Settlement Planning a Must for Taxable Recoveries

Discrimination Settlement = Taxable Settlement = Less After Taxes without Settlement Planning

This week DeSanto Rollins, a defensive tackle for Mississippi University filed suit in federal court against coach Lane Kiffin and the school for racial and sexual discrimination and negligence, saying he was kicked off the team during a mental health crisis.? Any discrimination settlement he receives could come with substantial tax problems that proper settlement planning and a structured settlement could help mitigate.?

Rollins, who is Black, is seeking $10 million in compensatory damages and $30 million in punitive damages. He claims he was not supported through his depression the way white and female athletes have been at Ole Miss.

If Rollins does prevail and obtains a sizeable discrimination settlement, will he have actually won anything or will taxes erode what he receives?? Rollins is claiming injuries that are considered non-physical as well as punitive, which Congress, the IRS and the courts consider taxable as income to him.

Requirements for Tax-Free Injury Settlements under Section 104(a)(2)

To ensure a tax-free injury settlement under Section 104(a)(2) of the Internal Revenue Code, it must meet two criteria: it cannot include punitive damages, and the compensatory damages must be related to a personal physical injury or physical sickness. Even physical manifestations of emotional distress injuries like ulcers or heart murmurs are considered taxable.?

This standard goes back to 1996 when Congress limited the exclusion for recoveries to physical, as opposed to personal injuries or sickness.? Nor can a taxpayer simply reallocate damages in a release for better tax treatment at the last second.?

Tax exemptions have specific characteristics:

• ?They should be narrowly construed.
• They need to be substantive.
• They should not be contradicted by extrinsic evidence, such as information found in a Complaint or articles from sources like Sports Illustrated, the Associated Press, or NBC news that discuss non-physical injuries or punitive damages.

Understanding the Tax Consequences: Gross Settlement Amounts, Attorney Fees, and Structured Settlements

The adverse tax treatment of taxable damages and punitive damages doesn't stop there for this particular case and others like it.? Under the Supreme Court decision of Commissioner v. Banks, 125 S.Ct. 826, a taxpayer would owe tax on the gross amount of the settlement or award, inclusive of what is being paid to their attorney.? Further, under the Tax Cut and Jobs Act of 2017, a taxpayer may not be able to deduct what is paid to their attorney on a taxable settlement with few exceptions.

It is conceivable a taxpayer with a multi-million dollar taxable settlement could walk away with little to nothing after taxes and fees.? Taxpayers anticipating a taxable settlement should obtain tax advice on the optimal settlement strategy, including options like tax-deferred payments via a structured settlement.

To ignore the tax consequences of a discrimination settlement (or any taxable settlement) and forgo settlement planning is akin to snatching defeat from the jaws of victory.

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