excluding part of a settlement from income?

[TaxHombre]

a client of mine received a $25K payment from his former
employer. the nature of his claims were as follows: "[the
plaintiff proposes to bring claim against the defendant in a
court of law, seeking] settlement of claims for lost salary
and other compensation, emotional distress, punitive
damages, attorneys' fees, costs and interests. In lieu of
this claim, the plaintiff demands payment] for a portion of
lost salary and other compensation, and other damages."

since some of the claim was for lost salary, and some for
emotional distress and punitive damages, is it possible that
some of the settlement is free of income tax?

i've never run into this situation before, and i welcome
your comments.

thanks,
peter desmond

 

[peter desmond]

a client of mine received a $25K payment from his former
employer. the nature of his claims were as follows: "[the
plaintiff proposes to bring claim against the defendant in a
court of law, seeking] settlement of claims for lost salary
and other compensation, emotional distress, punitive
damages, attorneys' fees, costs and interests. In lieu of
this claim, the plaintiff demands payment] for a portion of
lost salary and other compensation, and other damages."

since some of the claim was for lost salary, and some for
emotional distress and punitive damages, is it possible that
some of the settlement is free of income tax?

i'm wondering if this is so out of the ordinary that no one
has an opinion? my client, of course would like to exclude
the entire settlement on the grounds of emotional distress,
but the settlement does also mention "lost salary." salary
would be taxable.

peter

 

[MAT1040X]

a client of mine received a $25K payment from his former

employer. the nature of his claims were as follows: "[the
plaintiff proposes to bring claim against the defendant in a
court of law, seeking] settlement of claims for lost salary
and other compensation, emotional distress, punitive
damages, attorneys' fees, costs and interests. In lieu of
this claim, the plaintiff demands payment] for a portion of
lost salary and other compensation, and other damages."

since some of the claim was for lost salary, and some for
emotional distress and punitive damages, is it possible that
some of the settlement is free of income tax?

i'm wondering if this is so out of the ordinary that no one
has an opinion? my client, of course would like to exclude
the entire settlement on the grounds of emotional distress,
but the settlement does also mention "lost salary." salary
would be taxable.

Unless the settlement was for physical injury, it would seem
that the entire amount would be taxable. But that is just
an opinion, maybe someone has another view.

Mary Ann Thomas, EA in AZ

 

[L K Williams]

a client of mine received a $25K payment from his former
employer. the nature of his claims were as follows: "[the
plaintiff proposes to bring claim against the defendant in a
court of law, seeking] settlement of claims for lost salary
and other compensation, emotional distress, punitive
damages, attorneys' fees, costs and interests. In lieu of
this claim, the plaintiff demands payment] for a portion of
lost salary and other compensation, and other damages."

since some of the claim was for lost salary, and some for
emotional distress and punitive damages, is it possible that
some of the settlement is free of income tax?

i've never run into this situation before, and i welcome
your comments.

Only awards based on physical injury are excludable. Since
the basis on your client's claim is an employment issue,
there can be no physical injury involved and no portion of
the settlement can be excluded.

Lanny K. Williams, CPA
Nawarat, Williams & Co., Ltd.
Income Tax Services for Expatriate Americans

 

[A]

since some of the claim was for lost salary, and some for
emotional distress and punitive damages, is it possible that
some of the settlement is free of income tax?

No, only compensatory damages that are awarded due to
"physical injury or physical sickness" can be excluded from
gross income. All other compensatory and all punitive
damages must be included in gross income.

A

 

[Stuart O. Bronstein]

(e-mail address removed) (TaxHombre) wrote:

a client of mine received a $25K payment from his former
employer. the nature of his claims were as follows: "[the
plaintiff proposes to bring claim against the defendant in a
court of law, seeking] settlement of claims for lost salary
and other compensation, emotional distress, punitive
damages, attorneys' fees, costs and interests. In lieu of
this claim, the plaintiff demands payment] for a portion of
lost salary and other compensation, and other damages."

since some of the claim was for lost salary, and some for
emotional distress and punitive damages, is it possible that
some of the settlement is free of income tax?

i'm wondering if this is so out of the ordinary that no one
has an opinion? my client, of course would like to exclude
the entire settlement on the grounds of emotional distress,
but the settlement does also mention "lost salary." salary
would be taxable.

I've seen cases on this, but it's been a long time and I am
not exactly sure of what they say without looking them up.
My recollection (which may be incorrect) is that, unless the
settlement agreement allocates money among the various
categories, it will all be taxable.

Stu

 

[Hamlet the Prince]

The 25K is fully taxable. No exclusions apply.

 

[D. Stussy]

a client of mine received a $25K payment from his former

employer. the nature of his claims were as follows: "[the
plaintiff proposes to bring claim against the defendant in a
court of law, seeking] settlement of claims for lost salary
and other compensation, emotional distress, punitive
damages, attorneys' fees, costs and interests. In lieu of
this claim, the plaintiff demands payment] for a portion of
lost salary and other compensation, and other damages."

since some of the claim was for lost salary, and some for
emotional distress and punitive damages, is it possible that
some of the settlement is free of income tax?

i'm wondering if this is so out of the ordinary that no one
has an opinion? my client, of course would like to exclude
the entire settlement on the grounds of emotional distress,
but the settlement does also mention "lost salary." salary
would be taxable.

I've seen cases on this, but it's been a long time and I am
not exactly sure of what they say without looking them up.
My recollection (which may be incorrect) is that, unless the
settlement agreement allocates money among the various
categories, it will all be taxable.

In this case, all allocable categories are of taxable
nature, so the allocation itself doesn't matter.

 

[Stuart O. Bronstein]

I've seen cases on this, but it's been a long time and I am

In this case, all allocable categories are of taxable
nature, so the allocation itself doesn't matter.

Emotional distress is personal injury. The rest of the
categories, I agree, are taxable.

Stu

 

[Hamlet the Prince]

Emotional distress is personal injury. The rest of the

categories, I agree, are taxable.

There must be physical injury for the emotional distress
proceeds to be excludable. Emotional distress and the
physical symtoms therefrom are not per se physical injury.
If there is no physical injury separate from the emotional
distress, then the settlement proceeds related to the
emotional distress are not excludable. If there is physical
injury separate from the emotional distress, then the
proceeds received based on the claim of emotional distress
that is attributable to physical injury is excludable.

 

[L K Williams]

I've seen cases on this, but it's been a long time and I am

Emotional distress is personal injury. The rest of the
categories, I agree, are taxable.

I don't think so. True, emotional distress would be a
personal injury but that is not enough to make the related
damage exempt from tax.

The basic claim must be for a PHYSICAL injury or illness.
Emotional distress, requiring treatment, that arises from a
physical injury, may than be the basis for a non-taxable
settlement.

In this case, however, there was no physical injury -- the
claim arose from an employment issue. Mere personal injury
is not sufficient.

Lanny Williams, CPA
Nawarat Wiliams & Co., Ltd
Income Tax Services for Expatriate Americans

 

[Brian Collie]

I've seen cases on this, but it's been a long time and I am

Emotional distress is personal injury. The rest of the
categories, I agree, are taxable.

I disagree. Emotional distress is not an injury that allows
exclusion of damages.

Emotional distress is not considered a physical injury or
physical sickness for purposes of the exclusion from income
of damages received on account of physical injury or
physical sickness. But the exclusion from gross income does
apply to the amount of damages received for medical care
attributable to emotional distress. 5

Code Sec. 104(a) .

Thus, the exclusion from gross income does not apply to any
damages received (other than for medical expenses
attributable to emotional distress, as described above)
based on a claim of employment discrimination or injury to
reputation accompanied by a claim of emotional distress. The
term "emotional distress" includes physical symptoms (e.g.
insomnia, headaches, stomach disorders) which may result
from the physical distress. But, because all damages
received on account of physical injury or physical sickness
are excludable from gross income, the exclusion from gross
income does apply to any damages received based on a claim
of emotional distress that is attributable to a physical
injury or physical sickness.

 

[D. Stussy]

I've seen cases on this, but it's been a long time and I am

Emotional distress is personal injury. The rest of the
categories, I agree, are taxable.

Post-1995 emotional distress is taxable. It is not a
PHYSICAL injury.