Robert Wood – Founder of Wood LLP

Robert Wood, Founder of Wood LLP interview transcript:

Alan Olsen: A lot of time Personal Injury Lawsuits are taken on a contingent fee basis. When a person is awarded great lawsuit settlement, oftentimes after the attorney takes their fee from the lawsuit settlement a the plaintiff gets a tax form in the mail saying they owe tax on the full amount- including funds which were used to pay the attorney. What settlement fees are considered taxable vs non taxable income and what in an individual allowed to deduct?

Robert Wood: We’re all consumers of lots of things. But I think consumers, understandably think, gosh, they went to a lawyer and the lawyer is guiding them through a process of getting the money out of some kind of a legal claim. And the lawyers competent, and the lawyer must know about taxes. And I think AI is a danger area for plaintiffs lawyers, because some of them very well meaning will give some tax advice. And it may or may not be the right. I’ve unfortunately been an expert witness and a lot of cases over tax issues where my role is to explain the tax issues or give an opinion about whether something’s taxable or not or how something was handled. But, but most litigators, most tax lawyers can’t advise someone how to file a lawsuit. I wouldn’t be able to and most litigators are not competent on tax. So, so. So, everything most things I should say almost everything are taxable. Anytime you get money, you can pretty much assume the IRS and the state wherever you are, are going to view it as taxable. The big exception to that would be personal physical injury recoveries. And in using the term physical means that if something is Just an emotional distress recovery in emotional distress can be very severe. The IRS says that’s taxable. And there was a lot of litigation for decades over these kinds of issues. And a lot changed in a fundamental way in in 1996, in the tax code, inserting the word physical. So it’s got to be physical. There’s been endless debate since 1996, about what’s physical on that. And that’s still mostly up in the air. So I’d say, A, you’re right, that lawsuit settlements, somebody gets it, and they, you know, they, and they pay a lawyer. If it’s 40%, contingency, they recover, let’s make it a big number, they recover a million dollars, and the lawyer gets 400,000. And the client gets 600. So what just happened? Every just about every client will say, Well, I got 600,000, I didn’t get a million, because the client almost invariably doesn’t get the full million the lawyer wants to get paid, receives the million and then sends the clients 600. But in that example, the US Supreme Court has said the client just got a million dollars. And so to your point, Alan, which is a good one. So just a client. What about that 400? If the client is treated for tax purposes as receiving it, can the client deduct it? And the answer to that was for decades, for generations? Really? The answer to that was always Yeah, of course. There are different kinds of deductions. But yeah, there’s a deduction. And, and the law changed in a fundamental way controversially, in in 2018. This is the so called Trump tax bill or the kind of lousy name, they always give tax laws, lousy names, it was called the tax cuts and JOBS Act, passed around Christmas 2017. So that cut back on a lot of deductions. And it’s, then that’s still true. So there are lots of kinds of lawsuits where you really have to. And this is another thing that I do a lot of figure out a way to deduct, there usually is a way if you’re creative, but the ones that are really clear, just to go back to your question where someone doesn’t need to worry. If it’s all tax free money, it’s all because you know, they got run over in a in a crosswalk or something. It’s physical injury money. And it’s all compensatory, no punitive damages, which are always taxed, then they don’t have to worry about the legal fees. None of its income anyway, doesn’t matter if you say to the client get 600 or a million in my example. But most other contexts, you need to think about the deduction. The big one that you always get, just to make sure people aren’t worried about this is if it’s an employment case. And there’s some whistleblower cases that are thrown in there as well. So it’s an above the line deduction. So that means in my example, the former employee, let’s say it’s a wrongful termination case, gets the million dollar settlement, the lawyer takes 400, the client is almost invariably going to get a 1099, let’s say w two or 1099, reporting a million dollars, but they definitely get to deduct the 400. They just have to know how to do it. And so ISIS were there, for me, and a lot of these things where the rubber meets the road is making sure the client understands what their position is and how to do it. And making sure that their tax preparer, their accountant, or them, if they’re using TurboTax, or something like that, make sure that they actually do it, right. Because it’s a little tricky. It’s I wish it were not, but it is, and a lot of people mess it up. And then a year or two later, even though you know, the law on that point really isn’t controversial. They end up in an audit circumstance and they’re trying to, you know, defend a position that should have been easy in the first place.

Alan Olsen: At a high level, if I, if I can draw your million dollar example 40% attorney fees net of $600,000. If the full million is subject to tax, and attorney fees are not deductible, then 50% rate they’re walking out with roughly about what 300,000 of the 30% of that the settlement?

Robert Wood: Yeah. And an extreme case, as I say, I mean, they’re not to, you know, say this is subverting the rules or something. But, but one of the things about the tax laws But I know you, you know, is there a sort of infinite shades of gray. So there are certainly things that we as tax professionals, certainly things that people cannot do, arguments that you can’t make. But there are vast areas of things that are simply not clear or whether it’s sort of arguable you can do something, and it kind of depends on the circumstances. So yeah, the what you say is true, though, the way if you read the rules, literally, and you apply them literally, and you’re not creative. I mean, there have been some cases where someone actually because the legal fees are so high in some cases that are, you know, on appeal and go up and down the appellate courts and this kind of thing, so many sets of lawyers, or people have paid so much in legal fees, not been able to deduct their legal fees, and they actually lose money because of winning a lawsuit. And, of course, that makes no sense. And, but it does put a premium on sort of being aware beforehand, being aware before, ideally, before the client signs a settlement agreement, a lot of these things can be shaped in the document. And that’s not improper. In fact, it’s, it’s smart. It’s a shame not to do it. And knowing in advance, which again, you can do in the settlement agreement, generally, exactly what kind of tax forms you get. So almost everyone, the lawsuits settled in 20 2020, let’s say. And then in 2021, end of January, that’s when all these little forms arrive, the 1099 forms, and a lot of people open the mail and they’re shocked. Well, wait a minute, I got 600,000. How come it’s saying I got a million. And, you know, the worst thing to do is just ignore it. Because then, you know, a year later after they file their tax return, they have problems. So But yeah, I mean, you’re right, it makes the dollars can be dramatic. And someone can it’s not an easy thing to explain to someone. I mean, I because they want to think how can this be, you know, and it’s a tough thing to answer.

Alan Olsen: Oftentimes, these attorneys, negotiating settlements will quickly say, I don’t know anything about tax law, which is a, which is a code for you better go get some advice on whether or not this is taxable. Making sure you have competent by sound tech people that come to me on this, I send them to you, because I don’t want to deal with it. You know, you’ll hear about the things of Well, when I complain to the attorney, the attorney says, Well, why don’t I split this into two pieces? And I’ll just give you a net number. And, you know, and I don’t know what that’s about, but let’s say that they were heading down a path of, you know, only reporting to the IRS, the 1099. But I mean, what was the you know, the thing is, I guess there are things that people can do about but oftentimes in insurance settlements, those guys that lose that they’re not happy. They want the IRS to know,

Robert Wood: You raise a good point? I mean, I don’t think it happens a lot. But I have seen it, and I’ve occasionally been on. I mean, most of the time, I guess, because the party who’s receiving money is typically more worried about taxes than the party paying. And I mean, in a business context, defendants are always, almost always, you know, writing off deducting the cost, it’s a business expense. You know, they didn’t want to get sued, but it happened and they had to pay somebody, and they’re writing off lawyers fees. There are some exceptions to that in the sexual harassment area. Another thing that happened in 2018. But you’re absolutely right, that, that sometimes, a defendant behind closed doors with lawyers will be saying, we had to pay this person millions of dollars, you know, they were bad. And we didn’t, you know, we shouldn’t have had to pay, they’re angry. How can we make sure that this person pays as much tax as possible? I mean, that happens. And, and so, you know, the other side of that equation is the plaintiff and the plaintiff’s lawyer should be worried about that and thinking, Okay, before I sign this sort of, how can I get screwed in this deal? Are there? So but you’re right, it mean, being a plaintiff’s lawyer? I guess being any kind of lawyer is difficult. It’s hard to know how much tax advice to give you give any Do you just say, Look, I’m not competent. You got to get some tax advice, or at least I’m telling you, you should You know, you don’t have to. But it’s a it’s a difficult circumstance. And it kind of happens every day. Because there, there are so many lawsuits. Oh, and one other thing I shouldn’t say clearly this, I find this surprises a lot of people that it doesn’t matter if your case has been litigated up and down the courts for a long time, or it’s just a sort of a private mediation that nobody knows about, it’s all quiet sort of use, you know, you send a letter saying, I’m about to sue you. And then you meet quietly, how much evidence there is about the claims varies in those in and you’re typically much more hamstrung by the documents? In a case that’s been litigated heavily? You know, for obvious reasons, but it’s the same set of rules. What’s the case all about? What did you get? What are the documents say? You know, and what kind of tax positioning Can you do later?

Alan Olsen: So, do you find oftentimes that clients coming to you, independent of their attorney, personal injury attorneys say, hey, Rob, can you help look at these documents before I sign them? Is that a common occurrence?

Robert Wood: Yeah, I’ll be very common. And I would say, I mean, once in a while, I look at the documents and say, you know, it looks good. You know, go ahead and sign. But that’s pretty rare. I’d say 99 times out of 100 or more. There’s something it’s not that it’s wrong, that something can be improved. And a very common one would be, you know, it doesn’t it, it may categorize everything correctly, but it doesn’t say anything about a Form W two or 1099. And so we don’t want to open the mail at the end of January. And be surprised with that big 1099. And even though I said, you know, look, just me in almost every circumstance, the 1099 is going to be for the full amount. There’s a lot of can be a lot of jockeying. I certainly do a lot over, wait a minute, should this money be taxable? I mean, post traumatic stress disorder is a great example. So that’s very, I think the first client, as I saw it, with PTSD was with people coming out of the military, but it’s very common now in, you know, in sort of bystander cases, or cases involving something terrible, you see, or a terrible fear that you experienced some trauma that, you know, no one hits you. But it’s nevertheless very real trauma. Even in the workplace, it’s very common now that people end up with, you know, some kind of verbal abuse and pressure. And, and somebody else might react differently, but they react very badly in a life changing way. And there is no tax case that says, post traumatic stress disorder is one of these physical things that would make it tax free. But there’s also no case that says the reverse so. So I think there’s, I’ve written a lot of tax opinions on this, I think there’s a very good argument. And I believe strongly, it’s physical. I have no medical training, but I’ve read a lot about it. And I’ve seen a lot of clients with PTSD. And so that’s one of these examples where if you get the right things in the in the settlement agreement and the right tax treatment, and often I can convince a defendant, that that is correct. Sometimes I have to write them an opinion or something, then you position the client so that, you know, it doesn’t mean they’ll never have to pay any tax. But it typically means that I could read a tax opinion supporting a tax free treatment. And then, you know, even if the IRS examined said that I could defend it successfully. And, you know, the goal is, if you sort of if you turn back the clock and hadn’t done any of that. It’s sometimes possible to still come out that way later. But it’s a lot easier if you’ve put sort of the building blocks in place up front.

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Alan Olsen, is the Host of the American Dreams Show and the Managing Partner of GROCO.com.  GROCO is a premier family office and tax advisory firm located in the San Francisco Bay area serving clients all over the world.

Alan L. Olsen, CPA, Wikipedia Bio