Can you Win a Law Suit and Then Need to Pay Taxes – Perhaps for More Than You Received?

I have been around for 50 years of elections, so am not to be overly surprised by lack of common sense from Congress and our President, but the latest revelation makes my stomach hurt.

What Now??

With the new Tax Cuts and Jobs Act (TCJA) it is just coming to light that a person injured and later successful in suing must pay taxes on their entire recovery – including the attorney fees award.

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I have to pay more in taxes than received from my lawsuit!!!

Scenario #1: You hire a lawyer to sue for the wrongful death of your spouse.  That attorney does a terrible job (does not show up for court, fails to file necessary documents, etc.)  After losing the wrongful death action (which everyone says should have been a slam dunk) you sue the attorney for malpractice.  You are awarded $100,000; the attorney takes their fees $40,000 which leaves you with $60,000.

Result:  You pay taxes on the entire award of $100,000, depending on your tax rate, it could be $30,000.  Minus your attorney fees of $40,000, which leaves you with $30,000.  Your attorney also pays taxes on $40,000 fees.

How was it before the 2018 tax law?

You pay taxes on $60,000 left after your attorney is paid, probably around $18,000 (again depending on your tax rate) leaving you with $42,000.  Your attorney pays taxes on $40,000.

There can also be a situation where you pay more in attorney fees and taxes than you actually receive.

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Scenario 2:  Your neighbor or employer makes your life a living nightmare.  You sue and after years of litigation you receive an award of $5,000, plus $45,000 in attorney fees.

Result: you pay taxes on $50,000 of about $12,500 (assuming you can use the 25% rate), BUT YOU ONLY RECEIVED $5,000.  Your attorney pays taxes on $45,000.

Why this insanity?

Because the new tax law removed the miscellaneous itemized deduction category on tax returns, which is where you normally deduct payments to professionals such as an attorney.

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