One of the most frequently asked questions tax professionals receive is “Are injury settlement payments are taxable?” According to Code Sec. 104(a)(2), payments received as compensation for a personal physical injury or physical sickness are not taxable. The key term here is physical. Payments for emotional distress or other reasons that do not stem from a physical injury are taxable income. Likewise, a portion of punitive damages awarded are taxable income even if they are related to the physical injury. This is ultimately because the purpose of a punitive damage award is to punish the defendant rather than to compensate from the physical injury. A recent tax memo, TC Memo 2017-129, highlighted this code when the court ruled against the taxpayer. In this particular case, the Tax Court concluded that the payments the taxpayer received during a discrimination claim settlement were taxable.
The taxpayer suffered a physical injury not related to his employment. He was unable to fully return to his job because of his disability, and asked his employer for reasonable accommodation. However, the employer refused and terminated the taxpayer. The taxpayer brought a discrimination lawsuit alleging that the employer failed to make a reasonable accommodation to allow the taxpayer to work a different, more sedentary position. Eventually, the taxpayer and employer reached a settlement and the settlement payment was included in the taxpayer’s W-2.
After receiving his settlement, the taxpayer argued with the IRS that the settlement payment should be excluded from his income because of his physical injury. The Court noted that the settlement award was not a result of the taxpayer’s physical injury, but his alleged discrimination. As with any agreement, properly wording the settlement award description is critical to help ensure the desired tax outcome. Your tax advisor should review aspects of the agreement that determine the tax treatment of the settlement, prior to the agreement being signed.
If you have questions on this matter or would like to discuss your particular tax situation, please contact Aronson’s Tax Controversy Practice Partner, Larry Rubin, at 301.222.8212 or email@example.com.
Taxpayers should be aware of increased audits — Bloomberg News recently reported about the increasing number of audits conducted on high-net worth individuals. While overall audits have decreased, the IRS is focusing their time where they feel they can get the most bang for their buck. Historically known for utilizing more complex tax strategies, it’s important that high-net worth taxpayers make sure their support documents are readily available to backup potentially aggressive claims.
A representative of Deloitte has listed the IRS’s “favorite issues” of focus. The list includes:
Additionally, the IRS is distributing mass notices that address specific issues. For example, taxpayers claiming large charitable deductions should expect an automated notice requesting support. The best practice for addressing any notices or audit requests that come up is to respond promptly and with thorough support. Should you find yourself on the receiving end of an audit, please reach out to your accountant for support.
For questions or more information, please contact Aronson’s Jennifer Moss at Jmoss@aronsonllc.com.
In a recent news report, the state of Maryland identified 20 tax preparers believed by the state to be electronically filing fraudulent returns, and went so far as to publish the names of those preparing firms. Such returns typically claim deductions and credits that do not exist. While some taxpayers knowingly participate in the fraud, other taxpayers are not aware that it is being done.
We unfortunately live in a world where tax fraud and scams are becoming more brazen and aggressive. The vast majority who play by the rules are the ones who pick up the tab for the revenue lost by government agencies. We bear that cost. To help reduce fraud, we suggest the following:
For more information, contact Aronson’s Laurence C. Rubin, CPA, at 301.231.6200.
The Internal Revenue Service (IRS) LB&I audit division announced a series of campaigns for issues they have identified as ripe for noncompliance. LB&I handles tax examinations for businesses with assets in excess of $10 million. The success of these campaigns typically trickles down to other audit divisions and can become standard procedure.
One campaign is targeting S corporations that report losses to its shareholders, to verify that the shareholder has sufficient basis to deduct the loss. This does not mean every such S corporation will receive an audit notice. Some may be audited while others may receive letters questioning particular items on the return, asking for an explanation or clarification.
If you are a shareholder in an S corporation, we recommend that you review your basis schedule for accuracy or work with your tax advisor to begin maintaining one. It is the shareholder’s responsibility to support any loss claimed on the tax return.
For questions about this topic or more information, please contact Aronson’s Laurence C. Rubin, CPA, at 301.231.6200.
Are you aware of the 2016 tax return due date changes for certain federal and state income tax returns? The changes will have the greatest impact on flow-through entities including S corporations and partnerships, as well as C corporations. Individual income tax return due dates are not impacted. The legislation signed into law by President Obama last year, also known as the Highway Act (P.L. 114-41), generally affects returns with tax years beginning after December 31, 2015. For your convenience, the Aronson tax team has summarized the changes below.
Partnership return due dates have shifted from April 15, to March 15, or the fifteenth day of the third month after a fiscal year-end. This should facilitate timely preparation of Schedule K-1s for individuals and organizational owners or partners whose returns are due on April 15. S corporation income tax returns will remain due on March 15.
Corporate taxpayers’ income tax return is now due on April 15, a month later than the previous March 15, deadline. Corporate income tax returns for fiscal year taxpayers will be due on or before the fifteenth day of the third month following the close of the fiscal year. Certain exceptions apply to C corporations with taxable years ending on June 30.
State Income Tax Returns
Most states have changed their rules to conform to the federal due date modifications, or have existing due dates that do not require changing the rules in order to conform. There are a handful of states that have not conformed to the new federal C corporation return due dates. Notably, Illinois and Massachusetts still have a March 15, deadline for C corporations. Aronson is actively monitoring developments in these jurisdictions and will issue an update early next year.
Other Important Due Date Changes
Other federal due date changes from the Highway Act include:
Adjusting to the new deadlines may be a challenge for some taxpayers. Please feel free to contact Grant Patterson, Michael L. Colavito, Jr., or your Aronson tax advisor at 301.231.6200, if you have any questions or concerns related to these changes.