John Smith worked on a case for more than two years and received a lump sum payment of $300,000 for his work plus an additional $25,000 for pre-paid expenses. He wants to know how this money will be treated for tax purposes.

John’s company is what is known as an LLC or Limited Liability Company, and for U.S. federal income tax purposes, an LLC is treated by default as a pass-through entity. Since John is the only person in the company, the LLC is treated as a “disregarded entity” for tax purposes, and an individual owner would report the LLC’s income or loss on Schedule C of his individual tax return.

According to the IRS, Taxable earned income includes:
• Wages, salaries, tips, and other taxable employee pay
• Union strike benefits
• Long-term disability benefits received prior to minimum retirement age
• Net earnings from self-employment
• Gross income received as a statutory employee (What is Earned Income?, 2012)

According to the IRS description above, John earned a total of $325,000 from the case that would be considered taxable income. The $25,000 is included as income for the expenses that John has incurred over the past two years. However, John will only be able to deduct expenses that occurred during the current year and any prior year expenses should have been deducted in the tax year that they were incurred. If this was not completed, he should amend any previous year’s return to reflect the deductions. This money is reported as income and should be reported as such on John and Jane’s personal income tax return. John and his wife file jointly which means that the $325,000 would be taxed at a rate of 33% or $108,225 prior to any deductions. If the full $25,000 for expenses was taken this year, then the full amount can be deducted which would reduce the tax to only $99,999.

I am assuming that Mr. Smith is receiving this money directly and