Generally, the amount received in a lawsuit settlement is taxable, unless a specific tax law exclusion applies.
New case: A taxpayer saw an ad for a car priced at $36,800. But when he went to purchase the vehicle, the dealer said it was a mistake. The real price was $56,000. The taxpayer sued the dealer and settled for $17,000. The attorney retained a $2,000 fee, so the taxpayer received $15,000 as reported on a Form 1099-MISC. However, the taxpayer failed to report this amount on his tax return because he claimed it didn’t constitute taxable income.
The Tax Court noted that any tax law exclusions must be narrowly construed. Because the settlement agreement was silent on the award allocation, the entire $17,000 is taxable as ordinary income.
Tip: At least the $2,000 paid in attorneys’ fees was deductible as miscellaneous expenses, subject to the usual 2% floor. (Dang-Quang Cung, TC Memo 2013-81)