Here’s the story of how a cancer victim’s $250 million punitive damage award became a $140 million windfall for the Internal Revenue Service. Spoiler alert: The victim paid out of his pocket $400,000 for the privilege!
Somebody had cancer, which they got from the negligence of a corporation’s product. This person is dying. They hired an attorney to get some money to help their family after they’re gone, as well as bring some justice to bare on the corporation’s practices that led to harming this person (and others).
In high-profile lawsuits, it’s common for the attorney to take as little as 33 percent and as high as 50 percent of the settlement as their “fees.” (The law firm covers all the costs in payroll, filing fees and litigation costs with the hope of winning and recovering all of those costs as well as making a tidy fee for their services). In this case, the taxpayer (who’s dying of cancer) made an agreement to pay their attorney 50 percent of the proceeds.
After many costs, time, testimony, expert witnesses, deliberation, etc., the taxpayer’s attorney won a settlement of $250 million in punitive damages. Congrats to the attorney! Well done!
Now the application of tax law for 2018 and beyond for the next 10 years:
First, the attorney took half, or $125 million. They must pay tax on their net profit, so the IRS will come out getting about $40 million from the attorney.
Second, the taxpayer must report the gross settlement of $250 million as taxable income. Here’s where Congress really messed up. In the past, the taxpayer would be able to deduct all their related costs (such as attorney fees) on Schedule A, Miscellaneous Itemized Deductions and state taxes as well. Thus, under the old law, their tax (federal and state) would get about $75 million, leaving the taxpayer with $55 million net proceeds from the settlement. Does that seem unfair? Wait till you see what they get after applying the new tax law Congress did for 2018.
No more Miscellaneous Itemized Deductions, thus no deduction of attorney fees. Limit of state taxes to $10,000, so no significant deduction for state taxes paid. Thus, their tax (federal and state) now comes to $125,400,000. Let’s see, they originally got $250 million, they paid the attorney $125 million and now the federal/state taxes of $125.4 million. That means this poor taxpayer, dying of cancer, who won a $250 million settlement, will end up owing $400,000 out of his own pocket and have nothing for his family from this settlement! All together now, “You blew it Congress! Last-minute changes to the tax law usually has negative consequences for the least expected reasons!”
By the way, who really won in that settlement? IRS got $40 million from the attorney and about $100 million from the taxpayer, so they got more than half. The state got about $25 million, too. Thus, the only “winners” were the government and the attorney.
Don’t get mad at the attorney, though. The victim actually got an additional $39 million in personal injury award (personal injury isn’t taxable), so the taxpayer did end up with something after all. Good job, attorney. Boo, Congress!
Did you hear? Amos 5:11a says (about those who have rejected God and are about to be judged), “You trample the poor, stealing their grain through taxes and unfair rent.”
Kelly Bullis is a certified public accountant in Carson City. Contact him at 775-882-4459, on the Web at www.bullisandco.com and on Facebook.