The Illinois Trial Practice Weblog

More About the Tax Consequences of Confidentiality Clauses in Settlement Agreements

In a post earlier this month, I wrote about the tax consequences of confidentiality clauses in settlement agreements after reading about the issue in Trial Briefs from the Illinois Bar's Section on Civil Practice and Procedure. Now I see there's another article about the issue, this time in Trial magazine.

In "Avoiding the confidentiality tax bite," Randall O. Sorrels and Neel Choudhury have a number of practical tips for dealing with confidentiality agreements in settlement agreements, including these:

• If possible, don't agree to the confidentiality agreement at all;
• If a confidentiality agreement is necessary, specifically state in the settlement papers any amount the defendant paid as consideration;
  
• Even better, and assuming it's true, get the defendant to state expressly that nothing was paid for confidentiality; or,
• Obtain a private IRS ruling.

Unfortunately, the article's not available online.* Since it includes explanations of these points plus lots more, be sure to look it up if you're dealing with the issue.

*Correction, the article is available online to ATLA members. Go to the June 2006 issue of Trial and sign in. In addition, a reader emailed me a link to a slighter longer version of the same article at the Houston Business and Tax Law Journal: "Plaintiffs' Attorneys Beware: Little Known Tax Consequences Associated with Confidentiality Provisions" (pdf).

Tax Consequences of Confidentiality Clauses in Settlement Agreements

In a recent issue of Trial Briefs from the Illinois Bar's Section on Civil Practice and Procedure, Michael J. Marovich reported that confidentiality clauses in personal injury settlements might trigger tax consequences for the plaintiff.

Here's the rationale. A confidentiality clause is normally something that benefits the defendant--that is, something the defendant would be willing to pay for in a settlement. Though personal injury settlements normally aren't taxable, 26 U.S.C. 104(a)(2), this might not be true of income received as consideration for a confidentiality agreement. See Amos v. Commissioner of Internal Revenue, T.C. Memo. 2003-329, 2003 WL 22839795, 86 T.C.M. (CCH) 663, T.C.M. (RIA) 2003-329 (U.S. Tax. Ct. Dec. 01, 2003) (No. 13391-01),

In Amos, the court found that $80,000 of a $200,000 personal injury settlement was taxable as consideration for a confidentiality clause in a settlement agreement. There was no discussion of how the court arrived at the $80,000 figure. In his note, Marovich concluded:

It would appear that Plaintiffs have a strong argument for refusing to allow confidentiality agreements to be present in any settlement. In the alternative, the Amos case may provide a strong basis that the settlement amount of a case should be increased in order to compensate Plaintiff for the increased tax liability he or she incurs if a confidentiality agreement is made a part of the terms of any settlement. In addition, the Amos case seems to require that any Plaintiff's attorney advise their client of the tax consequences of including a confidentiality agreement in any settlement agreement. If a confidentiality agreement is made a part of any settlement, counsel for Plaintiff should, at least, make sure that a specific dollar amount is indicated in the settlement agreement as representing the worth of the confidentiality clause. This way the client has a specific dollar amount to claim on their year-end taxes versus having the IRS magically come up with one like they did in Amos.

Members of the Illinois State Bar Association can view Trial Briefs online. Details here.

Mediation Resources

There are a number of articles about mediation at Stephen Marsh's website, ADR Resources. Included among the articles is "Mediation Pitfalls and Obstacles," which notes:

• 24% of the failed mediations result from a lack of settlement authority. In a survey involving over 150 mediators and a substantial number of sessions, almost one quarter of the failures were the result of a necessary party not attending. Those with authority must attend in order for the process to work.
• 21% of the failed mediations result from a lack of preparation. Often referred to as a "inadequate discovery," the problems quite commonly reflect a party or an attorney who does not know enough about their own case to be able to settle the case.

Get Your Case Settled

Texas Attorney Howard Nations presents a very comprehensive overview of the settlement process, with tips for both plaintiff and defense, in "Persuasion in Settlement Negotiations," available from his firm's website.

Researching Settlements Online

From Jenkin's Law Library comes this useful article: "Verdict and Settlement Research on the Internet: There's Room for Growth," by Michelle Ayers (originally published in Pennsylvania Law Weekly). The article begins:

Conducting comprehensive jury verdict and settlement research [JVSR] has always been difficult, and even with the advent of the Internet, it's still not an easy task. However, the Internet has improved access with Web sites for free and fee-based collections.

But there's truth to the old adage, "You get what you pay for". What follows is a review of notable JVSR sources. Keep in mind one must always stay alert for newcomers, most of which will almost certainly publish directly to the Internet.

The article's focus is Pennsylvania, but it contains tips for learning about verdicts and settlements in other parts of the country, and may give you some useful ideas on how to get started in your own.