SETTLING CASES AND TAXES

Size: px

Start display at page:

Download "SETTLING CASES AND TAXES"

Chrystal Burns
8 years ago
Views:

1 SETTLING CASES AND TAXES WILLIAM A. ROBERTS The Roberts Law Firm (972) State Bar of Texas 28 TH ANNUAL ADVANCED CIVIL TRIAL COURSE August 31 September 2, Austin September 28 30, 2005 Dallas November 9 11, 2005 Houston CHAPTER 23

com State Bar of Texas 28 TH ANNUAL ADVANCED CIVIL TRIAL COURSE

3 WILLIAM A. ROBERTS Bill Roberts heads The Roberts Law Firm, the second largest tax boutique in Dallas, Texas, which specializes in federal tax litigation, planning, and asset protection. He is one of the foremost tax specialists in Texas, handling matters in all four federal districts throughout the state as well as the Fifth Circuit and the Tax Court. Prior to entering private practice, Bill was a Trial Attorney with the Tax Division of the United States Department of Justice. He is the former Editor-in-Chief of his law review. He graduated seventh in his class from Pepperdine School of Law in Mr. Roberts has been practicing law for over 24 years. He has been lead counsel for more than 120 Tax Court cases and tried over fifty cases in District Court. After receiving the Meritorious Award from the Justice Department, Mr. Roberts joined a Dallas tax firm in In January 1994, Mr. Roberts opened his own firm in North Dallas. He is licensed in Texas and California, the Commonwealth of Virginia and the District of Columbia. He is a frequent speaker throughout the state for professional organizations and universities on tax planning, IRS procedure and litigation matters.

Prior to entering private practice, Bill was a Trial Attorney with the Tax Division of the United States Department of Justice. He is the former Editor-in-Chief of his law review.

5 Settling Cases and Taxes Chapter 23 TABLE OF CONTENTS I. THE LAW CHANGED ON JANUARY 24, II. THE PRACTICAL EFFECTS... 1 III. WHAT TO DO... 1 A. Personal Injuries or Sickness... 1 B. Return of Capital... 1 C. Technical Tax D. Another Approach i

7 Settling Cases and Taxes Chapter 23 SETTLING CASES AND TAXES The problem: You do a great job. You receive a 1 million dollar settlement for your client. You were smart enough to do a 40% contingency. And your client ends up with.. $315, Result: You have taken what should have been a great result with a client that gushes at the mention of your name to another story of greedy attorneys. No referrals, no up side. We can change this with a little planning. First, the good news. There are only three (3) things to remember from this address. 1. Personal Injury 2. Return of Capital 3. Technical Tax. There is also one more advanced concept, see below. I. THE LAW CHANGED ON JANUARY 24, The law changed when the Supreme Court ruled in Commissioner v. Banks, No and Commissioner v. Banatis, No , that when a litigant s recovery constituted taxable income, such income includes that portion of the recovery paid to the litigant s attorney as contingent fee. Previously, in the legal world we all came of age in, attorneys fees were not included in income to the taxpayer. See the Fifth Circuit s position set out in Srivastava v. Commissioner, 220 F.3d 353, (C.A ). In our example above, under the old law, your client would net $413, or about $98, more. II. THE PRACTICAL EFFECTS. Assume that you secure a settlement of $2,000, for your client. Also assume the 40% contingency. And finally, assume it is a taxable recovery. Under the new rules your client will get $627, (and you will receive $800,000.00). Under the old rule your client would have netted an additional $169,987.00, after taxes. III. WHAT TO DO. First, some practical suggestions. 1. Get the CPAs involved. If the client has a CPA, use theirs. If not, use yours. But get basic tax advice early. 2. Think taxes before settlement negotiations. Better yet, think taxes when drafting the pleadings Don t be a tax expert. Call an attorney that is. (The expense is small, compared to the savings, and most tax attorneys will work on the come, albeit at a higher rate.) Here are the three basic ways to save your client taxes. The Supreme Court was very careful in its wording: when a litigant s recovery constitutes income. This is the key. Making sure you do not inadvertently make a recovery income to your client. A. Personal Injuries or Sickness The starting place is Section 104 (a) (2) of the Code. Gross Income does not include- (2) the amount of any damages (other than punitive damages) received (whether by suit or agreement and whether as a lump sum or as periodic payments) on account of personal physical injuries or physical sickness. This is the home run. If the money is to compensate either personal injuries or sickness, there is no tax. In our example of the one million dollar settlement, your client nets $600, The courts look first to the settlement documents (or the judgment) and secondly to the pleadings. 1. Make sure your pleadings address all physical injuries and sickness. (My definition of sickness is if there is a pill for it, it is a sickness). 2. Make sure the settlement document clearly addresses Section 104 injuries or sickness. (It helps). 3. Think on 2 levels. There are tax free recoveries and taxable recoveries. (Most cases have both). B. Return of Capital There are tax advantages in commercial and contract cases. Loss of Capital is seldom pled. It should be. There can be real savings to your client. In simple terms, return of capital is not taxable. Hence, any amounts recovered as return of capital are not taxable. Correspondingly, neither would attorney fees associated with that return be included under Banks. Again, the courts will look first to the settlement documents and then to the pleadings. They will seldom look at discovery. Let s take an example. Your million dollar settlement is for a breach of contract that leads to the failure of your client s company. They had invested $400,000 in their company. And we immediately come to why tax law is so frustrating. This scenario gives you two choices. In simplistic terms, if you bring your suit on behalf of the company, the corporation would receive roughly

No referrals, no up side. We can change this with a little planning. First, the good news. There are only three (3) things to remember from this address. 1. Personal Injury 2. Return of Capital 3.

8 Settling Cases and Taxes Chapter 23 $390,000. If you bring suit for the stockholders, they would receive $480,000. C. Technical Tax. There are numerous sources of income that are not included in Adjusted Gross Income for tax purposes. See for example, 26 U. S. C. Section 62. For example, in the case that changed the rules on Attorney s Fees, had that case been brought at a later date, the recovery would not have been includable in gross income under Section 62 (a) (19) (recovery for unlawful discrimination). Other sources that may not be subject to taxation are: 1. Certain Rents and Royalties 2. Certain Pension or Profit Sharing Plans 3. Alimony 4. Moving Expenses 5. Certain Condemnation Awards There are many others. Don t worry about tax law, but do have a tax litigator/planner you can talk to. There are too many rules, regulations and loopholes to ever learn and be a normal lawyer. D. Another Approach. Much of the Supreme Court s discussion in Banks centered on how the attorney is the agent and not the owner of the claim. Without getting to the ethical questions, there may be situations in larger cases where it would be in the client s tax interest to form a Joint Venture or Limited Partnership with the attorney. This is a novel approach and has many pluses and minuses. But in the right case it could be advantageous for you and your client. Acknowledgments: All tax calculations courtesy of Tony Morgan of Gollob, Morgan, Peddy & Co. They can be reached at

For example, in the case that changed the rules on Attorney s Fees, had that case been brought at a later date, the recovery would not have been includable in gross income under Section 62 (a) (19)

RECENT DEVELOPMENTS IN TAXATION OF COURT COSTS AND ATTORNEY FEES FOR INDIVIDUALS

RECENT DEVELOPMENTS IN TAXATION OF COURT COSTS AND ATTORNEY FEES FOR INDIVIDUALS NOTE: This article was referenced in the June 2005 In Brief in the article entitled, Taxes on Attorney Fees. It is a more detailed explanation of the issues discussed in that article. Our thanks to Philip