Often the courts and the IRS will look to the intent of the payor to determine the tax treatment of the nature of the award in a settlement agreement. In fact, even in cases where the language of the settlement agreement is explicit, courts may still look behind the settlement agreement to determine the true nature of the award.
By contrast, the mere intent of the taxpayer is insufficient. This is because the tax court has held that the mere belief of the taxpayer that he was settling a claim that was not set forth in the settlement agreement is insufficient to support his claim that the recovery was excludable from gross income. See Durret v. Commissioner, T.C. Memo 1992-682.
When the court does consider the payor’s intent it will consider all the relevant facts and circumstances. Robinson v. Commissioner, 102 T.C. 116 (1994). As an example of how the courts consider all these facts and circumstances, consider McCann v. Commissioner, 87 Fed.Appx. 359 (2004). There, the settlement agreement failed to specifically allocate $839,000 in damages. In making its determination that the payment was for $400,000 in damages and $439,000 in interest, the court noted that that same exact allocation was written on a check issued to the plaintiff by the defendant.
Similarly, in Hellesen v. Commisioner, T.C. Memo 2009-143 the court found that absent any evidence that payment was made on behalf of a personal physical injury or sickness, the court inferred the intent of the payor by looking at the Form 1099 he issued to the defendant, thus revealing that it was taxable.