Robert W. Wood, of Wood LLP, has made available for download his article, “IRS Tax on Legal Settlements Depends on Wording,” published in Forbes. The abstract is as follows:
The tax treatment of lawsuit settlements often depends on the wording of the settlement agreement. For example, in Blum v. Commissioner, T.C. Memo. 2021-18. Debra Jean Blum received a $125,000 settlement from a lawyer who botched her personal physical injury suit. Had she recovered in the original injury suit, that money would have been tax free. But she sued her lawyer for flubbing the suit, and she received an IRS Form 1099 for her settlement. Unfortunately, she did not report it on her return. The lessons of the Blum case are not limited to the tax treatment of legal malpractice recoveries. It does not mean that legal malpractice recoveries for botched personal (physical) injury lawsuits cannot be tax-free? But in any settlement, care is needed. Ms. Blum was in the hospital for a knee replacement, but was injured in a wheelchair accident. She hired a lawyer and sued the hospital for negligence, but her case was dismissed. When she sued her lawyers for malpractice, she was trying to get the money that she would have collected in her hospital negligence case.
Posted by Isabella King, Associate Editor, Wealth Strategies Journal.