LITIGATION SETTLEMENTS: HOW TO MINIMIZE THE TAXES

Steven G. Siegel , Esq.

 

August 29, 2005

TABLE OF CONTENTS

 
CHAPTER ONE: OVERVIEW: TAXES IN LITIGATION SETTLEMENTS 1
  A. What is The Importance of the Tax Considerations? 1
  B. Settlements, Judgments and the Presumption of Tax Liability 3

CHAPTER TWO: DETERMINING THE TAX CONSEQUENCES OF A PAYMENT – THE ORIGIN OF THE CLAIM TEST

 5
  A. The Origin of the Claim Test 5
  B. Determining the Origin of the Claim 6
CHAPTER THREE: TAXATION OF PERSONAL INJURY RECOVERIES 9
  A. General Rule: Exclude from Income Payments Received as Compensation for Injury or Sickness 9
  B. Exclusion for Payments Received Under Workmen’s Compensation Acts 11
  C. Damages Received on Account of Personal Physical Injuries or Physical Sickness 14
  D. Dealing with Prejudgment Interest in Personal Injury Actions 19
  E. Taxation of Punitive Damages 21

CHAPTER FOUR: THE IMPORTANCE OF ALLOCATION OF DAMAGE AWARDS

 24
  A. Allocation of Damage Awards – Income Tax Issues 24
  B. Allocation of Damage Awards – Estate and Inheritance Tax Issues 28
  C. Additional Estate Tax Concerns for the Successful Plaintiff 34
CHAPTER FIVE: RECOVERIES RECEIVED IN NON-PHYSICAL PERSONAL INJURY CASES 39
  A. Starting Points: Origin of the Claim; Allocation of the Recovery 39
  B. Is the Recovery Ordinary Income, Return of Capital or Capital Gain? 40
  C. Punitive Damages 41
  D. Special Offsetting Deduction for Compensable Injuries 42
CHAPTER SIX: FOCUS ON THE PAYOR – IS THE PAYMENT OF A SETTLEMENT OR JUDGMENT DEDUCTIBLE? 44
  A. Again - Analysis Begins with the Origin of the Claim Test 44
  B. Payments Arising from the Payor’s Business Activities 44
  C. Business Expenses as Capital Expenses 47
  D. Expenses for the Production or Collection of Income 48
  E. Deduction of Fines, Penalties, and Related Expenses 49
  F. Deduction of Punitive Damages 51
  G. Deduction of Damages Paid for Antitrust Violations 52
CHAPTER SEVEN: TAX TREATMENT OF LEGAL FEES IN LITIGATION SETTLEMENTS 54
  A. General Rule: Apply the Origin of the Claim Test 54
  B. Fees Incurred in Business, Personal or Capital Transactions 55
  C. Technical Dilemmas of Fee Deductions: Above/Below the Line, 2% Floors, Alternative Minimum Taxes 58
  D. Information Reporting to the Attorneys and Clients 63
  E. Attorneys’ Deduction of Litigation Expenses 66

CHAPTER EIGHT: PERIODIC PAYMENTS AND STRUCTURED SETTLEMENTS

 69
  A. Damages as Lump-Sum vs. Periodic Payments 69
  B. Structured Settlements 72
  C. Structured Settlements and Code Section 130 – Qualified Assignments 76
  D. Transfers of Structured Settlement Payment Rights 80
  E. Structuring (Deferring) Attorney Fees 85
CHAPTER NINE: SETTLING CASES USING DESIGNATED SETTLEMENT FUNDS AND QUALIFIED SETTLEMENT FUNDS 89
  A. Overview: The Problem and the Solution 89
  B. Designated Settlement Funds 90
  C. Qualified Payments 91
  D. Qualified Settlement Funds 91
  E. How DSFs and QSFs are Taxed 93
  F. Settlement Funds and Structured Settlements 94
  G. The “Hot Issue” – Using Qualified Settlement Funds in Single Plaintiff Structured Settlement Cases 95
CHAPTER TEN: SPECIAL & SUPPLEMENTAL NEEDS TRUSTS: ADDRESSING ENTITLEMENT ISSUES 98
  A. Overview of the Problem 98
  B. Overview of Government Benefits Programs 99
  C. The Settlement vs. Entitlement Dilemma 101
  D. The Use of Special Needs Trusts 101
  E. Using Special Needs Trusts with Structured Settlements 105
CHAPTER ELEVEN: DIVORCE & SEPARATION SETTLEMENTS – HOW TO HANDLE THE TAX ISSUES 107
  A.  Introduction – Overview of the Issues 107
  B. Alimony Payments: General Rules and Requirements 108
  C. Specific Requirements For A Payment to be Deemed Alimony 109
  D. Recapture of Alimony and Separate Maintenance Payments 118
  E. Child Support Issues 122
  F. Property Settlements – How To Address the Tax Issues 124
  G. Disposition of the Marital Residence in a Divorce 139
  H.

Who Is Entitled to Claim a Child as a Dependent – Who Gets the

            Child Care Credits?

 142