Mary and Manny Muffler were involved in an auto accident several years ago with an uninsured motorist. The uninsured motorist was at fault and caused significant injuries to Mary. Because of her injuries, Mary was unable to work for more than a year. At the time of the accident, Mary and her husband had two vehicles insured under separate automobile liability insurance policies through Farm State Automobile Insurance Co. (Farm State). Both insurance policies were purchased by Mary and her husband and had endorsements for uninsured and underinsured motorist (UM/UIM) coverage with policy limits of $50,000.

Although Mary filed a lawsuit against the motorist who was at fault in her accident, her counsel ascertained that the defendant had neither significant assets nor any insurance. Mary submitted a claim under her UM/UIM coverage to Farm State for compensation for her injuries in the automobile accident. Farm State took the position that Mary was entitled to recover under the UM/UIM coverage of only one of the two policies she and her husband held, resulting in an effective limit on recovery of $50,000. In taking this position, Farm State relied on antistacking provisions in its insurance contracts with Mary and her husband, under which the insured was precluded from aggregating or “stacking” his or her UM/UIM coverage under multiple Farm State policies. Mary agreed to settle her claim with State Farm for $32,000 plus $18,000 in attorney fees ($50,000 total).

After receiving the $32,000 payment several years ago, Mary became a member of a class action against Farm State that alleged that the antistacking rules constituted a breach of contract and a breach of a covenant of good faith and fair dealing in their insurance contracts, and that she was entitled to collect on the second policy. Farm State settled the claim. As a result, Mary received an additional $53,000 ($50,000 plus interest) payment pursuant to the settlement agreement as her pro rata portion of the settlement funds. During that year Mary was issued a Form 1099-MISC, Miscellaneous Income, reflecting the payment.

After appropriate research, determine how Mary (who has since divorced Manny) should report the $53,000 payment on her current year’s tax return and prepare (in good form) a research memorandum to the file. Write a client letter to Mary with your findings. Her address is 789 Mustang St., Shelby, CA 92111.