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Columns: Tax Talk
George Saenz, CPA   Expert: George Saenz, CPA
Tax Talk
Sexual discrimination lawsuit ends in taxes plus interest
Tax Talk

When are settlements taxed?

Dear Tax Talk:
When filing my 2006 taxes, my accountant included a letter to the IRS stating that I had received from a former employer a Form-1099 to show monies I received from a lawsuit won from my former company. The lawsuit was for sexual harassment and retaliation/loss of job due to the incident. The IRS is back at me. Do I have any recourse? My accountant deemed it nontaxable, but now changes his thoughts. Now I have accrued interest for not claiming it. I am also being taxed on my attorney's cut in the settlement.
-- Karen

Dear Karen,
Not only were you victimized at work, you also appear to have been the victim of an unknowing accountant. In 1995, the tax law was changed so that settlements from sexual discrimination lawsuits were considered taxable income. Perhaps your accountant just was not keeping current. Prior to this time, settlements were excluded on the basis that they were on account of physical injury. The law change distinguished physical from emotional injury and made awards on account of emotional injury taxable.

You can exclude from your income any reimbursement in the settlement that was for medical care due to the emotional distress. Also, you can claim your attorney's fees as an adjustment to your gross income so that you do not have to pay tax on the part of the claim that was awarded to your attorneys.

Unfortunately, you're stuck paying the tax and interest on the award. You should respond to the IRS letter indicating the amounts that should be excluded from the award as a result of medical care and attorney's fees, and attach appropriate documentation, such as invoices.

Bankrate.com's corrections policy -- Posted: Feb. 28, 2008
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