Legal Settlement Minimizing Tax Impact

[Luck_Club]

I'm currently settling a lawsuit for my company, and the other party wants to pay the settlement in a lump sum. The suit was for lost profits or lost income, so it is a taxable event. The income loss was over 10 years. I seek the wisdom and guidance of how to best handle this.

My attorney is telling me the following:
1) They want to settle with me personally (worst option in my mind).
2) A structured settlement isn't an option.

For a number of reasons I don't want to receive the rather large sum of income in 2017. It essentially has the impact of leaving me about 1/3 of the gross amount after taxes and another negative financial impact.

I know and fully intend to pay taxes on the income, so I'm not trying to avoid that, but structure the realization of that income.

My preferred receipt of the settlement would be:
1) payed to my company over a 10 year period
2) Paid to me personally over a 10 year period
3) Paid to my company in a lump sum in 2018
4) Paid to my company in a lump sum in 2017
5) Go to court rather than the lump sum personally in 2017.

 

[2017ish]

Who was the named plaintiff?

 

[pb4uski]

You say a structured settlement is not an option. Why not?

The defendant can pay the lump sum to an insurer and then the insurer pays benefits to the plaintiff over a period of time you define (10 years in this case).

Once the defendant has paid the money to the insurer, they are no longer obligated to you.t...

Another thought .... if the defendant wants to settle but is unwilling to allow a structured settlement then you need to ask for more to compensate you for the tax cost to the plaintiff of that form of settlement (ie; the defendant needs to make the plaintiff whole for the taxes on the lump sum). So if your damages are based on lost profits, presumably that is after-tax profits of let's say $1 million, and they insist on settling in a lump sum then you should strive to settle for an amount that nets you $1 million after-tax. Once you frame your demand that light they may decide that a structured settlement isn't so bad after all.

 

[Luck_Club]

Who was the named plaintiff?

The lawyer filed under my name DBA company name.

 

[pb4uski]

and I take it that your DBA is a Schedule C proprietorship? or LLC? or an S corp? but not a C corp?

 

[Luck_Club]

You say a structured settlement is not an option. Why not?

The defendant can pay the lump sum to an insurer and then the insurer pays benefits to the plaintiff over a period of time you define (10 years in this case).

Once the defendant has paid the money to the insurer, they are no longer obligated to you.t...

Another thought .... if the defendant wants to settle but is unwilling to allow a structured settlement then you need to ask for more to compensate you for the tax cost to the plaintiff of that form of settlement (ie; the defendant needs to make the plaintiff whole for the taxes on the lump sum). So if your damages are based on lost profits, presumably that is after-tax profits of let's say $1 million, and they insist on settling in a lump sum then you should strive to settle for an amount that nets you $1 million after-tax. Once you frame your demand that light they may decide that a structured settlement isn't so bad after all.

This is what I thought as well. Then when the payments come out they are taxable as income. I basically told my attorney that the settlement if it wasn't structured kind of wasn't worth it to me, and this is how they responded.

It is legally impossible to structure this type of settlement (a claim for lost income) without incurring a taxable event for the total amount of the “income” received (after expenses and legal fees are deducted to the extent allowable under the tax regulations).

Personal injury cases involving minors or catastrophic loss often have a structure included in the settlement that is non-taxable. This is because pain/suffering/disability compensation is not taxable as income under IRS or State rules.

In your matter the best accounting methods to deal with the influx of income may be amending prior year tax returns to spread out the income. You were making a claim for income lost over some very specific years. Did your accountant look into this aspect?

Your case is completely different from a personal injury case with a structured settlement – your case is 100% a claim for lost income and thus is subject to standard IRS rules for income received. The last thing we want is the IRS filing criminal charges against us for complicity to evade income taxes a client owes.

Here’s a relevant IRS link: https://www.irs.gov/pub/irs-pdf/p4345.pdf

Lost profits to a business are addressed on page two.

If filing amended tax returns is not a viable option, I suggest investing the lump sum in a manner designed to create income to offset the tax bill you will incur/pay in 2018 (or quarterly if that is your current methodology). Getting this settlement directly from the Defendant into an annuity will not avoid the tax issue.

 

[haha]

My preferred receipt of the settlement would be:
1) payed to my company over a 10 year period
2) Paid to me personally over a 10 year period
3) Paid to my company in a lump sum in 2018
4) Paid to my company in a lump sum in 2017
5) Go to court rather than the lump sum personally in 2017.

There are many experienced people who do this sort of thing over and over.

If this involves a considerable amount of money, why are you asking advice on an anonymous internet form?

Ha

 

[Luck_Club]

and I take it that your DBA is a Schedule C proprietorship? or LLC? or an S corp? but not a C corp?

Yes it is a schedule C business, and has 14 years of filing under an EIN.

 

[Luck_Club]

There are many experienced people who do this sort of thing over and over.

If this involves a considerable amount of money, why are you asking advice on an anonymous internet form?

Ha

Because, I have found this advice to be a good double check against the vagaries of personal self interest. I just don't want to screw it up.

I truly view this board as a group of anonymous friends who can give you advice with no malice, jealousy or ulterior motives.

 

[GrayHare]

There was an article in Forbes about this within the past 2 years, but darned if I can find it now. The jist was the parties have much flexibility in what restitution is called for tax purposes. For example, the payments might be termed "reimbursements". Now whether your case is subject to more limitations than what the Forbes article discussed I do not know.

If the restitution represents lost income over a period of years, but is to come as a lump sum in one year, it seems to me you have a strong argument that the tax on a lump sum would be greater than income spread across years, and thus the lump sum should be larger to reflect increased taxes.

 

[Luck_Club]

There was an article in Forbes about this within the past 2 years, but darned if I can find it now. The jist was the parties have much flexibility in what restitution is called for tax purposes. For example, the payments might be termed "reimbursements". Now whether your case is subject to more limitations than what the Forbes article discussed I do not know.

If the restitution represents lost income over a period of years, but is to come as a lump sum in one year, it seems to me you have a strong argument that the tax on a lump sum would be greater than income spread across years, and thus the lump sum should be larger to reflect increased taxes.

Found it and reading it now.. Thanks for the help.

 

[pb4uski]

This is what I thought as well. Then when the payments come out they are taxable as income. I basically told my attorney that the settlement if it wasn't structured kind of wasn't worth it to me, and this is how they responded.

I'm quite surprised that the defandant's counsel is giving you tax advice, but they may be right... what does your counsel and CPA say? I do note that the IRS document that they referred to says "If you receive a settlement for lost profits" and I'm not sure if the settlement is structured that you have received income or not... a good question for your CPA, including the possibility of amending past tax returns. But if that route is viable, then the settlement should include the cost of filing those amended returns since you would have avoided those costs absent their transgressions.

However, if the settlement would be taxable to you immediately then they should pay you an amount that, after taxes, is equal to the value of after-tax lost profits including the time value of money.

 

[Texas Proud]

Yes it is a schedule C business, and has 14 years of filing under an EIN.

Then why did your attorney put it down as a DBA?

From what it sounds like is YOU personally sued and the company... so, unless you can amend I think you are stuck....


I would think that the attorney would know what you can and cannot do...

BUT, I would not want to have this entity owing me any money after the settlement.... they already tried to screw you once, who is to say they will not do it again IOW, get all the money from them no matter how you structure it...


BTW, if the company collected it it would also be taxable in 2017... so, you would need to do tax returns for both ways to see what has the least tax impact... (that is if you can get the money to the corp)....

 

[Luck_Club]

I'm quite surprised that the defandant's counsel is giving you tax advice, but they may be right... what does your counsel and CPA say? I do note that the IRS document that they referred to says "If you receive a settlement for lost profits" and I'm not sure if the settlement is structured that you have received income or not... a good question for your CPA, including the possibility of amending past tax returns. But if that route is viable, then the settlement should include the cost of filing those amended returns since you would have avoided those costs absent their transgressions.

However, if the settlement would be taxable to you immediately then they should pay you an amount that, after taxes, is equal to the current value of after-tax lost profits plus the time value of money.

It is actually my attorney telling me all this not theirs. He is saying structured isn't an option. He is saying risk of court is high. I agree, and which is why the settlement looked like a good outcome, but thinking about it further it isn't. I was pushing to hold out for more, but he was pushing to settle.

 

[Luck_Club]

Then why did your attorney put it down as a DBA?

From what it sounds like is YOU personally sued and the company... so, unless you can amend I think you are stuck....


I would think that the attorney would know what you can and cannot do...

BUT, I would not want to have this entity owing me any money after the settlement.... they already tried to screw you once, who is to say they will not do it again IOW, get all the money from them no matter how you structure it...


BTW, if the company collected it it would also be taxable in 2017... so, you would need to do tax returns for both ways to see what has the least tax impact... (that is if you can get the money to the corp)....

I don't know why he did it personally. I know getting the money into the company will open up alternatives to delay the realization of income. They would be aggressive, but not evasion which is jail time.

 

[Texas Proud]

I don't know why he did it personally. I know getting the money into the company will open up alternatives to delay the realization of income. They would be aggressive, but not evasion which is jail time.

I disagree.... it is going to be income when you receive it no matter which entity gets it... if the corp gets it it will be income... now, you might have other ways to create a loss to offset the income, but if that cannot be turned into income at some point in time that is a stupid move...

 

[Luck_Club]

I disagree.... it is going to be income when you receive it no matter which entity gets it... if the corp gets it it will be income... now, you might have other ways to create a loss to offset the income, but if that cannot be turned into income at some point in time that is a stupid move...

I agree. I'm not sure how to do it yet, but I'm thinking of ways to delay the income through inventory purchases, capital equipment and other type of accounting rules. I'm not saying I can delay the whole amount, but I should be able to offload some of it.

 

[pb4uski]

Can you shelter a good portion of the settlement from tax by contributing the proceeds to a solo 401k which would offset the income?

The amending of past tax returns is an interesting angle, especially if your claim detailed damages as lost profits for specific years and if the settlement somehow acknowledges that and outlines what part of the settlement belongs to what years... not sure if it would work but it might be worth talking to a CPA if the settlement is significant.

 

[Texas Proud]

I agree. I'm not sure how to do it yet, but I'm thinking of ways to delay the income through inventory purchases, capital equipment and other type of accounting rules. I'm not saying I can delay the whole amount, but I should be able to offload some of it.

Is it a cash basis corp? But, IIRC even if it is buying inventory will not be an expense... capital equip can be expensed, so that is one way.... as long as you need those items...

 

[Texas Proud]

Can you shelter a good portion of the settlement from tax by contributing the proceeds to a solo 401k which would offset the income?

The amending of past tax returns is an interesting angle, especially if your claim detailed damages as lost profits for specific years and if the settlement somehow acknowledges that and outlines what part of the settlement belongs to what years... not sure if it would work but it might be worth talking to a CPA if the settlement is significant.

As an individual it will not work... cash basis taxpayer and it is when you receive the cash...

Now, there might be some obscure rule or reg that does cover this, so yes it is worthwhile in asking an expert...

 

[Luck_Club]

There are many experienced people who do this sort of thing over and over.

If this involves a considerable amount of money, why are you asking advice on an anonymous internet form?

Ha

As a final note on this. I did find a solution, but it wasn't easy. Because it was a breach of contract case and not a personal injury type case, the field of players was reduced to 1 that I could find which was Liberty Mutual.
https://lifemadeeasy.libertymutual.com/pages/ss-nonqualified.aspx



I start receiving 60 monthly payments on January 1, 2020.
Coincidentally the same day I will be willing to officially retire.
It is also the first year my income won't be counted in the FASFA.
And to top it all off, I get to deduct all the legal fees for my attorney this year, thus further reducing my income for the year.

 

[pb4uski]

Did your lawyer find the solution or did you? I assume that the payments are income so it will spread out the tax hit as you wanted?

 

[Luck_Club]

Did your lawyer find the solution or did you? I assume that the payments are income so it will spread out the tax hit as you wanted?

It was my effort. No one cares more about my money then Me.
I educated the attorney, and paid him for the privilege.

 

[pb4uski]

Things like that drive me bonkers.