Lawsuit Settlements And Taxes: 4 Things To Know

When you’re involved in a severe accident, you’re probably concerned about the damages and injuries you have sustained. Likewise, you might also be worried about the cost incurred and how to pay them. However, you shouldn’t pay for the damage others may have caused you. 

If all of your damages and injuries are caused by a third party, your best course of action is to file a claim for a maximum personal injury settlement. Although, getting fairly compensated is only one aspect of your total concerns.  

When you receive your compensations, you need to consider whether you need to pay the taxes or not. The paying of taxes may depend on the nature of the claims. Some of them do not require the compensated party to pay taxes, especially personal and physical injury cases.  

For the reason that, as a victim, you should use the compensation for your healing and start a new life once again. Moreover, whether it is taxable or not, getting the maximum settlement you need is still worthwhile. For better understanding, here are the things you need to know about lawsuit compensations and their taxes:

• Taxes Depends On The Nature Of Claims

According to the Internal Revenue Service (IRS), lawsuit settlements and court judgments are taxed the same. However, the taxes put on them may vary depending on the origin of the claims. For instance, if someone is filing a lawsuit claim on a company because of lost profits, the court will consider this taxable under ordinary income. Also, if you file a case for discrimination at work to seek severance claims, it will be taxed as a part of the received income. 

On the other hand, there are cases where you may receive compensation as a part of an overall discount. If you find damages on your condo unit and it’s proven to be because of the contractor’s negligence, these damages will not be treated as income. In most similar cases, the compensation you may receive can be used to lessen the amount of the unit.  

This case scenario is actually favorable on your part. Why? Because you don’t have to pay taxes at all. Nonetheless, there might be exceptions to this rule, so ask your lawyer about this before signing anything. 

• Physical Injuries And Sickness Are Exempted From Tax

This is one of the most important things that lawyers and clients should know. If you file a lawsuit for suffering personal injuries from accidents, such as car collisions, the compensation you may get should always be tax-free.  

However, all damages that are tax-free should be physical, which means that all injuries should be visible and may be perceived by the basic human senses. Other damages that may not be exempted from tax include emotional and mental stress.  

As mentioned above, income-based compensations are usually taxable. However, if physical damages are done due to the workplace environment, settlements under ordinary wages may be completely-free or partially taxed. It may also be accepted if a pre-existing disease was aggravated within work boundaries.

• Medical Treatment Costs Are Tax-Free

As stated, emotional and mental injuries are not exempted from tax, but if these conditions are treated under medical supervision, their treatment cost will remain tax-free. Fortunately, the term ‘medical expenses’ encompasses all that perform healing treatments, whether they are traditional or non-traditional in nature.  

Although, if deductions are made on the previous year due to reimbursement of medical expenses, you will be required to pay taxes. This is called the tax benefit rule. Accordingly, your settlement claims are free from tax as long as no deductions are made.

• Punitive Damages And Interest Are Taxable

This is another confusing part of recovering settlements. Even if your damages are entirely physical, you may be required to pay taxes if the claims are under punitive damages. It’s because punitive damages are considered punishment for the defendant.  

For example, you got injured in a car accident and received USD$100,000 for compensatory damages and another USD$200,000 for punitive damages. The compensatory damages are fully tax-free, but the punitive damages are not. In addition, punitive damages may influence the deduction of attorney’s fees and taxes. 

Also, the same rules may apply to interests. All pre-judgment and post-judgment interests are taxable, even if you receive tax-free settlement or judgment. With that being said, it’s better to settle your case outside the court to avoid pre-and post-judgment interest taxes.

Final Words

Receiving compensation is a top priority for most people who suffer physical, mental, and emotional distress, damages, and injuries. However, you have to consider the taxes that may reduce your settlement. But the good news is, taxes may only be given depending on the nature of the claims. Read this article from beginning to end and have a better understanding of effective ways to handle your lawsuit settlements and taxes.

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Interesting Related Article: “Claims Settlement After an Accident“