Lemon law settlement on a leased car

[User 5012232]

I received a "lemon" law settlement for $15,000 of which $10,000 went to the attorneys and $5,000 to me.  The car was a lease and the auto maker would not take the car back at the end of the lease because of an issue with the battery.  They had the new battery but still refused to take the car back.  They would not let me buy out the lease and replace the battery.  The "lemon" lawyer advised that I extend the lease for as long possible which according to my lease was 6 months on a month-to-month basis.  I extended the lease three times but the dealership then called and said I had to bring the car in because they would no longer extend the lease.  At that time the manufacturer refused to provide a new battery if I wanted to buy out the lease.  I was without a car for several months and then had to pay a deposit on a new lease.  How do I calculate how much of the 15,000 is taxable?  Thank you

[Opus 17]

Where is the car now?

What was the purchase price of the original lease?  (Typically, a lease is viewed as you buying a portion of the car and financing it.  For example, for a $40,000 car, you might buy "half" the car for 3 years for $20,000 which, with finance charges, gives you a monthly payment.  Then if you want to buy the car at end end of the lease, you pay the previously fixed price for the "other half.")  

[User 5012232]

After paying two additional months after the initial 36 month period, the GM dealership called and told me that I had to return the car/could not further extend the lease.  That's what I did.  I ended up not having my own car for several months thereafter. The purchase price of the original lease was $35,583.90.  Over the 38 months I paid $9,528.12 in lease payments and $3,750.00 at the origination of the lease for a total of $13,278.12.  According to the documents that I have and base on the 36 month lease, the residual value is $20,995.95.  Do I still have to pay tax on the $15,000.00 total settlement of which I only got $5k?  Thank you for the help.

[Opus 17]

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@User 5012232 wrote:

After paying two additional months after the initial 36 month period, the GM dealership called and told me that I had to return the car/could not further extend the lease.  That's what I did.  I ended up not having my own car for several months thereafter. The purchase price of the original lease was $35,583.90.  Over the 38 months I paid $9,528.12 in lease payments and $3,750.00 at the origination of the lease for a total of $13,278.12.  According to the documents that I have and base on the 36 month lease, the residual value is $20,995.95.  Do I still have to pay tax on the $15,000.00 total settlement of which I only got $5k?  Thank you for the help.

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Yes, some of the payment appears to be taxable.

Based on the purchase price and residual value, the price of the lease was $14,588.  However, somehow you only actually paid $13,278, and that's if the interest rate was 0% APR.  The Lemon Law settlement is treated as if you sold it back to the dealer for $15,000.  Since you received $1,733 more than you paid, that is the taxable amount.  It doesn't matter that 2/3 went to the attorneys, that's how the law works.  (2/3 seems high, is that legal in your state? You might want to check with the state government agency that regulates attorney services.)

If the interest rate was, for example, 4%, then you paid about $590 of interest, and your principal payment was $8900 plus $3750 down, for a total of $12,650, meaning that $2350 of the settlement is taxable.  

It depends on what you actually paid for the car over those 38 months, not counting interest.