You are a staff accountant for a regional CPA firm, Earnest & Wilson, CPAs. Vera Taylor, a long-time client, calls you regarding an accident her husband was in early last year. Veras husband, Walter, was sitting in his car waiting for a red light to change when he was rear-ended by a drunk driver. He spent months in the hospital, has significant medical problems, and will require ongoing care and treatment. His attorney sued the drunk driver who, luckily, was insured. Walter and Vera are in negotiations in an attempt to settle the suit. You have spoken to her about the accident in the past, but this call is about a possible legal settlement for damages

The insurance company, Wayward Casualty, has offered $1.2 million allocated as follows:

Pain and Suffering $200,000

Lost Wages $150,000

Medical Costs (past & future) $550,000

Punitive Damages $300,000

Vera also explained they will receive interest from the date of the accident to the date of settlement at 6%.

Walter and Vera believe the settlement is reasonable. However, in order to make a decision, she would like to understand the tax consequences of the proposed settlement. She would like you to write a letter so they can review it in detail with the attorney.

Questions.

Be sure to address each specific allocation item noting whether it is taxable or not.

Also, address whether Vera can take a deduction for any medical costs that are reimbursed.

Provide references and support for your conclusions.