If you happen to be awarded a settlement you need to be careful in how the proceeds are reported to avoid scrutiny by the taxing authorities. I just closed a file today in IRS Examination the facts of which surrounded unintentional incorrect reporting of a settlement. While wrapping loose ends up with the taxpayer we came up with a list of10 facts about reporting a settlement that had he known in advance would have saved a LOT of (my) time and (his) money. They are as follows:

1. Whether your settlement or award is excluded from income depends on whether the nature or source of the claim was due to physical injury or physical sickness.

2. Non-excluded income from a lawsuit must be reported on an information document like IRS Form 1099-MISC sent to the plaintiff and/or the plaintiff ’s attorney as well as to the IRS.

3. Even if a portion of the settlement is for physical injuries, and therefore excluded from income, amounts paid for medical expenses that were previously deducted would need to be included in income.

4. Attorney fees are treated separately and may be partly excluded.

5. If a portion of the settlement amount was due to injury, it is excluded under IRC Sec. 104(a)(2). This includes not only medical expense reimbursement for the injury, but also any damages for lost wages or earnings, sickness due to complications from the physical injury, or emotional distress caused by the injury.

6. If any portion of your settlement is taxable, the attorney fees allocated to the taxable portion of the settlement are includible in income.

7. Generally, the taxable portion of the settlement is reported on line 21 of IRS Form 1040 - other income. Deductible attorney fees are reported as a miscellaneous itemized deduction, subject to the two-percent-of-AGI limitation, on IRS Form 1040 Schedule A.

8. If the accident involved an automobile used for business, any taxable settlement income and associated deductible fees should be reported on Schedule C or on a corporate tax return if appropriate.

9. If the taxable portion of the settlement does not match up to the net amount shown on Form 1099-MISC, it is likely that IRS’ automated under-reporter (AUR) program will pick up the discrepancy.

10. To avoid an IRS CP-2000 letter, it is helpful to attach a statement and appropriate portions of the settlement explaining the nature of the claim and settlement and how these items were reported.