Long Beach, CA Startup Control & Liability : “The Settlement Tax Evastrusion*”

Long Beach, CA Startup Control & Liability : involves the importance of contracts and settlement agreements to state clearly the agreed-upon circumstances and basis for settlement. Non-tax advisors involved with startups will nearly always either (a) disclaim any knowledge or effects of money received in settlements (while encouraging their clients to go out and hire another attorney for the settlement team, or (b) cause the client to waive and take responsibility for any tax effects, or (c) both.

The facts for startups have occurred numerous times in the past and will occur numerous times in the future, forevermore. A startup company breakup or even an employee separation, even for legitimate reasons, causes pain, hurt, and physical symptoms of upset. Any abrupt change in the life of a human can be troubling and troublesome. But an agreement made to “settle up” at the end needs to be performed non-emotionally, at least considering the tax debt that will be created in the U.S. recipient of settlement monies.

When payments are made from a U.S. entity to a U.S. recipient, the main question is whether the payor may deduct the payment and whether the settlement recipient must include the payment in income. Payors and payees are thus at conflict once again, not directly, but through the tax system. Unfortunately, sorting out the tax answer occurs long after the settlement is agreed. What follows includes hardened positions, uncertain justifications, and a mental re-writing of the settlement history.

It is because this tax effect will not happen for years after settlement that tax considerations are usually pushed to one side by both sides of the settlement. This is especially harmful and costly for two more reasons. First, the character of the settlement payments can and could have been described and characterized directly, in the settlement document. The agreed upon treatment by the parties can be both stated & agreed. This also shows that the payor understands whether or not deduction should occur, and that the payee understands whether or not taxability of income will occur.

Secondly, it can help prevent whimsical imagination from taking root by forming a reminder for the fiction dreamer that the tax treatment was agreed upon and supported by language of the settlement agreement. A party to the settlement is reminded of the settlement at tax return preparation time and can read the reinforcing language of the agreement. Tax return preparation time for a January settlement can be 20+ months later. A taxpayer that has the settlement terms in front of them will facilitate fitting numbers into forms to give the most accurate tax picture.

A result might even be more severe when a paid tax preparer prepares a taxpayer’s tax returns. After all, the taxpayer might view the preparer as a “gate keeper” to be persuaded into a favorable position. The thinking is that if the gatekeeper can be made to agree, then surely the IRS must agree as well! No. IRS has its own rules — nothing is permanent until you are dead — and even then the IRS can stare quizzically at your estate tax returns for years, in hope of transmitting discomfort through your heirs and into your final resting place.

A 1099MISC is an unusual document particularly given recent emphasis upon creating more differentiation in 1099-type reports. IRS background writings suggest that wholly non-taxable payments don’t require a IRC section 6041 report (read: 1099) at all. Mixed payments suggest an IRC section 6041 report be prepared for the full amount of the mixed payment (so that it can be sorted out later). This seems to indicate that receipt of a 1099MISC should be a direct indication that the payor believes and will treat the payment as a deductible payment taxable to the payee.

If 1099MISC forms were generated and exchanged, given, or provided just before the close of settlement the chances for later disputes through the IRS as intermediary would be greatly reduced. Currently, the time for a 1099MISC may be on average less than 8 months after the settlement, and raising a question about the 1099MISC after it issues isn’t nearly as effective as preparing for it or dealing with it at settlement. Under current practice, when a payee receives a 1099MISC that is believed to be in error, the immediate and onerous burden is on the recipient of the 1099 report to argue & beg the issuer to change or withdraw it. Without a change or withdrawal or cancellation SOMETHING will happen to the payee. The probability of a future finding of non-taxibility by the payee will be greatly diminished.

Considering the settlement as a series of events, a tax minded drafter can insure that the settlement, the supporting facts, and justifying characterizations are understood and supported by both sides. If the payor were to emphasized that the settlement was taxable, the payee may want a higher payment (perhaps depending upon the payee’s marginal tax rate). In the alternative, a physical injury caused by the stress can be medically explored and documented while it was occurring and before it is cured.

Given the clear history and holdings that non-physical injury compensation is fully taxable, it would have been better to simply take the items into income. The thing to most avoid doing is to make an initial decision to “go for” non-taxability followed by an attention-getting, audit-inducing “evastrusion*” performance on the tax return. Startups have been known for petty “evastrusion*” for much smaller dollars surrounding the “start of business” (such forgetting the duty to capitalize before the day that business starts). Settlement agreements are much more critical because of the higher dollar amounts involved. The lesson is: “Learn to agree upon a supported tax characterization before an agreement is finalized.”

*Evastrusion, and particularly “Tax *Evastrusion” is a contraction of evasion and extrusion. Its a form of improper tax avoidance where a taxpayer makes up a fairy tale in which a taxable 3,840 pound bull is forced through a teacup chihuahua sized tax-free doggie door in a steel wall. (I’m still my own lexicographer.)

Curt Harrington
Harrington & Harrington — PATENTAX®
P.O. Box 91719, Long Beach, CA 90809-1719
Phone: (562)594-9784
Fax: (562)594-4414
Email: curt@patentax.com

Bio: Curt Harrington advises tax clients in Los Angeles County and Orange County, California and may be reached locally as shown on the business web site https://patentax.com/ . His background is more completely seen on the biography page https://patentax.com/curt/ .

Curt looks forward to advising tax debtors, the tax evasive, and business startups in the Long Beach, California area, particularly with an approach to helping structure business relationships to reduce the negative economic exposure of the startup entrepreneur in opposition to government authorities and vulture capitalists that endanger startup principals. Curt looks forward to speaking with you at (562)594-9784.

Other Sections within a Tax Debt Approach Blog:
Instructive Warning Cases
Bankruptcy & Offer-In-Compromise – The Hot Dog Stand Paradigm
A Tax Debt Only Comparison of Offer-In-Compromise and Chapter 7 Bankruptcy in California Graduating From a Homelessness Base Case
How Far Can You Delay Paying Federal Tax Authorities Before Criminal Tax Evasion Charges are Filed?
Taxpayer First Act Credit Card Trap
There are Usually 6 Tax Choices At Any Given Point In Time

Tax Evasion Avoidance Learning Blog :

Long Beach, CA Startup Control & Liability : “The Settlement Tax Evastrusion*”

https://rebrand.ly/TaxEvasionAvoidance ; articles include other articles Outside this blog:

USA V. RODRIGO LOZANO – Memorandum Opinion Invites Further Analysis (9/13/2019)

Full Disclosure (9/11/2019)

Civil Effect (9/28/2019)

Curt’s CriminalLaw.com Articles:

The Reentry Teachings of U.S. v. Vicente Cuevas-Lopez (9th Cir. 2019) (9/20/2019)

Why Judges Control Electronics Strictly (9/15/2019)

USA V. RODRIGO LOZANO – Memorandum Opinion Invites Further Analysis (9/13/2019)

Prerequisites for Imposing a Time Payment Fee Were Not Met (9/12/2019)

9th Cir. Unpublished Criminal Tax Evasion Case Indicating Full Disclosure as a Prerequisite to use of a “following in good faith” exception to “willful intent.” (9/11/2019)

New 9th Cir. Case With Potential Tax Evasion Effect – Civil Admissions Become Prosecutor Weapon against Non-Testifying Defendants (9/8/2019)

Know & Use the Burden of Proof in the Best Way (9/5/2019)

How Far Can You Delay Paying Federal Tax Authorities Before Criminal Evasion Charges are Filed? (8/10/2019)

Character (Habit)Evidence Can Show Impulsivity, But Not Simply Evidence Of Brain Injury (7/24/2019)


9th Circuit Rejects “One Day Late Rule” for Late Filed Return Tax Dischargeability (7/18/2016)

Unpublished 9th Cir. Case shows (1) that KNOWLEDGE instruction for 18 USC §1001 can be waived; & (2) even ambiguous agent notes & no recording can get a conviction – Use Right To Silence!! (2/1/2015)

Other Articles Outside this blog:
Debt Control Extensive Outline (8/14/2019)

Pre-Startup Efficiency – Introduction (Parts 1&2) (2016)

9th Circuit Rejects “One Day Late Rule” for Late Filed Return Tax Dischargeability (2016)

Give My Start-Ups a Break! (2015)

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