Some time ago, the IRS issued an Audit Techniques Guide on the taxation of lawsuits, awards, and settlements. As many tax practitioners can attest, there are a multitude of tax issues involving any one of these issues. In any event, and although the Audit Technique Guide (“Audit Guide”) is somewhat dated, it is still worth a read to get a quick review of the issues an IRS auditor will focus on when these types of issues have been identified in an IRS examination.
Introduction.
Section 104(a)(2) of the Code provides the tax treatment rules for amounts received “on account of personal physical injuries or physical sickness.” Generally, if a lawsuit or settlement amount fits within Section 104(a)(2), the payment is not taxable. However, the Audit Guide cautions IRS examiners that Section 104(a)(2) only applies to individuals because federal courts have concluded that a business entity cannot suffer a personal injury within the meaning of Section 104(a)(2).
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