal	Withholding/FICA/FUTA/SUTA	Withholding/FICA/ FUTA/SUTA	Withholding/FICA/FUTA/SUTA
Punitive	None	Withholding/FICA/ FUTA/SUTA	None
Attorney’s Fees paid directly to Plaintiff’s Attorney	None	None	None
Plaintiff’s Award and Attorney’s Fees paid to Plaintiff’s Attorney	Withholding/FICA/FUTA/SUTA for Wages - Nothing for Attorneys Fees	Withholding/FICA/ FUTA/SUTA for wages	Withholding/FICA/FUTA/SUTA for Wages - Nothing for Attorneys Fees
To Plaintiff From his/her Attorney	None	None	None

* Employment Taxes. In the case of payments to employees which qualify as wages, the payor is also responsible for the withholding and or payment, as applicable, of one or more of the following:

1. Federal Insurance Contributions Act (FICA) which includes the employer’s share of Social Security and Medicare tax;2. Federal Unemployment Tax Act (FUTA);3. State Unemployment Tax Act (SUTA)4. Collection of income tax and employee’s share of Social Security tax;5. If the taxpayer is a railroad employer, the Railroad Retirement Tax Act (RRTA) may apply.

** Backup Withholding. IRS Section 3406(a) requires a payor to deduct and withhold from a reportable payment a tax of 31% of the payment unless the payee supplies the payor with a taxpayer identification number. If the payor does not withhold and pay over the tax, he may be directly liable for it.

This is the eighth in a series of articles on issues surrounding the Taxation of Settlements and Verdicts. The chart below summarizes the taxable nature of a variety of settlements and verdicts.

Damage Award	Taxable?	Exceptions	Relevant Case Law / Statute
Physical Injury / Illness	No	Taxable if not recovered for a tort or tort type right	IRC Section 104(a)(2)
Back Pay	Yes	Not Taxable if qualified under Section 104	Rev. Rul. 96-65
Front Pay	Yes	Not Taxable if qualified under Section 104	Rev. Rul. 96-65
Emotional Distress	Yes	Not Taxable if qualified under Section 104	IRC Section 104(a)(2)
Medical Reimbursement	No	Taxable if already deducted	IRC Section 213
Medical Insurance Reimbursement	No	Taxable if already deducted	IRC Section 213
Pre Judgment Interest	Yes		IRS Section 61(a)(4) Rozpad v. Commissioner 154 F.3d 1 (1st Cir. 1998)
Post Judgment Interest	Yes		IRS Section 61(a)(4) Rozpad v. Commissioner 154 F.3d 1 (1st Cir. 1998)
Wrongful Refusal to Hire	Yes		IRC Section 61
Balance of Contract	Yes		IRC Section 61
Liquidated Damages	Yes		IRC Section 61
Reimbursement for Deductible for Losses	Yes	Not taxable if not previously deducted	IRC Section 61
Punitive	Yes		Ogilivie v. United States, 519 U.S. 79 (1996); IRC Section 104(a)(2)
Discrimination	Yes		Commissioner v. Schleier, 515 U.S. 323 (1995); Rev. Rul. 96-95
Defamation	Yes		IRC Section 104(a)(2)

This is the seventh in a series of articles on issues surrounding the Taxation of Settlements and Verdicts. This article addresses the question of whether the fact that attorney fees are provided for by a statute has any affect on including these fees in plaintiff’s gross income.

United States Supreme Court. The Supreme Court in Commissioner v. Banks, 125 S.Ct. 826 (2005) did not address the contention that application of the anticipatory assignment principle would be inconsistent with the purpose of statutory fee-shifting provisions, such as those applicable in Banks which was brought under 42 U.S.C. Sections 1981, 1983 and 2000(e) et. seq. In Banks, there was no court-ordered fee award or any indication in Banks’ contract with his attorney or the settlement that the contingent fee paid was in lieu of statutory fees that might otherwise have been recovered. The Court noted that the American Jobs Creation Act of 2004 redresses the concern for many, perhaps most, claims governed be fee-shifting statutes.

United States Tax Court. The United State Tax Court has addressed this issue at least twice since the Supreme Court’s decision in Banks.

Vincent v. Commissioner, T.C. Memo, 2005-95. In Vincent, the Petitioner’s contingent fee agreement with her attorney stated that the attorney would be entitled to a defined percentage of any recovery, unless, as occurred in Vincent, the attorney received his fees and costs pursuant to a fee shifting statute. The Tax Court followed the Court of Appeals for the Ninth Circuit which held that a defendant’s payment of a plaintiff/taxpayer’s attorney’s fees and costs pursuant to a fee shifting statute constitutes income to the taxpayer. Sinyard v. Commissioner, 268 F.3d 756 (9th Cir. 2001), affg. T.C. Memo. 1998-364. In Sinyard, the taxpayers and their attorney signed a contingent fee agreement similar to the one in Vincent. The settlement agreement apportioned some of the settlement so as to pay in full the attorney’s fees and costs pursuant to the fee shifting provisions of 29 U.S.C. secs. 216(b) and 626(b). The Court held that the apportioned funds were attributable to the taxpayers, who, in the Court’s words, “bound themselves to pay * * * [their attorneys] one-third of what they received. When * * * [the defendant] satisfied this obligation, the Sinyards were so much the richer. That they never laid hands on the money paid to the lawyers does not obliterate their constructive receipt.” Id. at 759.Green v. Commissioner, T.C. Memo. 2007-39. The United States Tax Court again addressed this question in Green V. Commissioner. It stated: A litigant generally may not exclude the portion of a recovery paid to his or her attorney where, as here, the litigant’s recovery constitutes income. Commissioner v. Banks, 543 U.S. 426, 436-437 (2005). This is true whether the attorney’s fee was paid on a contingent fee basis or under a fee-shifting statute. Sinyard v. Commissioner, 268 F.3d 756 (9th Cir. 2001), affg. T.C. Memo. 1998-364; Vincent v. Commissioner, T.C. Memo. 2005-95.

This is the sixth in a series of articles on issues surrounding the Taxation of Settlements and Verdicts. This article explains when and how the cost of attorneys fees may be deducted “below the line.”

For cases not covered by IRC Section 62(a)(20) the United States Supreme Court determined, in Commissioner v. Banks, 125 S.Ct. 826 (2005), that when a litigant’s recovery constitutes income, the litigant’s income includes the portion of the recovery paid to the attorney as a contingent fee. Therefore, the deduction for attorneys fees must be made “below the line” as an itemized deduction, subject to the 2% AGI limitation and the AMT rules.

Character of Award as Taxable or Non-Taxable Affects Deductibility. When only a portion of the award is taxable, then only a portion of the attorneys fees are deductible. Legal fees and court costs that are related to the taxable portion of the award are allowed as a miscellaneous itemized deduction subject to the 2-percent AGI limitation on Schedule A. The deductible fees and costs are determined by using the ratio of the taxable award to total award and multiplying the total fees and costs by this ratio. For example, assuming an award of $100,000, of which 80% was taxable, only 80% ($41,600) of the attorneys fees and costs of $52,000 would be deductible and even that would be subject to the 2% AGI limit.

Losing the Deduction Through the AMT. If the taxpayer’s income is too high, she may be exposed to the Alternative Minimum Tax (“AMT”) and thereby receive no deduction for the attorneys’ fees.

How the AMT Works. The AMT operates by adding back to a taxpayer’s income certain, but not all, deductions that, at a lower income level, would otherwise be available. The taxpayer is then taxed on this larger amount of income. The AMT operates on both the federal and state levels. Below the line legal fees are one of the deductions that is added back to calculate tax.

Example. The following is not a precise representation of the AMT calculations, but it shows the general impact of the AMT on awards. The calculation assumes the taxpayer had other income equal to or above the AMT exemption amount, not related to the damage award, and paid Minnesota Alternative Minimum Tax.

	Above the Line		Below the Line
Award Received	$210,000.00		$210,000.00
Less Attorney Fees	($70,000.00)		$0.00
Taxable Award	$140,000.00		$210,000.00
Less Federal Tax	($36,400.00)		($55,300.00)
Less State Tax	($11,134.38)		($17,062.50)
After Tax Recovery	$92,465.62		$137,637.50
Less Attorney Fees	$0.00		($70,000.00)
Amount to Plaintiff	$92,465.62		$67,637.50

Impact. After federal taxes, state taxes and effectively nondeductible attorneys fees, the client is left with less than 33% of the damage award. If the attorney charges 40% plus costs, the plaintiff’s share could easily be less than 25% of the total award. See Alexander v. Commissioner 72 F.3d 938 (1^st Cir. 1995) where the tax liability was greater than the taxpayer’s recovery.