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Is Accountant Malpractice Compensation Taxable?

If a taxpayer suffers a loss by reason of errors made by a tax advisor, and the tax advisor makes a payment to compensate the taxpayer for the loss. May the payment be excluded from the taxpayer’s income subject to tax?

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If a taxpayer suffers a loss by reason of errors made by a tax advisor, and the tax advisor makes a payment to compensate the taxpayer for the loss. May the payment be excluded from the taxpayer’s income subject to tax? The courts and the IRS have, in some circumstances, found such payments to be non-taxable returns of capital. In McKenny v. United States, a recent decision of the U.S. Court of Appeals for the Eleventh Circuit (126 AFTR 2d 2020-5943), however, the court concluded that the taxpayers could not exclude the payment at issue from income.

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