Is a Lawsuit Settlement Taxable?

Is the money I receive in a lawsuit settlement taxable?  If you have received money via a lawsuit settlement, you may be asking yourself this exact question.  Perhaps you were injured in a car accident, or filed suit against a prior employer for wrongful termination and are now receiving a monetary settlement.  The settlement may or may not be taxable depending upon all of the facts and circumstances surrounding your case.  The article below has been prepared by a tax attorney to provide additional information relating to whether or not proceeds from a lawsuit settlement need to be included in gross income on your individual income tax return.  Please remember, this article is for informational purposes only, and should consult your tax attorney or tax advisor regarding your specific facts and circumstances.

If your lawsuit settlement was the result of personal injuries and/or personal sickness you do not need to include the settlement amount, or that portion in your gross income as long as you did not take an itemized deduction of the medical expenses.  If you did previously take an itemized deduction of the medical expenses in prior years (this would likely be taken on a Schedule A) you must include the portion that was deducted and provided a benefit in prior years in your income.

Ok, so what about settlement awards and amounts for emotional distress and/or mental anguish?  If the award or settlement was for emotional distress or mental anguish that originated from personal injury or personal sickness, the proceeds from the settlement would not be taxable and thus not need to be included in your gross income.  However, if you receive a settlement amount for emotional distress or mental anguish that did not originate from personal injury or personal sickness, that portion or amount of the settlement is taxable, and thus would be included in your gross income.  If a portion of your settlement is taxable as emotional distress or mental anguish, the amount can be reduced by the amount that you paid for other medical expenses that are attributed to the emotional distress or mental anguish and that have not been previously deducted and medical expenses you previously deducted for the emotional distress and mental anguish that did not provide an actual tax benefit

What about non-personal injury type settlements?  What about a settlement for lost wages or lost profits?  If you receive money via a settlement for last wages, not only is the amount taxable and included in gross income, but the settlement amount is also subject to self-employment tax.  For example, if you sued a prior employer for discrimination or involuntary termination and requested lost wages, and won a settlement, the portion received for lost wages should be included in income and subject to self-employment tax.  If you filed a suit against a third party for lost profits and received a settlement for lost profits, the proceeds would be taxable, and would included in your business income.  It may depend upon the business structure, plaintiffs in the suit and other related issues as to the further taxation of those settlement proceeds for lost business profits.

What about settlement proceeds for lost property?  Typically, if the proceeds received for lost property do not exceed your adjusted basis in the property, then the proceeds would not be taxable, but rather would reduce your basis in the property.   However, if the amount received was in excess of your adjusted basis, the amount in excess is income.

What if you are paid interest on the settlement amount?  Generally, the interest would be taxable, and would included like normal interest from a savings account.

The above article has been prepared by John McGuire of the McGuire Law Firm.  John is a tax attorney and business attorney in Denver, Colorado.  Please feel free to contact John directly with any questions, comments and concerns.