To those of a certain age, the name Dennis Rodman brings up a lot of memories: great
rebounding for the Bulls in the NBA, alongside Michael Jordan; unspeakably odd visits to North
Korea’s dictator; and modeling some unexpected attire. But for a very few, that name also
conjures up the notion of tax law issues in personal injury settlements.
An excellent summary of this issue appears here, in an article by distinguished tax lawyer
Robert Wood. Click here to view the summary.
In short, the “Rodman tax issue” relates back to a case called Amos v. Commissioner, T.C.
Memo. 2003-329, where the Tax Court addressed whether a payment made in part for
confidentiality was, or was not, taxable to the plaintiff who had received it.
Dennis Rodman had allegedly kicked a patron at a game, and he later settled the patron’s
pending claim for personal injuries for $200,000. The settlement agreement included a
confidentiality clause, barring the plaintiff from disclosure of the incident and settlement. There
was no allocation in the settlement agreement as to what amount had been paid for
confidentiality, and what had been paid for the injury settlement – the latter sum would, of
course, constitute a tax-free receipt by the injured plaintiff pursuant to Section 104(a)(2) of the
Internal Revenue Code of 1986, as amended.
For that reason, the Tax Court decided to do the allocation itself, then finding that $80,000 of the settlement was for the purpose of maintaining confidentiality, and therefore that sum constituted taxable income to the plaintiff patron.
In a six, seven or eight figure personal injury settlement in which the settling defendant
requires a confidentiality clause as precondition of the settlement, this issue is a cause for
concern for plaintiff’s counsel. Mr. Wood’s excellent article relates two ways to deal with the
problem: avoid confidentiality clauses in the first place; or allocate a specific, smaller sum to
confidentiality obligations, and then declare that sum on the plaintiff’s tax return as income.
The purpose of this post is to suggest an additional alternative that we have not found
discussed in the literature: instead of the typical release executed by only the plaintiff, drafting a
bilateral release in which both sides, subject to necessary business and tax-related exceptions,
adhere to the same covenant of confidentiality. Upon agreement by counsel for all parties in
numerous cases, we have added this provision to the form of bilateral release executed by the
parties to conclude the case:
“Plaintiffs and their attorneys of record, and the Defendants and their attorneys of record,
expressly agree that each other’s reciprocal confidentiality covenant is the sole consideration
given in exchange for that of the other. No portion, amount, term, or condition of the settlement
is intended to represent a bargained for exchange of the agreement for reciprocal confidentiality.”
Such language makes clear that no allocation of the settlement sum between payment for
injury and payment for confidentiality is necessary for income tax purposes because, expressly,
no part of the defendant’s payment to plaintiff has been made to compensate for the covenant of
confidentiality. Including such a provision has the additional benefit of protecting the privacy of
the plaintiff, to the extent her identity might otherwise be intentionally or inadvertently disclosed
by an employee of a settling defendant.
At the time of settlement of a major personal injury claim, tax issues are usually far from
the forefront of plaintiff counsel’s mind. But a bit of caution at the time of settlement can go a
long way towards protecting the plaintiff from unpleasant surprises years later. The solution
proposed here is among those that should be considered.