Tuesday, February 18, 2003
If cases like Christopher J. and Vickilynn M. McCann keep showing up, someone is eventually going to start suing litigators who do not use tax consultants for malpractice. The McCanns won a $400,000 medical malpractice judgement against the Louisiana Patients Compensation Fund (LPCF), plus interest going back several years, with many of those years on a higher principal. This judgement survived one appeal, and then the parties settled over two years later for $839,000. The settlement agreement said it released LPCF from a long list of liabilities, which included interest and many other possible claims. There was no break-down of exactly what the $839,000 was for. The McCanns argued that the entire amount was damages. IRS said $255,983 was interest. (Settlement amount minus $400,000, subtracting litigators cut, plus a few thousand for a pro-rata amount of awarded costs.)
Tax Court found for the IRS. Since the settlement amount did not specify what damages were for, the settlement should be allocated according the original judgement.
So why was this allocation not in the settlement agreement? This case implies that LPCF may have had political reasons for not wanting to allocate more than $400,000, but it also makes it sound like such allocations were never discussed in settlement negotiations. They should have been. Tax-savvy litigators should always try to have settlement agreements allocate as much as possible to tax excludable items. If the entire settlement amount is deductible to the payer, which I assume to be the case (email me if I am wrong), allocating the settlement could represent free money the parties may split. Of course, the IRS could challenge the allocation (and the underlying judgement and laws in this case would have been good reason to do so), but they will have a tougher time doing so if the agreement supports the position.
Tax partners at law firms, please brief your litigators to spot these issues and call you. Settlement writing by the tax ignorant may not be quite as unethical as will writing by the tax ignorant, but it is on the same continuum. Don�t let your firm become a test case.