Tax Issues with Lawyer Legal Funding
Robert W. Wood
Robert W. Wood practices law with Wood LLP (www.WoodLLP.com) and is the author of Taxation of Damage Awards and Settlement Payments and other books available at www.TaxInstitute.com. This discussion is not intended as legal advice.
When you receive a loan, is the money taxable? Of course not, because you must pay back the money. That obligation prevents the loan money from being income. Of course, if the loan is later forgiven, that forgiveness can trigger tax, unless you can fall within one of the few exceptions to cancellation of debt income (such as bankruptcy or insolvency).1 Thus, loans aren’t taxed.
Can lawyers borrow too, just like anyone else? Of course, and, for that reason, many lawyers and litigation funders are fretting about Novoselsky v. Commissioner.2 In that case, a lawyer was taxed on litigation funding loans. It’s one of those classic bad-facts bad-law situations, and therefore, much of the hype needs explanation. In fact, this perfect storm is full of tax lessons.