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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.

How is my Settlement Taxed?

How is my settlement taxed?  If you are involved in a lawsuit and are anticipating compensation for damages, this is a question you may be asking yourself and it is important to understand the tax implications related to your settlement.  The article below has been prepared by John McGuire, a tax attorney and business attorney at The McGuire Law Firm to discuss the taxation of settlements for lost wages, lost profits and loss in value of property.  Please remember that this article is for informational purposes only and to consult directly with your attorney and tax advisors.

If your lawsuit is an employment related lawsuit for a claim such as involuntary termination or unlawful discrimination, the proceeds received for lost wages, severance pay or back pay are considered taxable wages and are subject to self-employment tax.  Thus, these settlement proceeds are subject to federal income tax, social security tax and Medicare tax.  Furthermore, these proceeds should be subject to withholding and therefore the payor (generally the employer) should issue a W-2 to reporting the wages or salary (income) and taxes withheld.  You would thereafter need to report this income on your 1040 individual income tax return.

What about lost profits from a trade or business.  Settlement proceeds received from lost profits will also be subject to self-employment tax and would be included in your business income.  Issues and facts may vary, but in general, proceeds for lost profit would be reported as income to your business as if the business had made the money.

What if your lawsuit involves property and the lost value of property or loss in value of property?  If the settlement amount for a loss in value of property is less than the adjusted basis in the property, than the settlement amount should not be taxable, but you need to remember to thereafter reduce the adjusted basis in the property by the settlement amount for future gain or loss determinations.  On the other hand, if the settlement amount you receive exceeds the adjusted basis in the property, this excess amount is income.  The income may be capital gain income, and a full discussion of this issue would be better served in a separate article.  You can review the instructions for Form 4797 and Schedule D, which discuss capital gain & loss, and the Sale of Business Property.

What if a portion of my settlement proceeds are allocated for interest?  Generally, the interest portion of the settlement would be taxable as interest income, and thus would subject to ordinary income tax.

What about punitive damages?  Punitive damages are generally considered “other income” and thus would be subject to ordinary income tax.Please note, you may be required to make estimated tax payments based upon your settlement amount, which you can review under IRS Publication 505.

John R. McGuire is a tax attorney and business attorney at The McGuire Law Firm.  John’s practice focuses primarily on tax issues & matters before the IRS, tax planning for businesses & individuals and business transactions and contracts from the formation of a business to the sale of a business.  John can be reached at John@jmtaxlaw.com

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You can contact The McGuire Law Firm to schedule a free consultation with a tax attorney in Denver, Colorado or Golden, Colorado.