After weeks, months, or even years, you have finally settled your lawsuit. What a great feeling! Unfortunately, you forgot to ask about how your settlement will factor into tax season. Can your settlement award be taxed? If so, how much will you have to pay? Let’s take a look at how taxes could impact your settlement award.
Can Your Settlement Award be Taxed?
Your settlement award may be taxable, depending on the circumstances of your lawsuit. For example, the Internal Revenue Service (IRS) does not tax settlements resulting from personal injury cases. That is because you had “observable bodily harm”, and should not be liable to pay taxes from your award. Cases that involve emotional distress may or may not be taxed. This often depends on whether you received medical treatment for the psychological injury, and the cause.
Generally speaking, settlement awards can be taxed if they result from the following:
- Punitive damages
- Interest accrued on awards
- Payments for lost wages
- Damages resulting from Title VII (Civil Rights Act) cases
- Damages resulting from copyright infringement, breach of contract, or patent infringement cases
- Payments for settlement of pension
- Payment for attorney fees or court costs included as part of the settlement award
Tax Considerations for Settlement Awards
In most cases, the IRS will require you to pay taxes on a settlement or judgment. There are a few things you should consider, however, as you prepare to file your taxes:
- Medical expenses are generally tax-free
- Allocate the settlement award properly (i.e. distinguish what various portions of the award are for)
- You may have to claim the award as a “capital gain”, rather than as “income”
- You will most likely have to claim the full award amount, then use a miscellaneous deduction of attorney fees.
In sum, it is best to consult with an attorney and a tax professional before filing your taxes if you have recently received an award settlement of any kind.