The new tax reform law means it's more likely than ever that plaintiffs will have to pay taxes on their gross recoveries from lawsuits. Contingent or hourly legal fees may no longer be deductible on tax returns. This means that on a $100,000 settlement where 40% goes to the attorney, the client is likely to be taxed on the full $100,000, even though the client only nets $60,000. Getting separate checks, one for the attorney and the other for the client, won't solve the problem.
This applies to many contingent personal injury cases, such as settlements where clients receive punitive damages related to a motor vehicle accident. Clients of qualified personal injury cases do catch a break. The new law won't affect cases where the entire recovery is tax free, but that doesn't apply to a lot of cases.
The other place plaintiffs can make use of an above-the-line deduction of attorney fees is when the suit is related to the plaintiff's trade or business. It's still possible that, if the client is in business, and the lawsuit relates to the business, the client could potentially deduct the legal fees as a business expense.
The rest of the time, with few exceptions, the client is likely to be on the hook for taxes on the full recovery amount.
Before now, even when clients couldn't take an above-the-line deduction, they could still take a below-the-line deduction by listing legal fees as a miscellaneous itemized deduction on their return. That's not as beneficial, but could still make a difference. Under the new legislation, that is no longer the case. The miscellaneous itemized deduction for legal fees is gone.
Because of these changes, it's particularly crucial to discuss tax consequences with clients and plan for them. Otherwise, clients are likely to be shocked when presented with a tax bill for substantially more money than they actually received. This news may also affect how much a case is settled for, or if a settlement is reached at all.
With the complications brought on by the new tax laws, referring clients to a tax attorney is now more important than ever. A tax attorney can identify key parts of the tax code to utilize to help mitigate the client's overall tax burden, leaving more money in the client's pocket and less sent to Uncle Sam. Why let unanticipated tax consequences undermine a successful settlement when you can call in a professional to prevent it? Call Travis W. Watkins Tax Resolution and Accounting Firm today for your Free consultation at 800-721-7054.