.The purpose of my challenge to Bassetman was to lighten the mood up around here, which IMO has gotten rather dark. No blackmail and no sociopath behavior (sorry DN). To prove my point, after you read my brilliant dissertation below, take a look at my new signature. My intent was to display it for the same 48 hours as Bassetman was to display his. I would have posted my response earlier but the firewall system at work now will not let me post to TSG. I can read but cant participate (sounds of thunderous clapping wave across the US). My response below goes into it a little more in depth then the IRS site and more then the email from Bassetmans friends. Ive attempted not to make this overly complicated for an issue which is very complicated. Most fights with the IRS deal with the allocation of the jury award.
.Your factual scenario is lacking in some details so Ill have to address variables to give a complete answer (by way of example, Im assuming, at least initially, that award was for a personal injury type suit versus a contract dispute). All states and the federal government exempt compensation for bodily injury, whether from a lawsuit award or a settlement with an insurance company, from taxation. Note that only applies to bodily injury (it also applies to certain types of property damage but I dont think you want me posting a treatise on this subject). If I sue you for slander and win 500 thousand I pay taxes on that award. It gets more complicated. Assume that as part of my claim for injury to my body from an automobile accident I assert lost wages for 2 months of 10 grand as part of my overall claim. If I settle with the insurance company the IRS and your local state tax collector will, rightfully, argue that you should pay taxes on the 10 grand of your settlement (you would have paid taxes had you not been injured). For that reason lawyers, at least the smart ones, structure a settlement to reflect that the payment is to compensate for bodily injury and pain and suffering. If, however, youre in a trial setting and your lawyer has asserted the lost wages as evidence then any jury award must, by definition, include the 10 grand in lost wages. Youre screwed, you got to pay on the 10 grand.
The more interesting situation (at least for us lawyers) is the case you described originally. Again, lets assume that the claim is for slander. Any settlement or jury award is going to be subject to possible taxation. Me, as the lawyer, representing the plaintiff, wants to minimize my clients exposure to the tax man (as a side note, anyone notice what day it is!). What I do is structure my retainer agreement to provide that the opposing side will pay my legal fee. When I strike a deal with an insurance company (whether before I file suit or after) I have them pay me direct what ever my contingence fee may be and the other portion to my client. By way of example, if I settle the claim for 450 thousand and my contingency fee is one-third, the insurance company writes me a check for 150 and my client 300 thousand. The insurance company doesnt care either way and, if negotiated correctly, the two check requirement becomes a major part of the settlement terms. The IRS and state taxing authorities have no claim for the taxes against my client as to the 150 paid to me because of the terms of the retainer agreement and the methods by which the settlement payment was made (obviously I have to pay taxes on the 150). This has been challenged in court and upheld as legitimate method to reduce the tax burden on the plaintiff. Tax avoidance is a God given right.
Now if the plaintiff has to go to trial he is screwed. The jury is going to make an award. The total sum is subject to tax even though the plaintiff pays a third to the lawyer. There is currently no mechanism in the law to have juries make separate awards in this type of situation. This is one of the many factors a lawyer considers when evaluating a settlement offer versus a possibly larger trial award. Think about it. If Im offered 450 grand to settle with the two check settlement system but I believe that I can get a larger award at trial I have to determine just how much larger must it be to be in my clients best interest to go forward with the trial. If I go to trial and only get a 500 grand award from the jury my client has just been screwed. You should also understand that the plaintiff could reduce his tax burden by deducting the attorney fees he pays at the generous IRS rate of the amount over 2% of adjusted gross income. (See IRS Publication 529.)
This discussion only applies to individuals. If youre a business or corporation then obviously you cant suffer bodily injury. However, notice that there is no need to practice tax avoidance. As a business or a corporation you can deduct the legal expenses in full (no 2% threshold). From that standpoint determining whether a settlement or trial is more advantageous to your client because demonstrably easier.
One last point, if what you posted had to do with a contract dispute i.e. he ordered a million widgets and didnt pay, then the person is just paying taxes on the profit he would have had had the person paid as agreed.
As to why the tax lawyers think the plaintiff has to pay taxes on 500 thousand rather than court reduced 325 thousand is beyond me. I would need additional facts to be able to respond. Generally, if a court, whether a trial court or an appellate court reduces a jury award the reduced award is the amount possibly subject to taxation.
If you have additional questions let me know.
CYA: NOTE THE FOLLOWING: The statements made in this post are not to be relied upon as legal advice. You should always consult with legal counsel in your jurisdiction for legal advice and assistance.