The taxability of a particular settlement should be written into the settlement agreement along with a provision that the plaintiff’s accountant is allowed to view the agreement to ensure appropriate reporting come tax season.
The general rule is that gross income includes income from whatever source derived unless specifically excluded under the internal revenue code.
However, there are exemptions. There are lawsuit settlements and awards that can be given from the internal revenue code, and they are listed below:
- All interest on awards is taxable; and
- All punitive damages, which are intended to punish or make an example of the defendant, are taxable except in certain wrongful death actions.
Personal Injuries. Compensatory damages, which are amounts paid to compensate for actual loss or injury, received for personal physical injury or sickness are not taxable. Also, damages for loss of wages or earnings, loss of earning capacity, and for emotional distress are nontaxable if caused by a physical injury or sickness.
Emotional Distress. Damages for emotional distress are taxable if not caused by physical injury or sickness even if the distress causes physical symptoms. The only exception is that damages paid that cover the cost of deductible medical care are excluded from income.
The taxability of a lawsuit settlement or award depends on the item the settlement replaces. If the item would be taxable income, the settlement or award is taxable as well. Below are some further examples:
- Class action and other settlements for consumer goods or services.
- Property damages where the amount received does not exceed basis.
- Damages for nonphysical injuries such as discrimination, libel, slander, etc.
- Workman’s compensation and other claims against employers.
- Damages for most business and contract claims.
If you have any questions regarding the taxes on your settlement, contact an experienced and trusted lawyer today to discuss your case.