The 'you get what you pay for' Case

Case: Dennis


Date: 12/5/11

Case in a Nutshell: The taxpayer failed to report proceeds from a racial discrimination lawsuit because she claimed to have consulted three tax preparers, none of whom told her it was taxable. This was reported on a 1099-MISC. She also failed to report wages because she claimed to not be able to procure a W2 form. The court found against the taxpayer on both counts.

Take Aways

1. You are responsible for paying tax on all income you earn regardless of whether or not the payee remits a W-2 or 1099 form to you. In this day and age it is not difficult for a CPA, with a signed power of attorney, to access your transcript. The current year forms may not be available until July so it may be necessary to file an extension, however, if you have no idea how much you earned and can’t obtain a copy of your W2/1099 this is another way to obtain the info to prepare an accurate return.
2. There are a number of gray areas related to the taxability of lawsuit settlements but this settlement doesn’t fall into any of those areas. Damages in this case were clearly for “loss of self-esteem, humiliation, emotional distress and mental anguish and pain” Petitioner suffered no physical injuries as a result of the harassment. Further petitioner signed a document from her attorneys which stated, among other things: Counsel has further informed Client that payment for non-physical injuries are generally taxable.”
3. The court did not assess the accuracy-related penalty against the lawsuit proceeds portion of under-reported income because she had consulted 3 tax preparers none of whom told her it was taxable. I strongly disagree with this finding. I don’t those preparer’s rise to the level of professionals and therefore I don’t think she took reasonable steps to consult with competent professionals. This is not a complicated issue. Any practicing CPA would have given her the correct info or at least conducted the research to arrive at the correct answer which would have required 30 minutes at most. She should have made an appointment with a CPA as soon as she received the proceeds instead of trying to call around and set the answer for free or on the cheap.
4. Although some independent accountants may be very competent there is no framework in place to compel them to be competent. CPA firms are heavily regulated and reviewed and even chain tax prep services have quality controls imposed at a corporate level by the franchise. Joe’s Accounting & Tax Prep likely just has Joe and he may be way too easy on himself.