Taxability of D&O Insurance reimbursement for legal fees and settlements with personal funds

[amikey]

Hi, as a director of a company that hasn't been able to pay its creditors, I had to settle directly with some of the creditors and had to bear the legal expenses over several years all with personal funds. The company had D&O Insurance which paid a lumpsum amount last year (2019) as reimbursement for my expenses and closed the account. Please advise on how I should file my taxes and what I should report. The insurance didn't send me any 1099-MISC.

[Carl]

If the business was a corporation that filed either an 1120 or 1120-S tax return, then you should have shown your out-of-pocket payments as capital contributions to the business, and let the business pay those legal fees and other stuff. That would then give you a "capital loss" on your K-1 (for an S_Corp) that could be claimed as such on your personal return.

Otherwise, depending on circumstances (to many to cover here) your legal fees just flat out may not be deductible by you on your personal 1040 tax return at all.

[Anonymous]

were you a shareholder? 

[amikey]

Hi,

Thanks for responding to my query.

I was an employee of the business, not a director, or a share holder.

I don't think the business filed anything to IRS. It basically went belly up and left us to fend us for ourselves in all legal matters. I therefore had no option but to pay lawyers from personal funds and negotiated settlements with personal funds. Finally, the insurance agreed to pay a small lumpsum to cover for past and any future expenses.

If I can prove that I spent the money paying legal fees and settling with creditors of my company (I have the signed settlement agreements), do I still need to pay taxes on those? I know that IRS will make me pay taxes on the amount I have to cover future expenses.

Thanks again for your time. 

[amikey]

No, thanks for asking, though.

[amikey]

Adding one bit of detail to clarify matters a bit.

One might wonder why the company didn't file for bankruptcy and why ordinary employees had to take legal protection at personal level.

The answer is that the company had a branch office offshore where a lot of the creditors reside. US bankruptcy protection doesn't help there. Legal fees and settlements took place offshore. The D&O Insurance payment took place in the US, and hence is subject to US taxes.