The Taxman Cometh - And Maketh Settlement More Expensive

After a successful (from the employee's perspective) trial, the employer agreed to a $1.2 million settlement. In order to minimize tax liability, the employee requested and the employer paid $799,000 to the employee and $401,000 to his attorney. The employee declared only the $799,000 as income.



The IRS declared a deficiency for the failure to report the $401,000. The Commission ultimately determined that the $401,000 could be counted as a miscellaneous business expense under § 115 of the Tax Code. Unfortunately, the employee was trapped by the now famous Alternative Minimum Tax (AMT) which does not permit the use of any miscellaneous deductions. An attempt to make it an above the line deduction under § 62 relating to certain employee reimbursement programs failed as well. Biehl v. CIR (9th Cir. 12/12/03) [pdf]. Mr. Biehl went from a triumph to a tax crises. Although perhaps sympathetic, the 9th Circuit offered little solace pointing out that: "If this result strikes some as bad policy, or unfair, the remedy is with Congress, not the courts."



Biehl emphasizes a problem that is significant enough that both sides of the organized employment bar have approached Congress with a proposed solution that would minimize the tax consequences of settlements. The most recent iteration is the Civil Rights Tax Relief Act of 2003. One of the problems is in the title itself, tax relief, e.g. a revenue drain. Leaving it in the category of an idea that has not yet borne legislative fruit.