Settlements

A settlement from a tax accounting firm for malpractice is tax-free, the Tax Court says. The firm advised a man to restructure his business as an ESOP-owned S corporation, and the taxpayer followed through with the plan. However, the accountants made a series of errors, including not forming the ESOP and failing to file the S election. The transaction later turned out to be a tax shelter, triggering a large tax bill from IRS. The man sued the accounting firm for malpractice, and the parties later settled the case for much less than what he paid to the Service. The settlement proceeds he got aren’t taxable because they compensated him in part for the taxes he paid as a result of the firm’s malpractice (McKenny, D.C., Fla.).