Keep New Tax Laws in Mind When Settling Lawsuits
We’ve often written about how important it is to get the advice of a good tax or estate lawyer, even if you’re involved in a case that doesn’t necessarily involve those areas. Legal areas that seemingly have nothing to do with wills or estates or taxes often do have consequences in those areas, and attorneys who have experience in some of those areas may not be competent in all of them enough to advise you properly about the consequences of legal decisions that you are making.
One area that is now of concern regards making settlements in litigation that include payments of attorneys’ fees. This is a result of the new tax laws recently passed by Congress.
Taxes on Lawsuit Settlements or Verdicts
Litigants who win trials or settle cases may find themselves being taxed much more than they used to be under the old laws. This is because of the elimination of tax breaks for attorneys’ fees.
Let’s say, for example, that you sue on a breach of contract and the contract has a provision that the winner gets attorneys’ fees. You win and you collect $100,000 in contractual damages, and $20,000 for your attorneys’ fees. Of course, you won’t see the $20,000—that will go to your attorney to pay what you owe them.
Under the old law, that $20,000 could be set off from the money that you received in the case. As such, you would only be taxed on the $100,000 that you actually netted.
New Law Changes Things
Now, the new law changes the ability to set off attorneys’ fees. This means that even though you may have given that $20,000 to your attorney, as far as the IRS is concerned, you pocketed—and should be taxed—on the entire $120,000.
The same would result in any case where an attorney works on contingency. Defamation cases, some intellectual property cases, and stockbroker negligence, among many others, are often handled this way.
Areas not affected are personal injury lawsuits, where the tax does not apply (except punitive damages, which are taxable). Additionally, most employment-based lawsuits, such as those involving whistleblowing or discrimination, are not taxable.
But sexual harassment claims do take a special hit because of a provision in the new law that does not allow the write off of attorneys’ fees where a settlement agreement has a nondisclosure or confidentiality clause. Because almost all do, many sexual harassment plaintiffs may find themselves paying taxes on fees that they end up paying to their attorneys.
Law Will Be Tested
Because the law is so new, it isn’t known yet whether there will be a workaround—for example, wording settlements or even retainer agreements with attorneys in certain ways that allow plaintiffs to continue deducting attorneys’ fees. As such, if you are in the process of settling a lawsuit, it is best to be aware of the law, calculate your potential tax burden, and negotiate any settlement with that in mind.
Make sure you don’t have tax burdens you aren’t expecting. Contact Tampa estate and tax attorney David Toback to discuss your tax issues or problems.