We recently represented a client in her wrongful termination lawsuit against her former employer.
The case was eventually settled out of court and we recovered a settlement of $75,000 for our client. As part of the settlement process, our client wanted to know what the tax consequences would be given the settlement award and the legal fees due to our firm.
An award for unlawful termination is considered income to the recipient and thus must be included in income, usually on line 21 of Form 1040 where it says, “other income.” The award is not subject to self-employment taxes.
For many years, however, it was not clear if an individual could deduct attorney fees for unlawful termination claims as an adjustment to gross income. As a result, the effect of including the entire award in income and not being allowed to deduct the attorney fees created a tax bill that, when combined with the attorney fees, almost equaled the award amount. Obviously, this seemed unfair. In fact, it created a disincentive to file unlawful discrimination lawsuits.
The good news is that recent legislation now allows an above-the-line deduction for attorney fees and court costs paid in connection with unlawful termination, discrimination and certain other lawsuits.
As a result, we let our client know that she can in fact deduct our fees on line 36 of her tax return.
At the end of the day, our client was very happy that she received compensation from her former employer and at the same time knowing she wouldn’t end up with a big tax bill to the IRS.
