In handling a matter which is not principally a tax problem, an attorney must properly advise the client, or adequately take into account, the tax implications of his actions. For example, when a lawyer settles a personal injury case for a client, the lawyer must account for the tax consequences of the settlement or advise the client accordingly. The lawyer must act similarly in representing clients in connection with the sale and disposition of real estate, the distribution of inter vivos versus testamentary gifts, and the division of pension benefits in a divorce case. These are just a few examples in which tax questions arise.
If an attorney fails to recognize the tax consequences of a transaction, and fails to advise the client properly or to otherwise account for the taxes, the lawyer may be liable to the client for the losses sustained by the client.
In a personal injury claim, for example, here are some general rules to keep in mind:
- Money received for personal injuries or physical sickness is generally tax-free
- Money received for economic loss, lost wages and benefits is generally taxable
- Money received for punitive damages is fully taxable.
- Money received for interest is fully taxable.
If you receive a lump sum payment of money as part of a settlement, you may also face a more troubling tax consequence: you may find yourself suddenly in a higher tax bracket, and then subject to higher taxes.
Your attorney has a duty to explore all of these tax implications and tax consequences with you before guiding you to make specific transactions or to accept specific settlements. Where your attorney has failed to guide you accordingly, or has otherwise failed to account for the tax consequences on your behalf, you may have a claim for legal malpractice.