Page 139 - TaxAdviser_2022

INDIVIDUALS

her divorce and the other was a malprac- humiliation, and loss of ability to enjoy
The taxpayer in tice lawsuit against her divorce attorney. life.” In October 2014, the defendant
The petitioner’s former spouse filed
and her divorce lawyer entered into a
Staples tried to for divorce in March 2010. As part of settlement agreement of $175,000. Of
stretch the scope of the divorce proceedings, the petitioner this amount, the taxpayer’s malpractice
Sec. 165 even further. participated in, and settled through, a attorney scooped up $73,500.
Upon filing her 2014 Form 1040,
mediation process. During the media-
tion process, the petitioner objected to U.S. Individual Income Tax Return, the
the mediated settlement agreement; taxpayer reported no “Other income”
In addition to screening returns to however, her objections were not sus- on line 21. In a “Line 21 statement” she
identify those eligible to exclude up to tained by the divorce court. In May listed the $101,500 of settlement income
$10,200 of unemployment compensa- 2012, following the agreed final decree from the malpractice suit but offset the
tion benefits, the IRS also identified that was entered in April 2012, the income by subtracting the same amount
and corrected returns that would be eli- taxpayer’s attorney filed for a new trial with the description “Misclassification
gible for the EITC, premium tax credit, requesting an additional settlement, stat- of lawsuit recovery of marital assets.”
and recovery rebate credit based upon ing that she received less than her equal The IRS issued a notice of deficiency for
excluding up to $10,200 of the allotted share. The motion for a new trial was tax on $101,500 but later amended the
unemployment income. For further dis- denied, and the taxpayer’s attorney was claim for tax on the entire $175,000.
cussion of this topic, see Sec. 85, below. supposed to file for an appeal but failed The taxpayer argued that the settle-
Unreported income — settle- to do so. ment proceeds were a nontaxable return
ments of attorney malpractice: In In October 2013, the taxpayer filed a of capital because they compensated her
Holliday12 (also discussed below under malpractice lawsuit against her divorce for the portion of her marital estate that
Sec. 1041), the Tax Court upheld the attorney, accusing him of negligence and she “was rightfully and legally entitled
IRS’s determination that the petitioner gross negligence and seeking, among to, but did not receive, due to the legal
failed to report income received from a other things, damages for “pecuniary malpractice of” her divorce attorney. The
lawsuit settlement, which, in fact, was and compensatory losses,” including IRS argued and the Tax Court agreed
related to a second lawsuit. One of the “damages for the past and future men- that the settlement proceeds were clearly
petitioner’s two lawsuits was related to tal anguish, suffering, stress, anxiety, from a settlement agreement in lieu

12. Holliday, T.C. Memo. 2021-69.

EXECUTIVE SUMMARY amended return because the • The Tax Court ruled that settle-
excluded amounts make them ment proceeds a taxpayer re-
• Among other notable develop- eligible for deductions or credits ceived from a malpractice lawsuit
ments in individual taxation in that were not claimed on their against a divorce attorney were
the six months ending December original return. gross income, rejecting the tax-
2021, courts in several cases payer’s argument that these were
again were required to determine • The IRS released an updated a nontaxable return of marital
if taxpayers claiming a theft loss audit guide relating to hobby estate property.
met the requirements of Sec. losses.
165, including whether a theft • Other recent cases dealt with
occurred under state law. • In a case involving retirement the earned income tax credit,
funds invested in gold and silver cancellation-of-debt income, the
• With respect to the exclusion of coins, the Tax Court held that alimony deduction, rollovers of
2020 unemployment compensa- a taxable distribution occurred IRAs, and the advance premium
tion benefits from income, the when the IRA owner took physical tax credit, among other matters.
IRS issued guidance addressing possession of the coins.
when taxpayers should file an

30 March 2022 The Tax Adviser