Rule on Taxation of Lawsuit Settlements and Awards - Coursework Example

Taxation Law Student’s Name Institutional Affiliation Taxation Law Issue Jones, who is an employee of Super Automobiles that deals with automobiles, enters into a futures contract with a broker. The broker is a member of a well-known futures exchange. However, he closes the contract after two months, having made substantial gains of $500,000. He did not make any more contact with the broker. Five months after the transaction, Ruth knocks him down in a road accident. The accident immobilizes and incapacitates him, meaning that he is not able to work again. In addition, he has to undergo intensive medical care and expensive physiotherapy. He sues Ruth for the losses, including the earning capacity loss, medical and other costs emanating from the accident and non-pecuniary losses. Ruth has insurance coverage with ABC insurance, which pays a lump sum payment of$1 million. Does Jones have any tax obligations? Rule Rule on Taxation of Futures Contracts Taxation of Financial Arrangements (TOFA) is the law that governs how financial products are taxed in Australia. This law is contained in the Income Tax Assessment Act 1997 and applies to certain types of taxpayers (Anderson, 2012). The following taxpayers are not covered by TOFA unless the elect irrevocably to apply to every financial arrangement they are involved in. These are individuals, investment schemes and superannuation entities which have assets worth less than $100 million, entities that are register by the Financial Sectors Act 2001, and have an aggregate turnover of less than 20 million dollars, and any other scheme or entity whose financial assets are worth less than $100 million (Noble & Neill, 2010). However, the aforementioned taxpayers may still fall within the TOFA law if the financial arrangements end more than a year after it was entered into, and can be described as a qualifying security. A qualifying security is a financial security where there is reasonable likelihood that at the time of its issuance, the payments under that particular security, without the interest accrued, exceeds the price at which the security was issued (Keith, 1997). This is something that is unlikely to affect futures contracts. Income tax effects of one’s entry into a futures contract are determined on whether or not the taxpayer is merely speculating is trading in the futures or is hedging them against a certain exposure (Noble & Neill, 2010). Therefore, three types of taxpayers enter into a futures contract. These are traders, speculators, and hedgers. A trader is someone who carries out routine business, where he or she systematically enters into a futures contract expecting a profit. Section 295/85 of the 1997 Act treats a superannuation fund as if those transactions in it were on a capital account. The same act states that capital gains tax provisions apply to the disposal of assets that includes futures contract; however, normal income tax provisions are excluded. There are some income tax treatments where TOFA is not relevant. The first one is in a trading stock. This means that a taxpayer cannot in any way assign their obligations or rights under a futures contract. For the taxpayer to realise a gain, they must close out all the futures by entering into an equivalent but opposite position. According to the 1997 Act, trading stock is anything that is acquired, manufactured, or produced for purposes of exchange, sale or manufacture. A trading stock is something that a trader acquires and holds it with a view of reselling it. Since futures contract needs to be closed out, they do not fall within the contextual meaning of trading stock (Noble & Neill, 2010). Traders are assessed on any income that has been derived from their trade in futures contract, and are normally allowed some deductions for the losses they have incurred. Any income that accrues to any party to a contract cannot be derived for purposes of taxation, until the contract has been closed out. This essentially means that any income or deduction from a close out on a contract is not derivable until the trader enters into an equivalent but opposite position that crystallizes the gains. After a futures contract has been closed out, the profit or loss for the trader or taxpayer is the difference between the futures position at its opening and its position at closing. This is called the net profit approach. If the income after closing out a futures contract can be described as ordinary income, consideration of capital gains tax provision is not necessary. However, if the income after closing out a futures contract falls outside the definition of ordinary income, then capital gains tax provisions must be considered. If, at the time, a trader or a taxpayer is closing out a futures contract, enters another similar contract that is to the initial one as part of what is known as a rolling futures strategy, then the trader or the taxpayer is supposed to realize taxable gains or losses, every time a futures contract is closed out (Noble & Neill, 2010). A trader can be exempted from Taxation of Financial Arrangement Provisions if they are entities or individuals that do not exceed some of the financial thresholds mentioned earlier in the paper. The second type of a taxpayer is known as a speculator. Unlike a trader who consistently enters into a futures contract expecting a profit, a speculator does so occasionally. If a speculator is engaging in any commercial operation or activity and in the course of the operation or activity enters a futures contract, the net profit that results at the closure of the futures contract will be considered as income if the speculator originally intended to make a profit (Noble & Neill, 2010). On the other hand, deductions can be available to any speculator that enters a futures contract if they intended to make a profit that can be described as income, and if a loss was made during the operation or activity. Under TOFA provisions, a speculator way is exempted from taxation if they are an entity or individual that does not go beyond the financial thresholds mentioned earlier in the paper. Rule on Taxation of Lawsuit Settlements and Awards Settlements and awards after lawsuits can be divided into two major groups. These are claims that arise from physical injuries and claims that arise from injuries that are not physical (Abramowitz, 1997). Tax treatment of any settlement or award depends on which category it falls. There are some key points that must be considered in determining whether the settlement or award is taxable or not. Award given for physical injuries is not taxable. The same applies to awards given for any form of sickness. Award for physical injuries or any form of sickness is not taxable regardless of whether the recipient is the party that was injured or not. Furthermore, any compensatory damage received because of emotional stress that can be attributed to a physical injury or sickness cannot be taxed (Abramowitz, 1997). There are some examples of emotional stress that are considered. These include insomnia, stomach disorders, posttraumatic stress disorder and even headaches. Punitive damages because of sickness or physical injuries can be taxed, but there are limited exceptions. On the other hand, awards and settlements for injuries that are not physical are taxable. There are several examples of nonphysical injuries. These include wrongful discharge from employment, defamation, slander, libel, discrimination, and breach of contract. Damages that one receives because of injuries that are not physical are taxable. Furthermore, compensatory damages that one receives on account of emotional distress caused by non physical injuries are also eligible for taxation. The taxable part of the damages can be reduced if the amount of expenses paid to treat emotional distress caused by these injuries is taken into consideration. Punitive damages are also eligible for taxation (Abramowitz, 1997). In some cases where there is physical injury, both punitive damages and compensatory damages are awarded. These include product liability claims and wrongful death. In such a case, the total amount that has been awarded must be divided between punitive damages and compensatory damages because one damage is taxable while the other one is not. Application About the income Jones gets from the closure of his futures contract, it is important to consider his income threshold and determine whether his income threshold falls within or outside the bracket, that is, tax exempt. After the closure of his futures contract after a month, Jones makes gains of $500,000. According to the Taxation of Financial Arrangements Provisions, any individual or entities that have assets that are worth less than $100 million and have an aggregated turnover of less than$ 20 million are not eligible for taxation. Any other schemes whose financial assets are not worth more than $ 100 million are not eligible for taxation under the TOFA provisions. Secondly, it is important to look at the length between the opening and the closure of the futures contract. The futures contract that enters into closes after just two months. TOFA provisions state that the above exempt groups can still fall within the taxation bracket if the financial arrangements they enter are closed more than one year after they are entered. When they last more than a year, they are referred to as qualifying security because its payments exceed the price of issuance of the security. Since the futures contract that Jones enters into is closed after just two months, it remains it does not meet the standards of a qualifying security, meaning that his income is not taxable. Thirdly, one should consider whether Jones is a trader or a speculator. A trader is someone who consistently enters and closes futures contracts while a speculator is someone who enters and closes futures contracts occasionally. In this case, Jones enters and closes his futures contract and does not make any more contracts with a broker. Under TOFA provisions, a speculator way is exempted from taxation if they are an entity or individual that does exceeds the financial thresholds set by the law. About the income that Jones gets from the insurance after being compensated by the court, it is important to look at the nature of the compensation. The Insurance Company compensates Jones after an accident that incapacitates and immobilizes him. The injuries he sustains make him unable to work any longer. Therefore, the damages awarded are because of physical injuries that he has sustained after an accident. The law provides that compensatory settlement and awards arising from physical injuries are tax exempt (Abramowitz, 1997). This means that Jones does not have any tax obligation on this account. Conclusion Jones does not have any tax obligations arising from the income he gets after the closure of his futures contract and the income he gets after the compensation he receives from the insurance company after the court awards him damages for the debilitating and incapacitating physical injuries he sustains from an accident. Taxation of Financial Arrangement provisions places a threshold on the amount of income that is taxable. The income Jones makes falls outside that threshold, meaning that the gains he makes after the closure of the futures contract are not eligible for taxation. Furthermore, the compensation he receives after sustaining injuries from the accident are not taxable. The law divides settlements and awards into two main groups. One group is taxable while the other is not taxable. Jones compensation falls within compensations for physical injuries which are tax exempt. Therefore, after careful analysis of the relevant laws, it is clear that Jones does not owe the taxman anything. References Abramowitz, K (1997). Tax law changes for damages received on account of  personal injury or sickness. Retrieved from http://www.nysscpa.org/cpajournal/1997/0797/depts/ft.htm Anderson, N (2012). Income tax treatment of awards and settlements. Retrieved from http://www.komisarbrady.com/pdf/Awards-and-Settlement-Issues-072010.pdf Keith, R (1997). Financial derivatives: An introduction to futures, forwards, options and swaps. London: Prentice-Hall Noble, A., & Neil, C. (2010). Taxation treatment of exchange traded futures. Sydney: Deloitte Read More