It`s important to know the tax implications of a settlement if you are awarded one. This topic can have many nuances. Working with an accountant and attorney who are experienced in this area can help you identify which parts of the settlement may be tax free and which require payment.
Taxes on a lawsuit settlement
Both parties can reach an agreement through settlement, saving time and money. This approach can sometimes result in a better outcome as it gives each side more control over the case and substantial compensation payments.
Be aware that any settlement may be subject to tax. Tax planning can help you reduce your taxable income before receiving settlement money. This will give you peace of mind in the years to come.
Tax exempt damages such as medical expenses should be discussed during settlement negotiations to avoid potential surprises in terms of taxation.
The IRS has also ruled that certain emotional distress damages are tax-exempt, for example if your employer`s actions worsen your multiple sclerosis symptoms; part of any settlement could be considered tax-free.
Non-economic damages
Non-economic damages compensate for losses which cannot be quantified financially. These include lost income, pain and suffering from physical injury, emotional distress, disability or disfigurement, as well as a decreased quality of life.
Most personal injury cases are settled outside of court.
Non-economic damages are calculated by multiplying a victim`s total economic damages with an appropriate multiplier, with higher multipliers applied in cases involving permanent impairment, catastrophic injuries and other significant damages.
When determining non-economic damages a jury will consider a variety of factors, such as subjective values, beliefs, emotional sensitivity, feelings of injustice, and disruptions to their lives caused by others.
Punitive damages
In cases where the defendant has committed oppression, fraud or malice, punitive damage may be awarded by a jury or judge in addition to compensatory damages. This is to make them an example.
Punitive damages awards usually depend on how reprehensible a defendant`s conduct was; most states limit them to no more than four times the amount awarded as compensatory damages.
The purpose of punitive damages is to discourage defendants from repeating the same behavior and to maintain an equitable system of civil justice by preventing plaintiffs from demanding excessive sums for minor events.
Attorney fees
Numerous federal laws, such as those protecting consumers from debt collection practices, employment discrimination and environmental harm, permit courts to award attorney fees to winning plaintiffs in court cases.
These awards are not deductible under current tax laws, as they are considered income to both the plaintiff and the attorney.
The new tax law undermines consumer protections in this way. The new tax law can make it harder for consumers to assert their rights and deny them vital benefits like the Earned Income Tax Credit.
If you are the plaintiff of a lawsuit settlement, make sure that you report it as income. If you don`t, the IRS could assess taxes on your entire settlement before deducting legal costs.