Bobby N. Harmon, CPCU, ARM
10951 Southgate Manor Drive, Apt. #4 Tel & Fax No. (502) 964-0694
Louisville, Kentucky 40229-1655
March 30, 2002
Dunn & Dunn
841 Bishop St., Ste 2221
Honolulu, HI 96813
RE: Harmon Ch. 7 Bankruptcy Case No. 99-04339
Dear Mr. Dunn:
This is regarding the unresolved issue of Kamehameha Schools’ failure to withhold Income and Social Security taxes from the bankruptcy settlement, and their failure to adjust my pension plan accordingly.
I believe that you mentioned to me that you were not an expert in tax law, so I would like to bring to your attention the following excerpt from an article published in The Bureau of National Affairs’ Corporate Counsel Weekly, Vol. 15, No. 43, p. 8 (November 8, 2000):
LAWSUIT SETTLEMENTS: TAX ISSUES FOR CORPORATE COUNSEL
by Robert W. Wood
When a lawsuit is settled and a corporation is the defendant, there are a host of tax considerations that should be taken into account. Most corporate counsel have been involved in disputed matters where the plaintiff insists on a certain tax characterization (for example, a recovery excludable as personal injury damages).
How to respond to this query, as well as various other pitfalls, deserves attention. In some cases, these issues will require the special assistance of a tax counsel. However, some of the issues can be solved by corporate counsel. At a minimum, corporate counsel must be able to spot the issues. The following list should be helpful in spotting the issues when they arrive.
Deductibility
The first thing that may worry corporate counsel on payment of a settlement amount (or a judgment) is whether the payment is deductible. In the vast majority of litigation arising in a business, the payment (together with associated attorneys’ fees) will be deductible. . . .
Another major area in which a deduction may be questioned is where the payment is in the nature of a fine or penalty. Under Internal Revenue Code Section 162(f), the payment of a fine or penalty is nondeductible. Note that this is only payment to a governmental entity. Punitive damages paid to private parties are fully deductible. Indeed, even if a payment is to a governmental entity and looks to be a fine or penalty, a deduction may still be available. . . .
Withholding Concerns
As all companies know, payments that are in the nature of wages are subject to withholding requirements for federal income tax, social security and unemployment tax, and generally state income and employment taxes as well.
If a lawsuit is brought regarding some kind of employment discrimination or wrongful termination, and a settlement is reached, the question is what portion of the settlement ought to be treated as wages....
As far as the IRS is concerned, it does not matter that the worker has not been employed by the company for many years. Sometimes litigation takes five years or more to resolve. The mere duration of time does not turn something that was wages into something else. Generally, companies look to what the parties requested in their litigation documents (briefs, mediation briefs, experts reports, etc.).
Example: Suppose the plaintiff claims that the wage loss in a million dollar suit amounts to $400,000, and the defendant claims that the wage loss amounts to only $200,000. If the suit ends up settling for $800,000, then it would seem that a minimum of $200,000 should be allocated to wages. Very frequently the other side’s expert testimony (or damage study) can be useful in arriving at tax characterization decisions.
A word should be said about penalties a company may face. The penalty for failure to withhold is significant . . . It is important to make this withholding determination before the case is fully resolved. . . .
Reporting (Form 1099) Obligations
In settling a dispute, if an amount is subject to wage withholding, as noted above, there should be tax withholding and the employer should send a Form W-2 to the IRS and the plaintiff. If an amount is paid as general damages, punitive damages, or most other kinds of damages, it is subject to the general rule that a Form 1099 should be issued for the amount of the payment....
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As I am currently proceeding in this matter on a pro se basis, I respectfully request the following factual information as it relates to you and this case:
1. The name of your Lawyer’s Professional Liability Insurance carrier;
2. The policy number and policy period for this policy;
3. The name of your insurance agent or broker that provided this coverage.
Thank you very much for your cooperation.
Very truly yours,
Bobby N. Harmon