Avitas structured settlement update 12 27 10 .pub

Structured Settlement Update
By John J. McCulloch, JD, CSSC
President, Avitas
Volume 12, Issue 2
December 27, 2010
Addressing Taxes a Must During Mediation and Settlement
In his recent article, Address Taxes When You Mediate Civil Disputes, author Robert Wood discusses the need to specify the
tax treatment of damages during mediation or alternative dispute resolution. Wood advocates that all parties should be ready to deal with the tax issues arising from mediation, and plaintiffs should ask their lawyers how taxes will be handled if the mediation is successful. Likewise, defendants should consider whether they can agree to any tax accommodation in settling the case. All the lawyers (especially those on the plaintiff’s side) should question whether there will be time to address tax issues during mediation or afterward. Mediators should think about what should be signed if the mediation is successful and whether that document should include tax language. Wood's article covers the various types of cases settled in mediation and the tax issues that can flow from the settlement if taxes are not addressed. In the employment litigation context, issues of whether all of payments are wages and subject to additional taxes and withholding, appropriate allocations between wages and non-wage damages, and whether any of the settlement has an equity feature (e.g., stocks) that can be taxed at a rate lower than ordinary income. In the personal physical injury settlement, Wood uses the example of a dispute mediated pretrial or post trial while a case is on appeal stemming from an award at trial for compensatory damages ($5 million), punitive damages ($20 million), and interest ($1 million). The case is mediated on appeal and the parties agree to resolve the dispute for $10 million. How will the payment be treated for tax purposes? Will it all be tax free as compensatory damages, or is some of it punitive damages or interest? What will the plaintiff and defendant provide in the settlement agreement? Wood advocates the use of some kind of term sheet at the conclusion of the mediation indicating that they have tentatively resolved the case for a specified payment and that the parties will cooperate to produce a final settlement agreement that both parties will sign that addresses the taxation of the damage payments. Binding settlement agreements are also used in mediation, but there is typically little opportunity to catch errors or address the tax issues. This can be problematic if there are arguments to be made for excluding some of the damages under Section 104. The plaintiff should be prepared to assert how much of an exclusion seems reasonable and how it can be documented. The defendant should be prepared to develop a position about what it is willing to do. Unfortunately, in most cases, the parties do not seriously consider the tax issues unless a dollar figure is agreed on by both sides. Wood feels that the possibility for mishandling the tax issues is significant, as there has been little time to consider all of the tax issues. How a settlement is postured, and how the defendant files its informational return on the settlement payment can have a huge impact on a plaintiff's tax position. It bears noting that while the plaintiff and the defendant may agree in a settlement agreement that the settlement is intended to be for personal physical injuries and therefore should not constitute income for tax purposes, the IRS can always disagree and is not bound by the settlement agreement. The article also address the benefits to the defense in specifying the taxation; while some defendants assert that it is only in the plaintiffs’ interest to set forth tax provisions in a settlement agreement, this is not true. First, defendants may have to address deductibility issues. Even more importantly, however, defendants need to know what they can and should do concerning withholding and information returns. Defendants are required to withhold and report on wage components in settlements, and must also file an informational return on any taxable non-wage settlement. Failing to address the taxes can lead to lengthy and expensive litigation for both parties. In Sheng v. Starkey Laboratories Inc., an employment claim was settled for $73,500 at a settlement conference. The attorneys could not, however, agree on the tax treatment of the settlement. Sheng’s attorney asked for an assurance that Starkey would not withhold taxes. Starkey asked Volume 12, Issue 2
Addressing Taxes a Must During Mediation and Settlement (con’t)
for indemnity in the event the IRS appealed, contending that no something to accomplish in alternative
thought withholding was required. settlement was ever reached because dispute resolution. Taxes may seem to According to Sheng’s lawyer, the parties the parties had not agreed on tax be a low priority, but they are agreed to meet again to iron out this consequences. A ‘‘mutual mistake of important to consider if the mediation nettlesome tax question. Later that day, fact’’ existed, Starkey argued. The goes well. Addressing the tax issues the parties learned that the judge (not the Eighth Circuit reversed, holding that sooner rather than later is good for magistrate) had granted summary there was no contract unless the parties both sides, plaintiffs and defendants. judgment to Starkey on December 17, agreed to all material terms. What is 1993 (three days before the settlement material must be evaluated when the Author's Note: Sheng is really a conference with the magistrate). When contract is formed, and subsequent cautionary tale; it is clear the defendants the judge became aware of the settlement events cannot make terms nonmaterial likely spent far more in litigation costs on December 20, he withdrew his grant of that were material at the time a deal than the entire $73,500 settlement and summary judgment. On December 21, he was being considered. The tax and could have avoided costly litigation by issued a new order endorsing the indemnity issues were material here, simply addressing the tax issues before settlement and dismissing the plaintiff’s and that vitiated the settlement. settlement. Tax issues should never be case. The plaintiff tried to enforce the $73,500 settlement while the defendant The final chapter in Sheng came on avoided; they can become valuable sought to reinstate the December 17 remand, when the court found the negotiation points for either side, summary judgment ruling. Starkey parties had reached agreement on all particularly with the use of nonqualified argued that there could not have been an essential terms. The court rescinded the structured settlements to mitigate the tax enforceable settlement because (a) the dismissal order and reinstated summary judgment in Starkey’s favor. liability of taxable damages. Conversely, parties were negotiating without the Still not satisfied, Sheng appealed utilizing a settlement consultant to help knowledge that summary judgment had again. Considering the case for a second identify possible exempt damages under failed to reach a complete agreement time, the Eighth Circuit said the Section 104 can increase the value of a because the tax treatment of the settlement did not hinge on tax issues. settlement tremendously; consider that a settlement proceeds had not been Moreover, the Eighth Circuit found $800,000 tax exempt settlement puts more addressed. The district court determined that the summary judgment motion money in a plaintiff's pocket than a $1 that the summary judgment ruling had did not give rise to a mistake of fact not matured into a court order before the settlement was reached and that the The article concludes with the position failure to agree on tax consequences did that plaintiffs, defendants, their not preclude a settlement. Starkey attorneys, and mediators all have Recent Noteworthy Cases
In each newsletter, we make mention of attraction, the suit said. She spent a employer, Net Trucking, had doctored
some of the notable cases of the week, year in a vegetative state before dying their logs to conceal this fact, an many of which would be suitable this November. The suit was filed to investigation discovered. Source: Fort candidates for a structured settlement. financially protect the family, who Wayne Journal-Gazette 12/08/2010 These cases can make a great point of incurred $1 million in medical bills. entry for a new client, or show additional Source: St. Louis Post Dispatch Suit Filed Against City of Cleveland
Suit Filed in Haunted House Death
$15 Million Awarded in Fatal Crash
A lawsuit has been filed against the An Indiana judge has awarded $15 investigating an accused serial killer. operators of a haunted house in St. Louis million to the family of a man killed by The suit claims police showed over the death of a teenage girl this a drunk driver. The crash killed four "deliberate indifference" in their November. Brittney Holmes visited the people. The drunk driver, Stanislaw investigation of convicted sex offender haunted house last Halloween and Gil, was unharmed. The truck driver Anthony Sowell. Sowell was arrested suffered a severe asthmatic attack after had also been driving longer than on reports of attacking women, but breathing in the smoke and fog in the federal regulations allow and his only in custody for two days. The Volume 12, Issue 2
Recent Noteworthy Cases (con’t)
remains of 11 women were later found in Chewing Tobacco Death Suit
could have been prevented had police A chewing tobacco manufacturer has 12/07/2010 more "aggressively investigated" the agreed to a $5 million settlement with accusations. Source: United Press the family of a man who died from Jury Awards $14 Million in DUI Crash
cancer, allegedly caused by the Lawsuit
product. The man began chewing A Florida jury awarded a family $14 $1.1 Million Award in First of 2600 tobacco at age 13 and died of tongue
Levaquin Settlements
cancer at age 43. Source: The Hartford million last week in a lawsuit filed over A Minnesota jury has awarded $1.1 Courant 12/07/2010 million to a man in a lawsuit against Man Dies Unloading Plane
Johnson & Johnson (J&J) over the lack of warnings of the company's drug A Chicago woman has filed a lawsuit been drinking all night at a local bar, Levaquin. The plaintiff claimed he against Boeing Inc. over the death of hit the truck the two young boys were suffered a ruptured Achilles tendon after her husband, who fell from a jet while riding in at about 80 mph. Source: Fort taking the drug and that the company unloading it in Kuwait. The man was on top of a mobile belt loader when the Meyers News-Press 12/03/2010 had not warned doctors or patients of the driver suddenly moved it, causing him risk of tendon injuries. The trial was the first of more than 2,600 Levaquin claims. to fall and suffer a fatal brain injury.

Source: http://www.avitas.structures.com/News/SSUpdate122710.pdf