Deductibility of Attorney Fees in Employee Benefits Cases Remains Unchanged
The Tax Cuts and Jobs Act of 2017 changed the tax treatment of attorney fee and other litigation-related expenses incurred by individuals. Congress suspended the deductibility of litigation expenses as “miscellaneous itemized deductions” through December 31, 2025. As a result, the costs and attorney fees associated with non-business-related litigation may no longer be deducted on a taxpayer’s Schedule A. Fortunately, however, plaintiffs who settle employee benefits cases may continue to exempt litigation expenses from their gross income in computing adjusted gross income. The Internal Revenue Code defines “unlawful discrimination” to include claims for employee benefits.
Likewise, the rule regarding the taxability of the plaintiff’s portion of a settlement payment remains the same. Whether the plaintiff’s portion of a settlement is taxable depends on who paid the cost of the benefit. If the employer paid the cost of the benefit, typically an insurance premium, the benefit received by the claimant, including any lump sum payment made to resolve a lawsuit, is taxable. On the other hand, if the plaintiff paid the cost of the coverage through payroll deduction or otherwise, the benefit is not taxable.
When a settlement payment is taxable, the plaintiff is required to report as income only the net amount the plaintiff received from the settlement, i.e. after the deduction of the attorney fee and costs. Internal Revenue Code Section 62(a) (20) (26 U.S.C. § 62(a) (20)) provides a deduction in determining adjusted gross income for attorney’s fees paid in connection with any claim of “unlawful discrimination” claim. Section 62(e) (18) defines an unlawful discrimination claim to include:
(18) Any provision of Federal, State, or local law, or common law claims permitted under Federal, State, or local law–
(i) providing for the enforcement of civil rights, or
(ii) regulating any aspect of the employment relationship, including claims for wages, compensation, or benefits, or prohibiting the discharge of an employee, the discrimination against an employee, or any other form of retaliation or reprisal against an employee for asserting rights or taking other actions permitted by law.
Thus, the taxpayer may deduct litigation expenses “in determining adjusted gross income,” meaning that a plaintiff should report on page 1 of his or her Form 1040 only what the plaintiff actually received from the settlement. This interpretation of the statutes is supported by Private Letter Ruling 200550004. This PLR, issued in 2005, involved a claim for pension benefits, rather than disability benefits, but there is no basis for distinguishing the two as both are employee benefits.
Clients should consult their accountant or tax attorney for specific advice and assistance regarding their personal tax returns. Please contact me if you have any questions.
© 2019 Andrew Whiteman
Whiteman Law Firm specializes in cases involving claims for disability insurance and other employee benefits. These cases typically involve application of a federal law, the Employee Retirement Income Security Act of 1974, known by the acronym ERISA, and are usually resolved through the benefit plan’s appeal process or federal court. We have helped hundreds of individuals with their claims for short-term and long-term disability insurance benefits.
Contact us for more information about our ERISA disability benefits practice.