Attorney-at-Law

BOILERPLATE CAN BE HAZARDOUS TO YOUR TAX HEALTH

In Uncategorized on 06/07/2021 at 16:56

We’ve all seen the standard general releases when a case settles. When attorney malpractice is on the menu, broadform is the plât du jour. Anything and everything, from the beginning of the world to the instant of signing.

We saw how that torpedoes Section 104 physical injury claims. See my blogpost “Would’a,” 2/18/21.

Today Judge Pugh fires a Tax Court longlance into Carol E. Holliday, 2021 T. C. Memo. 69, filed 6/7/21. Carol’s suit involved the common property with her loved-once. Carol claimed her divorce lawyer bulldozed her into a mediated settlement which left her $75K shortstacked. When he moved for a new trial and lost, he promised he’d appeal, but didn’t. So Carol’s next lawyer sued for negligence, gross negligence, deceptive trade practices, treble damages and attorneys’ fees.

Divorce lawyer’s insurer ponies up $175K in full settlement, which malpractice lawyer gets, cuts Carol a check for $101,500, and takes the rest as his fee.

Of course, (a) divorce lawyer sends Carol a $101,500 1099-MISC , (b) Carol reports nothing, (c) IRS hits Carol with a SNOD for the tax on the $101,500, d) Carol claims she got only the property she should have gotten in the marital split, thus no accession to wealth, and (e) IRS ups the deficiency to cover the $73,500 the attorney got, while allowing Carol the miscellaneous itemized deduction therefor and dropping the chops.

True, return of capital is not taxable. But reading the settlement agreement, it’s not clear what Carol got. Her malpractice claim got settled; there’s no admission or assignment of guilt or fault.

“Petitioner argues that the settlement proceeds are only for those claims that involve the marital estate and that they represent compensation for lost value or capital because they ‘are based on her recovery of the property interest that * * * [she] rightfully should have received from her divorce as her share of the marital estate.’ But the settlement agreement says that the settlement proceeds are for the release of  ‘all claims * * * of whatever kind or character, known or unknown * * * which * * * [petitioner] may have against * * * [malpractice defendants] arising out of or related to the * * * [malpractice lawsuit].’ Petitioner thus asks us to look through the settlement agreement and consider only her claims related to recovery of marital property. We decline to look beyond the plain terms of the settlement agreement, and we conclude that the settlement proceeds were to compensate her for her attorney’s malpractice and therefore are taxable.” 2021 T. C. Memo. 69, at pp. 11-12.

Judge Pugh obviously has never been involved in a malpractice litigation. I have been, and I’ve witnessed others. No settling defendant or their insurer will ever itemize, under any circumstances, anything. Every settlement agreement will be in the broadest form human imagination or artificial intelligence can devise. The best petitioner’s counsel can do is put in all the litigation papers, and try to get in expert testimony that no malpractice settlement agreement ever states what was really settled.

And even then, it’s a forlorn hope.

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