Are settlement payments made through a non-disclosure agreement taxable? That’s the question more and more people are asking due to recent news headlines. The answer is not as straightforward as you might think so we’ll have to look back in history to get an answer.
Dennis Rodman and the ’97 Bulls
On January 15th, 1997 the Chicago Bulls were slated to play the Minnesota Timberwolves. During the game, power forward Dennis Rodman fought for a rebound and ended up falling into a group of photographers on the sideline. Frustrated from the fall, Rodman lashed out and kicked one of the photographers, Eugene Amos, in the leg.
Amos was carried out on a stretcher, treated at a local hospital and later released. Rodman was suspended for 11 games without pay – costing him upwards of $1 million. Not only did Rodman lose $1 million from his suspension, but he eventually settled with Amos for $200,000 through a confidentially agreement.
All in all, the kick heard round the world would cost Rodman $1.2 million. However,the Bulls would go on to win the championship later that year despite Rodman’s 11 game suspension.
Amos v. Commissioner of Internal Revenue
For the taxable year in which the settlement payment was received, Amos excluded the entire amount from his gross income. Settlements for personal damages are typically excluded from gross income, however, the agreement that Amos signed included a confidentiality agreement.
The Internal Revenue Service argued that the amount in question was not for personal injury but was instead for Amos’ silence as it pertains to the settlement. Amos argued that the entire amount was for personal injury because there was no stated value for the confidentially agreement.
The US tax court ultimately decided that $80,000 was paid for the non-disclosure portion of the settlement and $120,000 was for damages.
Are NDA’s Taxable?
In short, payments received through a non-disclosure agreement may be taxable even If there is no specified dollar amount attributed to the non-disclosure portion of the settlement.
To avoid this trap, those entering into a NDA should have the contract drawn up to specifically state what portion is for damages and what portion is for confidentiality of the settlement.
Ultimately, to avoid any unforeseen tax or legal ramifications of entering into a non-disclosure agreement contact a trusted lawyer or CPA.
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