Deductibility of Lawsuit

[Tax20213]

If my business is sued and I'm required to pay can I deduct the settlement fee as an expense on my return. Also, is the income received by the party receiving the settlement funds required to include it in income?

[Opus 17]

If you pay a legal settlement as part of doing business, the settlement is a deductible business expense, except that you can't deduct anything related to illegal conduct.  (Not all business disputes involve illegal conduct, of course.)

If you pay more than $600, you need to collect their tax number with a W-9 form, and issue a 1099-MISC (unless they check the box on the W-9 that they are an S- or C-corp, in which case you don't issue a 1099-MISC.).  If the payment is compensation for services performed by a subcontractor, you would issue a 1099-NEC.  If the plaintiff was an employee and the settlement is partly or all for lost wages, you would issue a W-2 as if it was regular wages and you are responsible for withholding the employer's share of social security and medicare like any other W-2.  

Once you issue the correct tax report (1099 or W-2), whether the money is actually taxable to them depends on their circumstances and is between them and the IRS.  

[Vanessa A]

Yes, you can deduct the settlement fee as an expense on your return.

If you are making a payment of more than $600 you should send the party receiving the settlement a 1099 Misc.