The IRS often scrutinizes settlement agreements to ensure that the payments to a plaintiff receive their proper tax treatment. In making their determination, typically courts and the IRS will look to the (i) language of the complaint, (ii) the settlement agreement, and (iii) the intent of the payor. While no one single factor is controlling, careful tax consideration, consistency in reporting, and documentation at every step will greatly improve the chances that the agreed upon settlement will be respected by the tax authorities.
However, these three factors become more difficult to analyze when the lawsuit involves a greater number of claims. When there are multiple claims involved, the allocations surrounding them must be reasonable and tied to the underlying nature of the case. Even with due diligence, there will often be a certain amount of uncertainty in attempting to reach desired tax results.
