In Uncategorized on 10/28/2015 at 20:22

If you remember my blogpost “An Unsettling Settlement,” 10/3/11, you’ll remember judges look to see what the parties really settled, not what they claimed the settled, when deciding if settlement proceeds are taxable, and, if they are, how they are characterized.

So it clearly behooves practitioners to make sure they buttress any deductibility or characterization claim in a settlement agreement.

In New York, too often cases get settled with nothing more than a stipulation of discontinuance with prejudice, and an exchange of form general releases.

I like settlement agreements. They need not be filed (in fact I won’t file unless a court orders filing, and I’ve never seen that). But they can be mighty handy.

This is the lesson Judge Laro teaches Ronald Lawson and Karen Bey, 2015 T. C. Memo. 211, filed 10/28/15.

Ron sued Bank of America twice, alleging a total of $68K was abstracted from his accounts due to BOA’s negligence and breach of fiduciary duty.

Karen has enough troubles of her own, which take up most of the opinion, but they’re the non-substantiation type and fact-driven, so I’m sticking to Ron’s story.

Ron settles both lawsuits for a $40K payout. Ron only gets $31K, because his lawyer and court costs get paid. But the only documents are a stip of discontinuance and a form general release; no agreement stating what was settled.

Ron claims he only got back the money that was wrongfully taken from him, thus no accretion to wealth. IRS claims that you can’t tell what was settled from the documents, the burden is on Ron, and he can’t carry it with the paper he has.

I note in passing that Judge Laro is an accomplished tax practitioner, but it would seem he hasn’t done much general litigation. My offer of proof for the foregoing: “The general release and the stipulations are silent as to whether the payment was supposed to restore funds taken from Mr. Lawson’s account or was just to get rid of a nuisance lawsuit.” 2015 T. C. Memo. 211, at pp. 29-30.

Judge, no one settles a “nuisance lawsuit” where the claim is $68K for $40K. At best, if the lawsuit really has nuisance value, the offer might be $5K. A settlement at nearly two-thirds of the demand means plaintiff had a case.

Howbeit, here’s the warning for New York lawyers (and others): “Under the origin of the claim doctrine, courts look into the nature of the underlying claim to determine whether a settlement payment or judicial award is excludible from gross income and to determine the proper tax treatment of the proceeds. Courts look to the terms of a settlement agreement to determine whether a settlement is taxable. Where the agreement is silent as to the basis of the settlement or where the agreement does not specify that the payment was for a reason that a court finds to be nontaxable, this Court has held the settlement payment to be taxable.” 2015 T. C. Memo. 211, at pp. 28-29. (Citations omitted).

Of course Ron was pro se, and the opinion doesn’t disclose if he asked his attorney to testify.

Granted, negotiating the settlement agreement might be just as much work as negotiating the deal that gave rise to the settlement. But, if done right, it might save the client a lot of tax.

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