Emotional Distress

Today TaxMama hears from Keri in Massachusetts, who tells us. “I just received an offer for a $50,000 settlement for emotional distress due to a sexual harassment lawsuit I have against a company. They want to 1099 me at the end of the year for the settlement. So I need to know before I agree to this if I am going to have to pay taxes on this settlement or not? I’ve heard, with emotional distress cases you do “not” have to claim it; but I need to know for sure.”

Dear Keri,

Consider meeting with your own tax professional to get a
definitive opinion. This is a big decision.

I don’t know who told you emotional distress settlements were tax free. Perhaps the company’s attorney?

In general, unless you’ve had a physical injury, or needed to get treatments for physical symptoms resulting from the emotional distress, the settlement is taxable.
http://www.irs.gov/publications/p17/ch12.html#en_US_publink100033120
http://www.irs.gov/publications/p525/ar02.html#en_US_publink100098487

IRS says: You can exclude “damages you receive for medical care due to that emotional distress. Emotional distress includes physical symptoms that result from emotional distress, such as headaches, insomnia, and stomach disorders.”

So, take a close look at the real tax effects of that award with a tax professional who can run some projections for you to see what the net cash to you will be.

For tax purposes, I believe this is the formula (I may be wrong – that’s why it’s important for you to work with some who has experience with distress settlements – ask your attorney who s/he works with on similar cases):

Step One

1) You have to report the full amount of the taxable portion of the award in your income.
2) Attorney fees get deducted on Schedule A, less 2% of your adjusted gross income (add your usual income to the amount of the award and multiply it by 2%)
3) Now compute the IRS and state taxes that result

Step Two:

1) $50,000 – Start with the amount of the award.
2) (17,500) – Deduct attorney fees

3) ( 2,500) – Deduct any fees the attorney must disburse.
3) ( 9,000) Deduct IRS and state taxes. (Approx 30%)

So, what’s left?About $21,000 or so.

That planning meeting will help you decide if the net check

is really worth it. Before you turn down any offer, speak with your attorney about the realistic chances of getting a higher settlement – or of winning a larger judgment in court (after court costs).

Stay tuned to the Comments on TaxQuip #1134 to see if anyone has any further suggestions.
http://taxquips.com/index.php?id=1134

Good luck!

And remember, you can find answers to all kinds of questions about sexual harassment and other tax issues, free. Where? Where else? At TaxMama.com

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