Academic journal article Journal of Accountancy

Avoiding Penalties When Reporting Damage Awards and Settlements: Four Steps CPAs Can Take

Academic journal article Journal of Accountancy

Avoiding Penalties When Reporting Damage Awards and Settlements: Four Steps CPAs Can Take

Article excerpt

Many businesses and government agencies have paid out damage awards or settlements to third parties for various violations. Whenever an award or settlement must be paid, proper federal tax reporting is required to avoid potentially substantial tax penalties. CPAs should be familiar with the four steps of such reporting, to properly advise clients.

HOW MUCH IS TAXABLE?

Depending on the type of award, all or part of the amount paid may be taxable. So the first step is to determine the part of the award or settlement that is taxable. Likewise, attorneys' fees paid to an injured party's attorney also may be reportable as taxable income to the injured party That was the case in Banks, II, 125 SCt 826 (2005), when the Supreme Court held that the contingent attorneys' fees were taxable to the injured party

FORMS

Next, the proper form must be used to report the taxable amount paid. Generally, if the per son receiving the funds is a past or present employee, and the payment is for past, present or future wages or other employment compensation, form W-2 must be filed and given to the employee for the taxable amount of such compensation. On the other hand, nonemployees receive form 1099-MISC (miscellaneous income). Payments for nonwage or noncompensation amounts would always be reported on form 1099-MISC, even for employees. If interest is paid on an award, it should be reported on a separate form 1099-MISC. Similarly, the payment of attorneys' fees related to taxable awards or settlements must be reported on form 1099-MISC to the injured party. Certain includible attorneys' fees and costs may be deductible; see IRC section 62(a)(20). …

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