Indemnity Payments as Income
What happens if you get hit with a tax bill
from the IRS, and the other party indemni-fies you for it? Is the indemnity payment
income? If so, can you require the indemnifying party to “gross up” any payment
There is often confusion surround-
ing the taxation of indemnity pay-
ments, but the IRS usually views them
as income. 4 The IRS has frequently as-
serted the payment of another person’s
income tax (directly or indirectly) is
gross income to that person. 5 Taxpay-
ers often argue otherwise, citing Clark
v. Commissioner for the proposition
that tax indemnity payments are ex-
cludable from gross income. 6
As to whether a gross up for taxes is
required, that is a drafting issue. Many
parties will not even think of it, and if
they do, they may not want to explicitly
raise it. A provision that says the plaintiff will indemnity the defendant for all
tax consequences of a settlement may
be inartful and not specific. But it may
be more likely to be signed than one
that is long, and that says the plaintiff
must even gross up any required taxes
on the indemnity payment itself.
As with many other common and useful clauses in legal documents, tax
indemnity provisions are a drafting
staple. They are often a good idea, and
they can be adapted for a variety of
purposes. Even so, one should not assume that they fix all tax problems. NWL
Robert W. Wood practices
law with Wood LLP in
San Francisco. He is the
author of numerous tax
books including Taxation of Damage
Awards and Settlement Payments (www.
TaxInstitute.com). He is a member of
many state bars, a certified tax spe-
cialist, and a frequent expert witness.
He is a tax columnist for Forbes and for
Tax Notes. He can be reached at wood@
This discussion is not intended as legal
1. C.I.R. vs. Banks, 543 U.S. 426 (2005).
2. See Wood, "When Defendant Employers Are
Sued (Again) for Withholding Taxes," Vol.
148, No. 10, Tax Notes (September 7, 2015),
3. See Wood, "Tax-Free Physical Sickness
Recoveries in 2010 and Beyond," Vol.
128, No. 8, Tax Notes (August 23, 2010),
p. 883; Wood, "Is Physical Sickness the New
Emotional Distress?" Vol. 126, No. 8, Tax
Notes (February 22, 2010), p. 977.
4. See e.g., Priv. Ltr. Rul. 9833007 (Aug. 14,