Dear Tax Talk,
Taxability of court-ordered money
If someone gets a settlement from a pharmaceutical
company for a lawsuit against a prescription drug they took,
does it have to be claimed as income when doing taxes?
A settlement for personal physical injuries is never taxable.
If the drug was proven to have adverse side effects that would
cause physical harm, then the settlement would not be taxable
income and would not be reported on your tax return.
A settlement that stems from mental suffering,
however, such as age or sex-based discrimination, would be
In an interesting turn, the law has changed
with respect to the deduction of contingent attorney's fees
in damage awards. Usually an attorney will accept a damages
case on a contingent-fee basis. The attorney charges up to
40 percent of the awarded damages.
The Internal Revenue Service has been contending
in the courts for a while that the litigant must claim the
full amount of the damage award as income, if otherwise taxable,
and claim a miscellaneous
itemized deduction for the 40-percent attorney's fee.
Since miscellaneous itemized deductions are not tax deductible
minimum tax, a claimant ended up with little of the award
after paying the attorney and the IRS.
The IRS was successful when the Supreme
Court decided in January that its position was a correct interpretation
of the law. However, the decision was rendered practically
moot by the American Jobs Creation Act of 2004. The act changed
the rules so that a claimant will only pay tax on the amount
awarded net of attorney fees. This new law applies to a broad
array of legal claims. Unfortunately however, the act's provision
is only effective for awards and settlements occurring after
its enactment on Oct. 22, 2004. For those cases settled prior
to that date, it appears that the IRS's position will be the
-- Posted: Feb. 15, 2005