We previously discussed the taxability of the PG&E settlements that many fire victims are receiving (See, Is My PG&E Settlement Taxable? from August 3, 2021). We received a few questions recently:
Q1: I received a payment of 30% of the total award that is due to come to me. How do I allocate that award?
A1: Most taxpayers have received the worksheets from the Fire Victims Trust (FVT) that shows the details of the award. So, if you receive a payment for 30% of the total award, then you should allocate it across the award categories shown in the worksheets.
In addition, the FVT has stated that preliminary payments are meant to represent a pro rata allocation of the expected approved claim.
If the settlement agreement is silent as to the allocation (Or you decided not to get the worksheets from the FVT that show the allocation) then the amount received should be allocated based on the claim for damages.
(Knuckles v. Commissioner; Threlkeld v. Commissioner).
Q2: I understand how the Feds tax the award. Does California tax it the same way?
A2: Yes, in general California conforms to the Federal treatment of gross income under IRC 61. (CA RTC 17071)
Q3: How do I handle the attorney fees paid to obtain an inverse condemnation award?
A3: Legal fees paid to litigate/obtain a condemnation award are offset against the amount of the award and thus reduces the amount realized and thus the amount that needs to be reinvested to get full gain deferral under IRC 1033. (Rev. Rul. 71-476).
E.g. Taxpayer received a condemnation award of $500,000. They paid $150,000 in attorney fees to get the condemnation award. So, $500,000 – $150,000 = $350,000 that is considered the amount realized from the condemnation. This amount will be included in the overall calculations to determine if the taxpayer has a gain on the casualty.
(Author’s note: This does not mean that all of your attorney fees are treated this way. Only a specific subset of your fees related to a condemnation award).
Q4: What if I took a loss on my 2017 tax return and now that I am receiving PG&E money, I no longer have a loss?
A4: Under the tax benefit rule, the excess is included in income in the year received to the extent of the tax benefit received in the earlier year. (Treas. Reg. 1.165-1(d)(2)(iii) and Mager v U.S.).
(Author’s note: This calculation always hurts my head and I do taxes all year long. So, it may not be something the lay person wants to tackle).