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Hypo: a tenant is forced from their home, due in part to negligence…

Hypo: a tenant is...
Hypo: a tenant is forced from their home, due in part to negligence or wrongful behavior by a landlord, sues the landlord. The tenant's attorney breaks his professional obligations, the tenant finds this out, and the attorney withdraws which puts the entire case in jeopardy. On his own, the tenant gets a settlement from the landlord's insurance company, however, the amount would have been much bigger if the tenant's attorney had kept his / her professional obligations. The settlement check covers only expenses (from the past and within the next 5-10 years) incurred from the tenant being forced out of his home into a more expensive place (not pain and suffering). Two settlement checks are issued. One is from the landlord's insurance company to the tenant. The other is issued from the insurance company to the tenant's former attorney (as that amount is in dispute between the tenant and former attorney). The tenant's former attorney and the tenant later settle for more or less the expenses the former attorney incurred. The former attorney also demands that the way the firm handled or mishandled the case not be made public knowledge. The tenant agrees.

Questions:
1. Does the tenant's attorney now have to issue a 1099 MISC to the tenant for the amount that the tenant kept from the check issued to the attorney from the insurance company? 2. If the tenant has receipts to show that the expenses incurred, due to higher rent payments (whereas past place was rent controlled), moving, and commute expenses, over the next 7 years were greater than the total of the 2 settlement checks, can the tenant treat both the payments non-taxable? 3. Can the settlement be treated as regular income or must it be taxed as if the tenant was an independent contractor? 4. Would the tenant be likely to raise a red flag and/or an audit if he/she did not report the income as taxable? 5. How long should the tenant hold onto receipts related to the case and costs to prove that he / she lost money despite the settlement award?
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Answered in 1 hour by:
2/18/2013
Jesse Handel
Jesse Handel, Tax Preparer
Category: Tax
Satisfied Customers: 309
Experience: 10 years tax preparation. IRS Registered Tax Preparer.
Verified

Hello and thank you for coming to our website. We appreciate the opportunity to help you with your questions. I hope that this issue doesn't affect you personally, because the IRS rules that apply are going to seem very unfair under the circumstances; however, they are the rules.

 

To take your questions in order:

1. If the amount that the tenant kept from the attorney is over $600 and, if there is paperwork showing that money as a payment from the attorney to the tenant (if there was written notification or information that the money the insurance company issued to the tenant's attorney would go to the tenant), then the lawyer should issue a 1099-MISC to the tenant. The attorney will probably also want to do this if he/she can justify it because it allows him/her to remove that amount of money from the attorney's taxable income. If the attorney issues a 1099-MISC to the tenant, the amount the tenant received should be reported in Box 3, Other Income; rather than Box 7, Nonemployee Compensation. This is covered in the instructions on filling out Form 1099-MISC. It sounds as if there was no punitive part to the legal settlement. If there had been, that amount would have been listed in Box 3 on a 1099-MISC issued from the insurance company to the tenant.

2. Unfortunately, since ordinary living expenses aren't included in any tax deductions or issues (except when job-related), the expenses associated with this case can't be used to offset any of the taxable legal settlement. The IRS has ruled that legal settlements not involving physical injury or disease are taxable income.

3. The amounts the tenant received for the settlement should be reported to the tenant and the IRS on 1099-MISC, Box 3, "Other Income". The amounts should be reported as "Other Income" on the 1040 Form. Since this income is not in Box 7 and was not involved in any way with employment or services received, this income won't be reported on a Schedule C and it won't be subject to the self-employment tax. Any attorney's fees can be deducted on Schedule A, as expenses subject to the 2%-of-AGI limit.

4. If 1099-MISCs are reported to the IRS, the IRS will either reject the return if it doesn't reference the 1099s that the IRS received or they will definitely come after the taxpayer. The IRS receives copies of all of this paperwork and their computer program matches forms received with the taxpayer's Social Security Number with the income and forms reported on the return as one of the first checks a return goes through when it is processed.

5. The receipts won't matter because the IRS won't allow them to be used to offset the settlement income. All other papers relating to this issue should be stored for a minimum of 3 years, the normal time period the IRS goes back on audit. A maximum of seven years wouldn't be a bad idea, because if the IRS decides there may be fraud involved in the tax return, they can go back seven years. Actually, there is no real previous year at which the IRS can't demand to see documents, since the statute of limitations doesn't begin until the tax fraud is found, so there isn't really a statute of limitations on the IRS. They rarely go back more than 3 years and almost never go back more than 7 years. In general, they only go back more than 3 years if they find or think they've found an ongoing pattern of fraudulent returns.

6. If the tenant paid the former attorney $600 or more in 2012, then the tenant should issue a 1099-MISC to the attorney with the payment reported in Box 7.

 

Here is the information from the IRS website about legal settlements: http://www.irs.gov/Businesses/Small-Businesses-&-Self-Employed/Lawsuits,-Awards,-and-Settlements-Audit-Techniques-Guide#_Toc305586646

 

Here is where you can find the information about preparing and filing Form 1099-MISC:

http://www.irs.gov/pub/irs-pdf/i1099msc_12.pdf

 

Here is the actual form 1099-MISC: http://www.irs.gov/pub/irs-pdf/f1099msc_12.pdf

 

I hope this information answers your question satisfactorily. If you need more information about this question or clarification of any information that I've provided, I'll be happy to continue working with you on this question until you're satisfied.

 

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Customer reply replied 4 years ago

Excellent replies thus far; I apologize for the delay but before finishing I have a few additional questions.


 


What if the tenant did pay the attorney and/or the attorney's law firm, more than $600 in 2012, but, due to poor relations between parties, the tenant cannot obtain the attorney's social security number and/or the attorney's tax payer ID number (EIN)? - - Ie - without this information can a 1099 MISC be filed against the former attorney or will the IRS not allow it?


 


------


 


Now assume that the tenant does get ahold of the attorney's / attorney's firm's taxpayer ID information.


 


If the attorney claims the payment received was less than his or his firm's expenses put into the case, can the tenant still file a 1099 MISC against his former attorney (ie - force the attorney to explain to the IRS that the payment received was less than the expenses created to receive this income)?

The attorney is required by law to provide his EIN or SSN, whichever he uses to designate his business. If the attorney refuses to provide that information, then you can use Form W-9 "Request for Taxpayer Identification and Certification" to obtain the information. An attorney is required to promptly supply its TIN and is subject to a penalty under Section 6723 and its regulations if they refuse. The details can be found on www.irs.gov "Instructions for Form 1099-MISC" 2012 edition, page 2.

 

The attorney's expenses are irrelevant to the filing of a 1099. As long as you have checks or other documentation that you paid the attorney more than $600, you are required, not just allowed, to issue a Form 1099-MISC. He has to explain his expenses on his tax return. That part is his problem, not yours.

 

Hope this helps. Good luck in your fight. Let me know if you need more information.

Jesse Handel
Jesse Handel, Tax Preparer
Category: Tax
Satisfied Customers: 309
Experience: 10 years tax preparation. IRS Registered Tax Preparer.
Verified
Jesse Handel and 87 other Tax Specialists are ready to help you
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Customer reply replied 4 years ago

FYI - I've been informed that several parts of this answer may be incorrect. Basically, if one is not engaged in the trade or business of engaging attorney's services for property / tort claims one does not need to issue a 1099 to an attorney (per http://www.irs.gov/pub/irs-pdf/i1099msc_12.pdf). Also, if the settlement was not to reimburse lost wages (income) but physical injury / losses incurred by the tenant claimant due to the injuries then to that extent the settlement funds are not taxable to the tenant / claimant. However, the funds paid to the attorney may be considered income to the attorney. Actually my understanding on this is not fully clear but this is the gist from of another expert opinion. Nonetheless, I appreciate your earlier feedback; thanks.

You are correct about the 1099-MISC being allowed, but not required. The law that required the issuance of the 1099-MISC was passed as part of the Affordable Health Care Act and then removed by Congress later. The tenant isn't required by law to issue a 1099-MISC to the attorney, however if the tenant wants to deduct the amount paid to the lawyer as Schedule A expenses subject to the 2%-of-AGI limit, the 1099-MISC will be the strongest documentation of this expense and will ensure that the attorney is taxed for the income. However, as long as the amount paid to the attorney can be proven from receipts or other documentation, the 1099-MISC is optional not required.

In retrospect, I did word this answer very poorly. The insurance company should not issue a 1099-MISC form to the tenant, because the money provided by the insurance company is straight reimbursement. If the insurance company did issue a 1099-MISC for this part of the settlement, then the tenant should include a statement with his/her tax return that the 1099-MISC was issued for nontaxable reimbursement of actual expenses.

The money paid to the tenant by the former attorney is much less clear-cut. It is easy to prove if audited that the insurance settlement offsets actual expenses, however, the money paid by the former attorney because the tenant could have received a larger settlement had the attorney not been negligent could be considered (and in my opinion, would be considered) to be punitive damages rather than related to actual monetary losses. There is no way to prove any actual monetary loss to the tenant that is being paid for by the attorney and that would make the attorney's part of the settlement taxable income. I apologize that I failed to clearly differentiate between the two types of settlements.

Thank you for a chance to correct and clarify my answer. I'm sorry that I wasn't as accurate and clear as I should have been.
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Customer reply replied 4 years ago

Hmm...This long answer / explanation is helps me understand some concepts or issues that I had not understood earlier. Thanks for taking the time to clarify in such detail. Thank you again!

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