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Are Confidentiality Provisions in a Settlement Agreement Taxable or Not?

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A lady filed suit for personal injuries arising from a defendant’s negligent conduct. At mediation, the defendant asked the plaintiff to sign a settlement agreement containing a provision that the the terms of the settlement would be confidential free from public disclosure. This type of agreement is typically referred to as a "confidentiality agreement" or "gag order."

The purpose of a so-called confidentiality agreement is to keep other claimants and their attorneys "in the dark" concerning the terms of a settlement, and to avoid other parties and their counsel from being able to discover what another has received for personal injuries which would (1) encourage other claimants to file lawsuits for similar injuries; (2) help fortify their position in future negotiations contending that their claim should receive a similiar settlement award; or (3) allow counsel to argue that their client's claim is worth more money than the claim just settled, because the injuries in their case are more severe and/or the defendant's conduct is more egregious than the case just settled.

From the Plaintiff's perspective, a confidentiality agreement presents a significant consequence.  In the case of Amos v. the Commissioner of the Internal Revenue Service, T.C. Memo. 2003-329, the United States Tax Court concluded that, notwithstanding that the settlement of a claim for personal injuries constitutes non-taxable income to the recipient, the consideration received for the provisions securing the confidentiality of the settlement were not. In other words, when a settlement is based solely upon a claim for personal injury, the monies recovered are non-taxable income to the recipient except for that portion of the agreement mandating confidentiality of the settlement. In settlement agreements that incorporate a provision for confidentiality, the terms of confidentiality may change the characterization of a transaction from one of non-taxable income to taxable income at least as to that portion of the agreement that was necessary to secure the confidentiality of the settlement.

What the Amos decision means to any Plaintiff is that if the Plaintiff agrees to a confidentiality agreement, a portion of the settlement that is deemed consideration pertaining to same constitutes taxable income upon which the Plaintiff will be required to pay a tax thereon to the IRS.Therefore, in order to protect the Plaintiff from any tax consequences associated with a confidentialty agreement, the agreement should also provide that the defendant, defendant’s insurance carrier AND defense counsel agree to indemnify and hold harmless the plaintiff as to any tax consequences that the plaintiff may be required to bear should the IRS determine that additional taxes, penalties and/or interest thereon are owed as a result of the agreement. The hold harmless and indemnification provision should include, but not be limited to, any attorney fees and costs the plaintiff should bear should the IRS assert a claim against the plaintiff pertaining to same.

To insure that a settlement agreement protects your legal rights and remedies, you should contact an experienced attorney for a free initial consultation. There are few things in life that are free, but having a free initial consultation with Mr. Morton is one of them! You may contact his office to schedule an initial free consultation by calling 208.344.5555 or toll free at 888.716.8021 or by completing the online contact form at http://www.mortonlawyers.com/contact.cfm

Category: General

Alan Morton
Advocate for Justice/Trial Lawyer

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