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Personal Injury settlements and confidentiality clauses

It is not uncommon for the defense to ask the attorneys at TheLawFirm.com to agree to a confidentiality clause when we settle a case. Because we focus on serious personal injury and wrongful death, the stakes are high. We are seeing this commonly in our nursing home abuse cases.

But since personal injury compensation is generally tax free, what is the issue? The problem arises out of a United States tax court case. This case involved an incident in which Dennis Rodman, a basketball player, during the course of a game landed on a group of photographers and twisted his ankle.  Mr. Rodman then kicked one of the photographers, Eugene Amos.  Mr. Amos was immediately taken to a local hospital and the next day sought medical treatment from the Veterans Affairs Medical Center.  The medical reports from the local hospital and the VA did not disclose any serious injuries.  Nevertheless, Amos filed a complaint against Rodman seeking damages for personal injury.  The case settled for $200,000.

The Confidential Settlement Agreement and release stated that the amount of the settlement was $200,000 and included the standard language that Rodman would be released from any and all claims by reason of any damage, loss or injury sustained by Amos as a result of the incident.  The confidentiality clause of the release said that the terms of the agreement and release were to be kept confidential.  The Release also contained a liquidated damages clause to the effect that if there was a material breach of the Confidentiality Agreement, Rodman would be entitled to $200,000.

Believing the settlement to be tax free as a settlement for a personal injury, Amos excluded from his gross income the $200,000. However, the tax court held that the determination of the nature of the claim is factual.  The court stated that the character of the settlement payment hinges ultimately on the dominant reason of the payer in making the payment. 

Amos argued that the entire amount of the settlement was excludable from gross income as personal injury settlement.  The IRS argued that, except for a nominal amount for the minor injuries, the settlement was compensation for Amos’ agreement to the confidentiality provision.  The court held that Rodman’s ‘dominant reason’ in paying the settlement was Amos claimed physical injuries, but that there was a separate payment for Amos’ acceptance of the confidentiality clause.  The court determined that $120,000 of the settlement amount was for Amos’ claimed physical injuries and $80,000 was for confidentiality. The court noted that the Settlement Agreement lacked an express allocation between the physical and non-physical injury.

There are a number of ways that personal injury lawyers can address confidentiality agreements.

First, we can simply refuse them. This is our usual course of action. It is possible that this will preclude settlement but that has not been our experience.

Second, if the confidentiality clause is of integral importance, we can agree on a specific allocation of consideration between the physical injury and the confidentiality clause.  The danger to this is that the IRS can look beyond any nominal consideration and make a determination based on the substance of the transaction.

Third, we could agree on reciprocal promises of confidentiality without additional consideration.  The same danger of allocation by the IRS exists.

Fourth, we can ask for an indemnity provision compelling the defendant to indemnify the plaintiff for adverse or unforeseen tax consequences. 

Fifth, we could seek a private IRS ruling in advance of finalizing the settlement.  We have never done this as it is expensive and time consuming.

The bottom line for injured plaintiffs is that a confidentiality clause may turn what they think is tax free personal injury compensation into a taxable amount. Helping to minimize this risk, or avoiding it altogether, is where the experienced lawyers at TheLawFirm.com come in.

Please contact us at 1(855) 464-0808 or for a free legal evaluation of your claims today!

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