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The IRS has a keen interest in the tax treatment of litigation settlements, judgments and attorney fees. Thus, any payment for services of $600 or more to a lawyer or law firm must be the subject of a Form 1099. It does not matter if the law firm is a corporation, LLC, LLP or general partnership.
If the settlement check is jointly payable to the plaintiff and its attorney, the defendant is required to issue a Form 1099 to the attorney under § 6045 as amounts paid in connection with legal services. As a result, both the attorney and the plaintiff receive Form 1099s for the entire settlement amount.
Even payments for services to incorporated law firms trigger a Form 1099. Practice varies, but most lawyers do not need to issue a Form 1099 to their client for settlement monies. The reason is that lawyers receiving a joint settlement check to resolve a client lawsuit are usually not considered mayors of the money.
Notably, any amount of a settlement payment for damages with respect to personal injury or death is exempt from tax. However, if an amount awarded for damages is held in a deposit account and interest accrues on that amount before it is paid out, that interest is taxable as income.
Recoveries for physical injuries and physical sickness are tax-free, but symptoms of emotional distress are not physical. Many plaintiffs take aggressive positions on their tax returns, but that can be a losing battle if the defendant issues an IRS Form 1099 for the entire settlement.
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