topic Are business related settlement payments deductible? in Business & farm

Are business related settlement payments deductible?

ryanm89 — Thu, 06 Jun 2019 05:25:08 GMT

Last year I reached a settlement agreement with another business involving intellectual property and paid them an amount for the settlement. Can I deduct that as a business expense? Where in the IRS code does it explain these rules?

Yes, amounts paid for settlements are deductible as long...

ChristinaR — Thu, 06 Jun 2019 05:25:08 GMT

Yes, amounts paid for settlements are deductible as long as the basis of the suit is in fact a business matter and not personal. In other words, the acts that gave rise to the litigation must have been performed in the ordinary course of your business. The settlement amounts also cannot represent fines or similar penalties paid to a government for the violation of any law. Any amount of the settlement that is punitive in nature (designed to punish the wrong doer) instead of compensatory is not deductible.

In TurboTax, the amount paid to your attorney is entered into "Legal and professional services." The amount paid to the other party can be entered under "Other expenses" with a short description, "legal settlement of business dispute."

Please see this recent ruling by the IRS on the deductibility of settlement costs as ordinary and necessary business expenses: https://www.irs.gov/pub/irs-wd/1412002.pdf

Re: Yes, amounts paid for settlements are deductible as long...

NYCMIKE1234 — Thu, 06 Feb 2025 17:07:12 GMT

what about whether the loan was for biz capital expenses , but the settlement was for the debt and all liabilities?

Re: Yes, amounts paid for settlements are deductible as long...

DaveF1006 — Thu, 06 Feb 2025 18:28:51 GMT

Yes, amounts paid for settlements are deductible as long as the basis of the suit is in fact a business matter and not personal. In other words, the acts that gave rise to the litigation must have been performed in the ordinary course of your business.

The settlement amounts also cannot represent fines or similar penalties paid to a government for the violation of any law. Any amount of the settlement that is punitive in nature (designed to punish the wrong doer) instead of compensatory is not deductible.

IRS Notice 201412002

@NYCMIKE1234

Re: Yes, amounts paid for settlements are deductible as long...

NYCMIKE1234 — Thu, 06 Feb 2025 18:32:16 GMT

not sure if your correct , if the settlement was about a defaulted loan to acquire a building ,that capx not deductible?

Re: Yes, amounts paid for settlements are deductible as long...

DaveF1006 — Thu, 06 Feb 2025 18:40:16 GMT

To clarify, what is the capx?

Re: Yes, amounts paid for settlements are deductible as long...

NYCMIKE1234 — Thu, 06 Feb 2025 18:58:40 GMT

Capx is capital expenses , such as acquiring a business or a building

Re: Yes, amounts paid for settlements are deductible as long...

DaveF1006 — Thu, 06 Feb 2025 19:15:17 GMT

To clarify your question, are you asking if the capital expenses you incurred in acquisition of the building deductible in addition to the settlement? This isn't clear to me.

@NYCMIKE1234

Re: Yes, amounts paid for settlements are deductible as long...

NYCMIKE1234 — Sat, 08 Feb 2025 13:23:56 GMT

i dont believe a settlement is deductible if the original loan even if it were business was used in a capital expense transaction , it had to be a loan for regular business deductions

Re: Yes, amounts paid for settlements are deductible as long...

DianeW777 — Sat, 08 Feb 2025 14:02:30 GMT

A deduction is allowed if initiated for business purposes by a business. The deduction is based on what the settlement payment was actually for. An example that would not qualify would be settlements for discrimination. However this is not the reason for this particular situation. The reference provide by @DaveF1006 (IRS Notice 201412002), as well as IRS Publication 334, will provide additional guidance. If the settlement paid for a capital item or a necessary, ordinary business expense will depend on how it is deducted.

Personal legal settlements, under the Tax Cuts and Jobs Act (TCJA) provides no deduction (2018-2025). No change has been initiated at this time.

@NYCMIKE1234

Re: Yes, amounts paid for settlements are deductible as long...

NYCMIKE1234 — Sun, 09 Feb 2025 17:53:53 GMT

A couple of questions, what if settlement involved both personal and corp ? Would I deduct that portion that is corp ?
Any more examples of settlements that which were deductible as ordinary and necessary deductions based having its roots in a capex event ?

Re: Yes, amounts paid for settlements are deductible as long...

DaveF1006 — Wed, 12 Feb 2025 14:59:03 GMT

To clarify, would you elaborate on the types of settlements you have?

Re: Yes, amounts paid for settlements are deductible as long...

NYCMIKE1234 — Wed, 12 Feb 2025 19:23:16 GMT

yes, and thanks for following up , release and final satisfaction of claims of all parties , resulting from a defaulted s corp debt , the originally the debt was to acquire a capital asset

Re: Yes, amounts paid for settlements are deductible as long...

DaveF1006 — Thu, 13 Feb 2025 01:25:30 GMT

Yes, business related settlement payments are deductible. If a settlement involves both personal and corporate components, you generally need to allocate the settlement amount between the personal and corporate portions. Only the corporate portion can be deducted as a business expense. The personal portion is not deductible. It's important to accurately document the allocation and ensure it reflects the nature of the expenses.

Examples of Deductible Settlements from Capex Events

Settlements that are deductible as ordinary and necessary business expenses, even if they have roots in a capital expenditure (capex) event, can include:

Legal Fees: If you incur legal fees to defend or perfect title to property, these fees are generally capitalized. However, if the legal fees are related to the ordinary operation of the business, they may be deductible.
Repair Costs: If a settlement involves repair costs that restore property to its original condition, these costs may be deductible as ordinary and necessary business expenses.
Environmental Cleanup: Settlements related to environmental cleanup costs can be deductible if they are necessary to comply with environmental regulations and are considered improvements to the property.
Breach of Contract: If a settlement arises from a breach of contract related to the ordinary course of business, it may be deductible as an ordinary and necessary business expense.

Are business related settlement payments deductible

@NYCMIKE1234

Re: Yes, amounts paid for settlements are deductible as long...

NYCMIKE1234 — Thu, 13 Feb 2025 13:08:47 GMT

Irs strongly believes the origin of claim prevails , if the debt originated from a capex , the settlement can only be amortized or depreciated , if the settlement has its roots a capex transaction , can you cite more examples of you opinion

Re: Yes, amounts paid for settlements are deductible as long...

DaveF1006 — Thu, 13 Feb 2025 18:00:38 GMT

Yes, you may be correct depending on the type of lawsuit it is.. In researching this topic, this area is gray to say the least. This reference from the Tax Advisor does say though" that he proper tax treatment of a recovery or payment from a settlement or judgment is determined by the origin of the claim. In applying the origin-of-the-claim test, some courts have asked the question "In lieu of what were the damages awarded?" to determine the proper characterization (see, e.g., Raytheon Prod. Corp., 144 F.2d 110 (1st Cir. 1944))". The proper characterization can be interpreted if the expenses are directly related to acquiring, improving, or constructing a capital asset. If so, then the expenses should be capitalized.

In researching various sources, a rule of thumb should be followed. If the lawsuit settlement expenses are directly related to acquiring, improving, or constructing a capital asset, they should be capitalized. This is consistent to the origin of claim concept whereas if all expenditures for capital expenditures are capitalized, so should settlement expenses from CAPEX lawsuits.

However if the lawsuit settlement expenses are not directly related to the acquisition, improvement, or construction of a capital asset, they should be expensed in the period incurred. For example, if the lawsuit pertains to operational issues, such as breach of contract or employee-related matters, then these could be expensed.

In my previous answer, the examples I gave were indirect expenses that could be expensed rather than capitalized. The key caveat on whether the type of settlement involved direct or indirect expenses.

@NYCMIKE1234