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My client is planning to settle out of court with her
insurance company, as the agent who sold her a policy
misrepresented the terms of the policy and now my client will
be surrendering her policy. In the terms of the agreement the
Insurance company is also going to reimburse my client the tax
consequences she will incur on the growth portion of the
surrender value.

After speaking with the insurance company they stated they
will provide my client with a 1099-R for gain on the Surrender
Value. Secondly the Reimbursement Amount for the taxes on the
gain my client pays will issued a 1099-MISC.

My primary question is that will my client be taxable for the
1099-MISC distribution as well?? Being that this is a
reimbursement of the taxes the client will incur as a result
of the insurance companies mistake, and not an attempt to make
a profit, the client as well as myself don't believe it should
be treated as such.

Is there a way to report this as a special case to the IRS so
that the client isn't in actuality losing a part of the
reimbursement proceeds??


Both parts of the reimbursement are taxable. If the numbers are calculated correctly, she won't be losing a part of the reimbursement proceeds (as you mistakenly think).

Here's how it should work. Let's assume the 1099-R portion of the settlement is $1000 and your client is in the 25% tax bracket. She will owe $250 in taxes. If the insurance company were to give her $250 (reported on 1099-MISC), she would owe an additional $62.50 in taxes. The solution is to give her $1000/(1-.25) = $1333.33; $1000 via 1099-R and $333.33 via 1099-MISC. She will owe 25% of the total amount ($333.33) in taxes and will be left with $1000 after taxes.

Ira
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