legal fees

[jklcpa]

Client received a settlement in '07 from Exxon class action lawsuit. Settlement received is part compensatory damages & part interest income. Client received only a 1099-INT for the interest portion.

A letter shows detailed breakdown of gross settlement & related expenses. The 1099-INT reports the interest income NET of its share of prorated legal fees.

During some of the years covered by the lawsuit, this gas station was a Schedule C activity. The compensatory damage award is basically because Exxon overcharged dealers for their gasoline purchased. (Dealers were supposed to get a price break in their gas purchase costs if they agreed to charge customers different rates depending on cash or credit card payment. Exxon did not honor their end of the agreement & continued to charge Exxon dealers the higher price for the gas.)

Many years ago, my client incorporated the business (got a similar settlement this year in his corp) so he no longer has the Sch C operation. My question: should he report the gross damages as other income & the legal fees on Sch A, or can he net the legal against the damage award?

If he still operated as a Sch C today, how would he report this?

[cientax]

Client received a settlement in '07 from Exxon class action lawsuit. Settlement received is part compensatory damages & part interest income. Client received only a 1099-INT for the interest portion.

A letter shows detailed breakdown of gross settlement & related expenses. The 1099-INT reports the interest income NET of its share of prorated legal fees.

During some of the years covered by the lawsuit, this gas station was a Schedule C activity. The compensatory damage award is basically because Exxon overcharged dealers for their gasoline purchased. (Dealers were supposed to get a price break in their gas purchase costs if they agreed to charge customers different rates depending on cash or credit card payment. Exxon did not honor their end of the agreement & continued to charge Exxon dealers the higher price for the gas.)

Many years ago, my client incorporated the business (got a similar settlement this year in his corp) so he no longer has the Sch C operation. My question: should he report the gross damages as other income & the legal fees on Sch A, or can he net the legal against the damage award?

If he still operated as a Sch C today, how would he report this?

I would use the TIN on the 1099INT and report it on the 1040 if SSN is used, otherwise I would use the EIN of the corp if the corp EIN is on the 1099 and report on the corp return. If it is netted already, then I would use the net, otherwise I would use the gross then deduct the legal fees elswhere on the corp return.

The legal fees would be subject to 2% of AGI if SSN is used on 1099INT. If the SSN is used on the 1099INT then IRS will be looking for it on the 1040 and not on the corp return. If the 1099 is already NET of legal expenses then I would only report the net amount and not have any deductions against the gross. If you use the gross income then try to net it of the legal expense on Sch-A, then he/she would lose some of the deduction because of the Sch-A 2% limitation, unless they can otherwise itemize misc expenses.

I would also look at whether it would benefit his tax situation because if you report it as Other Income on the Sch-C, it will probably be subject to SE tax. I the 1099INT has his personal name and SSN instead of his company name (Sch-C name) and EIN, then it would benefit to report it on line 8 of the 1040, depending on how much interest income there is.

[jklcpa]

Thanks for the reply, but you misunderstood slightly.

Exxon did split the settlement to my client because at one time he was operating as a proprietorship on Sch C and now he is incorporated. He received a check in his personal name & SSN, and also a check to the corp reported using EIN.

EACH settlement has a portion that is compensatory damages and a portion that is interest. Personally, he received 2 documents: a letter and a 1099-INT. (He also received the same 2 documents in the corp)

When Exxon prep'd the 1099-INT, they reported the interest net of the legal fees. There was no reporting whatsoever of the damage award. I am going to report the gross damages & report the legal fees on Sch A.

Since he no longer has a Sch C I hadn't considered the SE tax aspect of the damages, but you do make a valid point.

[Maribeth]

Thanks for the reply, but you misunderstood slightly.

Exxon did split the settlement to my client because at one time he was operating as a proprietorship on Sch C and now he is incorporated. He received a check in his personal name & SSN, and also a check to the corp reported using EIN.

EACH settlement has a portion that is compensatory damages and a portion that is interest. Personally, he received 2 documents: a letter and a 1099-INT. (He also received the same 2 documents in the corp)

When Exxon prep'd the 1099-INT, they reported the interest net of the legal fees. There was no reporting whatsoever of the damage award. I am going to report the gross damages & report the legal fees on Sch A.

Since he no longer has a Sch C I hadn't considered the SE tax aspect of the damages, but you do make a valid point.

Okay . . . . the research that we've done so far, which isn't much, is that the interest is reportable on Schedule B. My client is still a Schedule C and the rest of the award, net of the attorney fees, is going to Schedule C because it is a "refund" of an overcharge and would have been reflected in the COGS section of Schedule C.

I would love for someone to have a cite or letter ruling or anything that would say we could take it off of the Schedule C but I don't believe that would happen.

Maribeth

[BulldogTom]

Warning, this is unresearched, off the cuff. Take it for what it is worth.

You know that the basis of this payment is because of the business activity of several years ago. As you point out, the overcharged fuel was included into COGS and deducted in that year. The "refund" is therefore taxable on the Sch. C. If that is the case, the legal fees and interest should also go on the Sch C, because they are based in the same business transactions. It does make the Interest subject to SE tax, but it gets 100% of the legal deducted with no haircuts.

What would you have done if rather than a lawsuit, the Proprietor had hired an attorney, proved to Exxon that they violated a contract, and Exxon agreed after 2 years that your client was right and paid the refund, legal fees, and some interest to cover the use of the funds during the dispute. It would all go on the Sch. C, wouldn't it?

Another thought is how the Sch C disolved and the Corp came into being. If the corp assumed all the assets and liabilities of the proprietor, then all can go on the 1120. The corp steps into the proprietors place for its claim on Exxon.

Again, just thinking (or typing) out loud.

Tom

Lodi, Ca