Belleville: 618-234-9800 | Edwardsville: 618-656-2244 | ST. LOUIS: 314-421-2325

By: Natalie T. Lorenz

Imagine, you finally get the check you have been waiting for after your case settled or ruled in your favor. You are excited and most of all relieved to have the money you needed. You spend that money to pay off your medical bills, replace things that were damaged, or even just spoiling yourself. Now, it is tax season and while you are filing you find out that you had to pay taxes on that settlement. The money is gone and now you have to pay the taxes on the money out of pocket. What are you going to do?

Rewind. Start thinking about taxes before you file your claim. Knowing that the money you obtain from your case is going to be taxable should be a big factor in the amount you ask for and the course of action your case takes. Considering taxes during every stage of your case may influence settlement negotiations or assist the parties in planning a recovery pursuant to a judgment to achieve favorable tax treatment. The effect your case has on your taxes can be significant if you do not consider the tax consequences.

The fundamental principle governing the taxability of settlements and judgments is that the origin of the claim controls the tax treatment of any recovery, whether the recovery is received pursuant to judgment or pursuant to settlement. According to the U.S. Supreme Court, any money paid is to be taxed in the same manner as the item for which it is intended to be a substitute in the same manner as would be the case if received without filing a. As a general proposition, the converse is also true. The deductibility of a payment made pursuant to judgment or settlement depends on whether the amount could be deducted for federal income tax purposes it had been paid before the case was filed.

The Tax Cuts and Jobs Act amended the deductibility of payments made to settle sexual harassment and abuse claims. This provides that no deduction is allowed for any settlement, payout, or attorneys’ fees “related to” sexual harassment or sexual abuse if such payments are subject to a nondisclosure agreement. Counsel for employers should take particular care to avoid inadvertently disallowing a deduction when drafting severance agreements containing general releases. There is no caselaw interpreting this new provision, and a court could potentially view a payment subject to a general release as a payment for the release of a sexual harassment or sexual abuse claim. If the severance agreement is subject to a nondisclosure provision, the payment may not be deductible, depending on how this provision is interpreted by the courts.

Professional Services Disclaimer: Please note that the information presented here is as an educational service, and while it contains information about legal issues, it is not legal advice. No warranty is made regarding the applicability of the information presented to a particular client situation, and the information set forth is not a substitute for original legal research, analysis and drafting for a particular client situation.