The Risk Of Over-Structuring In Taxable Settlements.
The alternative minimum tax on fees, costs and interest paid by a plaintiff in taxable settlements creates a risk of structuring too much of the settlement. Plaintiffs in those situations may end up without sufficient money to pay tax. Thus, pro forma tax returns should be run on every taxable settlement involving a structured settlement.
Note that the alternative minimum tax does not apply to Civil Rights cases. It will apply in all other taxable cases, including interest and punitive damages recovered in nontaxable cases. Thus, care should be taken in every taxable case to compute the amount of tax to permit the plaintiff to make an informed decision about how to receive the settlement proceeds. In appropriate cases, that tax can be somewhat mitigated by structuring the attorneys fee.
An example: a client receiving a $1,000,000.00 settlement with fees and costs of $550,000.00 has only $101,000.00 left for immediate cash. Thus, there is probably no room for a structured settlement. The calculations are as follows:
| Calculation of Net Available to Plaintiff |
| Settlement Amount |
$1,000,000.00 |
| Federal Regular Tax |
($134,808.00) |
| Net Federal Alternative Minimum Tax |
($141,692.00) |
| California Regular Tax |
($49,008.00) |
| California Minimum Tax |
($23,492.00) |
| Fees and Costs |
($550,000.00) |
| Net to Plaintiff |
$101,000.00 |
Notes about the federal taxes above: The plaintiff will pay the higher of the federal regular tax ($134,808.00) or the alternative minimum tax ($276,500.00). In the above illustration, the AMT exceeds the regular tax by $124,192.00. The federal miscellaneous itemized deduction for the attorney’s fees and costs of $550,000.00 gets reduced by 2% of adjusted gross income ($20,000.00) to $530,000.00. The AMT has a $45,000.00 exemption amount, which phases out to zero for this taxpayer.
Notes about the California taxes above. The plaintiff will pay the higher of the California regular tax ($44,233.00) or the state minimum tax ($72,500.00). In the above illustration, the minimum tax exceeds the regular tax by $28,267.00. The California miscellaneous itemized deduction gets reduced by 6% of adjusted gross income ($40,711.11) to $489,289.00.
