Lemon law settlement taxable?

Forum|Forum|7 years ago
June 6, 2019
3 replies
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Still a little confused with Lemon law settlement tax. I'm receiving a lemon law settlement of about $27000 where $9,000 is going to the attorney. The value of the vehicle is currently $18,000 (Trade in value) and I Originally paid $43000 1.5 years ago with all taxes and fees. Is that $18000 taxable?

TurboTax Premier Windows

Best answer by PatriciaV

Expert Reviewed

It depends. A lemon law settlement is only taxable for the part that exceeds your loss, which is the amount you paid compared with the fair market value of the 'lemon' at the time you bought it.

Subtract the fair market value from $43,000 and compare the result to the $27,000 you received. If your loss is less than $27,000, then the excess would be taxable. Note that legal fees are not deductible.

PatriciaVAnswer

Level 15

Expert Reviewed

It depends. A lemon law settlement is only taxable for the part that exceeds your loss, which is the amount you paid compared with the fair market value of the 'lemon' at the time you bought it.

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skylinegtr2022Author

Level 2

Thank you! I don't have to report this on my tax this year since I recently settled. When I file my tax next year, do I subtract the fair market value what the car is worth now or the fair market value when I file tax next year? What happen if I trade-in my car? And the trade-in value is less than selling the car privately. I can't sell the car because the Fair Market Value is a lot less than what I owed on the loan.

jenna6

Level 2

We just won a lemon law case for our car. We won $83,000, but only walked away with $60,600 and had to return the vehicle. We are trying to figure out if any of that is going to be taxed?

Here is the breakdown: Taking into consideration your total sales price, mileage offset, Mfg Rebate, and incidental damages your actual damages are $27,000.

Accordingly, there are $56,000 in additional damages here ($83,000 - $27,000). As explained, the additional damages have a 40% contingency fee per your retainer agreement. $56,000 x .4 = $22,400.

Therefore you will receive $27,000 + $33,600 ($56,000 - $22,400) = $60,600.

Lawyers will receive $22,400.00 + a motion for our attorney’s fees, costs and expenses.

Thank you!

abauman10

Level 2

Hello,

I am currently in the same situation you were in. Did you ever receive clarification on what your tax liability was? Were you taxed on the full $56,000 of additional damages or just the take home amount of $33,600? Thank you.

lissnad23

Level 2

I won the settlement. I bought a Van and I paid 10000 during a year then with the settlement I got back my 10000. so Only one year used the market value was higher. then, I guess this $10000 is not taxable but I got a 1099-misc how using turbotax can I do to don't declare ?

RobertG

Level 12

A lemon law settlement is only taxable for the part that exceeds your loss, which is the amount you were paid compared with the fair market value of the 'lemon' at the time you bought it.

You need to report the 1099-Misc income to avoid getting correspondence from the IRS.

So you should enter it twice, once as a positive number, and once as a negative number to offset the income.

To report the income in TurboTax, enter 1099-Misc in the search box
Select Jump to 1099-MISC
Enter the information from the 1099-Misc
On the Does one of these uncommon situations apply? page select This was money from a lawsuit settlement
You will then be asked Do either of you have another 1099-MISC? Say no.
To offset this income go to Income and Expenses
Under less common income, select Miscellaneous Income, 1099-A, 1099-C.
Under Miscellaneous Income, 1099-A, 1099-C, select Other reportable income.
You will be asked for a description and amount, enter the lawsuit amount as a negative number to offset the gain.

The income, and the offset to income should appear on Schedule 1 line 9.

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ChrisPD

Level 2

@ChrisPD wrote:

Robert,

I've read several of the recommendations on how to report the gain or loss on a cash and keep lemon law settlement and I'm still not certain on how the gain/loss works. Some of the posts contradict each other on their advice. I was awarded a settlement under the state Lemon Law whereby I was awarded $40k (including legal fees) on a vehicle with an original FMV = $46k. Some of the advice in this blog recommends reporting the gain as a difference between the original purchase price $46k and the FMV at the time of the settlement which was about $19K. The way I understood it, the taxable amount would be the difference between the settlement of $40k and the net loss on the value of the vehicle ($46k original FMV - $19k FMV at time of settlement = $27k loss), so $40k settlement - $27k loss in value = $13k taxable income. Would this be correct?

FMV is not relevant. What counts is your adjusted cost basis.

Example 1. This is a personal vehicle, never used for business. You paid $46K. The lemon law settlement is $40K (use the total, don't split out the fees). This reduces your adjusted cost basis to $6K. Then, sometime in the future, you sell the car as a used car for $8K. Now, you have a $2000 capital gain, because the selling price is more than your adjusted cost basis. (Most people who sell used cars don't have a capital gain because they sell for less than their cost basis, but here your cost basis is reduced by the settlement.)

Note that if you were to consider the settlement as (for example) $30K for the car and $10K for legal fees, the adjustment to the basis is $30K and the $10K in legal fees is miscellaneous other income. Since there is no tax deduction for personal legal fees that you pay, there's nothing to offset that taxable income and you pay tax on it. So it's better to treat the entire payment as towards the car's cost basis.

Example 2. This is a personal vehicle also used for your schedule C sole proprietorship, and you have taken mileage deductions for 30,000 business miles using the standard rate. The depreciation built in to the standard mileage rate is about 25 cents per mile (it varies), so you have $7,500 of depreciation to account for, your adjusted cost basis in the car is now $38.5K. With a $40K lemon law settlement, your cost basis is reduced to zero and you have a $1500 taxable capital gain now. Later, if you sell the car used for $8,000, the entire selling price will be capital gain since the adjusted cost basis at the time of the sale is zero.

So if my adjusted basis in the example is $6k ($46k original purchase price - $40k settlement), and I traded the car in this year (2022) on a new car and the trade in value was $22k, then my taxable gain would be $16K, which is the trade in value of $22k less the adjusted basis of $6k. I don't know whether or not I'm going to receive a 1099 because the attorney was very quick to tell me they don't advise on tax matters and would not tell me whether or not I'll get a 1099. Would this all be reported as other income or some type of gain on sale of? The vehicle was used for personal use only...I don't own a business.