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Future loss settlement taxability

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tranquility

Senior Member
What is the name of your state (only U.S. law)? CA (But Federal is focus of question)

I'm not really looking for an answer, but for how to look at things.

Taxpayer sues deceased's estate planning attorney for advice to deceased and settles. Because of planning, taxpayer has to pay additional amounts in property taxes for as long as property is held. (Basically, could not take benefit of law allowing basis retention for transfer between parent and child.) Settlement is to compensate for the direct financial loss. The "loss" was not deducted, but the difference between what the property tax would have been and what it is will be deducted every year it is paid. Taxpayer is a cash basis taxpayer.

Is the settlement taxable? In this year?

Some possibilities. First, it is completely taxable in this year and will be deducted in future years. Not a great outcome for the taxpayer, but, will certainly make the IRS happy. Second, though the taxpayer is cash basis, because of the tax benefit rule, the income is taken in for each year the deduction is taken until it is used up. Making the settlement a wash. Third, we reduce the basis of the property by the amount of the settlement and take normal deductions for property tax payments. Fourth, we reduce the basis of the property by the amount of the settlement, take in income and a deduction each year for the difference in property tax payment and increase the basis by the difference each year. Fifth?

Again, the easiest is just to take in the income now and the deduction over time. Any ideas on how to not make that happen?
 


justalayman

Senior Member
This is obviously out of my league but a couple of your ideas seem, to me, to not be possible.

The last two where you speak of adjusting the basis of the property. How can you do that? The basis is a matter of record and a settlement does not actually change that. The damages payment is simply an attempt to correct the financial issue suffered by the party. It does nothing to the actual facts of the matter that were the underlying basis for the suit.

If my statement is way out of line feel free to slap me upside the back of my head and tell me to sit back down


(In my trade it is often stated; just stay in the truck kid, in reference to letting the journeyman handle the problem while the not ready for prime time apprentice just stays out of the way)
 

davew128

Senior Member
I honestly don't see a reasonable position other than #1. I can see no reason where the settlement is excluded. I don't an application of the tax benefit rule either. You're planning on an actuarial accretion of the settlement over the client's life expectancy?
 

tranquility

Senior Member
The last two where you speak of adjusting the basis of the property. How can you do that? The basis is a matter of record and a settlement does not actually change that.
When there is a loss in value to a property that does not exceed the basis, compensatory awards are not taxable. But, the basis is reduced by the amount of the award.
 

justalayman

Senior Member
When there is a loss in value to a property that does not exceed the basis, compensatory awards are not taxable. But, the basis is reduced by the amount of the award.
Thanks and good to know but...

was there an actual loss in value of the property or simply a loss realized by the taxpayer due to (I presume) some bad advice? What you described does not alter the value of the property but only caused a loss of a tax reduction due to the value assessed only for tax purposes of the taxpayer.

In addition you are speaking of a settlemt. A settlement is quite different than a judgment in many situations. Can a settlement be treated the same as a judgment would be in this situation?

feel free to quote WC Fields if apprpriate.
 

tranquility

Senior Member
I honestly don't see a reasonable position other than #1. I can see no reason where the settlement is excluded. I don't an application of the tax benefit rule either. You're planning on an actuarial accretion of the settlement over the client's life expectancy?
No one really wanted to litigate this for any one of a number of issues. Part of the settlement had to do with assessing damages. (They determined 10 years.) Realistically, there are no damages until the taxes are paid. The taxpayer could sell it today and damages disappear.

I gave myself a tap-tap need some time to think delay by asking for the settlement papers so I can see exactly what the agreement was. I agree the easiest way that clearly fits is #1. That is a big old hairball that is going to be coughed up, especially when rateable issues arise based on the gross. For one, there's going to be a passive loss suspended that, in effect, is going to give $25K MORE in income than planned for. Sure, most of these things will come back over time. But, probably at a lower marginal rate than the dollars added today are.
 

tranquility

Senior Member
was there an actual loss in value of the property or simply a loss realized by the taxpayer due to (I presume) some bad advice? What you described does not alter the value of the property but only caused a loss of a tax reduction due to the value assessed only for tax purposes of the taxpayer.
Yep, that is a problem. Yet, is not the tax burden intimately associated with the value of the property--at least to the taxpayer?

In addition you are speaking of a settlemt. A settlement is quite different than a judgment in many situations. Can a settlement be treated the same as a judgment would be in this situation?
It's an arms length settlement and would be treated the same as a judgment. The only real argument on such things come up on allocating the damages. Compensatory, punitive, physical injury etc. None of the usual problems between a settlement and a judgment are implicated here.

feel free to quote WC Fields if apprpriate.
"If you can't dazzle them with brilliance, baffle them with bull."
I'm not sure if any option but #1 does not fit the quote perfectly.
 

justalayman

Senior Member
Yep, that is a problem. Yet, is not the tax burden intimately associated with the value of the property--at least to the taxpayer?

It's an arms length settlement and would be treated the same as a judgment. The only real argument on such things come up on allocating the damages. Compensatory, punitive, physical injury etc. None of the usual problems between a settlement and a judgment are implicated here.


"If you can't dazzle them with brilliance, baffle them with bull."
I'm not sure if any option but #1 does not fit the quote perfectly.
No, the value remains the same. Value is a factual matter. The amount the property is assessed (not actually valued) at for tax purposes is not a reflection of the actual value and I would think the irs deals with true value.

As an example: I pay taxes on my property based on an assessment (not an actual valuation) of about 3/4 of market value due to a homestead exemption as well as an cap on increases limited to the cost of living regardless of actual market value increases. The value remind at 4/4 regardless of me enjoying a reduced tax burden due to the reduced assessment. In the situation at hand the property remains valued at the market value, and would even if the tax advisor had advised properly. Only the assessed value differs. That is not a loss of value of the property but merely a mechanism to reduce the tax burden for some reason.
 

justalayman

Senior Member
Yep, that is a problem. Yet, is not the tax burden intimately associated with the value of the property--at least to the taxpayer?

It's an arms length settlement and would be treated the same as a judgment. The only real argument on such things come up on allocating the damages. Compensatory, punitive, physical injury etc. None of the usual problems between a settlement and a judgment are implicated here.


"If you can't dazzle them with brilliance, baffle them with bull."
I'm not sure if any option but #1 does not fit the quote perfectly.

It was the: go away kid, you bother me

Quote i was referring to.
 

davew128

Senior Member
Yep, that is a problem. Yet, is not the tax burden intimately associated with the value of the property--at least to the taxpayer?

It's an arms length settlement and would be treated the same as a judgment. The only real argument on such things come up on allocating the damages. Compensatory, punitive, physical injury etc. None of the usual problems between a settlement and a judgment are implicated here.
You're really over thinking this. What is the nature of the claim? That the client is incurring additional real estate tax because of professional error by the attorney. The "damages" are higher real estate tax. You and I both know that in CA real estate tax is NOT directly linked to the value of the property when there is a familial change of ownership. The reason your client is paying higher real estate tax is because for whatever reason, the advice given by counsel bypassed the normal rules and paperwork to keep that in place and your client now IS paying real estate tax directly corresponding to the property value at the time of transfer. No loss in value occurred, just an increased expense. This increase in tax has no relation to the value of the property with regards to an arms length transaction. Whether the transfer was done correctly or not has no relation to the amount a willing buyer would offer for the property now.
 

tranquility

Senior Member
You're really over thinking this.
That over thinking is how I get a sweet job indoors with air conditioning rather than having to go up on a roof in the summer and pour tar. I recognize the vast majority of my job at tax prep time is ministerial and simple compliance. But, when some result from what I think is the correct treatment differs from what is fair, I consider different treatments. I would insert a judge Learned Hand quote here, but decline.

Settlements/judgments are such a flexible area, I'm just looking for thoughts of directions that could save the client some money. Of course, there must be a balance between the cost of my time and the potential savings times the chance of those savings. Admittedly, if I had to pull the trigger today, I know how I would report it. But dang if it does not seem unfair. I'm shocked, SHOCKED to find that gamb...unfairness is going on in here. It's just that I don't have a lot of experience in settlements in general and none even approaching these facts and I hate to default to "give the government more" without great consideration. I guess I'm just trying to prevent The Man from screwing a client.

I accept I might not be able to. I feel it is my sacred duty to see if I can.
 

tranquility

Senior Member
It was the: go away kid, you bother me

Quote i was referring to.
No, I get where you were going. It's just that I was looking for brainstorming. I know the basics of the law. I was looking for thinking. Any suggestion was/is greatly welcomed. Thinking is not the same as knowing. Thank you for your contribution. It had thinking. I truly appreciate it.
 

justalayman

Senior Member
That over thinking is how I get a sweet job indoors with air conditioning rather than having to go up on a roof in the summer and pour tar. I recognize the vast majority of my job at tax prep time is ministerial and simple compliance. But, when some result from what I think is the correct treatment differs from what is fair, I consider different treatments. I would insert a judge Learned Hand quote here, but decline.

Settlements/judgments are such a flexible area, I'm just looking for thoughts of directions that could save the client some money. Of course, there must be a balance between the cost of my time and the potential savings times the chance of those savings. Admittedly, if I had to pull the trigger today, I know how I would report it. But dang if it does not seem unfair. I'm shocked, SHOCKED to find that gamb...unfairness is going on in here. It's just that I don't have a lot of experience in settlements in general and none even approaching these facts and I hate to default to "give the government more" without great consideration. I guess I'm just trying to prevent The Man from screwing a client.

I accept I might not be able to. I feel it is my sacred duty to see if I can.
if I was in California and and I needed something other than a 1040ez for my taxes I would surely seek you out. Creative accounting while staying within the bounds of the law to benefit their clients is what pro's get paid to do. I have no problem seeing you as a pro.
 

davew128

Senior Member
That over thinking is how I get a sweet job indoors with air conditioning rather than having to go up on a roof in the summer and pour tar. I recognize the vast majority of my job at tax prep time is ministerial and simple compliance. But, when some result from what I think is the correct treatment differs from what is fair, I consider different treatments. I would insert a judge Learned Hand quote here, but decline.

Settlements/judgments are such a flexible area, I'm just looking for thoughts of directions that could save the client some money. Of course, there must be a balance between the cost of my time and the potential savings times the chance of those savings. Admittedly, if I had to pull the trigger today, I know how I would report it. But dang if it does not seem unfair. I'm shocked, SHOCKED to find that gamb...unfairness is going on in here. It's just that I don't have a lot of experience in settlements in general and none even approaching these facts and I hate to default to "give the government more" without great consideration. I guess I'm just trying to prevent The Man from screwing a client.

I accept I might not be able to. I feel it is my sacred duty to see if I can.
And your point is? You posted facts and I walked through the methodology of how I see the law applying to those facts. Thats what pros like us do. Sometimes we have tunnel vision in how we see things which is why we seek second opinions. Of the options you listed, the first one was what I thought was clearly the correct response. Is that definitively the best result? Absent something in the law I am not aware of, which still does occasionally happen, maybe? Sometimes we don't always get the result we want.
 

tranquility

Senior Member
And your point is? You posted facts and I walked through the methodology of how I see the law applying to those facts. Thats what pros like us do. Sometimes we have tunnel vision in how we see things which is why we seek second opinions. Of the options you listed, the first one was what I thought was clearly the correct response. Is that definitively the best result? Absent something in the law I am not aware of, which still does occasionally happen, maybe? Sometimes we don't always get the result we want.
The point is, my tax spidey sense is tingling. I hate to do the obvious when that tingling is going on. While I have not looked at the case(s) yet to really distinguish, I'm looking for a result something like:
http://www.philadelphiabar.org/WebObjects/PBAReadOnly.woa/Contents/WebServerResources/CMSResources/TaxAspectsofLitigation.pdf
Claims for Lost Tax Benefits. In Clark v. Comm’r, 40
B.T.A. 333 (1939), acq. 1957-2 C.B. 4, and Rev. Rul. 57-
47, 1957-1 C.B. 3 the Tax Court held (and the IRS
ultimately agreed) that a payment made by a tax
practitioner to reimburse a client who had overpaid taxes
due to faulty advice was not includible in the taxpayer’s
income. The holdings were premised on a variant of the
tax benefit rule – i.e., recovery on a non-deductibleexpenditure
(federal income taxes paid) should not produce
income. See also, Concord Instruments Corp. T.C.M.
1994-248 (malpractice award received by taxpayer due to
attorney’s failure to timely appeal adverse Tax Court
decision allocated between non-taxable portion for
additional tax owned and taxable portion for interest owed.)
In a series of private rulings, however, the IRS has tried to
narrow the scope of Clark. In the IRS’ view, where a third
party reimburses a taxpayer for income taxes paid, the
reimbursement will constitute income – unless the
difference is the result of payment of more tax than the
minimum that would have been due absent return
preparation errors. See PLR 9226033 (where taxpayer paid
no more than minimum amount of tax properly due,
taxpayer is taxable on breach of contract damages due to
misrepresentation of tax consequences on securities found
ineligible for Section 936 credit and a lease found ineligible
for safe harbor lease status). For a discussion of the
distinction between Clark and the 1992 private rulings in
the context of damage determination (i.e., the need for a
“gross up”) see Centex Corp. v. U.S., 55 Fed. Cl. 381 (Fed.
Cl. Ct. 2003).
 

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