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Lev
Lev, Tax Advisor
Category: Tax
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Experience:  Taxes, Immigration, Labor Relations
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Earlier this year I left my job due to discrimination I faced

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Earlier this year I left my job due to discrimination I faced which resulted in physical injury. My separation from the firm was pursuant to a settlement agreement--we agreed to go our separate ways and I was paid a sum of money. In the complaint I drafted that sparked the settlement discussions and my eventual separation from the firm, I argued that not only was I the victim of discrimination, but also that I suffered damages "on account of physical injury." I therefore wanted the settlement amount to be given to me on an untaxed and non-taxable basis (pursuant to Section 104(a)(2) of the IRC). At my employer's request, I provided a letter from my physician describing how the conduct of my employer resulted in physical injury. Moreover, at that time, I contacted the IRS via its hotline and confirmed that the injury that I complained of was of the type contemplated by IRC 104(a)(2).

In the end, because my employer wanted to avoid any exposure that might arise from an IRS review of the payments being made to me, when they paid the settlement amount they would only agree to give me a non-taxed sum of about 40% or so of the total, and they taxed the balance of the settlement award as if they were paying me for lost wages. We specifically agreed, however, that the language of the settlement agreement would not state the basis of the taxed and non-taxed portions of the settlement award, mainly because this is exactly what the IRS would review in trying to determine if the amount was taxable. So, with respect to portion from which they took taxes, the agreements states "[employer will pay X] for settlement of [my] claim," and that I would "receive a W-2 form reflecting this payment." With respect to the non-taxed portion, the agreement says, "[employer will pay Y] for settlement of [my] claims of compensatory damages" and that I will receive a Form 1099 reflecting that payment.

Of course, my position is that I complained of and was compensated for "physical injury" that my employer caused me. However, as noted above, taxes were already taken out and paid to the government for part of the settlement amount. Finally, then, here's my question: When I file my 2012 tax return, how do I go about getting back from the government the taxes that my employer paid on my behalf pursuant to the settlement? Is there a particular tax form that I would complete that essentially says that I, through my employer, overpaid taxes (because I was paid a lump sum pursuant to a settlement agreement to compensate me for physical injury--which is not taxable income)?

I realize that in seeking a refund in these circumstances (and for an amount here in excess of $100K), that there is a good chance that I'd be audited, but at that time (or any time) I would be able and willing to provide the supporting materials alluded to above.

I guess in the end this is a procedural question of sorts (i.e., what forms to use and/or how I would go about getting a refund in these circumstances), but any insight anyone could give me on any aspect of this situation would be greatly appreciated. The tax professional I'm currently working with wrongly continues to view the amount of the settlement that was taxed as wages, although (1) the settlement was neither sought nor obtained to recompense me for lost wages, (2) the parties deliberately removed referenced to "what the payments were for" from the language of the settlement agreement itself because it was known that I would approach the IRS on my own to seek a tax refund; and (3) the payment was in fact to compensate me for physical injury, injury that the employer required me to prove with evidence from my doctor, as a prerequisite to settlement.

Thanks in advance for your help.
Submitted: 1 year ago.
Category: Tax
Expert:  Lev replied 1 year ago.

LEV :

Hi and welcome to Just Answer!
You are correct - see IRS publication 525 - Do not include in your income compensatory damages for personal physical injury or physical sickness (whether received in a lump sum or installments).
Thus - the amount of settlement that is a compensatory damages for personal physical injury is not taxable - and should not be reported on form 1099MISC.
If your employer incorrectly reported that amount - you need contact the payer and ask to correct form 1099MISC. If they refuse - you may file a formal complain to the IRS.
There is no separate form to request refund for withheld taxes - all withheld amount you need to report on your tax return - form 1040 - line 62 - www.irs.gov/pub/irs-pdf/f1040.pdf
Then - you will calculate your actual tax liability and if withheld amount is more than your actual tax liability - you should calculate your refund on line 73.

LEV :

Do not include into taxable income nontaxable portion of the settlement.
If your employer will refuse to correct form 1099MISC and still will report on that form nontaxable part of the settlement - you would need to attach a note to your tax return - explain your circumstances and that you contacted the payer asking to correct.
In additional - to support your position - you may attach a copy of the settlement document.

LEV :

Considering large amount - most likely - the IRS would not release your refund immediately, but as long as your arguments would be accepted - the full refund should be issued.

LEV :

Please be sure ask for clarification as needed.

Lev, Tax Advisor
Category: Tax
Satisfied Customers: 22704
Experience: Taxes, Immigration, Labor Relations
Lev and 8 other Tax Specialists are ready to help you
Customer: replied 1 year ago.
Thanks for your quick response.

I just want to confirm that I understand. Are you saying that the best way to go about getting a refund of the portion of the settlement that I paid taxes on is to explain the situation to the IRS (in a letter, perhaps) when I file my 2012 tax returns?

Please note that one problem that I face is that this was not a "mistake," as such. We agreed not to characterize the settlement payment in any particular way. So, I can't really go the the IRS and complain that my employer refuses to correct the the W-2 and instead issue a 1099.
Customer: replied 1 year ago.
There doesn't seem that there's a way of completing the tax returns in a way that explains why I believe I should not be paying taxes on the settlement. Am I therefore in a situation in which I'm creating my own submission to the IRS? In other words, should I complete my tax returns as if I should have received the entire settlement on a Form 1099, and then simply add supplemental information (along with the W-2 information that should have been on a Form 1099), separately asking for a refund?
Expert:  Lev replied 1 year ago.
That is correct - you will claim your refund on your tax return.
In case your employer will report nontaxable portion of the settlement as taxable income - and you will not be able to resolve the issue with the payer - you would need to explain your position to the IRS and explain what you did to resolve the issue with the payer.

The fact that you agreed not to characterize the settlement payment in any particular way - would made your position less strong - and there is a risk that the IRS would disagree to treat that part of the settlement as made for damages for personal physical injury...
In this case and considering large amount on stake - I suggest to have a local CPA representing you with the IRS and helping to prepare a note to the IRS.
Customer: replied 1 year ago.
Okay, thanks very much for your help. One last thing, I was thinking that I should be as comprehensive as possible when providing supporting documentation to the IRS. Specifically, I would like to provide my initial complaint, the settlement agreement and a declaration describing all the relevant circumstances. Would this be appropriate or overkill?
Expert:  Lev replied 1 year ago.
The issue with your situation - the IRS would be mainly looking into the settlement document - and would expect that amount for damages for personal physical injury is clear determined in that document.
All other arguments - in conjunction with the fact that the payer reports that amount as taxable - and you do not want to object that fact - are very weak.
I would say - there is a great risk that the IRS would not accept your position to treat that amount as not taxable. Because of that - I strongly suggest to have a local CPA representing you with the IRS.
Lev, Tax Advisor
Category: Tax
Satisfied Customers: 22704
Experience: Taxes, Immigration, Labor Relations
Lev and 8 other Tax Specialists are ready to help you

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