A common question among plaintiffs is: "Are lawsuit settlements taxable?" The IRS has certain rules and exemptions in place to help you understand what happens to the money. While most settlements are not taxable, some are. If you have suffered a personal injury or illness, for example, the settlement will not be taxable, as long as you did not itemize medical expenses in the prior years. If you did, however, your settlement must be included in your income.
There are exceptions to the taxation rules for lawsuit settlements, though. Certain types are excluded from taxation, including emotional distress and psychological anguish. However, if the damages were not caused by a physical injury or illness, you may still be taxed. If you believe that a settlement is taxable, you should review your settlement agreement and make sure it outlines the taxable portion. If it does not, you may have to pay a large portion of your settlement back to the IRS.
In addition to the IRS's tax rules, the IRS requires plaintiffs to pay their attorney's fee. In other words, a lawsuit settlement that exceeds $240,000 may be taxable. However, if you win your case, you will only have to pay your lawyer a fee of 40% of the settlement. That means that you will only have an income of $240,000 - not $370,000 as you originally thought!
Personal injury damages, which are compensated by the plaintiff, are usually not taxable. However, you must report any settlement funds that you receive as income. Remember, you can only use this tax break once. Some injuries are not visible, such as sexual harassment, slander, and defamation. However, emotional distress is treated similarly. If you think that you are a victim of discrimination, you should consult with an attorney about your options.
The IRS does not tax personal injury settlements if the plaintiff can prove that they suffered visible injuries. Therefore, it is best not to include these settlement amounts in your income section. For example, major claims settled by car accident lawyers are nearly always non-taxable. But personal injury lawyers are the exception to this rule. For example, car accident lawyers almost never charge income tax on settlements for major claims. The reason for this is simple: personal injury attorneys don't include these compensation payments in their clients' income taxes.
However, a small portion of a lawsuit settlement may be taxable. This is especially true when a settlement includes attorney fees. You may have to pay taxes on a significant portion of the money, including lost wages. Those wages would have been taxed if you had been able to work without interruption. As a result, you must consider all the tax implications before deciding whether to accept the settlement.