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Ask the tax adviser

Tax Talk with George SaenzHow much tax is due on a lawsuit award and getting the appropriate tax break for donating a car.

How much tax on lawsuit award?

Dear Tax Talk:
What percentage of taxes do I pay on money received from a car accident lawsuit? Is that tax percentage taken from the awarded amount or from the amount received after the lawyer's one-third and accrued fees?

Thank you.
Richard

Dear Richard:
Money recovered under a car accident lawsuit would generally consist of two components: 1) damage to the vehicle and 2) payment for physical injuries, including maybe lost wages. Both components are generally tax-free. The portion that is intended to pay for damage to the vehicle is generally the cost of the repairs to the vehicle.

Under the principles of involuntary conversion, recoveries or insurance reimbursements for damaged property are generally not taxable, provided that the amounts recovered are spent to repair the property. If the amounts are not spent to repair the damaged property, the amount recovered would still not be taxable, if it does not exceed the cost of the property damaged.

Amounts recovered for physical injury are not taxable, even though part of the settlement may be designated for lost wages. If the recovery includes punitive damages, then the portion that is punitive is taxable.

Since the recovery in the car accident lawsuit is tax-free, the attorney's fees are not deductible nor would they be income. Recent tax case law has held that in situations where the recovery is taxable, the portion retained by the attorney is included in income of the taxpayer. The fees would then be a miscellaneous itemized deduction subject to reduction by 2 percent of adjusted gross income.

Further, this treatment could cause the taxpayer to fall into the alternative minimum tax since miscellaneous itemized deductions are not deductible for the AMT. Therefore, before accepting a settlement that may be taxable, you should review the tax consequences to possibly restructure the attorney's fee arrangement or estimate the taxes due on the settlement.

Getting the most from a car donation

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Dear Tax Talk:
What are the rules for donating a car? I keep hearing different interpretations of the tax laws, and the Internal Revenue Service information is not easily understood.

My car is worth about $2,500 wholesale blue book and $4,600 retail. Can I deduct the full amount or only a portion?

Thanks,
Brian

Dear Brian:
A contribution of property to a charitable organization provides you with a charitable contribution deduction equal to the fair market value of the property donated. Fair market value is defined as the amount that a willing buyer and seller would agree on where neither party is under a compulsion to buy or sell.

Wholesale bluebook value or trade-in values assume that the buyer is under a compulsion to accept the car and therefore a discount is provided by the seller. Whereas retail value assumes that neither party is under a compulsion to accept the deal at the stated price. Therefore, as a starting point in determining the value of the vehicle, I would use the retail value and adjust it appropriately for mileage and accessories and its current mechanical condition and appearance.

If the value of the car exceeds $500, you must complete Internal Revenue Service Form 8283 at the time that you file your tax return. If the value of the car exceeds $5,000, IRS regulations require that you obtain an appraisal to be submitted with your tax return as well as complete additional information on IRS Form 8283. In this case, Form 8283 requires that the charitable organization sign such form acknowledging receipt of the property. Therefore, I recommend that you have the organization complete the acknowledgment at the time that you make the gift to avoid delays in filing your tax return.

You also can check out Bankrate.com's story on donating vehicles if you'd like to read more.

 

-- Posted Oct. 27, 2000

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