“have you or someone you know taken the drug Acutane… if so, you may be entitled to cash compensation… call 1800-bad-drug…”

So what are the tax consequences of receiving compensation for your damages?

Well, it depends… Some damages and settlement proceeds are tax exempt under IRC § 104(a)(2) while other damage awards or settlement proceeds are fully taxable.

For example, say you sued the brokerage firm that embezzled $200,000 from your account.  The brokerage firm ends up settling and agrees to compensate you $300,000.  Initially, It may appear that you have recovered your original loss of $200,000, plus an additional $100,000 for the hassle and headache of the whole ordeal.  As you can see from the illustration, your bottom line will not look so rosy.

Thus, if you receive compensation from another party by virtue of filing a lawsuit, qualifying as member of a class action, or become entitled to a payout from an existing settlement fund, ask your attorney about the tax consequences.

Here’s a further rundown of the basics, thanks to Law.com:

5 Things Every Plaintiffs Attorney Should Know About Tax Law

While tax law may seem dull and irrelevant to most attorneys’ day-to-day practice, in order to better serve their individual clients, plaintiffs attorneys should always keep the following five basic tax laws in mind, and advise their clients accordingly.

1. Attorney Fees Are Taxable
2. Awards for Personal Physical Injuries Are Exempt From Tax
3. Insurance Proceeds
4. Lump Sum or Structured Settlement Payments
5. Reporting of Awards

Give Momma one more year of jet-setting!

New York Times columnist Paul Krugman famously  dubbed the Bush 2001 tax cuts the “Throw Momma From The Train Act”, because the estate tax was eliminated for just one year—2010. But as 2010 grinds on without a federal estate levy, it’s becoming clear that Krugman got it wrong.  Any Momma who would ride the rails (even the pricey Acela) probably isn’t worth shoving to a grisly demise.  It’s the Mommas flying on their private jets who need to pack parachutes or watch their backs. Without a doubt, the one- year lapse in the federal estate is a boon to heirs of the superrich. (At  least four billionaires, including George Steinbrenner have died so far this year.)  But for ordinary families, it is creating all sorts of grief and unintended consequences and might even cost some of them extra federal tax, to say nothing of lawyers’ bills.

One set of problems relates to wills that were written assuming there would be a tax; provisions  in such documents could inadvertently disinherit children or a spouse, or could subject an estate to unnecessary state estate tax.  (For more on these issues, click here. For a map showing 2010 state estate taxes, click here.)

Another set of problems relates to a trade-off Congress made in the 2001 law: In return for eliminating the estate tax in 2010, it also did away with the full “step-up” in basis for capital assets for 2010. In other years,  the basis cost of a  decedent’s capital assets–stocks, bonds, jewelry, real estate, artwork and so on– gets adjusted to its market value at his death, or six months afterward.  (The executor gets a choice.) Conveniently, that allows heirs  to sell all the property immediately with no capital gains income taxes due. But for those dying in 2010, the step-up in assets going to non-spousal heirs is limited to $1.3 million, with another $3 million in step-up allowed for assets left to a spouse.   This means some heirs of estates worth several million could end up paying more in total federal tax than they would have had their benefactor died in 2009, when all assets got a step-up in basis and the first $3.5 million of an estate going to non-spousal heirs was exempt from estate tax. (Amounts left to a citizen-spouse aren’t subject to estate tax, since Uncle Sam figures to get his when the second spouse dies.)  These moderately well-to-do families get hit with extra capital gains taxes because their benefactor died in 2010 instead of 2009, but they don’t save much or any estate tax, compared to 2009

While an unknown number of families may pay more, a greater number of them are having to shoulder a big paperwork and administrative burden.  Assuming capital assets (including a home and stocks) total more than $1.3 million, family members and executors must locate old records showing what assets were purchased for (if such records even exist) and deal with all sorts of complicated and potentially divisive issues such as which assets, going to which heirs,  get allocated the limited basis step-ups…

Considering the complicated nuances, it might be wise to keep Momma – and her private jet – around for another year.

August 19th marked the “Cost of Government Day” for 2010.  This is the day the average American has earned enough gross income to pay off his or her share of the spending and regulatory burdens imposed by government at the federal, state, and local levels.

Sadly, working Americans toiled 231 days this year just to satisfy government imposed – 8 days later than 2009 and a full 32 days longer than 2008.

We are likely to see one of the following scenarios (or a combination thereof):

1. Congress does nothing and allows the Bush tax cuts to expire (the tax laws from 2001 will reactivate on Jan. 1, 2011);
2. Congress passes legislation to extend ALL of the Bush tax cuts (Congressional Republican’s Position);
3. Congress passes legislation extending SOME of Bush’s tax cuts (Obama’s Plan- extend some of the stimulus measures, place new limitations on itemized deductions and allow the tax cuts benefiting taxpayers making $250,000+ to expire); or
4. Congress passes the legislation recently proposed by Congressional Democrats (similar to Obama’s plan but without extending stimulus measures and with no additional limitations on itemized deductions).

Despite the legislative unpredictability, taxpayers can still stay a step ahead by putting together a game plan for each of the possible tax scenarios above.

So check www.MyTaxBurden.org to see where you stand…however Congress decides to act (or not act).

Many speculated that Congress would enact interim Legislation preventing a complete repeal of the estate tax in 2010; however, their failure to act has created an array of complications and confusion.    Because the underlying legislation encompassing the repeal is everything but logical, the short-lived repeal will sunset (expire) at midnight on December 31, 2010.  But to really understand the complexity of the estate tax repeal and the resulting problems, I find it necessary to understand the process that accomplished this obscure, one year repeal.

In 2001, the newly elected President Bush, committed to following through with his campaign promises of tax cuts and repeal of the estate tax, introduced the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA).  EGTRRA called for a number of tax cuts that would phase-in over a number of years.  The repeal of the estate tax was merely a legislative concession.

Prior to EGTRRA, there were several attempts to repeal the estate tax that failed to gain Congressional support.  Because the repeal supporters knew from experience that a bill calling for repeal would never get passed, they slipped the repeal into one of EGTRRA’s many amendments by utilizing the reconciliation process.  The reconciliation process allowed the Senate to pass the amendment with just a majority vote (instead of the typical super-majority vote required) and avoid budget constraints.

The caveat is that a reconciliation amendment cannot decrease revenue beyond a ten-year period unless offset by specific spending cuts or revenue increases.  With EGTRRA forecasting a revenue loss of $1.35 trillion, the ten-year limitation (known as a sunset provision) mandated an automatic termination of the bill at the end of the ten-year period.

So here we are, almost ten years after EGTRRA’s enactment, facing an uncertain future and a dismal economy.  As our country faced one economic blow after another over the past 10 years, the CBO’s projected $5.6 trillion surplus for the 2002-2011 fiscal years has plummeted to a growing $10 trillion deficit.  And so the debate rages on…Should the tax cuts be extended or should Congress do nothing and let them expire?

Although it seems logical that a repeal of the estate tax would decrease the need for estate planning, the opposite is true.  With the clock ticking and no resolution in sight, estate planning attorneys are left scrambling to ensure their client’s estate plans provide for a multitude of alternatives to account for the legislative uncertainty.

Maybe Congress is attempting some kind of twisted population control initiative… kick the bucket this year and the government will give your estate a tax holiday…

Another Dissatisfied IRS Customer

As a tax attorney, I have the pleasure of routine interaction with the IRS.  However, I must confess my dealings with the IRS are not as efficient and streamlined as I would like.  Therefore, it came as no surprise to find that the IRS’s customer satisfaction is far from stellar.  Surprisingly I did not expect to see social icon, Facebook,  vying so competitively with the IRS for the most unsatisfied customer service award…

Wall Street Journal, Users Rate Facebook Slightly Above the Tax Man:

Facebook plans to announce it has reached a milestone 500 million users this week — but that doesn’t mean the masses are happy customers.  The American Customer Satisfaction Index, developed by the University of Michigan’s Business School, included Facebook in its regular survey of consumer satisfaction with companies.

The result: Facebook came out with one of the lowest ranks of any company measured by the Index – a 64 out of 100. That puts Facebook in the bottom 5% of all private sector companies, and in the same range as the IRS tax e-filing system, airlines and cable companies.

Keep Prayin' Wesley, Prison is Scary... Just ask Lindsay Lohan

With the US Court of Appeals recent decision to affirm Wesley Snipes’ criminal tax conviction, it looks like Wesley Snipes may have to rely on the royalties from his cheesy “Total Gym” Infomercials to pay off his substantial legal fees and restitution incurred from his long battle with the IRS.  I wonder if the Federal Prison has a Total Gym??  Maybe he can shoot an updated Total Gym infomercial from prison…

This affirmation strikes close to home.  Not only was Snipes born in Orlando, Florida, on July 31, 1962, graduating from Jones High School in Orlando, but it was the Federal District Court out of Ocala, Florida that secured Snipes’ guilty verdict.

Despite residing in Windermere, Florida, Snipes filed multiple unsuccessfully motions in an attempt to move the trial location from the Federal District Court in Ocala, Florida to New York.  Snipes argued that Ocala, Florida was the “most racially discriminatory venue available, with the best possibility of an all-white jury,” and that the Ocala area was a “hotbed of Klan activity.”

Snipes was charged with multiple counts of criminal tax fraud.  Count One charged Snipes and his two co-defendents, Eddie Kahn and Douglas Sosile with conspiracy to defraud the Government by impeding the IRS and its collection of Income Taxes.  Count Two charged all three defendants with filing false claims of refund for income taxes Snipes paid in previous tax years.  Count Three through Eight charged Snipes alone with six counts of willfully failing to file his income tax return for years 1999 through 2004.

Snipes became involved with co-defendents Kahn and Sosile sometime in 2000 when he joined Kahn’s shady organization, “American Rights Litigators” (ARL), a subsidiary of Kahn’s other organization, “The Guiding Light of God Ministries.”  Despite having no legal training, Kahn, through ARL, taught Snipes how to could avoid paying taxes via Constitutional and Statutory arguments challenging the IRS’s authority to collect tax. With ARL assistance, Snipes sent voluminous letters to the IRS, challenging their authority to collect tax by asserting the “861 Argument.”

The 861 Argument (from IRC Section 861(a)) basically says that domestic earnings of Americans do not qualify as “taxable US income” because such is not specifically listed as a source of taxable income.  This is a horrible argument seeing that IRC Section 61 is the broad provision for income INCLUSION.  Without a specific provision EXCLUDING income from tax, the income will be included in taxable income.  Despite one of his arguments asserting his Constitutional rights as an US citizen, Snipes conversely argued that he was not and had never been a US citizen, therefore was a non-resident alien whose sole source of income came from sources wholly outside of the US.

Snipes did not stop at merely refusing to pay income taxes in 1999-2004 despite earning over $37 million, but he also sent multiple altered 1040X Forms to the IRS in an attempt to collect a refund for over $20 million from income taxes he paid in prior years.

On February 1, 2008, the District Court’s Jury found Snipes guilty on Counts Three through Five for willful failure to file individual income tax returns for years 1999-2001, sentencing him to 36 months of incarceration.  Although the convicted charges were only misdemeanors, the court was able to enhance Snipes’ sentence by the aggravating factors, including Snipes obstruction of justice (destroying evidence and hiding money in foreign accounts) and the substantial financial loss to the government (over $41 million in loss taxes).

Instead of his frivolous 861 Argument, Snipes should have claimed insanity for letting Kahn and  his “Guiding Light of God Ministries” brainwash him into thinking that he was never a US citizen.  Seriously, if he’s not a citizen of the US, where the heck does he reside…the “Guiding Light” in the sky?

The NCAA seems to be making an example out of USC’s violations by hitting them with severe sanctions, including revocation of championships, player record statistics, scholarships and essentially removing them from the BCS for the next couple years. With a substantial number of USC’s violations stemming from actions relating to individual players, the IRS is now chasing down former College All-Stars to collect tax on the multitude of gifts they received – complete with penalties, interest.

According to NCAA’s USC Public Infraction Report, Reggie Bush received over $300,000 of “gifts” and “benefits” from various agents.  Which leads us to the question, how can the IRS tax Mr. Bush on these “gifts?”

Generally, a gratuitous transfer of property will not result in tax consequences upon the recipient.   However, the IRS will consider the gift to be income if the recipient provides “consideration” or something of value to the donor of the gift. The problem with Mr. Bush’s situation was that EVERYONE wanted something of value from him…he was the one of the hottest commodities the NFL had seen in a while.

From the IRS’s standpoint, all the luxury gifts, limos, designer clothing, travel accommodations, as well as the rent-free living arrangements provided to him (and his entire family), were taxable items of “Gross Income.” The Internal Revenue Code broadly defines Gross Income as “all income from whatever source derived.”   Considering the items of income arose from events taking place over five years ago, the IRS will likely receive a generous “gift” of penalties and interest in addition to Mr. Bush’s income tax.

Although the extent in which the IRS will benefit from USC’s Sanctions is uncertain, I have no doubt that without stricter institutional governance, we will see the IRS stepping up their game to cash in on the college football fever.

And if that wasn’t enough, you then must decide who is worthy of receiving these precious items that seemingly reflect your indention upon this planet.   After agonizing whether or not leaving a drug-addict daughter a portion of the estate would be more detrimental than gratuitous, we throw in the towel and rationalize that we will worry about it later.

Unfortunately, none of us can cheat death.  We can pretend that it doesn’t exist, but it will be at the expense of our loved ones.  Leaving your loved ones to duke it out is never a good option–absent a twisted sense of humor.

Although daunting, the hassle, headache, and huge legal fees associated with estate planning can be avoided by following a few simple words of advice.

1. Make a list of your assets, dividing them up by category (real property, liquid accounts, family heirlooms, etc.)
2. Make a list of the people you would like to leave something from your estate
3. If there are specific things you want to give a particular person, put that item next to the person’s name
4. Think about how you envision spending your retirement days–do you want to live it up traveling the world or find a modest, comfortable retirement community

Once you have sketched out your big picture objectives, it becomes much easier to ensure that you are getting an estate plan that can carry out your wishes while eliminating unnecessary estate planning documents.

Last, shop around.  When talking to an estate planning attorney, be specific about what you need.  Get a price quote and for good measure, get another opinion.

Below is a starting point for assessing your 2010 tax situation and determining whether or not consulting a tax attorney might help you reduce your bottom line this year.

Basics

Because many tax benefits are tied to or limited by adjusted gross income (AGI) — IRA deductions, for example — a key aspect of tax planning is to estimate both your 2009 and 2010 AGI. Also, when considering whether to accelerate or defer income or deductions, you should be aware of the impact this action may have on your AGI and your ability to maximize itemized deductions that are tied to AGI.

Traditional IRAs:

Individuals who are not active participants in an employer pension plan may make deductible contributions to an IRA. The annual deductible contribution limit for an IRA for 2009 is $5,000. For 2009, a $1,000 “catch-up” contribution is allowed for taxpayers age 50 or older by the close of the taxable year, making the total limit $6,000 for these individuals.

Individuals who are active participants in an employer pension plan also may make deductible contributions to an IRA, but their contributions are limited in amount depending on their AGI. For 2009, the AGI phase-out range for deductibility of IRA contributions is between $55,000 and $65,000 of modified AGI for single persons (including heads of households), and between $89,000 and $109,000 of modified AGI for married filing jointly. Above these ranges, no deduction is allowed.

Roth IRA conversions:

Regardless of income, taxpayers can convert traditional IRA accounts to Roth IRA accounts. Previously, taxpayers with modified adjusted gross income over $100,000 could not make the conversion. Also, married persons filing separate returns are now eligible to make the conversion. Note that the converted amounts are includible in income, however, for conversions taking place in 2010, a taxpayer can elect to ratably include the amount over two years in 2011 and 2012.

Lower capital gains rates:

The 15% capital gains rate (0% for taxpayers below the 15% tax bracket) will increase to 20% in 2011. Qualifying dividends taxed at reduced capital gains rates will be taxed at ordinary income rates beginning in 2011.

Lower income tax rates:

Legislation in 2001, reduced the tax rates on ordinary income through 2010.  Accordingly, these rates will likely change beginning in 2011.

2009 Tax Rates: 10%, 15%, 25%, 28%, 31%, and 35%

2010 Tax Rates: 10%, 15%, 25%, 28%, 33%, and 35%

This is the rate at which your last dollar of income is taxed. Although tax brackets are indexed for inflation, if your income increases faster than the inflation adjustment, you may be pushed into a higher bracket. If so, your potential benefit from any tax-saving opportunity is increased (as is the cost of overlooking that opportunity).