In most cases, the applicant/employee is looking for the largest payment and wants to avoid or delay the payment of settlement taxes. The plaintiff`s lawyer is often in the difficult position of reaching a settlement that reduces the amount of taxes owed to appease his client, while the defendant`s lawyer wants to ensure that the case is resolved accurately with as little ongoing risk as possible. Regardless of how a particular party wishes to call the settlement, the Internal Revenue Service (IRS) has been very clear in its interpretation of the taxation of these settlement products. Settlements and judgments are imposed based on the origin of the claim – the type of damage claimed by the plaintiff. If the action is directed against competing companies for loss of profits, a settlement represents a loss of profits that is taxed as ordinary income. If a person is fired at work and prosecuted for discrimination in search of wages, the reimbursement is taxed as a salary. However, a lawsuit brought by a condominium owner against a negligent contractor is generally not taxed as income. Instead, the recovery is treated as a reduction in the purchase price of the condominium by the owner. These rules are full of exceptions and nuances that go beyond the salary level of a modest recourse lawyer. In general, however, IrS regulations contain detailed provisions on joint checks and how Form 1099 should be issued in such cases.
Most of these rules mean that lawyers receive Forms 1099 when their names appear on comparative exams. If the settlement is with the applicant`s employer and includes a loss of wages, the employer paying the settlement must report the payment on a Form W-2 and withhold applicable income and social security taxes. If the statement is taxable income other than employees` wages, the payment is reported on a Form 1099-MISC. A settlement agreement should specify whether the recipient will receive a Form W-2 or Form 1099. The average bill for bodily injury is about $24,000. Therefore, a typical settlement assignment might look like this: Likely because of these tax considerations, Mr. Best filed a motion with the court asking the court to remove the wording of IRS Form 1099 from the agreement. In his motion, he argued, among other things, that the wording should be removed because counsel for the defendants had misrepresented to him during settlement negotiations that an IRS Form 1099 was required under federal tax law. Not surprisingly, the defendants disagreed. Since Form 1099 is not required in all cases, settlement discussions related to the issuance or non-issuance of a Form 1099 may be the subject of heated debate between the parties. First, the payee of the settlement payment will regularly ask the payer not to issue Form 1099, which gives the payer greater flexibility in reporting items on the recipient`s tax returns.
On the other hand, the payer will regularly attempt to issue a Form 1099 (even if none is required) to avoid possible penalties in case of non-filing of the information return. Getting Form 1099 isn`t much fun, but at least it`s a reminder to include the payment on your tax return. Even many Form 1099 issuers may not particularly like the form. Lawyers should pay special attention to these rules, and not only when settling cases or concluding real estate transactions. More than many other companies and professionals, lawyers frequently send and receive 1099 forms. Customers also take great care of these rules, especially if they receive a large and bold Form 1099 in the mail that they did not expect. To help their clients avoid receiving Form 1099, some of the plaintiffs` lawyers ask the defendant for a cheque to pay to the Jones Law Firm`s trust account. Many defendants are willing to issue a single Form 1099 to the Jones law firm in this situation. Technically, however, Treasury regulations dictate that you must treat this jones Law Firm Trust account check as a joint check to be paid to the lawyer and client. This means that two 1099 forms are required in full quantity.
Example: Larry Lawyer makes a payment of $400,000 to the co-lawyer, but Larry does not issue a required Form 1099, even though his CPA told him he was required to do so. In addition to other remedies, the IRS can impose a fine of $40,000. The main area where a lawyer must issue a Form 1099 to a client is the area where the lawyer performs important oversight and management functions. In many cases, the tax rules are not very clear about what exactly these management and oversight functions are, but it is not enough to be a plaintiff`s lawyer and take care of the settlement money. For example, the distribution of proceeds from a class action lawsuit may trigger the large-scale issuance of Form 1099. In addition to the default $270 penalty, the IRS may also attempt to deny a deduction for the item that should have been reported on a Form 1099. That said, if you don`t issue a form for a $100,000 consultation fee, the IRS could claim it`s not deductible. It is usually possible to defeat these types of draconian punishments, but the severity of the threat always makes it a strong threat. Mitch Dubick focuses his practice on tax litigation, representing retail and corporate clients before the IRS and state tax authorities, as well as commercial, real estate and tax planning. His more than 30 years of experience and cost-effective solutions have made him the first choice for clients, accountants and other lawyers to manage their tax disputes, including audits, overdue statements, appeals, debt collection matters (including liens and withdrawals), payment agreements and compromise offers. .